The Big Picture Oil and Gas auction: How will the new Model

work?
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INSIGHTS

12/9/2015

The Big Picture Oil and Gas auction: How will the new Model work?
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Summary:
In a significant change in policy connected to oil and gas production, the NDA government has decided to auction 69
fields based on Revenue Sharing Mechanism instead of the existing Production Sharing Contract. The Production
Sharing Contract with Reliance Industries had come in under controversy leading to the issue being for arbitration.
The new mechanism will be applicable to marginal fields. It is also to be noted that out of 69 fields to be auctioned,
63 had been relinquished by ONGC and remaining 6 by Oil India as they found it not viable to explore because of
the small size of the fields apparently. Meanwhile, as part of this policy the government has allowed the operators
who win the auction to sell at a price they fix without the interference of the government. Presently, in case of major
fields, government has been fixing the prices. However, a committee appointed by the government under the
chairmanship of Vijay Khelkar had recommended that Production Sharing Mechanism is better that Revenue
sharing to attract investments.
In production-sharing contracts, companies win blocks by quoting the highest minimum work programme and
recover their investment before sharing profits with the government. This model was criticised by the Comptroller
and Auditor General and also by a few government-appointed committees.
Kelkar comiittee had argued that production sharing is more suited to attract investment. The committee was
against accepting the biddable revenue-sharing contract model due to the inherently misaligned risk-return structure
which leads either to lower levels of production due to resultant reduced exploration efforts and lower recovery ratio,
or to high windfall gains to operators, encouraging contract instability due to political economy factors.
The new bidding system will also mark a change in favour of a unified licensing regime that the government has
been working on. Licences will cover all hydrocarbons found in the field, including oil, gas and shale. The new policy
also stipulates winning bidders will be exempted from paying cess on crude oil and gas production to the Centre. Oil
companies are now required to pay Rs 4,500 as cess on every tonne of output from nomination blocks. The Centre
collected Rs 15,934 crore as cess on crude oil from explorers in 2014-15.
However, the royalty rates applicable to these fields will be the same as those applied under the New Exploration
and Licensing Policy (Nelp): 12.5% for onshore blocks, 10% for shallow discoveries, and 5% for deep-water blocks
in case of oil. Royalty rates for gas production will be 10% for onshore blocks, 10% for shallow water, and 5% for
deep-water blocks.
Revenue Sharing mechanism will safeguard the governments interest in case of a windfall arising from a price
surge or a surprise geological find. The revenue-sharing matrix over the life cycle of the field will be directly linked to
output levels and price. The government has not kept a fixed revenue share because it would not have protected the
Centres interest in case of any windfall gains.
However, some experts say that given the current low oil price, this new policy might not attract much investor
interest.

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