With a view to analysing the Kelkar Committee Report on domestic fuel production, we critically consider certain recommendations in Part I of the Committee´s Report.
In December 2013, a committee headed by Vijay Kelkar (the former Secretary of Finance) (Kelkar Committee/Committee) published Part-I of its recommendations for enhancing the domestic production of fuels and reducing import dependency by 2030. The Kelkar Committee, which had been constituted by the Ministry of Petroleum & Natural Gas (MPNG), endorsed the use of Production Sharing Contracts (´PSCs´) in the sale of fuel by the private sector to the government. The Committee found the PSC structure greatly preferable to the revenue-sharing model championed by the Rangarajan Committee, whose recommendations preceded these. These new recommendations have created quite a stir in the industry, coming in the background of the CAG´s allegation that the private sector takes undue advantage of the PSC structure to ´goldplate´ its expenses.
In this article, we critically consider certain recommendations in Part I of the Committee´s Report, which relate to (i) the significance of sufficient coal supply; (ii) the suitability of PSCs vis-a-vis revenue-sharing models (´RSMs´) in relation to the exploration and production (´E&P´) of fuel by private contractors; (iii) the need for change in sectoral policy; and (iv) the regulation of the ´government take´ under PSCs, against the need to incentivise private participation to achieve the larger objective of national energy security.
NELP to OALP: Need of the Hour
The NELP was conceptualised in 1997 as a new framework for auctioning exploration acreage to both public and private entities, ending the monopoly of the public sector and evening the playing field. The contractual framework between the government and petroleum companies both prior to and during the NELP regime, has been provided by PSCs. The NELP regime faces certain issues. There has been little interest from foreign oil companies in the blocks auctioned thus far, perhaps indicating that the chosen blocks are unattractive in comparison to other options worldwide.The lack of availability of in-depth data on the existing blocks discourages bidders further, since they are unable to compute the risk and returns inherent in the exploration of these blocks.
The government has announced that an Open Acreage Licensing Policy (OALP) is presently being formulated, which will replace the NELP. The OALP, as presently envisaged, will permit bidders to bid for blocks of their choice on a year-round basis. The government has entrusted the DGH with the responsibility of creating a National Data Repository for prospective bidders to access. The Kelkar Committee has recommended an immediate shift from NELP to OALP, using the data available with national oil companies, for the time being. In addition to increasing bid participation by offering greater freedom to bidders, the rollout of the OALP may result in increased exploration of deepwater blocks, which have historically remain under-exploited due to the great risks perceived in terms of return.
Analysis: Advantages of PSCs over RSMs
Having analysed the comparative benefits offered by the PSC and RSM systems, the Committee concluded as follows:
The use of a global competitive bidding process reduces the probability that a bidder would ´goldplate´, since he would then be unable to offer competitive terms. It is clear that the primary advantage offered by PSCs lies in their bidding process; contractors bid on the reward receivable by the government in each case. The contractors take on all initial risks including the risk of exploration and discovery of little or no hydrocarbons. The contractors are permitted to mitigate their initial risks by quoting a high cost recovery factor (CRF), but would likely receive an unattractive fiscal package from the government in return. Thus, a spectrum of options is available for the contractors to choose from as per their respective risk appetites, while simultaneously protecting the revenue interest of the government.
Under RSM, hydrocarbons would likely remain undeveloped and unproduced as the minimum economic thresholds are higher than those under PSCs. Further, contractors who are barred from contractually recovering their costs prior to sharing profits, would presumably stand disincentivised from maximising revenue. This would inevitably lead to a natural selection away from projects across operating environ¡ments and thereby, adversely impact the government´s energy security objectives.
Significantly, projects under the RSM-model have faced fundamental problems where the meaning of the term ´revenue´ itself has been disputed. For example, in the case of the Delhi airport (developed by DIAL, a GMR Infrastructure group company) the problem concerned the meaning of ´revenue´ as the group had won the bid by promising to share 46 per cent of ´revenue´ with the Airports Authority of India (AAI). However, a dispute subsequently arose on whether certain interest-free deposits provided to the GMR Group constituted revenues or liabilities. Lack of clarity at such a fundamental level only serves to further discourage the private sector from participating.
In addition to the above, the Committee noted
that the PSC model ensures a stable regime where the interest of the government is protected even in case of changes in factual circumstances from the ´as bid´ scenario. For several reasons including the above, the Committee took the view that the PSC model (with the recommended modifications) will strike the right risk-reward balance for private contractors while protecting the interests of the government as well. This view has been received with great enthusiasm from industry participants, since the unpredictability around recoverability of resources made RSMs risky for them.
Recommendations on Tax
In the bid to improve the PSC regime, the Committee suggests replacing it by tax and royalty regime. In this regime along with the corporate tax, a super profit tax will also be imposed so as to give an equitable access to the upside gains in the project to the government, avoid time-inconsistency problem and simplify the implementation of E&P contracts.
The Income-tax Act, 1961 (´IT Act´) currently provides for a tax holiday for a period of seven years to companies undertaking commercial production of mineral oil and natural gas from O&G blocks awarded under NELP VIII. Thus, 100 per cent of deduction is allowed of the profits earned by the companies.
As per the recommendations of the Kelkar Committee, the tax holiday should be extended to the companies engaged in the production of all kinds of hydrocarbons. The period of the tax holiday is also suggested to be increased to 12 years. The companies should also be allowed to avail the tax benefits as soon as PSC is signed with the government rather than waiting to come into effect only after it is tabled in Parliament. As the tax benefit is provided on the profits earned by the companies, thus steps are suggested to help the companies to provide services in a cost-effective manner. A relaxation in the social security and provident fund norms are suggested for the expatriates that are hired on the project due to skill shortage within the country. It is also suggested to reiterate non-applicability of service tax on cash calls made by operator to other partners in a consortium. In relation to the international operations, it is suggested that rate of tax on dividends received from foreign subsidiaries is reduced from 16.99 per cent. Also, the tax regime should be revised to provide benefits to the Indian companies when they are operating in the host countries on PSC basis that do not impose taxes on international players but underlying PSCs already account for the government´s proceedings.
The recommendations of the Kelkar Committee were made in the background of a great upheaval in the energy industry, with the private sector up in arms against the government, which was also under great pressure from the CAG. The government reacted by erring on the side of prudence and adopting the arguably conservative ´revenue-sharing´ mechanism in favour of the much-maligned ´production-sharing´ mechanism to hydro¡carbon exploration arrangements. However, the Kelkar Committee´s endorsement of the PSC mechanism may swing the regulatory pendulum back in favour of the private sector. A more investor-friendly regulatory regime coupled with an enthusiastic private sector, would undoubtedly put India on the fast track to energy security.
The article had been authored by Aakanksha Joshi, Divya Srikanth and Janhavi Sharma.