In any natural resource-based industry where exploration, development and commercialization of a resource involves substantial investment, the investor has to be extremely careful and circumspect.
Before initiating the project and spending money, through a rigorous and scientific process involving inter alia surveys and complex exploration techniques, the company must make a credible assessment of the quantum of resources in place and projection of viability taking in to account the production and likely price.
For a resource like gas which belongs to the nation and where necessary investment running in to billions of dollars are allowed to be fully recuperated ‘up front’ by the operator under production sharing contract (PSC), the bar in terms of ‘credibility’ and ‘authenticity’ of reserves in place has to be high. There is an added equally compelling reason.
The fate of user industries especially critical sectors like fertilizers and power, is inextricably linked to continued and un-interrupted supply of gas. If, estimates of reserves go wrong leading to disruption of supplies, these industries would be left high and dry. They will be forced to import at much higher prices and may not even be able to fully to make up the shortfall.
In case of high profile KG-D6 fields, government had approved in 2006 recoverable reserves to be around 10 trillion cubic ft (Tcf) with production commitment of 80 million standard cubic metres a day (mmscmd). Production started in 2009 and after reaching a peak of 60 mmmscmd in 2010, it declined precipitously and now hovers around 13 mmscmd. This forced RIL and its new partner BP to re-state the reserves to 2.9 Tcf.
The gross violation of production commitment led the Director General Hydrocarbons (DGH) to levy a penalty initially US$ 1 billion, subsequently increased to about US$ 1.9 billion. RIL contested the penalty and took the matter to arbitration panel. This meant that government can’t recover the amount until the panel completes the proceedings and pronounces its verdict.
Ironically, constitution of the panel itself got embroiled in controversy with RIL and DGH sticking their neck out in regard to appointment of a third member. Despite intervention of Supreme Court (SC), the member is still to be appointed.
Meanwhile, SC is hearing 2 PILs (public interest litigations) – filed by ‘Common Cause’ an NGO and Gurudas Dasgupta – which seek cancellation of contract and disallow increase in price from existing US$ 4.2 per mBtu to US$ 8.4 per mBtu from April 1, 2014; deferred for now in view of on-going elections.
RIL blames the initial overestimation of the quantum of gas in the KG basin to ‘the risky nature of the exploration and production business and the risks inherent in the application of ‘existing knowledge to exploration findings’.
In its submission to SC, it has argued that by their very nature, reserves are liable to revision and in exploration and production operations, they are revised. The final estimation of a reservoir size is only by material balance method after it is in production for some time. The revised calculation is based on this method.
The discovery in KG basin was made in 2002. RIL submitted an initial development plan (IDP) to DGH in 2004. An addendum to initial development plan (AIDP) was submitted in 2006. The AIDP assessed the reservoir size and characteristics as perceived by the company at that time. According to RIL, this was done per good international petroleum industry practices.
The company now finds that the characterization of the reservoir size has gone completely haywire. RIL/BP/Niko have even debunked the AIDP and feel that it would be a waste of money to carry on development of the kind envisaged therein. All this sounds bizarre!
Are we to believe that gas exploration and production business is so risky that no assessment of reserves can be made with any degree of reliability? Will estimate keep changing as production activity moves forward? Are we to surmise that the reserve estimates cannot be trusted until production actually commences and field has been in production for a certain period of time?
Will team RIL want us to believe that the credibility quotient has almost touched zero? If that be so, why would anyone venture to make investment at all? Why would government approve billions of dollars of capital expenditure only to face actually recoverable reserves to be a fraction of what was estimated?
On an objective and dispassionate reading of situation, it turns out that having messed up things RIL is now using alleged riskiness of exploration business as a scapegoat to wriggle out. A draft report by CAG clears points towards its omissions and commissions and the petroleum regulator acquiescing in.
According to the report, RIL switched from discovery to commercial discovery without even getting an appraisal program approved by DGH required as per the PSC. Appraisal programme would have enabled it to delineate the reservoirs to which the discovery related in terms of thickness and lateral extent besides determining the characteristics thereof and quality of recoverable petroleum therein.
In 2004, DGH had approved a US$ 2.47 billion IDP for recoverable resource at 3.81 Tcf (in place reserves of 5.45 Tcf) and corresponding production 40 mmscmd with first gas coming in August 2006. However, in October 2006, RIL submitted vide an addendum to IDP increases in capital expenditure requirement to US$ 8.8 billion and recoverable reserves to 12.04 Tcf (in place reserves of 14.164 Tcf).
In December 2006, a management committee (MC), comprising representatives of DGH, oil ministry and the operator, approved revised plan for US$ 8.8 billion putting recoverable reserves at 10.03 Tcf and doubling of output to 80mmscmd.
What was something not seen during 2002-2004 but surfaced in following 2 years viz., 2004-2006 which prompted RIL to increase recoverable reserves to more than 3 fold from 3.81 Tcf to 12.04 Tcf? How did capital expenditure zoom more than 3.5 times from US$ 2.47 billion to US$ 8.8 billion? How did MC approve reserves at 10.03 Tcf which was 2.7 times the level earlier approved in 2004?
There has to be a correlation between the quantum of reserves and capital expenditure. When, the MC approved a lower figure of 10.03 Tcf (as against 12.04 Tcf claimed by RIL), why was capital expenditure not reduced on pro rata basis?
These bewildering questions require detailed investigations and scrutiny and hopefully, CAG audit will un-ravel the answers. Prima facie, these expose the hollowness of RIL’s newly propounded theory that ‘one cannot be definite about precise quantum of reserves until the field is in production for some time’.
If one were to accept this then, how is it that even before start of production (in fact, even before production date is finalized), RIL makes a huge upward revision in reserves and the same is approved by government albeit with slight downward adjustment.
Clearly, operator had an eye on an ‘inflated’ capital expenditure and increase in reserves was meant to justify it. When, reality dawned – with production coming no where near committed level – reserves were re-stated at 2.9 Tcf which is close to level initially approved in 2004. Pertinently, capital spend was reduced to US$ 5.6 billion yet remained much higher than 2004 figure of US$ 2.47 billion.
The trail of events smack of an attempt to derive a bonanza from use of a national resource and belated effort of operator to attribute the slips in reserves and production to alleged ‘riskiness’ of exploration and production business only tantamount to ‘defending the indefensible’!