By Ruma Dubey

The news which greeted us all of us today morning with almost sadistic pleasure was about Reliance Industries being slapped with a notice from the Oil Ministry, disallowing cost recovery of US$ 1.45 billion  from KG-D6 offhsore fields.

For most of us, all this is a lot of mumbo jumbo, not very easy to understand except what we do understand that feathers are ruffled between RIL and the Oil Ministry and it is facing a huge penalty. So to understand this battle better, a quick guide, cutting right to the bone.

Q: First and foremost, what is this cost recovery business?

A: In simplistic definition, cost recovery is the method of arriving at the revenue wherein gross profit is not recognized unless and until the company recovers its entire cost.

Q: Why is the Govt not allowing cost recovery to RIL?

A: The Govt has stated that production from the two KG-D6 gas blocks - D1 and D3 has fallen to 37 mmscmd, much lower than RIL’s commitment of 61.88mmscmd. The Govt has blamed the fall in output fairly and squarely on RIL because it has not kept up its commitment to drill 22 wells in the field and blamed the company for violating production sharing contract obligations. The Govt wanted RIL to drill two more wells and connect two other wells by Q1FY12 and drill another 9 wells by end of FY12. RIL did not comply with this and instead stated that gas production rate will remain in the range of 40-38 mmscmd v/s earlier estimate of 80 mmscmd till mid-2013. It also stated that it will also not hook up new wells to the production line till mid-2013/14. The Govt is thus miffed and wants to penalize the company. It is disallowing a cost recovery of $457 million for FY11 and $778 million for FY12.

Q: What is the feud between RIL and the Govt?

A: RIL has received US$ 8.8 billion as capex for development of the field approved in 2006 and at that time, it was approved on the commitment of an output of 61.88 million metric standard cubic meters per day (mmscmd).  Till date RIL has spent US$ 5.694 billion on D1 and D3 and recovered US$ 5.258 billion from the sale of gas produced from the two oil blocks. Under the exploration policy, company is first allowed to recover its cost incurred on developing the fields against the oil and gas revenue earned. After this, the company is allowed to share a portion of the production with the government, termed as profit petroleum.  And now the oil ministry wants to limit the cost recovery in direct proportion with the slippage in output in line with the scheduled time frame.

Q: What was the agreement between RIL and Govt?

A: Today this agreement, known as the Production Sharing Contract (PSC) has become the biggest bone of contender. Many state it was not penned right and leaves critical areas of production and pricing completely ambiguous.  The PSC came into effect on 12th April 2000 and on 8th Aug 2011, the Govt granted approval to RIL to assign 30% of its participating interest under the PSC to British Petroleum. On 8th Sept, 200, the CAG found serious irregularities in the PSC stating that huge contracts were given out by RIL for the KG Basin gas field.  On 23rd Nov, 2011, RIL issued an arbitration notice to Govt stating that Govt was allowed to reduce the cost recovery amount as per the PSC.  RIL has stated that there is no provision under the PSC which limits the cost-recovery to either production levels achieved by a contractor or to the extent that facilities are utilised under a development plan at any given point of time.

Q: Why has the Govt woken up now and decided to penalize RIL?

A: There are many murmurs in the corridors of power. One states that after the rap given on its knuckles by the CAG, the Govt has become proactive. Another says that the Govt suspects RIL is deliberately sitting on gas, showing lower gas production as gas prices have fallen. Prices are expected to recover by 2013 and hence when prices rise, RIL will suddenly be ‘able’ to scale up production.  Ditto reason why it is not linking the oil wells to the production line.  And another says that RIL has already more than recovered its cost by selling 30% to BP for $7.2 billion, so what cost recovery is it really talking about?