Wednesday, November 18, 2015

The search for the optimal PSC

In a departure from existing investment recovery model of production sharing contracts (PSCs) in oil and gas blocks allotted for exploration, India's Ministry of Petroleum and Natural Gas now proposes to adopt the revenue sharing model in all their future PSCs. The “bidders will bid the percentage of revenue that they will share with the government against two revenue scenarios—when revenue is less than or equal to lower revenue point or when revenue is more than or equal to the higher revenue point”. It also proposes to permit them to price and market gas as well as bid for areas/blocks of their choice (open acreage licensing).

In the former, the explorer recovers the entire capital investment before revenues or profits are shared, whereas in the latter, the revenue/profit sharing starts as soon as the production begins. Accordingly, while the investments risks are mitigated in the back-loaded sharing model, the latter transfers all the risks to the explorer and leaves the government as a rent seeker. The former runs into problems of valuation of investments made, with explorers incentivized to gold-plate their investments, while the latter is far simpler to monitor and suits a risk-averse bureaucracy.

I have blogged earlier on India's most famous gas pricing controversy, challenges of PSCs, and the dilemma for governments between maximizing auction revenues and allowing commercial viability. While the decision for the most appropriate type of PSCs is a difficult one to make, I have written in favor of a more nuanced approach, with a slight preference for a hybrid capital investment recovery model. The preference was also motivated by the fact that India does not have large oil reserves and is almost completely dependent on oil and gas imports, thereby making any new production a bonus.

My concern with the revenue sharing model is more fundamental. Given the risks involved with deepwater oil exploration, especially in an area not known for rich deposits, India needs to attract the major international oil exploration firms with the expertise and technology required to prospect efficiently. But a PSC where all the risks vests with explorers and the government is a passive rent-seeker may discourage the major firms, especially at a time of low international oil prices with not-so-promising medium term prospects. 

The major exploration firms will find the proposed structure attractive only if the technical and political risks are low enough and commercial attractions large enough. The PSC structure may be one militating factor too many.  

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