In October 2015, the GoI has invited comments from stakeholders on a consultation paper on a new fiscal and contractual regime wherein some fundamental changes are proposed. These include:
• Uniform Licensing Policy: A uniform licensing policy to enable E&P operators to explore and extract all hydrocarbon resources including CBM, shale gas/oil, tight gas, hydrates will replace the current NELP and CBM regimes.
• Open Acreage Licensing Policy: As per this policy an open system is to be put in place which is continuous in nature and allows companies to submit bids for areas of their choice. Upon receipt of Expression of Interest, the Directorate General of Hydrocarbons (DGH) will validate authenticity of the bid and shall carve out the block. After obtaining the necessary clearances, bids will be invited from all interested parties including those which submitted the expression of interest.
• Revenue Sharing Contract: In this model the bidders will bid the percentage of revenue that they will share with the GoI against two revenue scenarios i) when the revenues are less than or equal to the lower revenue point and ii) when the revenues are equal to or higher than the higher revenue point. The percentage government revenue share at revenue points falling between the lower and higher revenue point shall be interpolated on a linear scale.
• Pricing and Marketing Freedom for Natural Gas: It is proposed to provide pricing and marketing freedom for natural gas in order to incentivize production
The GoI has invited comments from stakeholders on a variety of such issues including operationalising (modalities and standard procedure) open acreage licensing, work programme – mandatory or biddable – and its weightage in bid evaluation and technical qualification and its weightage in bid evaluation.
ICRA believes that several of the measures proposed in the consultation paper are in keeping with the long standing demand of the incumbents and are in line with the global best practices in the E&P sector. Additionally with the natural gas spot prices being low globally and expected to remain low in the near to medium term owing to competition from crude oil derived competing fuels, this could be the right time to consider pricing freedom of natural gas.
Auction of small and marginal fields likely to commence in the near term
In September 2015, the government announced its intent to auction 69 small and marginal fields to private firms on a revenue sharing model. While the contours of the revenue sharing contract, to be based on a revenue based linear scale, are being finalized some of the proposed incentives for bidding include freedom to price and sell the crude oil and gas in the domestic market, exploration to be allowed for the entire duration of the contract period and exemption from oil cess.
With the auction of marginal fields, the private sector’s appetite for investment in the upstream sector under the revenue sharing regime along with the different incentives will be tested. In the production sharing contract, operators are allowed to recover all investments from the sale of oil and gas before sharing any profits with the government but this contract structure has been criticised by the Comptroller and Auditor General suggesting that it encouraged gold plating by the operators to postpone higher share of profits to the government. From the government perspective, the revenue sharing model allows greater transparency and lower room for government interference and safeguards the government interests in case of any windfall gains arising out of any quantum jump in production and/or steep hike in realizations. On the other hand the revenue share model was sharply criticized by the private sector at the proposal stage, stating that it will not encourage maximization of production and will misalign risk-reward structure. Nevertheless the auction of marginal fields is expected to commence in the near term (February 2016 as per some media reports) which would bring forth the response of the private sector to the revenue sharing model. In case the bidding evinces a positive response the GoI might replicate the revenue sharing model in the future NELP rounds as well.
Under-recovery burden of PSU upstream companies almost halves in Q2 FY16 from the level of Q1 FY16
Around 47% (yoy) fall in average Indian Basket crude oil prices in H1 FY16 led to yoy lower under-recoveries (including cash transfer under DBTL) on LPG and kerosene in H1 FY16, which along with nil under-recoveries on diesel led to 69% (yoy) fall in GURs to Rs. 159.4 billion in H1 FY16 from Rs. 511.1 billion in H1 FY15. The under-recovery sharing burden on upstream companies (ONGC and OIL) decreased to Rs. 6.8 billion in Q2 FY16 (against Rs. 164 billion in Q2 FY15 and Rs. 13 billion in Q1 FY16) and Rs. 19.8 billion in H1 FY16 (against Rs. 319 billion in H1 FY15). The share of upstream companies in GURs was 12% in H1 FY16 on a lower GUR base against 62% in H1 FY15. The under-recovery burden on PSU upstream companies, in terms of discount, has been significantly lower at around US$ ~2-2.5 /bbl in Q2 FY16 (against US$ 56/bbl in Q2 FY15) and US$ ~3.5 /bbl in H1 FY16 (against US$ 56/bbl in H1 FY15). In line with global crude oil prices, gross realisations of upstream companies were lower by ~45% (yoy) in H1 FY16; however, due to a material fall in subsidy burden, net realisations showed a yoy improvement in H1 FY16. However, in qoq terms, gross realisations of upstream companies decreased by US$ ~13 /bbl (qoq) in Q2 FY16, which led to fall in net realisations by US$ 10-11 /bbl despite lower discount provided to share under- recovery burden. In absolute terms, subsidy burden of ONGC decreased by 93.6% (yoy) to Rs. 17.3 billion in H1 FY16, while that of OIL decreased by 93.8% (yoy) to Rs. 2.5 billion in H1 FY16. GAIL has been exempted from under-recovery sharing since Q3 FY15 and we expect the trend to continue.
Material fall in GURs expected in FY 16 following soft crude oil prices and DBTL
ICRA projects gross under-recoveries (GURs) of OMCs to decrease by ~58% from Rs. 723 billion for FY15 to Rs. ~300 billion for FY16 (estimated at average Indian basket crude oil price of US$ 51/bbl and INR/US$ of 65 for FY16). Apart from lower crude oil prices, the GURs are on a declining trend due to lower domestic LPG subsidy as fake/multiple connections have been disconnected /surrendered with implementation of direct benefit transfer scheme for LPG (DBTL). DBTL is also significantly reducing the leakage of LPG (domestic) for commercial and Auto-LPG purposes.
Under-recovery sharing formula is a boost for the PSU upstream companies
In August 2015, the GoI announced that it would share under-recovery upto Rs. 12 /litre on SKO (PDS) while the balance under-recovery on kerosene will be borne by the PSU upstream companies. With regards to LPG (domestic), the GoI approved a fixed subsidy capped upto Rs. 18/kg under the Direct Benefit Transfer for Domestic LPG (DBTL), which translates to Rs. 255.6 per cylinder. Following this announcement, the under-recovery burden on the PSU upstream companies is expected to significantly decrease in FY16 which would help them in the current scenario of low crude oil prices. ICRA estimates that the upstream discount going forward – in the near to medium term – would be low ranging from nil to US$ ~5 /bbl for gross crude oil realisations of US$ 35 /bbl to US$ 60/bbl. Although PSU upstream companies may benefit with lower under-recovery sharing burden as per the revised subsidy sharing formula, their profits may still decline if crude oil prices sustain at current low levels.
Soft crude oil and natural gas prices to adversely affect profits of upstream companies
Crude oil prices have declined to US$ ~35-40 /bbl over the last few weeks after being lower than US$ 55-60 /bbl since the beginning of CY2015. Prices are expected to remain at low levels in the near term because of high supplies, modest global demand and the decision of OPEC to defend market share. Therefore, the profits of upstream companies are expected to be under significant pressure in the near to medium term. Besides, fall in domestic gas prices in April 2015 and subsequently again in October 2015 would lead to deterioration in the profitability of the upstream players during FY16.
Marginal upside to crude oil production expected
Over the medium term upside to crude oil production is expected to be driven by ONGC commercializing its marginal fields in addition to EOR/IOR initiatives of ONGC and OIL even as production from Cairn India’s Rajasthan field is expected to remain flat in FY16. Notwithstanding the anticipated increase in production, dependence on import of crude oil is expected to remain high given the large demand– supply gap and the growth in domestic consumption of petroleum products.
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