The oil and gas sector has recorded phenomenal growth over the past year. New initiatives have been taken to revive activity in the exploration and production (E&P) segment. Gas transmission infrastructure is being strengthened. The prospects for the city gas distribution (CGD) segment have improved significantly. There has also been a spate of project announcements with respect to expanding liquefied natural gas (LNG) infrastructure and refining capacity. Indian Infrastructure presents views of leading sector experts on the sector’s performance over the past year…
What has been the progress in the oil and gas sector in the past year?
In a major policy drive to encourage domestic E&P activities, policy reforms, including the Hydrocarbon Exploration and Licensing Policy (HELP), the Open Acreage Licensing Policy (OALP), the Discovered Small Field [DSF] Policy, the National Data Repository (NDR), and the Policy for Enhanced Recovery Methods have been undertaken over the past couple of years. These policies have stabilised in the past year.
Noteworthy steps have been taken to promote clean energy as well. These include leapfrogging to BS-VI norms for auto fuels, and the launch of the National Policy on Biofuels, 2018, and the Sustainable Alternative towards Affordable Transportation initiative. In February 2019, the government introduced a host of measures such as classification of 26 sedimentary basins into three categories without the need to share revenue or production from Category II and III basins (unless there are windfall gains), maximum cap of 50 per cent for revenue sharing with the government, and allowing contractors complete marketing and pricing freedom (except for exports).
In the past year, significant activity has taken place with regard to natural gas infrastructure development, besides reforms for liberalisation in the natural gas sector. With the conclusion of the ninth and tenth CGD licensing rounds, an enabling environment has been created for infrastructure development that will enable the reach of natural gas to areas that have more than 50 per cent of the country’s population. Also, progressive steps have been taken towards creation of a natural gas trading hub and liberalisation of natural gas infrastructure (which is a precursor for a trading hub to operate).
A slew of reforms notwithstanding, the domestic production of oil has been declining, while that of gas has increased only marginally. This has resulted in a further rise in dependence on imported oil and gas (in the form of LNG). While public sector E&P companies have had record high oil price realisations due to elevated global oil prices, their internal accruals and balance sheets have been weakened by large dividend and share buyback cash outflows, debt-funded acquisition of other public sector units (PSUs), etc.
With regard to the downstream sector, refining margins remained volatile due to interplay of crack spreads, oil price differentials and oil price volatility. However, marketing margins attained some stability despite a few hiccups during the year. Moreover, the subsidy payout to oil marketing companies (OMCs) was delayed by the government, resulting in high working capital borrowings for these entities. Global LNG prices have softened, resulting in some challenges for marketing margins, though this benefited end users. CGD companies had a good year due to tailwinds in the form of the ban on polluting fuels such as fuel oil and petcoke in a few states, rise in motor spirit and high speed diesel (HSD) prices on the back of higher taxes, and relatively low spot LNG prices.
What has been the impact of key policy and regulatory initiatives of the government?
Under HELP, there has been a shift from the production sharing contract regime to the revenue sharing contract regime. The new contracts covered under HELP provide various benefits to contractors. This is likely to ensure faster decision-making and speedy project implementation. Under the new regime, contractors get the complete right to explore and produce oil and gas and all other types of hydrocarbons during the entire contract period, along with certain fiscal incentives such as low graded royalty rates, and exemption of oil cess and customs duty. This reform of reduced government intervention should encourage investment considering global oil prices are recovering.
Under DSF II, a total of 145 bids were received in 24 contract areas, and there was more-than-anticipated participation by new entrants from India as well as foreign countries. Production from areas offered in DSF I is likely to start as per contract timelines from 2019-20 onwards and now DSF II areas will follow, as a continuum, to add to domestic production and increase the numbers of oil and gas operators in the country.
The impact of the transition from the New Exploration Licensing Policy (NELP) to HELP may take some years to be felt as areas given prior to the HELP auction rounds will coexist for exploration and development activities. This may pose a challenge in the implementation of different policies at a given point in time.
HELP also has some challenges. For instance, the policy has failed to attract big players and foreign companies operating in the sector. Moreover, the Directorate General of Hydrocarbons (DGH) has discretionary powers to accept/ modify an area for which an expression of interest (EoI) has been submitted and applicants are obliged to participate in the subsequent bidding if more than 50 per cent of the area is accepted by the DGH as mentioned in the EoI. In the first round of HELP auctions for 55 oil blocks, no foreign oil company submitted an EoI. Apart from low global crude prices, one of the reasons for this was the requirement that a holding company with a participating interest in a block must take permission from Indian authorities if it wishes to undertake a structural change.
The government has certainly taken positive steps and is trying to create a conducive environment for the oil and gas sector. However, the nature of the sector is such that policy
initiatives take a long time to show any impact. We do expect to see the impact of policy initiatives by way of increased domestic production, an operational gas hub, and increased investment for infrastructure creation. However, this impact will only be visible in the years to come.
The government’s intent has been good, and this has resulted in a flurry of E&P reforms such as those for enhancing domestic production of oil and gas (announced in February 2019) and the fast-track award of blocks under bidding rounds of the DSF Policy, HELP and the OALP. That said, benefits in terms of higher domestic oil and gas production will be realised only over the next three to five years. With regard to the CGD sector, the success of the ninth and tenth bidding rounds that resulted in the award of 136 GAs is a significant achievement, as this will result in deeper penetration of natural gas in the country. Moreover, greater emphasis on the development of the eastern and north-eastern parts of the country by setting up interstate gas transmission pipelines is a positive development.
What are the key challenges that remain unaddressed?
India is largely dependent on the import of crude oil to meet demand. The production of crude oil has declined over the years and the discovered oil reserves are depleting. The country has inadequate transmission and distribution infrastructure.
The implementation of the goods and services tax (GST) has led to an increase in the cost of compliance for the sector. This is because, even though major petroleum products (including crude oil, white petroleum, diesel and natural gas) have been kept out of the GST ambit, other products such as liquefied petroleum gas (LPG), fuel oil, kerosene, naphtha, etc. are included. Input tax credit is available only for tax paid on input capital goods for manufacturing taxable or exempt petroleum products. No corresponding credit of GST paid on machinery and services, plant and other input expenses for manufacturing of excluded products is allowed. The rate of tax on services has increased from 15 per cent to 18 per cent, impacting the eco-nomics of upstream companies that have high consumption of services. Piped natural gas (PNG) continues to be taxable under the earlier tax regime at a higher rate of 26-28 per cent as compared to 18 per cent GST on other competing liquid fuels. These issues need to be addressed at the earliest in consultation with industry stakeholders.
The direct tax policy has also come under scrutiny time and again. Take the instance of Indian revenue authorities disputing the applicability of tax holiday under the provisions of the Income Tax Act, 1961, to commercial production of natural gas instead of oil. Similarly, the presumptive tax regime under the act for non-resident oilfield service providers was disputed by the revenue authorities for almost a decade with significant funds being stuck in the form of tax demand. In both cases, contractors had to approach the judiciary.
Policy certainty is needed and disputes such as retrospective applicability of the indirect transfer tax by the revenue authorities on transfer of Indian oil and gas assets by Cairn to Vedanta (there was also dispute on royalty payment for this transaction), royalty payments to the government/PSUs, etc., need to be avoided. Given that the sector is capital intensive in nature and has long gestation periods, policy certainty is of the utmost importance.
In the gas sector, the national gas grid still awaits completion. Low capacity utilisation of existing pipelines and pipeline developers bearing volume risks are two factors causing investor interest in financing future pipeline authorisations to wane.
A revision in the domestic gas price formula for nomination blocks, bureaucratic hurdles in securing approvals for field development plans, delays in getting statutory approvals for E&P blocks, litigation by the industry against the Petroleum and Natural Gas Regulatory Board (PNGRB) for various tariff-related anomalies for gas pipelines, giving open access to incumbent CGD networks where the marketing exclusivity period is over, setting up of a gas hub for trading, and timely roll-out of BS-VI auto fuels are some of the key challenges in the sector that remain unaddressed.
What is the sector outlook for the next one-two years?
India is the third largest energy consumer in the world, after China and the US, and has the fastest growing number of energy consumers, thereby making the sector quite conducive for investment. Globally, the demand for crude oil and petroleum products is declining; India is an exception to this trend. Oil and gas being an important sector, initiatives have been taken by the government for increasing E&P of domestic petroleum resources and to ease market conditions to attract investments. As per the India Hydrocarbon Vision, 2025, 100 per cent of the sedimentary area is to be appraised. So far, only 48 per cent of the basinal areas have been appraised, implying that about half the sedimentary basins have undiscovered potential of hydrocarbons.
Investment inflows are expected to increase in the sector as government policies in retail and refining are attracting foreign players. Recently, Saudi Aramco announced the acquisition of a 20 per cent stake in Reliance Industries Limited (RIL). The downstream sector is especially witnessing a lot of traction, with RIL and British Petroleum also planning to form a new joint venture company that will include a retail service station network and an aviation fuel business across the country. Besides, the Abu Dhabi National Oil Company (Adnoc) awarded the exploration rights for the Abu Dhabi Onshore Block 1 to an Indian consortium that comprised Bharat Petroleum Corporation Limited and Indian Oil Corporation Limited. Adnoc is looking to expand its presence in India by investing in refining and petrochemicals projects. The outlook for the coming years could focus on collaborations and investment inflows.
Indian gas markets are on the verge of a fundamental change. The upstream policy has been revamped with open acreage being implemented, gas pricing has been freed, a trading hub is under development and a large number of gas distribution areas have been licensed. Developments in global LNG markets, availability of LNG and lower spot prices will further boost this drive to entirely deregulate Indian gas markets and make them fully competitive. This in turn will have a significant impact on increasing the share of gas in the energy mix.
Given the muted outlook on global crude oil prices due to a slowing global economy and increasing US supplies, E&P companies’ profits are likely to decline in the current fiscal year. PSU OMCs are likely to have fewer concerns related to under-recoveries on LPG and superior kerosene oil, and marketing margins on auto fuels. However, refining margins should soften due to large capacity additions in the Middle East, Africa and China that should outpace demand growth for petroleum products. Nonetheless, refineries should get a boost in their margins from 2020 onwards, when new International Maritime Organization norms on bunker fuels kick in and result in a higher demand for HSD; this benefit should sustain for at least a year. Petrochemicals margins should also correct due to the ethylene and aromatics supply glut, which should take two-three years to be absorbed by the market. The CGD segment should do well in the existing GAs, with a steady rise in compressed natural gas conversions backed by favourable conversion economics, and healthy spreads in PNG (industrial) sales due to the tepid spot LNG price outlook. However, since many CGD companies will be in the midst of setting up networks in new GAs, commissioning of these projects in a timely manner without cost overruns will be key to their viability. With respect to gas marketers, significant volatility in inter-fuel economics will keep their marketing margins stressed. Nonetheless, the gas transmission segment should do well with a possible rise in volumes and the benefit of the rise in tariff levels allowed by the PNGRB recently. W
“The impact of the transition from the NELP to HELP may take some years to be felt as areas given prior to the HELP auction rounds will coexist for exploration and development activities. This may pose a challenge.”
Gokul Chaudhri, Partner, Deloitte Touche Tohmatsu India LLP
“The government has certainly taken positive steps and is trying to create a conducive environment for the oil and gas sector. However, the nature of the sector is such that policy initiatives take a long time to show impact.” Ankit Gupta, Managing Consultant, Oil and Gas, ICF International
“The government’s intent has been good, and this has resulted in a flurry of E&P reforms, though the benefits in terms of higher domestic oil and gas production will be realised only over the next three to five years.”
K. Ravichandran, Senior Vice President and Group Head, Corporate Ratings, ICRA Limited
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