Ambani gas battle: The inside story

It isn’t too often that the Ruias of the Essar Group—or any Indian business house for that matter—are able to steal a march on the Ambanis. Reliance Industries Ltd (RIL) and Essar have been head-on competitors since the nineties, with the Ruias present in most sectors that the brothers Ambanis are operating in—right from refining and oil marketing (RIL) to telecom and power, which is Anil Ambani’s turf since the brothers split four years ago. Oil & gas exploration is also an area common to both conglomerates, although Reliance’s operations are way ahead in terms of size and scale. Now how’s this for irony: the Ruias are ahead of Reliance in the queue for receiving gas—gas that has been explored and produced by RIL itself!

If you’re wondering how on earth that is possible, it’s pretty simple: Whilst RIL is free to market the natural gas it produces—it is producing 31 million metric standard cubic metres per day (mmscmd), which is expected to hit a peak of 80 mmscmd—it’s up to the government to decide which sector gets the gas first. So according to the gas utilisation policy, existing fertiliser units should get first priority, then the LPG and petrochem industries, then power, then city gas—and it’s after all those sectors that refining, which is one of RIL’s core operations— gets a look-in. Essar Steel, along with a couple of other steel producers, has been allocated the gas that was reserved for the city gas sector, which hasn’t been able to pick up its entire allocation. Reliance, meantime, will have to wait some more time to fire up its refineries with the gas that it has explored and produced.

Indeed, the government’s gas allocation policy has plenty to do with the battle royal that involves Mukesh and Anil Ambani and the government. According to a production sharing agreement (PSC) signed between the government and RIL, the gas produced from the KG D-6 fields has to be utilised in accordance with the utilisation policy. And it’s this policy that’s working against the interests of Anil’s RNRL, which has no power units operational, and hence can’t be privy to gas. RNRL has two gas-based power projects on the drawing board—a 7,480 MW unit in Dadri in UP, and a 2,800 MW plant at Shahpur in Maharashtra.

But as Minister for Petroleum Murli Deora said in Parliament as BT was going to press: “This (Dadri power plant) is neither installed nor functional.” The government also says that if they have to give gas to a still-on-the-drawingboard plant why only to Anil’s? Why not to NTPC or some other corporate? The upshot: RNRL can’t get gas, and shouldn’t be hankering for it. Anil rubbishes this claim and says that the government had agreed to supply gas to Dadri. He adds that the fact that RIL has not been able to sign a “bankable gas supply contract” has only resulted in the Dadri project—and other power projects—getting delayed. Anil hopes to get the first phase of his gas-based power projects up and running 30 months after securing supply.

So whose gas is it anyway; what should it be priced at; how much of it should be supplied; and for how long— these are the questions on which hinge sizeable fortunes of the two warring Ambani brothers, as well as the government. At stake are billions of dollars. Just two of the gas fields Dhirubhai 1 and Dhirubhai 3—of RIL’s 18 in the KG Basin D6 block—have the potential to yield revenues of just under $40 billion (Rs 1,92,000 crore) over their lifespan (in a best-case scenario).

Such wealth is conditional on one crucial dynamic: Price. The two prices being, well, haggled, over are $2.34 (Rs 112.32) per mmbtu (million metric British thermal unit), at which Anil wants to buy 28 mmscmd over 17 years; RIL wants to sell at $4.2 (Rs 201.6) per mmbtu subject to revision after five years. The difference of just under two dollars in the respective prices being demanded can result in profits or losses that run into billions of dollars.

Anil, for instance, feels that if he has to buy gas at $4.2 per mmbtu, his company Reliance Natural Resources Ltd (RNRL)—set up to supply gas to his proposed power units—will lose a cool $1 billion (Rs 4,800 crore) over 17 years. What’s more, he alleges that RIL is attempting to make “super-normal” profits of over Rs 50,000 crore by pricing its gas at $4.20. The Mukesh camp, for its part, reckons RIL will incur a loss of $5 billion (Rs 24,000 crore) at peak production of 80 mmscmd from Dhirubhai 1 and Dhirubhai 3 if the government approves a price of $4.2 but RIL has to sell at $2.34—which is the case being made by the Anil camp.

For the moment, it’s advantage Anil, what with a division bench of the Bombay High Court, in a June 9 order, upholding the price of $2.34. Analysts point out that this is akin to a cash transfer to Anil Ambani, and could impact RIL’s net present value (NPV) by as much as $3.6-4 billion (Rs 17,280-Rs 19,200 crore). RIL, of course, isn’t happy and has approached the Supreme Court in the hope of a different interpretation. Anil was the first to approach the apex court on the grounds that RIL has—as per the High Court’s verdict—failed to file an agreement with regard to gas supply to RNRL; RIL says it can’t do so without government approval (on price, tenure and quantity).

Anil also feels that the High Court should have asked RIL to supply gas as per the terms of the supply to NTPC instead of asking it to negotiate an agreement with RIL again. Also approaching the SC is the government, which has been shaken from its slumber after the High Court order, which has significant implications on the government’s rights to formulate and implement the gas utilisation policy and on the production sharing contract (PSC).

Being a somewhat silent witness to the fight, the government has suddenly swung into action, dusting off its PSC, quoting gas supply policy and challenging a mid-2005 memorandum of understanding (MoU) between the brothers in the Supreme Court on July 18. What’s got the government’s goat is that the MoU—signed in the presence of the Ambanis’ mother Kokilaben—also has the option of entitling Anil to 40 per cent of all future Reliance gas (albeit at market prices).

The petroleum ministry’s beef is that the brothers are fighting over something that doesn’t belong to them. Anil counters that the price of $2.34 is not part of family arrangement but one that is included in an agreement approved by RIL’s board. RIL contends that neither its board nor the shareholders know of the MoU and so are not bound by it. That the court has lent legitimacy to the family MoU has clearly rattled the government, which is dead against the option of a sharing arrangement of the gas (not just from KG D-6 fields but also from other fields to be explored and operated by RIL) in a ratio of 60:40 (with RNRL getting 40) as proposed in the MoU.

It’s at this point that the battle takes a fascinating and conspiratorial twist with the RNRL camp suggesting that the bogey of sovereign ownership is being raised with the sole purpose of “bailing out RIL and helping them renege on their contractual commitments”. The crux of this accusation lies in the apparent leeway that RIL was given to jack up, via a process of ‘price discovery,’ the price from $2.34 to $4.20. Government officials point out the price was approved by the EGoM (empowered group of ministers).

Anil has claimed that the cost of production of gas in the KG Basin is $1.41, and at $4.20, it is working on a huge profit margin. He says that “it would be against public interest to price gas in India for any user above $1.5 (Rs 72),” and that India has the highest short-term gas prices in the world.

The ADAG camp points out that the $4.20 price has been determined by the government for the purpose of determining its own “take” as part of the PSC. RIL, it says, is free to sell gas at a price that’s lower. RIL officials counter that such an arrangement—of one government-approved price (of $4.2) and another of selling price ($2.3)—will be disastrous as its return on capital would hurtle into negative territory. Worse, this will scare away investors from future exploration of gas in India.

Interestingly, RIL says it will have a positive return on capital (of 5 per cent) in case both prices are set at $2.34, but that’s an unlikely eventuality. Also, freedom to price lower that $2.34 will also mean freedom to price higher than $4.2. What happens to the government approval for pricing and allocation? Already there are a clutch of gas-based power producers who are buying gas at $4.2— 18 mmscmd in all—and who have complained of competitive disadvantage if any other producer is given power at a lower rate than what they have been asked to pay.

Meantime, Anil has also accused his brother of “goldplating costs,” what with capital expenditure going up by Rs 25,000 crore to Rs 45,000 crore when production was doubled to 80 mmscmd. The capex, feels Anil, shouldn’t have gone beyond Rs 20,000 crore (from Rs 12,000 crore for 40 mmscmd). RIL officials dismiss such allegations. They point out that since 2003-2004 (when the initial development plan was blueprinted), over the next 3-4 years costs of drilling, hardware, people and equipment shot up between two and four times.

Also, they point out that although production estimates doubled, capex didn’t. “The fastest deep-water development record (from discovery to production) is six years in Egypt. We did the same in the KG Basin in 6.5 years, with much worse weather, no preexisting infrastructure or services. CERA (Cambridge Energy Research Associates)—the global standard in monitoring cost efficiency—has rated RIL as one of the top 100 projects on cost management,” points out a senior RIL official.

To be sure, RIL’s fixation with costs is legendary. But then along with low costs, RIL seems to have been also obsessed with low prices (of gas). That brings us to the crucial (starting) point of how the $2.34 price was arrived at in the first place. Cut to 2003-04: The state-owned NTPC embarks on a two-stage international competitive bid process for supply of 12 mmscmd of natural gas to fire its Kawas and Gandhar power stations (in Gujarat). RIL emerges as the sole bidder with its $2.34 bid—which went on to become the only available benchmark for long-term contracts in power generation.

Unfortunately the letter of intent didn’t translate into a gas sale & purchase agreement (GSPA) as NTPC went to court in 2005 around a clause relating to unlimited liability. The matter is still in the courts. The government is yet to approve of the $2.34 price for NTPC, too. In fact, petroleum ministry officials are believed to have reprimanded RIL for offering its gas in this manner (to the lowest bidder). The ministry would have liked RIL to instead have signed up with the highest bidder. That would have been a “competitive arms length sale,” which was mandated in the PSC the government signed with RIL in April 2000.

RNRL’s contention is that since the RIL-NTPC dispute has nothing to do with price, $2.34 should hold good. Yet, what’s significant is that this price—as well as the announcement of the Dadri project—took place before the brothers carved out the Reliance pie. Analysts point out that the group, then under the Chairmanship of Mukesh with Anil as his (trusted?) lieutenant, would have been keen to set a low benchmark price of gas in a bid to fuel its power ambitions with low-priced gas (although the other view is that when the NTPC price was fixed, gas was prized around that level globally). Perhaps Mukesh never dreamt that a day would arrive when he would have to part with some group assets, thereby disturbing the well-integrated chain that the Ambanis had built.

After the settlement with Anil, Mukesh’s trump card of low-priced gas is turning out to be his Achilles’ heel. That Mukesh virtually blindly signed on a MoU that seems loaded against him doesn’t help his case either, and lends some credibility to the $2.34 number. The High Court saw virtue in that price. Will the Supreme Court follow the same line of thinking? There’s no clear-cut solution in sight — which is perhaps a natural consequence of a family dispute turning into a corporate battle and further snowballing into a fight to protect a national asset.

Whose gas is it anyway?
The MoU between the two brothers on June 18, 2005 entitles REL to 28 mmscd of gas from the KG Basin. Additionally, in case the contract between RIL and NTPC for 12 mmscd doesn’t materialise, the MoU also provides for the Anil Ambani Group to get the NTPC entitlement as well, taking the total entitlement to 40 mmscd.

“Thereafter, for the entire future the balance reserves (including new discoveries of gas from new explorations and/or bids as may be submitted from time to time), the quantity of gas would, at the option of the Anil Ambani Group (exercised from time to time), be split in the ratio of 60:40 with 60% to the Mukesh Ambani Group and 40 per cent to the Anil Ambani Group.” (The same MoU)

“Whether the respondents by a privately-negotiated MoU, the full content of which has not been made public till today, deal with the allocation and use of natural gas, which is a valuable and scarce commodity and a national asset belonging to the Union of India? Whether in a private settlement, the property of the Union of India can be appropriated and used as the respondents’ (RIL’s) private property...” Government’s Special Leave Petition to the Supreme Court filed on July 18, 2007

Mukesh Ambani’s commitment of 40% of all future gas finds to Anil Ambani’s companies has raised the hackles of the government. Article 297 of the Constitution of India lists petroleum as a resource, which the Union of India has an authority over. Article 6 of the PSC states that the resources will be discovered and explored in the interests of India. Here, for crude, the contractor has full freedom. But for gas, the government’s utilisation policy and pricing policy—both given out by the EGOM—are the curtailing clauses. The affidavits submitted by the government in the Bombay High Court included the PSC.

The mother’s role
The MoU signed between the brothers on June 18, 2005 says: “Kokilaben recognises that a long-term, stable source of gas from RIL, which has the largest find of gas, was absolutely essential for the growth plans of the Anil Ambani Group, and in order to enable Anil to carry REL to even greater heights. Kokilaben has, therefore, specially stressed and impressed upon Mukesh (that he) shall personally ensure that at the time of finalisation of the binding gas supply agreement the terms provide the required comfort and stability in these agreements, even if that means some departure from the NTPC standard.”

In April 2006, Kokilaben gave her “final direction” on the MoU which stated that “there are two types of issues pending...those in the personal domain and those that are in the corporate domain.... I will not give any decision or direction on matters which are in the corporate domain since they are public listed companies.” This is from a letter that is believed to be in the possession of both the brothers. Both RIL and RNRL are listed companies and this is perhaps the reason why the mother isn’t intervening.

Going by the public statements made so far, the Anil Ambani’s side seems keener to seek the mother’s intervention than Mukesh Ambani. Perhaps, because, as the MoU states, she had made a special mention for completion of a bankable gas supply agreement during the process of division of the business. But going by her April 2006 letter, she seems reluctant to intervene in any matter that involves listed companies.

Several versions on pricing
RIL: The government’s approval is needed for the gas sale price. A lower gas sale price implies a subsidy from Reliance and loss to the government.

RNRL: The government approval is only needed for the price for calculating royalty, profit share and income tax. The contractor (Reliance) is free to sell to anyone at a lower price. For example, it’s possible to have one price for sale and another price for valuation of government’s share in profits.

Government Version-I: Under the Production-Sharing Contract, government had said that the contractor is free to sell gas at “arm’s length prices”, the government will approve prices prior to the sale of gas.

Government Version-II: The report on gas pricing stated that price should be market-determined, that government intervention is required if no arm’s length price can be obtained, the contractor is free to sell to anyone at a price lower than the government-approved price and how the resultant under-recovery would be shared is a subject matter of mutual discussion between the seller and buyer.

Government Version-III: In its affidavit, the government says that it has an explicit role in approving sale prices and gas cannot be sold at a price that’s different from that used for its valuation.

Bombay High Court (Sept. 2007): …The respondents (RIL) cannot be directed to sell or supply gas at subsidised rate and to incur losses. The effect of MOU, therefore, needs to be interpreted to mean that the applicant is entitled to the share and supply of gas at a reasonable price, quantity and tenure provided both the parties agreed to the suitable arrangement.

Bombay High Court (Sept.-2007): RIL and RNRL to adhere to the exact contents of the MoU of June 2005, which specified price of $2.34/mmbtu for 17 years.

For now the focus of argument has shifted to the validity of the entire gas-supply agreement in the MoU signed between the brothers. But the issue of pricing remains the key and its resolution can’t be postponed, no matter how many new aspects are looked into.
Source: CLSA Report and BT Research

The NTPC-bid saga: Root of the current dispute
NTPC was to be RIL’s first gas buyer. RIL won the bid to supply gas to NTPC at $2.34/mmbtu in 2003—six years before the company began gas production. But despite being the chosen bidder—RIL says it was the “preferred” bidder and was never really awarded the bid—the two companies never reached a gas-supply agreement because of dispute over sharing of liabilities. The matter has been in court since 2005.

When the NTPC bid was made there was no Mukesh Ambani versus Anil Ambani. The idea behind bidding low could have been to get a prestigious customer like NTPC, which would have helped in raising funds for capital expenditure. Besides, the then-unified RIL would have wanted to benefit from cheap gas and cheap power to become a dominant player in everything from well-heads (gas) to wall sockets (electricity supply). The division between the brothers undid the plan.

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$1.41 or $2.34 or $4.2? Decoding the price

Who wins, who loses? After scurrying through reams of documents and tonnes of numbers, what seems evident is that RIL is in the sweetest spot if gas prices are at $4.2 per mmbtu. But if—as Anil wants—the government-approved price is $4.2 and selling price is $2.3, RIL could lose big time. The Anil camp, though, thinks that even at a gas price of $2.34, RIL will be working at chunky profit margins. And for the government, it’s a straightforward correlation—the higher the income from gas sales, the more it gains.

DID YOU KNOW

The many avatars of RNRL

• March 24, 2000: Was called Reliance Platforms Communications.Com
• Jan. 3, 2003: Renamed Reliance Energy
• Jan. 16, 2003: Became Reliance Wattage
• July 25, 2005: The status of the company changed to Public Ltd.
• August 10, 2005: Became Global Fuel Management Services Limited
• Jan 9, 2006: Reliance Natural Resources Ltd. (RNRL)

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What’s RGTIL?

• Stands for: Reliance Gas Transportation Infrastructure, a wholly-owned subsidiary of RIL
• Earlier known as: Gas Transportation & Infrastructure Co Ltd. (GTICL), which got approval for setting up a pipeline in August 2004
• Pipeline capacity: 120 mmscmd
• Initial investment: Rs 30,000 crore
• Current pipeline tariff: $1.25 per mmbtu (or 30 per cent of well-head cost of gas)
• Budget bonanza: Pipeline sector gets 100 per cent benefit in first year itself!

And all about the gas utilisation policy

Order of sector-wise priority, reasons for priority

• Fertiliser: Ideal feedstock for urea production
• LPG and Petrochem: Need to boost domestic LPG production to reduce imports
• Power plants: All sources of energy, included coal and gas, need to be harnessed to achieve 8-10% growth
• City Gas: Vital necessity for urban dwellers
• Refineries: Currently using costly alternatives like crude/fuel oil for processing and burning naphtha
• Other Industries: Sponge iron, ceramic units

The possible solutions
Though a quick end to dispute isn’t likely, the final solution could be any of these.

• It’s Mukesh who committed to the MoU that now binds him to supply gas at the price and quantity Anil wants. Since by Mukesh’s own admission his company or the government were not part or privy to the MoU, it is he or RIL who should compensate the government for loss of revenue from the supply of gas to Anil at $2.34/mmbtu. Downside: Power companies currently buying gas at $4.2/mmbtu could contest differential pricing as anti-competitive.
• RNRL gives up its demand for $2.34/mmbtu price, but continues to have claims on 28 mmscd gas share from KGD6 as well as 40% share in future gas discoveries by RIL. Downside: Having been unwillingly drawn into the brothers’ feud, the government’s strongest attack is going to be on Anil’s claim on future discoveries. Softening that stance won’t be easy or quick.
• Allow complete freedom to RIL to price gas and repeal the system of government approval of gas pricing formula. Caveat: RIL could continue to supply gas to RNRL—or even NTPC—at $2.34 mmbtu, but its pricing could go much higher than $4.2 to some buyers just as it could supply gas to itself at less than $2. Will that be fair?
• The Supreme Court could annul the provisions of the MoU that deal with gas sharing and supply. The court could also ask RIL to compensate RNRL for non-supply of gas at $2.34/mmbtu, but at a formula that doesn’t hurt RIL too much. Downside: RNRL becomes a shell company and ADA group’s new gas-based plants (Dadri and Shahpur) face delays and or uncertainty.