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Ambani vs Ambani: Fight for gas

By Balaji Chandramouli     July 17, 2007

This is yet another front in the battle between the Brothers Ambani. In the second week of June, Anil Ambani, Chairman, R-ADAG, made a presentation to four Union ministers including Petroleum Minister Murli Deora and Agriculture Minister Sharad Pawar and four top bureaucrats including Cabinet Secretary K.M. Chandrasekhar on why the government must not approve the gas pricing proposed by his brother Mukesh, Chairman, Reliance Industries (RIL), India's largest private sector company.
At stake for Reliance Industries (RIL) is the profitability of a business in which it has already invested $6 billion (Rs 24,600 crore) and from which it expects to generate revenues of around $2 billion (Rs 8,200 crore) next year and close to $5 billion (Rs 20,500 crore) at the end of five years. Ironically, RIL could well be at the receiving end of a government that, in the past, has helped it grow from strength to strength. Here's why.

Can Anil make a difference?

The thrust of Ambani Jr's argument on the gas pricing issue is the alleged non-transparent manner in which RIL has arrived at the price; it claims RIL solicited bids in a limited manner-from five power generation and five fertiliser companies on the basis of a pricing formula that left little flexibility for the buyer.

The power and fertiliser ministries are only too keen to lend an ear to Anil. Most of them are in the public sector, and pay less than half the average delivered price (this includes transportation) of around $6 (Rs 246) per mmbtu (million British thermal units) that RIL is seeking. And, given that demand for gas is 50 per cent higher than the existing supply of around 80 mmscmd (million standard cubic metres per day), they are only too keen to tie up large volumes at reasonable rates. This, however, is not an easy task, as the gas market in India does not operate on market principles.

Export of domestic gas is not allowed; hence, RIL cannot shop around for the best price-global prices range from $2 (Rs 82) per mmbtu in West Asia to $9 (Rs 369) per mmbtu in the us, compared to $3-5 per mmbtu that Indian bulk buyers like NTPC and public sector fertiliser units are willing to pay. Then, distortions in the domestic power and fertiliser sectors, which account for 70 per cent of consumption, ensure a high level of government regulation.

In the power sector, for instance, only 60 paise is collected for every rupee of electricity generated owing to high transmission and distribution losses. Result: private investments are not forthcoming, leaving the supply business mostly in the hands of the state. In the case of the fertiliser sector, farmers buy urea at a subsidised price and the government reimburses the fertiliser companies. "We would like to ensure a fair price for the power sector, given its relevance to the economy," says Anil Razdan, Secretary, Ministry of Power.

But Anil Ambani's motives in trying to beat down the price of RIL's gas by uniting buyers (he is also lobbying with state power departments) is not quite driven by altruism. At stake for him is gas supply for his proposed 7,000 mw power plant in Dadri, Uttar Pradesh, which was promised when the Ambani brothers parted ways two years ago. When nothing materialised, Anil approached the courts to enforce the deal.

This week, the Bombay High Court granted an interim stay, which effectively restrains RIL from selling around 56 mmscmd of gas to a third party, effectively locking up 70 per cent of RIL's peak gas production of 80 mmscmd. Assuming that RIL would use some of this gas for its own captive use, the volume of gas for open sale further drops.

Legacy woes

RIL's legacy of low-priced contracts don't end there. Having bagged an ntpc contract to supply gas for 2,650 mw of fresh capacity a few years ago, it refused to seal the deal, prompting ntpc to also drag RIL to court. The next date for hearing the case has been set for July 2. Interestingly, Anil's restraint order assumes that RIL will not sell gas to NTPC. For RIL, besides getting a good price for gas, it needs to extricate itself from the clutches of the two consumers. Worse, the two consumers claim that their respective deals have been struck at $3 per mmbtu, half the price he is asking today.

Notwithstanding the onslaught of his younger brother, Mukesh Ambani has worked out a sound strategy to market his gas. He successfully negotiated with GAIL India to use its networks to supply RIL gas to consumers. Without it, RIL would not have been able to access consumers. This is a replay of its strategy in the refinery business nearly a decade ago, when it entered into a contract with public sector retailers to sell products from its 27-million tonne Jamnagar refinery-years before it rolled out its own petrol retailing network. The only difference: the power and fertiliser companies, who are bulk buyers of subsidised gas, are unwilling to pay market-related prices.

So, how did RIL get to discover its price? From a shallow market, argues Anil Ambani, since RIL has sought bids largely from private generation companies that do not directly sell power to consumers; they sell power to the state utilities that are mostly bankrupt. Hence, Ambani Jr's argument goes, price discovery should reflect the utility's appetite and not the generator's alone. Secondly, there are few generators who will pay this price since coal is far cheaper-by as much as 30 per cent in certain cases.

The Ministry of Chemicals & Fertilisers, meanwhile, has also not agreed to the pricing-its say matters since it pays the subsidy bill. "We have voiced our concerns to the Energy Coordination Committee and are hopeful that the Ministry of Petroleum will not approve RIL's gas price unilaterally," says a fertiliser ministry official.

While the outcome of the court cases, the possibilities of buyers ganging up and the heavy hand of government intervention will, at worst, dent the profitability of RIL, there is yet another issue which can jeopardise its gas business: the government is now examining whether its regulator, the Directorate General of Hydrocarbons (DGH) was justified in allowing Reliance to retain its entire block in the kg basin covering about 8,000 sq km, even though its commercial discoveries extend over a mere 10 per cent of the area.

Under the contract, the only way that RIL could keep the entire block was by demonstrating that the entire block was rich in hydrocarbon reserves within a stipulated time-frame. Else, it was required to relinquish 25 per cent of the area after the first phase of the contract (three years), and another 25 per cent after the next phase (two years). RIL progressed into the second phase with little resistance-all that the Director General of Hydrocarbons V.K. Sibal asked of it was further investigation to prove the contention that the acreage was floating on hydrocarbons (gas or oil).

At the end of the second phase, Reliance claimed that it had undertaken technical evaluations called "three-dimentional seismic studies" to prove its contention. The DGH allowed it to retain the entire block and progress into the third phase without relinquishing any part of the block on the basis of this study.

RIL's exploration efforts in the blocks it bagged in 2001 would have come to a close this month. It would have been able to undertake only commercial exploitation of its finds from now on-but for a year's extension that the DGH has recently granted (it has got extensions in the past as well). Interestingly, this is based on delays owing to the government's inability to provide timely clearances from defence and environment ministries in the earlier phases. Sibal did not respond to BT's attempts to contact him.

Recently, Petroleum Minister Murli Deora blocked an attempt by his ministry to legitimise this move by the DGH (since, the DGH is not empowered to take this call). Further, he has ordered a review of the DGH decision itself. The reason: if the decision was wrong, the government stands to lose significant revenues. That's because the auction of the relinquished blocks would have generated higher revenues for the government owing to two factors-gas prices have soared three-fold since Reliance won the bid for the blocks in 2001, and, secondly, prospects of striking hydrocarbons in the kg basin have vaulted following RIL's discovery.

There is no better proof of this than the higher share that Reliance was willing to give the government for an adjacent block it won in 2005 against stiff competition from several global majors like ENI and Petronas. Interestingly, this auction was the result of Cairn Energy relinquishing a portion of its block. By allowing Reliance to squat on a good part of the block, the regulator has also ensured that RIL's reserves are not soaked up by contractors in the neighbourhood. This will, naturally boost its future profitability.

Anil Ambani's crusade against his brother's gas pricing formula does seem to be finding responsive ears, but that's not the point. India has become an attractive destination for oil and gas exploration, but the contract regime has not kept pace with the improving market situation.

The government continues to allow contractors to recover the costs involved in exploration even though this incentive is no longer required. It is also ruing its decision against setting up an independent regulator for the exploration business, an option it had two years ago when it moved a Bill to set up a regulator for the refining and marketing and gas supply business. Clearly, being blessed with mineral resources is not enough. Its management is equally critical.

- additional reporting by Aman Malik

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