Insights into Editorial: Oil Slip
08 March 2016
Finance Minister Arun Jaitley has rightly affirmed fiscal rectitude and addressed the challenge of growth and rural distress in the recent Budget. However, analysts feel that the 2016 Budget has failed to lay out a clear roadmap for the petroleum industry, which is already in poor shape.
- Finance Minister’s budget speech lacked 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%.
Such reaction from the government raises the following 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?
- Is its emphasis on clean energy substantive or a rhetorical flourish?
Analysis of key proposals:
The Finance Minister made three policy announcements:-
- The price of gas from newly discovered fields would be determined through the market and linked to the price of alternative fuels.
But, initially it was not clear, 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.
- However, the petroleum sector was not happy with the proposed ad valorem rate of 20%. 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.
- Third proposal 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.
This was a positive move. However, there is a concern that this money would be diverted for other purposes. Previous experiences also suggest the same. So far, the clean energy fund has been managed by the finance ministry and the money out of it has not always gone towards clean energy research but for financing unrelated activities like cleaning the Ganges.
- Finance Minister seems to have missed the opportunity to allay these fears by assuring that the money would be managed by people with domain expertise and not subject to political or financial exigency.
Before proceeding further, 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% of our requirements. This will go up to near 90% 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 some recent studies, 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.
- Besides, 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. This will automatically yield no interest in high-cost, complex and long-gestation exploration opportunities.
- Hence, it’s time to concentrate in 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.
Indian cities are amongst the most polluted in the world. Also, forest cover is denuding along with the receding water tables. Clean energy is the sine qua non for breaking the currently unhealthy linkage between growth, energy demand and environmental degradation.
Now, what are the choices before the government?
- First, 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
Conclusion:
In sum, in spite of a few positive statements and announcements that impact the oil sector, considerable omissions remain. The sector appears to be shining on the outside, but the tinted windows hide what lies underneath.
