AAP vs Reliance - the gas pricing controversy

Mother of all scams

The FIR filed by the Aam Aadmi Party (AAP) against Reliance Industries and ministers in the UPA government, on allegations that they jointly rigged the prices of gas, has brought into the mainstream headlines a highly technical and complex issue. This analysis by NDTV tries to cut through the fog of jargon, and sift through the claims and counterclaims to understand if there is any substance in the claims made by AAP, and in the defence mounted by Reliance, and the government

The First Information Report or FIR filed by the Aam Aadmi Party against Reliance Industries and ministers in the UPA government on allegations that they jointly rigged the prices of gas, has brought into headlines a long-running dispute.

Since Reliance struck gas in the KG-D6 block in the Krishna Godavari basin in 2002 - seen as a validation of allowing private players into gas and oil - controversy has never been far.

The FIR, based on a complaint by a former bureaucrat, begins by referring to the first controversy that broke out in 2007, during the tenure of Murli Deora as Oil Minister, accused of colluding with Reliance to try and push up the price of gas.

The reality is more complex, linked to the confused nature of gas pricing in India. Gas, unlike petrol, is not meant to be priced by the government. As per the rules, the supplier - in this case Reliance - is meant to discover the price in the market by inviting bids from buyers, but at an arms' length. The government can step in only if it feels the price is not fair.

The first price of KG-D6 gas was 'discovered' in 2004, when Reliance bid and won a tender to supply gas to the public sector National Thermal Power Corporation (NTPC) for $2.34 per mmbtu (million metric British thermal units), for a period 17 years.

Around the same time, the Ambani bothers split. One of the terms of the split was Reliance (Mukesh Ambani) agreeing to supply gas to the power plants of Anil Ambani, at the same terms - $2.34 per mmbtu for 17 years. But Reliance refused to supply gas to both and they separately took it to court. This, Reliance's critics say, was proof that it wanted a higher price.

Reliance, however, told NDTV that they broke off the deal with NTPC because of an unfair liability clause in the agreement.

They also said when they asked the government to clear the deal with Anil Ambani, the government refused. Reliance has, in its possession, a 2007 letter from the Oil Ministry, which said the $2.34 amount is not market discovered, since Reliance was bidding low to get the NTPC contract. Reliance says that they then approached more than a dozen customers in the power and fertilizer sector, and came back with a price of over $4.3 to $4.9 per mmbtu.

The matter was referred to an Empowered Group of Ministers (EGoM), headed by Pranab Mukherjee, which settled on a rate of $4.2 mmbtu, on the logic that a higher price leads to greater revenue for the government. This decision raised strong protests at that time, now being repeated by the AAP, that the government was doing favours to Reliance in the guise of protecting its own interests.

As proof, AAP cites the view taken by a committee, headed by then Cabinet Secretary KM Chandrashekhar, which strongly objected to the hike, saying "the gas pricing formula submitted by RIL suffers from several infirmities in respect of both, the formula employed and the bidding process", implying that the buyers from whom Reliance got the quotes were not truly representative. Strong objections were also raised by Surya Sethi, who was Principal Advisor, Power and Energy, to the Government of India. He told NDTV that $2.34 per mmbtu was already a discovered market price at which Reliance was making a profit, and there was no need to hike it to $4.32.

As for the argument made by the Oil Ministry that the higher the price of gas, the faster Reliance can recover its costs and the quicker the government can share in its profits, Sethi said the government WAs not in the business of making profits alone. He said the high price of gas, a limited commodity, had a cascading impact on the price of power and fertilisers, which impact the common man.

The allegations of collusion are also based on the premise that the Oil Minister at the time was Murli Deora, who is seen as close to Reliance. Deora, who is named in the FIR, rubbished that charge, saying he simply went on the EGoM's recommendations.

But the AAP claims a subsequent letter Reliance wrote to the Oil Ministry in 2009, in which Reliance seems to say that wellhead price of gas - in other words, their cost of production - is under one dollar, is further proof that there was no reason to inflate the price from over $2 to over $4. To quote from the letter, Reliance says, "The wellhead cost per/unit (mmbtu) of Natural Gas in accordance to the above notification works out to US $ 0.8945 per mmbtu and the wellhead value for the purpose of payment of Royalty works out to US $ 3.3105 per mmbtu."

Reliance has denied this, saying the letter was simply a calculation of royalty, and that their cost of production in 2007 was between $3-4 per mmbtu. But the FIR says Reliance continued to receive unfair benefits, with the second gas price hike last year recommended by the Rangarajan Committee, set up to come up with a formula for gas pricing. The Committee considered the average of the import price of gas, as well as the price of gas at major gas trading hubs like the US, UK and Japan, and came up with a figure of $8.4 per mmbtu.

Surya Sethi has criticised this, saying the "Rangarajan committee's formula makes no sense whatsoever. The reason it makes no sense is because ostensibly, they say that this is the market price, but first of all there is no market for natural gas in the world. The only market that exists is in North America, the true market, where gas on gas competition is there and the market must follow certain characteristics, the market where demand and supply are fairly well balanced, the market is fully-fungible, and there is no such market anywhere in the world other than North America. And the price of North American gas is under $4, while here it has been priced at $8." Reliance, however, says their current cost of production is close to $7 per mmbtu, so the $8.4 price is fair.

But even critics of the Committee's decision agree that there is little doubt over Dr Rangarajan's integrity. But, as in the case of the earlier price hike, there is suspicion over political collusion, since the decision was taken under the watch of Veerappa Moily as Oil Minister. Moily replaced Jaipal Reddy who was Oil Minister between January 2011 and October 2012.

Under Reddy's tenure, Reliance was penalised over US$ 1 billion for falling output from its KG Basin gas fields. The matter is now in arbitration between the government and Reliance. reliance had argued that this was because they had overestimated the reserves in the fields, an argument rejected by Reddy, who ordered the imposition of the penalty. Reddy was replaced shortly afterwards by Moily. In an exclusive interview to NDTV, Reddy denied any agendas at work behind his removal, saying he was simply doing his job.

Moily has earlier claimed he was not favouring Reliance, and that a higher gas price mainly benefits the public sector Oil and Natural Gas Corporation (ONGC), which is the biggest producer of natural gas in India.

Some say that the argument - that a convergence in the interests of government and Reliance doesn't amount to collusion -- would be taken in better faith if there was greater arms' length between Reliance and the oil and gas policy establishment, specifically the practice of a large number of bureaucrats from the Oil Ministry becoming associated with the company after leaving service.

One of the members of the Rangarajan Committee, for instance, is JM Mauskar, a former bureaucrat and now a part of the Observer Research Foundation, a Reliance-funded think tank in New Delhi. Similarly, Sunjoy Joshi, another member of the Observer Research Foundation and who spoke in defence of the price revisions, was earlier Joint Secretary, Exploration in the Oil Ministry.

The other allegation in the FIR is over whether Reliance is deliberately escalating its costs. In 2004, when Mani Shankar Aiyar was Oil Minister, the ministry approved Reliance's plan to develop KG-D6 at $2.39 billion to produce 40 mmscmd of gas. Just two years later, in 2006, with Murli Deora in the saddle, the Oil Ministry approved an amended plan by Reliance that it needs to spend four times that amount, $8.8 billion, to produce only double, 80 mmscmd of gas.

The FIR suggests Reliance had a motive to pad its expenses: as per its contract with the government, Reliance first needs to recover its costs, before sharing profits with the government. So the higher the costs it declared, the longer it can delay sharing profits. The FIR says that was one of the reasons Mani Shankar Aiyar was replaced, a suggestion he laughs off.

Reliance claims the jump from $2 to $8 billion was spurred by massive increase in oil prices in those years, which in turn pushed up the cost of drilling equipment which rose by 540% in the same period. Deora told NDTV that he has no recollection of sanctioning the amended, $8 billion plan, saying as minister, he couldn't recall every detail.

The AAP has rejected these claims, saying a report by the Comptroller and Auditor General (CAG) on Reliance's expenses has found evidence of gold plating. The CAG report doesn't say that in so many words. It does, however, raise questions on how Reliance chose its vendors, saying "several instances, where multiple vendors were pre-qualified. However, when technical bids were received, all vendors (except one) were rejected and the contract was finally awarded on a single financial bid."

Reliance has rubbished these charges, producing three independent audits from global agencies which found no evidence of padding expenses. Moreover, they argue that simply padding costs has no long-term benefits. But Prashant Bhushan, one of the petitioners in the gas pricing issue in the Supreme Court, has alleged that Reliance brought black money from its inflated expenses through front companies.

The petition has annexed a letter by the Indian High Commission in Singapore dated August 31, 2011. The probe found that a Singapore-based company, Bio Metrix Marketing, had invested Rs. 6,500 crore in a number of Reliance companies, including Rs. 3,000 crore in Reliance's gas pipeline company. But the report finds that the director of the company, Atul Kumar Dayal, has been an old advisor of the Reliance Group and has been the Director in almost 30 Reliance Group companies.

The report says that it is "highly probable that the amounts have come from mostly tax havens to form a circuitous route. And the source needs to be ascertained." But those familiar with the development say "Atul Dayal is Reliance's counsel. Investments by Bio Metrix were open, transparent and perfectly legitimate transactions. These investments were made out of loans raised from ICICI bank, Singapore branch. ICICI has confirmed this fact to regulators. Regulators have investigated the matter and found no substance in allegations."

With claims and counterclaims piling up, the only point on which there seems to be agreement is that India needs a less confusing, more consistent gas pricing policy. While on one hand, the existing Production Sharing Contract mandates market pricing, on both occasions - in 2007 and 2013 - it is the government which has stepped in to quasi-administer the price. Surya Sethi argues that the Indian market is not mature enough to throw up a gas price, and so perhaps there is a need to do away with the pretense of a market-determined price, and have government-administered pricing based on giving the producer a reasonable rate of return.

The complexity of these debates only underlines the need for a detailed independent probe, devoid of political colour, to ascertain the charges of political collusion. With election season looming, that seems unlikely.