Barometer Rising

• Solicitor-General’s report indicates scope for GOI to initiate arbitration proceedings against Reliance.
• Law ministry keen that petroleum ministry discuss all the options, implications with law advisor
• Law ministry says administrative ministry is to take final call on action
• GOI is cautious; petroleum ministry will have to stick its neck out

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The petroleum ministry finds itself in an uneasy state of suspended animation. Months after it sought the law ministry’s opinion for taking legal action against Reliance Industries—for its failure to deliver the promised quantum of gas despite a several-fold increase in capital expenditure in its D6 Block in the deep-sea Krishna Godavari basin—the ball has been neatly lobbed back in its court. “The petroleum ministry will have to take a final decision and call,” Salman Khurshid, the minister of law and justice, told Outlook.

That’s awkward for the petroleum ministry, which is looking for a stronger signal to build a case against Reliance, particularly after the Comptroller and Auditor General of India (CAG) held the ministry and the regulator Directorate General of Hydrocarbon responsible for lapses in the monitoring of the exploration and production activities. “We are keen that whatever maximum permissible (action) should be taken. We are awaiting official indication from the law ministry and the solicitor-general,” said senior petroleum ministry sources.

The problem is that given the wider implications of taking legal action against a top-bracket private operator—in a newly opened field at that, and hence with no precedence—the law ministry seems to be proceeding cautiously.

While Reliance has refuted CAG charges of not following transparent policies on expenditure, petroleum ministry officials admit there is no getting away from a huge drop in gas production from the D6 block. Then, against Reliance’s investment of $5.69 billion in the block till March end, the company has recovered $5.26 billion. The government’s share of profit petroleum (after recovery of capital expenditure) will grow only after Reliance recovers its investment.

Curiously, while media reports have referred to solicitor-general Rohinton F. Nariman’s note to the law ministry in mid-August, petroleum ministry sources claim, “We’ve not been given the opinion officially. It is still with the law ministry”. Khurshid clarifies that the delay was in part due to the earlier solicitor-general, Gopal Subramaniam, demitting office in July before he could complete his report. “The present solicitor-general has given the opinion that there is scope for arbitration in the production-sharing contract (PSC),” says Khurshid.

To the queries put up by the petroleum ministry, Nariman states that the government of India has a case to stop the contractor (Reliance and Niko) from recovering expenditure incurred, which has “resulted in excess capacity/under-utilisation of assets created”. The solicitor-general also states that there is a case for reversing the cost entitlement the contractor has already recovered despite not being entitled to under the PSC.

The law minister explains these official views have not so far been formally communicated to Jaipal Reddy’s ministry as “in the present assessment of the exploration policy we don’t know what they (the petroleum ministry) would like to do.... Arbitration is a halfway house...there is provision for imposing penalty and even cancellation of contract under the PSC... but have legal consequences.” The law ministry says senior petroleum ministry officials could interact with their legal advisors to understand the issues.

Meanwhile, reacting to media reports with “consternation”, Reliance has written to the petroleum ministry, questioning its proposal to link cost recovery to production. It warned this would trigger “unnecessary disputes between the contractor and the government, leading to needless arbitration proceedings”. When contacted, Reliance declined comment.

Mukesh Ambani A worried Reliance has warned against “unnecessary disputes”. (Photograph by Sanjay Rawat)

Experts say while the PSC is modelled on global practices, it isn’t totally appropriate for Indian conditions, particularly when safeguards are diluted (as in case of Reliance). Energy expert T.N.R. Rao says the blame lies with the government for “removal of the expenditure ceiling, without approval of the management committee, beyond certain limits.”

Under the PSC provisions, both parties—the government and the contractor—can initiate action. The first recourse for dispute resolution is through discussion. If there is no resolution in 90 days, they can refer the matter for arbitration under the Arbitration and Conciliation Act 1996, which provides for both the parties to appoint their arbitrator and the two in turn to appoint a third arbitrator. The verdict, expected in four months, is based on the majority view and is binding on both parties.

Given governance lapses by both the petroleum ministry and the dgh, sources reveal that CAG is having “second thoughts” about a further audit of the four exploration blocks (including D6) and another 20 exploration blocks. The CAG is not keen to take the place of corporate auditors, who have to report annually to the government. As CAG reports are placed in the legislature, and not given to the ministry, action can be delayed.

The fact that CAG did not quantify the loss helped Reliance ride the gold-plating charges (showing higher costs to bring down government revenue) without adverse market reaction. J. Thunuguntla of smc Global Securities feels “a legal battle will be very negative for the company” (RIL’s share valuation has fallen from Rs 1,124.9 two years back to Rs 787).

Will the government take recourse to legal action? The desire to woo investments—and the need to emit “right signals”—has seen governments turn a blind eye to malpractices. A possible indication of the political thinking comes when law minister Khurshid points out that while the PSC does provide for arbitration, “it must be clear that the interpretation should not upset the applecart.”