ICRA COMMENTS ON POLICY FRAMEWORK ON

REFORMS IN THE UPSTREAM SECTOR

ICRA: E&P reform measures will improve investor

sentiment and are credit positive
1
Page

K. Ravichandran Prashant Vasisht Abhishek Dafria

+91 44 4596 4301 +91 124 4545 322 +91 22 6169 3344
ravichandran@icraindia.com prashant.vasisht@icraindia.com abhishek.dafria@icraindia.com
 On February 15, 2019, the Union Cabinet approved the Policy framework on reforms in Upstream sector for enhancing domestic exploration and production (E&P) of
oil and gas. The objective of the Policy is to attract new investments in the E&P sector, intensification of exploration activities in hitherto unexplored areas and
liberalizing the policy in producing basins. The Cabinet decision was based on the recommendations of a High-powered Committee on Enhancing Domestic Oil and
Gas Exploration. The decision signals a paradigm shift in the core goal of the Government, moving from revenue-maximisation to production-maximisation, with
focus on exploration in untapped areas. The need for policy reforms was felt owing to stagnant/declining domestic production of oil and gas, rise in import
dependence and decline in investments in E&P activities.

The policy reforms focus on the following areas:

1. Increasing exploration activities in unexpected areas: In basins where no commercial production is there (category II and III basins 1), exploration blocks
would be bid out exclusively on the basis of exploration work programme without any revenue or production share to the Government. On successful
discovery, the production and full revenue will accrue to the operator, with Government asking for no share. This is apart from marketing and pricing
freedom, which has been assured in all basins. Only in case there is windfall gain, and annual revenue exceeds USD 2.5 billion, government will take a share
of additional revenue. Royalty and statutory levies, however, will be paid by Contractor.

Impact: The exclusion of revenue or production share with the government in basins where no commercial production is there would increase the potential
upsides for the successful bidders and is expected to incentivize exploration activities in hitherto virgin territories. Accordingly, the policy aims to balance the
risk and returns for areas perceived to have higher risk owing to their uncertain prospectivity. The lone bid criteria of exploration work programme is
designed to ensure a more thorough exploration of such areas.

1
Category-I: Basins with established commercial production; Category-II: Basins with known accumulation of hydrocarbons but no commercial production achieved so far;
Category-III: Basins having hydrocarbon shows that are considered geologically prospective; Category-IV: Basins having uncertain potential which may be prospective by
analogy with similar basins in the world
2
Page
 2. Unallocated/unexplored areas of producing basins: The bidding will continue to be based on revenue sharing basis but more weightage would be given to
work programme. In Category I basins, where potential is established and production is taking place, to give boost to further exploration in unexplored areas
of these basins, the weightage of revenue sharing has been reduced from 50% to 30%. Also, in order to ensure that revenue sharing does not disincentivise
higher production, the maximum revenue sharing has been capped at 50%. The policy also provides for shorter exploration period and fiscal incentive for
commencement of early production.

Impact: For unallocated/unexplored areas of producing basin the increase in weightage given to work programme would drive greater and more thorough
exploration effort in all parts of the block as typically E&P blocks are several hundreds to thousands of square kilometers. Providing an upper ceiling on
biddable revenue share, besides preventing unviable bids, would also ensure higher returns for the operators thereby incentivizing higher production. It is
also designed to maximize the work program as bidders would bid a higher work programme to secure highly prospective blocks thereby leading to a more
intensive exploration program.

2. All basins: The contractor will have full marketing and pricing freedom for crude oil and natural gas to be sold at arm's length basis through transparent and
competitive bidding process. In gas, it is also extended this to those fields whose first Field Development Plan (FDP) is yet to be approved. Fiscal incentive is
also provided on additional gas production from domestic fields over and above normal production. It also gives concession in the royalties in case the oil
fields are brought to production earlier.

Impact: Providing full marketing and pricing freedom for crude oil and natural gas production would boost the viability of blocks where i) gas is the main
produce ii) the geology is challenging (such as offshore or frontier areas) requiring higher capex for exploration and development and is expected to
incentivize production from even difficult areas besides increasing the revenues and returns from other, more benign geologies.

With the goal to increase the mix of natural gas in the overall energy mix, the GoI’s policy provides a push for increasing the production of gas. To this effect,
marketing and pricing freedom has been granted for those new discoveries whose FDP is not yet approved and fiscal incentive provided for additional gas
production over and above the normal production. The domestic pricing of gas has remained below the cost of production for several fields for many years
which coupled with lack of pipeline connectivity has disincentivized development of natural gas fields. Domestic gas prices have been pegged to the prices
prevailing at international hubs through the modified Rangarajan formula, in the absence of a price discovery mechanism owing to the lack of a gas trading
hub. As the international hubs are located in gas abundant areas the domestic gas prices have been low. Providing marketing and pricing freedom to gas
producers would go a long way in increasing the production of gas by incentivizing development of gas discoveries.
3
Page
 4. Production enhancement of NOCs: To enhance production from existing nomination fields of ONGC and OIL, enhanced production profile will be prepared
by both PSUs. For production enhancement, bringing new technology, and capital, NOCs will be allowed to induct private sector partners. The cabinet also
decided to give 66 fields of NOCs to private operators for increasing the production. NOCs will get a share in the increased production apart from getting
what was being produced by them.

Impact: The GoI has attempted to increase the accountability of the NOCs for production enhancements through a structured production performance
assessment and permission to induct new technology and capital through induction of private sector partners. For these 66 fields accounting for about 95%
of the total oil and gas production of the country, the intent of GoI is to maximise recovery of hydrocarbons by choosing field specific implementation
models including JVs.

5. Ease of doing business: Measures will be initiated for promoting ease of doing business through setting up coordination mechanism and simplification of
approval of DGH, alternate dispute resolution mechanism etc.

Impact: The GoI is also initiating measures for simplification of approvals by DGH and settlement of disputes which remain the two most contentious issues
facing the Upstream sector.

In summary the policy framework aims to make the fiscal and approval regimes more attractive for both FDI and domestic investments, thereby incentivizing
E&P investments and higher production. Overall, ICRA believes the reform measures are credit positive for the sector, which should lead to improved
profitability for the incumbents and make exploration more attractive.
4
Page
Page
5
Page
6