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The $8.8-billion illusion

Anil Ambani says RIL’s revised capex figure for development of two gas fields is inflated; the government says that number is being misread.

Puja Mehra | Print Edition: September 6, 2009

The Ambani vs Ambani battle has now well and truly become the government’s battle, too. Anil Ambani has raised questions about the government’s fairness in two ways: One, by disputing the capital costs of KGD6 Basin (which are approved by the government) and two, by claiming there can easily be dual pricing of the gas, which will ensure that his group company Reliance Natural Resources Ltd (RNRL) will get gas at $2.34 even as the government’s profit share is protected.

We spoke to V.K. Sibal, Directorate General of Hydrocarbons (DGH), to get the official view on critical issues of cost, price and eligibility of gas for RNRL.

Costs are of Two Types: Incurred ($6.6 bn) and Estimated ($8.8 bn)
Sibal clarifies that the $8.8 billion figure— which the Anil camp says is the government-approved capital expenditure for Reliance Industries Ltd (RIL) to produce 80 million metric standard cubic metres a day (MMSCMD) of gas, and which is apparently ‘goldplated’ and designed to favour RIL—is only an estimate. “The Product Sharing Contract (PSC) does not provide for recovery of estimates of contractors,” the DGH says.

A field development plan estimate, such as $8.8 billion, at any point depends on the projections of international prices of steel, rigs and various inputs. Any changes in the prices or the projections of the prices of inputs and services can inflate or deflate it.

Naturally, it is not what is recoverable. “The whole idea of putting out an estimate is that the contractor should be able to determine if the field is commercially viable or not,” explains Sibal. “As long as the contractor is confident of a field’s commercial viability, its cost estimates are acceptable since they make no material difference.” He says that $8.8 billion is only techno-economic data and not cost revcoverable.

HALF-TRUTHS AND STATS
$8.8 bn is merely a field development plan estimate that is not what is recoverable.
$6.6 bn* is the actual expenditure, of which RIL has recovered $48 mn*.
$53 mn* is the actual sales revenue.
$0.529 mn is the government’s share of profit petroleum** for 2008-09.
Rs 46.31 cr# is the royalty received by the government.
*Till March 31, ‘09 for gas field D1 D3
#Till May ‘09
**Revenue minus royalty minus opex minus capex

What, in fact, is audited and approved for cost recovery for a contractor is the actual cost incurred according to the PSC. The exploration and field development costs incurred during a year are audited in the subsequent year after which they become eligible for recovery. For the D1 and D3 gas fields, so far, RIL has spent $ 6.6 billion on exploration and development. Of this, RIL has taken a recovery of $48 million.

Is There Scope to Inflate Costs?
Sibal says the total discovered reserves of the gas in the field have also gone up from 3 trillion cubic feet (TCF) to 14 TCF. Production as per the revised field development plan has jumped from 40 MMSCD per day to 80 MMSCD per day. Sibal clarifies that if costs go up then not only will the government’s share in revenue fall, the contractor’s share will diminish, too. Sibal doesn’t see any scope for inflating costs.

“The PSC clearly lays down the procedure for hiring services and equipment, including the heads of expenditure allowable. These are taken on through international competitive bids and, of course, all the expenses are subsequently audited as per the PSC twice—once by the contractor’s auditors and then by external auditors appointed by the government. Additionally, in this case, the CAG has undertaken the third audit,” retorts Sibal.

The moot point, however, is whether the audits did take place at all. There were reports suggesting that the office of the Comptroller and Auditor-General (CAG) had stated that the DGH’s claim that RIL’s capex had undergone three audits were not true. Sibal, however, disputes that and proclaims that the CAG itself has audited D6 over the last one year and the final report is awaited.

“In fact, a CAG request for some additional information has just reached us, which we will soon provide. After an uproar, the government had also got RIL’s estimates validated by two independent experts that were appointed through international competitive bids. Further, Goldman Sachs has independently compared these estimates with 32 comparable projects worldwide and found D6 to be the most costeffective operation,” he adds.

The audits by independent experts, he points out, were done through international bids in accordance with the PSC and the reports are available.

The Costs Will, in any Case, Have no Bearing on Price
“Petroleum products are not priced according to the cost of production, Rather the prices are benchmarked to the prices emerging from international markets,” says Sibal. “Thus, the cost of producing gas from D6 has no bearing on its price.” Since there is no international market for gas, the government has barely notified a formula for determining the price at any given time. For the first five years, this price comes to $4.2 per MMBTU.

The price notified by the government was arrived at by calling in bids from potential buyers that included the ADAG group.

MORE LITIGATION, ANYONE?

Mukesh Ambani has submitted to the courts that he had not informed either the Board or the shareholders of RIL of the details of the MoU with his younger brother over the division of the Reliance empire. Does the non-disclosure constitute a violation of the rights of RIL’s shareholders and Board members? Corporate Lawyer Diljeet Titus, proprietor of Titus and Co. Advocates, provides some leads:

INVESTIGATION: The Company Law Board (CLB) can order an investigation into the affairs of RIL under Section 235 of the Companies Act, 1956, if at least 1/10th of its shareholders apply for it. Non-disclosure of the material clauses of the Gas Supply Contract (GSC) will be construed as an act that defrauds the shareholders, creditors, or any other person.

OPPRESSION AND MISMANAGEMENT: The directors, including Mukesh Ambani, owe a fiduciary duty to RIL, which they can exercise. The fiduciary relationship requires them to act in the best interest of RIL and not for the promotion of any group interest or individual interests.

BREACH OF RIL’S CODE OF CONDUCT: Mukesh Ambani’s failure to disclose his interest in the GSC can be regarded as breach of a Code of Conduct, which clause 49 of the listing agreement requires public listed companies to lay down.

VIOLATION OF THE RIGHTS OF THE BOARD: Failure to disclose their interest, whether direct or indirect, in a contract and seeking the Board of Directors’s approval for it within three months can be a violation of Section 297 of the Companies Act, 1956.

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