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Liberalization of Oil and Gas Sector Continues Apace - International Law Office

International Law Office

Energy & Natural Resources - India

Liberalization of Oil and Gas Sector Continues Apace

June 30 2003

Upstream Sector
Refining
Transportation and Distribution of Petroleum and Petroleum Products
Marketing Petroleum Products
Foreign Direct Investment
Petroleum Regulatory Board Bill 2002


In recent years the government of India has deregulated the domestic oil and gas industry with the objective of encouraging private participation and eradicating price controls. Specifically, the upstream, refining, transportation and marketing sectors have been reformed.

Upstream Sector

The Directorate General of Hydrocarbons, which was established in 1993 under the Ministry of Petroleum and Natural Gas, supervises and regulates exploration and production activities.

The directorate supervises these activities in blocks or fields which were opened for private participation by the government pursuant to the new exploration licensing policy. The activities include:

  • evaluation of bids;
  • contract management;
  • review of exploration and production activities and performance;
  • monitoring of safety and environmental aspects; and
  • related activities.

Although the government began the process of offering exploration blocks to private parties in 1979, a structured form was assumed only in 1998 with the announcement of the new exploration licensing policy. In 2000 the government approved the award of 25 exploration blocks to domestic and foreign entities, entering into production sharing contracts with exploration and production contractors, setting out the terms and conditions for the conduct of exploration, development and production activities. Pursuant to such contracts, the contractor is authorized to carry out exploration and production activities and recover approved costs from crude and natural gas petroleum produced from the field. A certain percentage of the remaining petroleum (so-called 'profit petroleum') is deemed to belong to the government.

Exploration and production activities can be commenced only upon issuance of an exploration licence and mining lease respectively, pursuant to the Oilfields (Regulation and Development) Act 1948 and Petroleum and Natural Gas Rules 1959.

The government has announced three rounds of the new exploration licensing policy since 1998. In May 2003 the government announced the fourth round of bidding at New Delhi. A total of 24 blocks (11 land blocks, 12 deepwater blocks and one shallow water block) were placed on offer and the bid closing date is September 30 2003. The government will enter into a model production sharing contract with the successful bidders once the fourth round of the new exploration licensing policy has been finalized, with input from existing exploration and production companies and other stakeholders.

Refining

The government enjoyed a monopoly over the refining sector until June 1998. Since then, the sector has been de-licensed and the establishment of new refineries is permitted (on a greenfield basis) by private entities, either on a wholly owned basis or through joint ventures with the government.

Transportation and Distribution of Petroleum and Petroleum Products

The transportation and storage of petroleum and petroleum products requires permits and authorizations, including those listed under the Explosives Act 1884, the Static and Mobile Pressure Vessels (Unfired) Rules 1981 and the Gas Cylinder Rules 1981.

The pipeline infrastructure comprises pipelines for the transportation of crude oil, petroleum products and natural gas. Occasionally, the government emphasizes the need to implement the 'common carrier' principle in the operation of privately owned pipeline networks (excluding pipelines for captive use), with a view to making pipeline capacity available to third parties. Already, the process has been initiated in connection with pipelines for the transportation of petroleum products, pursuant to the Guidelines for Laying Petroleum Product Pipelines 2002. Although the tariff for use of such pipelines is subject to government control, no provisions or principles of tariff determination have been laid down.

The requirement for the development of petroleum (including natural gas) and petroleum product pipelines in accordance with the common carrier principle is incorporated in the Petroleum Regulatory Board Bill, which is pending before the Parliament.

The government is authorized to grant a right of use over private lands for the laying down of petroleum pipelines pursuant to the Petroleum and Minerals Pipelines (Acquisition of Right of User in Land) Act 1962. In 2000 the Gujarat legislature passed the Gujarat Water and Gas Pipelines (Acquisition of Right of User in Land) Act 2000, conferring similar powers over the state government for the granting of a right of use for the laying down of pipelines and for regulating pipelines on the common carrier principle. However, this legislation led to a dispute between the central and state governments as to exclusive competence to regulate natural gas pipelines. The matter is now the subject of a constitutional challenge by way of presidential reference and is pending before the Supreme Court.

The Petroleum Regulatory Board Bill, which is currently before Parliament, regulates the entire petroleum sector, including the establishment and operation of natural gas pipelines. The board to be constituted under the bill is empowered to regulate transportation tariffs for common carrier systems under the act. However, no specific norms or objective criteria for tariff determination are specified.

Marketing Petroleum Products

Previously, the marketing of petroleum products in India was undertaken predominantly by the government of India, through corporations owned or controlled by it such as:

  • the Indian Oil Corporation Limited;
  • Hindustan Petroleum Corporation Limited;
  • Bharat Petroleum Corporation Limited; and
  • IBP Company Limited.

These companies marketed the full range of petroleum products for consumption in various sectors and enjoyed a virtual monopoly over the marketing of so-called 'controlled products' for over almost 25 years, resulting in the absence of any competition or rival participation.

Moreover, petroleum product prices were controlled under the administered pricing mechanism (APM) which was introduced in 1977. A cost-plus pricing mechanism prevailed under the APM, allowing a predetermined rate of return and subsidized pricing. An oil pool account was established to reconcile the interests of the various participants in the petroleum chain with those of consumers.

Although the process of dismantling the APM commenced only on April 1 1998, private participation was allowed with respect to certain petroleum products even before this date (eg, private marketing of lubricants was allowed in 1993). In dismantling the APM, the central government first deregulated the marketing of all petroleum products except motor spirit, high-speed diesel, aviation turbine fuel, liquid petroleum gas for domestic consumption and kerosene for public distribution. The marketing and pricing of aviation turbine fuel was deregulated on April 1 2001.

On March 8 2002 the government announced guidelines for granting authorizations to private players for the marketing of transportation fuels. The salient features of the 2002 guidelines are as follows:

  • The application must be made in the prescribed form pursuant to the Motor Spirit and High-Speed Diesel (Regulation of Supply and Distribution/and Prevention of Malpractices) Order 1998. The application must include details of the applicant's proposed marketing scheme, the source of the products, tankage and other infrastructure proposed to be established, the method of transportation of the fuel, and the total quantum and type of products to be covered.
  • Within a 10-year period, a minimum investment of Rs20 billion is required in exploration and production, refining, pipelines or terminals for liquefied natural gas or crude oil. The investment must add to existing assets and/or lead to the creation of new assets in the eligible activities, and must be in the form of equity or 'equity-like' instruments (eg, convertible debentures) or debt with recourse to the company. Further, the applicant must provide a bank guarantee to cover the investment for the stipulated 10-year period.
  • A certain percentage (approximately 11%) of total retail outlets must be introduced for 'remote' and 'low service' areas.

As of April 1 2002 the central government deregulated the consumer prices of transportation fuels (other than aviation turbine fuel, which was deregulated on April 1 2001), and allowed the prices to be market determined. It retained the subsidies on domestic fuels such as kerosene and liquid petroleum gas, while announcing its intention to phase them out in between three and five years' time. In the interim, these subsidies are borne by the Consolidated Fund of India.

Foreign Direct Investment

The permitted levels of foreign investment in the various stages of oil and gas activities are set out below.

Activity permitted Permitted level of foreign direct investment
Exploration and production
(i) 100% in small fields through competitive bidding;
(ii) Up to 60% for unincorporated joint ventures in medium-sized fields; and
(iii) Up to 51% for incorporated joint ventures in medium-sized fields.
Refining Up to 26% in case of public sector units. The government must hold 26% and the remaining 48% must be held by the public.
Up to 100% for refineries in the private sector.
Pipelines Up to 51%
Infrastructure related to marketing and marketing of petroleum products Up to 74%
Market study and formulation in the oil and gas sector 100%
Investment/financing in the oil and gas sector 100%
Trading and marketing 100%, provided that a minimum of 26% Indian equity is gained over five years (subject to the conditions of the government circular of March 8 2002 including the minimum investment requirement of Rs20 billion).

Petroleum Regulatory Board Bill 2002

Currently, the Petroleum Regulatory Board Bill 2002 is before the Lower House of Parliament, the Lok Sabha. It proposes the establishment of the petroleum regulatory board to regulate the transportation and sale of petroleum and petroleum products (which are defined as including liquefied natural gas) in order to:

  • protect the interests of consumers and entities engaged in specific activities;
  • ensure the uninterrupted and adequate supply of petroleum and petroleum products in all parts of the country;
  • promote competitive markets; and
  • govern connected or incidental matters.

Pursuant to the bill, the board has jurisdiction to decide any dispute or matter arising between parties relating to the refining, processing, storage, transportation, distribution, marketing and sale of petroleum and petroleum products. The board may pass orders and issue directions as it deems fit, or refer such matters for further investigation.

The courts will not have jurisdiction to hear any lawsuit or proceeding in respect of any matter that the board is empowered to determine; nor can the courts grant an injunction in respect of any action taken (or to be taken) in pursuance of any power conferred by or under the bill.

The bill gives the central government express power, in the event of war, natural disaster, strike, industrial unrest, joint action by any group leading to disruption of supply or any other circumstance affecting the public interest, to:

  • assume control or management of any entity;
  • suspend that entity's operations; or
  • entrust control or management of the entity to any agency of the central or state government.

The board exercises regulatory and adjudicatory powers pursuant to the bill. The board also has wide-ranging powers under the bill, including tariff fixation for use of common carrier networks, and authority to award compensation (including consequential damages) to persons affected by any violation of any direction or order issued by it. It is therefore important that the bill incorporates provisions for ensuring that the board, when constituted, is in a position to function as an independent and impartial body.

Comment

For various activities, foreign investment in the petroleum sector remains capped. February 2003 press reports indicated that the Ministerial Group on Foreign Investment has approved 100% foreign investment in exploration, refining and pipeline activities. However, the government has not announced a change in foreign investment limits and existing limits continue to apply. An increase in the limits would be welcome, in order to facilitate greater investment in the domestic oil and gas industry.


For further information on this topic please contact Bahram N Vakil or Manisha More at CZB & Partners by telephone (+91 22 5639 6880) or by fax (+91 22 5639 6888) or by email (bahram.vakil@czbpartners.com or manisha.more@czbpartners.com).



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