New hydrocarbon policy is an improvement. But the government must address ‘softer’ operating issues, writes Vikram Mehta
“HELP” is an apposite and timely acronym for the recently enunciated Hydrocarbon Exploration Licensing Policy. The acronym is apposite because the exploration sector does need help. India is amongst the least intensively explored countries. The production of oil and gas, as a result, has stagnated in recent years. The acronym is timely because, intended or otherwise, the government has signalled its readiness to recalibrate the licensing and operating terms to reflect the current tough and competitive market requirements. It is also timely because the acronym that it replaces—“NELP” (New Exploration Licensing Policy)—has lost its bite. In fact, NELP has been in abeyance for so long that many refer to it the “no exploration licensing policy”.
HELP makes several positive changes. For instance, it introduces the concept of “open acreage”. This will allow companies to define the contours of the block they wish to explore. Under NELP, this delineation was done by the Directorate General of Hydrocarbons. It establishes the principle of market-related pricing. This will replace the de facto policy of administered pricing. It gives companies the freedom to market the products. Hitherto, marketing rights were circumscribed by bureaucratic intervention. In short, HELP is an improvement on current terms and should be well received by the industry. However, what HELP does not address—and which perhaps at this stage it could not—are the “softer” operating issues. It is reported that the government has plans to present HELP to potential investors through roadshows in global capitals. If correct, they should add to the script their intended plan to tackle these concerns.
The global energy market has undergone a paradigmatic change. This is manifested by the recent collapse in the price of oil. This collapse is not without precedent. Oil prices have shown comparable volatility in the past. What is unique are the forces that have driven this decline and their implications for the future trajectory.
Historically, oil prices have followed a cyclical path, with decadal long transitions from peak to trough and vice versa. For instance, the price of oil in 1970 (annualised inflation adjusted to March 2015) was $20.63 per barrel. In 1980, it peaked at $107.36 per barrel. By 1990, it was down to $41.78 and continued to drift lower, troughing at $17.26 in 1998. Ten years later, in 2008, it hit triple digits, averaging $100 per barrel.
A reason for these long cycles was the increasing costs and rigidity of exploration and production. As companies shifted their gaze from relatively low-cost and geologically straightforward onshore basins to difficult and complex environs like Alaska and the North Sea, they got locked into an industry model that was capital-intensive and relatively unresponsive to market dynamics. Like the captain of a supertanker, it was not easy for them, with billions in sunk costs, to shift direction.
Today, this reason has weakened for two reasons. On the supply side, it is because of fracking technology. The operating model for the exploration and production of unconventional hydrocarbons enables companies to shut down production relatively quickly when prices are down, and ramp it up equally rapidly when prices rise. The lead time is in months and not years. US shale (tight oil) production has dropped by about 7,50,000 barrels a day over the past year because of low prices. But this lost production could be brought back into the market within six to eight months, if prices strengthened to levels that met the companies’ threshold criteria of profitability.
On the demand side, it is because of the structural improvement in the efficiency of oil usage. In the 1980s, the US consumed approximately one barrel of oil for every $1,000 addition to their GDP. Now they need less than half that amount for the same incremental GDP gain. Similar efficiency gains have been recorded in Europe. Demand will continue to increase for the foreseeable future because there is no alternative to oil as a transportation fuel, but the combined impact of these two factors will be to shorten and smoothen the price cycle. Prices will be volatile but they will, in consequence, be “lower for longer”.
It is against this global backdrop that the government must plan its roadshows. It knows that HELP will not be easy to sell. All companies have severely retrenched exploration budgets and India has never ranked high on their geological map as a prospect. But the effort must be made. It will not be enough to simply emphasise the competitiveness of our fiscal and commercial terms. That will meet only the necessary prerequisite. In addition, the government must also address the “softer” operating issues. There are a number of such issues but two need emphasis.
First, the operationalisation of a signed contract is a cumbersome and time-consuming process. There are a plethora of approvals to secure and companies are often caught in the cross hairs of inter- and intra-ministerial and Centre and state disputes. For instance, companies have in the past often not been able to drill in their preferred location because of objections from the defence ministry. Or carry out their development plans because of differing interpretations of the contract by the governments of states in which their operations are based. The roadshows will need to assure potential investors that the government will function as a seamless entity and that companies will not confront unexpected delays. In this straitened economic environment, no company can afford budgetary overruns.
Second, tax administration is a major bugbear. The retrospective tax controversy has compounded an already deep concern about dispute resolution. Most oil companies in India are embroiled in one form of legal dispute or the other. The roadshows must commit that companies will not face an overzealous tax bureaucracy. These assurances fall within the government’s “ease of doing business” programme. They can, therefore, be made with conviction. They must be made. Else, the effort will become an exercise in futility.
This article first appeared in The Financial Express on April 6, 2016. Like other products of the Brookings Institution India Center, this is intended to contribute to discussion and stimulate debate on important issues. The views are those of the author.