Oil slip The petroleum industry is in poor shape. Budget 2016 fails to lay out a clear roadmap Vikram S Mehta
I am one of the quick-fire commentators who complimented the finance minister on budget
day for both affirming fiscal rectitude and addressing the challenge of growth and rural distress.
On closer reading of the fine print, I hold on to my initial reaction. This said, I was concerned at
the brevity and imprecision of his comment on the energy sector. I did not expect a more
detailed pronouncement — the budget is not the occasion for sectoral policy statements — but
I did expect a clearer enunciation of intent, especially since energy has been an important part
of the prime minister’s agenda. This lack of clarity did lead to a sharp reaction from the market.
The stock price of ONGC tanked by 10 per cent.
It also triggered, in my mind at least, three fundamental questions: Does the government
appreciate the severity of the crisis facing the petroleum industry? Is it serious about reviving
domestic oil and gas exploration? And is its emphasis on clean energy substantive or a
rhetorical flourish?
The FM made three policy announcements. The first was that the price of gas from newly
discovered fields would be determined through the market and linked to the price of
alternative fuels. It was not clear, at least initially, whether “newly discovered” meant
discoveries yet to be made or those already made but not monetised. It was also not clear
whether the price would be linked to low-priced coal, the higher-priced imported liquefied
natural gas or to a fuel between these two price points.
The second was to switch the calculation of cess on oil production from a specific rate (fixed
rupees per barrel produced) to ad valorem (percentage of value). This is what the companies
had lobbied for and it was a sensible move. The fixed charge of $9.1 per barrel produced was
affordable when prices were hovering around $100 per barrel but a crushing burden in the
current low price regime of around $35 per barrel. What took the wind out of this proposal was
the ad valorem rate of 20 per cent. For, at that rate, the tax burden came down by only $2 per
barrel from $9 to $7 and for so long as the price of oil remained in the current range. In the
event prices rise to the average level predicted by analysts of $45 per barrel in 2016, this
benefit will be wiped out and companies will find themselves in the same financial straits they
are in today. I can understand the FM’s logic for imposing the tax. He needs the money. But
what I cannot understand is the illogic of, on the one hand, expecting ONGC/ OIL to increase
domestic exploration and, on the other hand, sequestering almost 25 per cent of their revenues
through this indirect tax.
The FM’s final doff to the energy sector was to double the cess on coal production from Rs 200
to Rs 400 per tonne, and to direct that this money be used for financing clean energy. Again,
like the switch to ad valorem, this was a positive.
There was a lingering concern, however, that this money would be diverted for other purposes.
So far, the clean energy fund has been managed by the finance ministry. The money has not
always gone towards clean energy research but for financing unrelated activities like cleaning
the Ganges. This concern might have been allayed somewhat had the FM assured listeners that
the money would be managed by people with domain expertise and not subject to political or
financial exigency.
The government must internalise three hard truths: One, India’s dependence on oil and gas
imports will increase in the short to medium term. We currently import around 75 per cent of
our requirements. This will go up to near 90 per cent by the end of this decade. We are and will
remain hugely vulnerable to the vicissitudes of the international market.
Two, the petroleum industry is in terrible shape. According to consultants Wood Mackenzie,
every private oil company loses cash at $30 per barrel. All are now on a massive cost-cutting
exercise. They estimate that over the period 2015-2017, the companies will take out $200
billion of expenditure and that exploration investment will drop from around $95 billion in 2015
to less than $40 billion in 2016. Cost-cutting will not save the highly leveraged companies from
bankruptcy and there will be a plethora of stranded assets available for sale at a discount. The
message for us is there will be no interest in our high-cost, complex and long-gestation
exploration opportunities.
If anything, the interest will be in our lower-cost, shorter-gestation and technology-intensive
marginal fields and that too by niche players funded by speculative private equity funds.
Three, our environment is under stress. Our cities are amongst the most polluted in the world,
our forest cover is denuding; the water tables are receding — the list is long. Clean energy is the
sine qua non for breaking the currently unhealthy linkage between growth, energy demand and
environmental degradation.
These three hard truths present the government with three clear choices. If it wishes to
accelerate exploration, it will have to stop milking the ONGC cow. Private investors will not step
into the breach. A downward recalibration of the ad valorem tax rate would be a positive first
step.
Second, if it wishes to increase domestic production, it should do what many oil-producing
countries, including China, the US , the UK and Malaysia, have done in response to the current
low oil price regime and offer tax credits and exemptions for incremental production from
marginal fields and enhanced oil recovery.
And third, if it wishes to give a fillip to clean energy, it should put together a more robust
package of subsidies and concessions; place its flag on the masthead of electric vehicles and
cement R&D partnerships between government entities, private corporations, universities and
research laboratories.
Of course, if it has no appetite for any of this, it can continue to view the energy sector as a
financial palliative.
The writer is chairman of Brookings India and senior fellow, Brookings Institution
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