India's oil supply deficit spurs reforms to lure foreign capital

India's rapidly growing domestic oil supply shortfall is regarded increasingly as a crisis in that country. With forecasts calling for a continued rise in imports of crude oil, natural gas, and refined products, the government is stepping up efforts to attract foreign investment to oil and gas exploration and development, massive expansions of refining and petrochemical capacity, and integrated energy schemes such as Enron Corp.'s liquefied natural gas import/electric power project at Dabhol.

Current estimates put the overall potential investment needed to meet India's energy needs in the early part of the next century at $100-150 billion.

While India has in the past made faltering steps toward this kind of initiative-only to eventually discourage prospective investors in its petroleum sector amid political turmoil-a new sense of urgency accompanies the latest government efforts at reform, deregulation, and sweetening of fiscal incentives.

The author, an Ottawa consultant who has long tracked India's trade, mining, and energy sectors, analyzes the current situation and proposed changes and what the future has in store for India's petroleum sector.

Economic growth

India has a population of about 950 million and a middle class of 250 million people, whose desires for a better lifestyle are expanding rapidly.

Prior to 1990, economic growth in the country had been slow and erratic, tending to average about 3.5% per year. After the country's liberalization program, started in 1991, the economic growth rate rose sharply to 6.5-8.5%/ year. The demand for energy also grew to sustain these higher economic growth rates.

At the Fifth International Energy Conference at Goa, India, in December 1996, analysts and government officials noted that with the rise in the demand for refined products and the drop in production of crude oil and refined products, India's demand for imported oil has rocketed, placing India's balance of payments in a critical situation.

So it has become imperative that the country cut its dependence on petroleum imports by increasing indigenous production and tying in with equity supplies through joint ventures or farmouts in proven hydrocarbon regions overseas.

In recent years, under a virtual monopoly on exploration and production held by two state companies, Oil & Natural Gas Commission (ONGC) and Oil India Ltd. (OIL), efforts to find enough oil to satisfy the country's growing demand have fallen short.

In addition, production from existing oil fields has been declining, notably Bombay High, the supergiant producing complex off India's western coast that provides most of the country's oil production.

Accordingly, the United Front Government-now a coalition of parties under new Prime Minister Inder Kumar Gujral and Finance Minister Palaniappan Chidambaram-has taken a number of steps to increase the pace of oil exploration and production.

At the same time, the government has called for an increase in domestic refining capacity to 2.2 million b/d from the current 1.208 million b/d by 2010. This added capacity will be just enough to cover expected domestic requirements for refined products and excludes exports to earn foreign exchange.

In addition, the distribution and marketing infrastructure, which includes pipelines, ports, terminals, and storage, will require major investments.

Petroleum demand

India's Ministry of Petroleum and Natural Gas predicts the country's demand for petroleum products will jump to 155.3 million metric tons/year (3.106 million b/d) by fiscal 2006-07 from 80.9 million tons/year (1.618 million b/d) in fiscal 1996-97 (see table, p. 26).

India's consumption of petroleum products rose sharply during 1994-96, growing at a rate of 11%/year. However, during the next 10 years, that growth is estimated at 6.6-6.9%/year. Naphtha, used as a feedstock for the manufacture of fertilizer and for power generation, is expected to show fairly strong growth of 8-10%/year, and demand for high-speed (auto) diesel (HSD) in the longer term is projected to grow at a rate of 8-8.5%.

To compare the growth rates of petroleum products demand with forecast overall economic growth, a January 1997 report on India's infrastructure outlook by the National Council of Applied Economics Research concluded that a "flexible-optimistic" outlook for India's economy would mean GDP growth rising to 8%/year by 2006 from the current average of 6%/year.

This would imply that investment in infrastructure would rise from 5.5% of GDP to the average Southeast Asia level of 8%, thus requiring an investment of $50 billion/ year. However, the government estimates the required infrastructure investment by 2006 would break out as: power $150 billion, telecommunications $41 billion, roads $19.5 billion, and urban infrastructure $55 billion.

Reforms

To help sustain this economic growth rate with adequate oil and gas supplies, Minister of Petroleum and Natural Gas T.R. Baalu has been pushing for an accelerated exploration and development plan for hydrocarbons, which would open up the sector to the private sector and invite foreign companies, among other reforms.

However, implementation has been slow. Among market reforms, there has been a sharp rise in the price of some petroleum products closer to free market levels, but nothing else has been accomplished (see related story, p. 27).

However, a radical policy change was proposed at the end of February in the government's fiscal 1997-98 budget. This called for sweeping changes in India's exploration and production policy and improved fiscal terms for private/foreign investors.

Ahead of the February announcement on new E&P terms, speculation had been that the government would accept the recommendations of the Restructuring (R) Group chaired by Vijay Kelkar, then Secretary of the Ministry of Petroleum and Natural Gas.

Some of the main policy changes, in addition to those covering new exploration terms and incentives, that the R Group recommended were to dismantle the Administered Price Mechanism, which controls prices of petroleum products, end the cross-subsidy of such products as diesel and kerosine, and change the royalty rate structure.

These suggestions were made in January 1996 but were held up for lack of political consensus.

However, some recent developments have spurred the government to finally call for action on reforms. The oil price spike in 1996 and early in 1997, together with domestic crude oil production falling short of the government target by 4.8 million tons (96,000 b/d), sent India's balance of payments into a sharp deficit, triggering a need to implement reforms as soon as possible.

E&P activity sluggish

During the last few decades, India's exploration and production activity has been sluggish.

Part of the blame lies with the government's policy of leaving exploration in the hands of ONGC and OIL. While India's petroleum potential is considered attractive, apart from Bombay High, only two other large hydrocarbon regions have been identified: Assam and Gujarat. Even here, the density of exploratory drilling is low compared with the proven hydrocarbon regions in Canada and the U.S.

India began the search for oil in 1886, with a noncommercial oil well in Upper Assam. In 1889, the Assam Railway & Trading Co. struck oil at Digboi, Upper Assam. Later, this area was acquired by Burmah Oil Co. Until 1956, exploration was confined to the Assam-Arakan region.

Currently, however, most of India's oil is produced from fields off Bombay on the west coast.

India is endowed with 26 sedimentary basins covering an area of 1.72 million sq km, of which the offshore area to 200 m water depth totals 380,000 sq km.

The sedimentary basins have been categorized into four categories as a function of the geological knowledge of the basin, presence and/or indication of hydrocarbons, and the current status of exploration. Thus Category I basins are proved, whereas Category IV basins are considered prospective based on analogy with other proven basins in the world.

The R Group has characterized India as underexplored. Using the Ministry of Petroleum and Natural Gas figures for ONGC, which account for 90% of India's hydrocarbon reserves discovered to date, and estimating the same figure for OIL, total "established geological/in situ" reserves (original oil in place) are put at 6 billion tons of oil equivalent (toe).

However, total hydrocarbon re- sources, including possible and probable estimates, for basins onshore and offshore to 200 m water depths, are estimated at 22 billion toe.

This shows that so far, only 27% of India's potential hydrocarbon re- sources has been found.

Exploration and production costs in the oil and gas sector are relatively low in India, so it makes economic sense to explore in the country.

However, multinationals so far have not had much luck in exploring India, and the national oil companies' success rates have now declined.

B.C. Bora, chairman and managing director of ONGC, has said that the discovery of new oil in India will become increasingly difficult, requiring use of more sophisticated technology.

Existing exploration terms

Current exploration terms call for:

• Production-sharing contracts. In the case of crude oil and associated gas, the contract period is as much as 25 years, with an option to extend another 5 years. In the case of nonassociated gas, the period is 35 years.
• The exploration period is for a maximum of 6 years, consisting of three commitment phases.
• Companies would have to relinquish 25% of the contract area after the first phase and a further 50% of the original contract area in the second phase.
• There is no signature or production bonus or royalty/duty on production.
• Contractor companies would be exempt from the payment of customs duties and taxes on supplies for petroleum exploration.
• Contractor companies would be required to offer the entire share of oil accruing as cost oil or profit oil to the government until India achieves oil self-sufficiency. Payment to the contracting company will be made at the international market price based on a basket of reference crudes to be agreed in each contract.
• ONGC/OIL will share in the risk in the venture with equity interest varying from 25% to 40% from the beginning.
• Cost recovery will be ring fenced by the producing area. Exploration costs can be recovered from the producing area located in the block.
• Contractors will have the freedom to market natural gas.

Exploration license rounds

Since 1991, the Indian government has held six rounds of bidding for exploration acreage and offered 125 blocks ranging in size from a few hundred square kilometers to 50,000 sq km.

Sixteen contracts have been awarded. Among the companies that have been awarded contracts or participated in bidding include Royal Dutch/ Shell Group, Occidental Petroleum Corp., Amoco Corp., and Enron Corp.

The government also has offered private companies the opportunity to participate in the development of previously discovered small and medium-sized fields.

The first offer was made in August 1992, when five medium-sized fields and 13 small fields were awarded. The second offer was made in 1993.

In other efforts to broaden participation in Indian exploration, several major Indian downstream public sector companies-Indian Oil Corp. (IOC), Hindustan Petroleum Corp. Ltd. (HPCL), and Bharat Petroleum Corp. Ltd. (BPCL)-have decided to form strategic alliances to pursue exploration and production of oil and natural gas in India and abroad.

In addition, the government also introduced the Accelerated Program for Exploration (APEX), carrying an estimated $2 billion investment with a focus on:

• Deepwater exploration, to be undertaken by multinational oil companies in joint ventures with ONGC and OIL. The international oil companies are to transfer new technology to the ventures. The areas are high risk, require huge investments, and offer high rewards.
• A national seismic survey program that is essentially reconnaissance in nature.
• Encouragement of domestic companies to acquire acreage abroad with good geology, attractive fiscal terms, good logistics and geopolitical environment, and contract stability.

Exploration policy changes

The Indian government is considering further liberalization of its exploration policy, unveiling some general reforms last March (OGJ, Apr. 7, 1997, p. 39).

Among the main features of the policy:

• The national oil companies, ONGC and OIL, will compete with the private sector in exploration. They will be paid the international oil price.
• There will be no mandatory public sector participation with the private sector for exploration.
• Sedimentary basins onshore and offshore will be divided into grids, so that companies can easily demarcate their blocks.
• The government will move to the open acreage system.
• The fiscal regime will minimize "fiscal deterrence."
• Companies will be permitted to amortize exploration costs against other business carried on by the same company.
• The Ministry of Petroleum and Natural Gas has suggested that import duties on equipment for exploration be expensed.
• An "empowered committee," headed by the Petroleum Secretary, will reduce the time period for approval to 6 months and progressively to 3 months.
• The Indian Income Tax Act allows liberal setoff of exploration losses against other business and 8 years of carry-forward of losses from date of commercial production.

Further reforms

The R Group has suggested this timetable for further petroleum reforms:

• Phase I, 1996-98: Rationalization of the tariff structure; deregulation of natural gas pricing; elimination of regulatory channels for imports of heating oil and asphalt; partial deregulation of the marketing sector; and removal/ reduction of the subsidy on such refined products as HSD, kerosine, and LPG.
• Phase II, 1998-2000: Pricing of crude oil to be on the basis of the average price of comparable crude; rationalization of the royalty and duty on crude oil; and a further deregulation in the marketing sector.
• Phase III, 2000-02: Deregulation of imports of remaining petroleum products. Total deregulation of upstream and downstream sectors.

Investment outlook

Primary energy consumption in India has grown at a rate of about 6.1%/year from about 65 million toe in the early 1970s to 202 million toe in 1993.

This growth rate can be compared with the world average during the same period of only 1.5% per year. On a per-capita basis, India's consumption of petroleum products is low at 90 kg, compared with a world average of 900 kg per capita.

Indian oil consumption is projected to rise from 75 million tons in 1995-96 to 113 million tons in 2001-02 and 155 million tons by 2006-07. If economic growth reaches the level of 7-8%/year, then oil consumption will rise at a higher rate.

To meet this projected oil demand of the early 21st century, the estimated investment required is $100-150 billion during the next 10-15 years.

Specifically, the sectors which will have investment opportunities in-clude:

• Boosting refining capacity to 2.2 million b/d by 2010 to meet the requirements of domestic consumption.
• Distribution infrastructure, such as cross-country pipelines, port terminals, and tank farms.
• Exploration and production opened up further to the private sector and with foreign participation.
• Opening up the refining sector for joint ventures with the private sector.

Under a liberalized economic policy, the entire petroleum sector will be open for investment through joint ventures and strategic alliances.

In order to achieve quick results, both the government of India and the individual state governments will have to act in a businesslike manner and approve proposals within a reasonable time frame.