Corporate Dec 8, 2012
By Kartikeya Tanna
Last week, Tehelka magazine carried a piece on what it calls a "shady deal" and a "scandalous contract" between the Narendra Modi government and a Barbados company. This was followed by the Congress party raising questions both in and outside Parliament. What caught everyone's attention, however, was Arvind Kejriwal's regurgitation of this "scam" and his rather alarming conclusion that it was even bigger than the 2G spectrum scam. At the centre in the Gujarat State Petroleum Corporation (GSPC).
In the atmosphere that India finds itself in recently, any government dealing which does not quite fit within one's worldview is peddled as a humongous scam.
Due to the numerous facts that need to be put forth, this counter may be wordy, but necessary. But a disclosure is in order here. This writer, a partner at Tanna Associates Advocates, Ahmedabad, is representing GSPC and the Gujarat government before the Justice MB Shah Commission of Inquiry. The Commission is inquiring into, inter alia, allegations against GSPC.
First and foremost, the contract with the Barbados company was entered into by GSPC. While GSPC is a Gujarat government-owned company, it has a board of directors enjoying sufficient autonomy in business related matters. Business decisions taken by GSPC, in that sense, are not akin to decisions taken by a government department in regular course.
At the heart of the accusations lies the fact that a 10 percent participating interest in the Krishna-Godavari basin block GSPC won in the NELP (New Exploration and Licensing Policy) bid, potentially worth millions of dollars, was gifted away to a company that had capital value of merely $64. According to GSPC, the company, GeoGlobal Resources Inc. (GGR), was given that interest in lieu of its technical and geological expertise for gas exploration. The Tehelka piece, however, quotes GGR's disclosure before the US authorities which states that it had no exploration experience before venturing into India.
So, what is this company? How did it land such a lucrative deal with a state-owned oil and gas company?
At this point, it will be useful to go back briefly to the early 1990s when India opened up the hydrocarbon sector. GSPC started its exploration and production business (E&P) around that time by participating in the government of India (GOI) bids for development of oil/gas fields. GSPC was originally a petrochemical company. Therefore, to venture into the E&P business, it had to rely on other experts in the sector.
To develop five small discovered oil/gasfields which it was awarded by the Union government in 1993-1994, it inducted a Canadian company Niko Resources Ltd. Niko was offered participating interest in the range of 33-40 percent. While it can reasonably be believed that this business decision was taken independently by GSPC, it is interesting to note that a Congress government was in power at that time.
Niko brought in technical expertise and the latest technologies at that time which resulted in the Hazira gasfield becoming a major field. Much beyond the initial estimate of 50 million cubic metres, Hazira actually produced 30 billion cubic meters, almost 600 times!
Why is Niko's relationship with GSPC important? Niko's geophysical expert was Jean Paul Roy who was instrumental in the Hazira success. Roy also worked with Reliance Industries Ltd for some time.
When the government announced the NELP-III bid round for acquiring fields for exploration and production, GSPC unsuccessfully contacted several E&P companies, including ONGC, to partner with it. Most E&P companies had been captured by other giant players in the bidding process. It is important to understand here that NELP-III bid rounds were invitations for exploration and not development. Those having some knowledge of the oil and gas sector shall appreciate the sheer magnitude of risk involved at the exploration stage.
To ask in hindsight why GSPC did not select its partners by way of a bid is to ignore the realities of how little interest the exploration business with GSPC generated back then. Auction is not a sine qua non to be followed in every situation, even if there is scant interest in what one is offering.
(In contrast, GSPC has invited bids when its projects have entered the development stage which has many takers.)
Not wanting to let go of the huge potential that the Krishna Godavari (KG) basin had, GSPC contacted its old associate from Niko, Jean Paul Roy, to explore the possibility of engaging with him to review the potential of blocks offered by the government. Around that time, Roy set up his own company, GeoGlobal Resources Inc, to offer his technical expertise and intellectual property rights he owned.
What Tehelka has focused on to arrive at a sensational conclusion is the $64 net worth of GGR at the time it entered into a deal with GSPC. It is true that the company was new and recently incorporated, but the individual running it was an expert with almost a decade of experience with GSPC, particularly in the Hazira gasfield. Moreover, he had also worked with Reliance which initially discovered natural gas reserves in the KG Basin.
In his negotiations with GSPC, Roy agreed to provide expertise and IPR only if GSPC offered him some participating interest (if GSPC won the block). GSPC was in a hurry with the NELP-III bidding deadline approaching fast and it receiving scant interest from potential partners.
At this stage, a legitimate question arises. Experts providing valuable technical input and bringing their intellectual property rights to the table usually command a 2-3 percent interest, if not a flat fee. Why give GGR a 10 percent stake in production sharing which would be worth millions of dollars?
The answer is simple - under the bidding policy of the government of India for the NELP-III Bid Round, no entity was allowed to participate in a consortium for less than a 10 percent share.
Tehelka also concludes that because GGR assigned 5 percent participating interest to the Roy Group (Mauritius) Inc, a company fully controlled by Roy himself, it raises serious questions about the "mala fide of the entire deal". While such a transaction, a legally permissible one commonly made by non-operators for efficient risk-allocation, was between GGR and Roy Group, GSPC only had to concern itself with GGR's obligations under the agreements they entered into. Where exactly is the mala fide, or even a hint of it?
Where exactly is the mala fide, or even a hint of it?
Each entity holding a 10 percent interest would also be responsible for an equal share towards the costs of exploration. In the extremely risky oil and gas sector, many companies try to dilute their risk by roping in partners who can bear costs to the extent of their interest.
However, GGR and Roy had no financial capacity to contribute towards 10 percent of the exploration costs. And, yet, Roy's expertise and IPR contribution was vital. GSPC and GGR, therefore, entered into a 'Carried Interest Agreement' whereby GSPC would 'carry' GGR for (in other words, bear the burden of) its 10 percent share towards the exploration costs in lieu of which Roy was to provide continuous technical support for exploration. More crucially, GGR would not earn any revenues from monetisation of the natural gas until (a) all priority payments/disbursements were made, including royalty to government; and (b) GSPC was reimbursed all costs it paid on GGR's behalf.
The Carried Interest Agreement protected the interests of both GSPC and GGR. Jubilant Enpro P Ltd. was also inducted into the consortium as a 10 percent partner.
What Tehelka and Kejriwal focus on is that this company, worth $64 at that time, would potentially earn thousands of crores without sharing even a dime towards exploration costs. What GSPC, as a company desirous of securing the KG block bid, focused on at that time was the choice between the 80 percent it would earn with technical expertise from GGR and letting go of that potentially lucrative 80 percent share.
So, what went wrong? Due to the changes in technology, the interpretation of the 3D seismic data indicated that GSPC could explore deeper rock formation (of the Cretaceous age) which had earlier never been explored on the eastern coast of India. As drilling activity progressed, the initial estimates drastically shot up. High oil prices were also a contributing factor.
Due to the increase in costs, GSPC demanded GGR to pay its share of 10 percent of the costs incurred in excess of the initial estimate. GSPC also asked GGR to pay interest on that amount. This led to a dispute between GSPC and GGR as to the terms and import of the Carried Interest Agreement.
Several attempts at negotiation failed. Since GGR refused to accede to GSPC's demands, GSPC took a decision in 2010, admittedly a courageous one, to terminate the Carried Interest Agreement. It also sent a letter to the government of India asking for an amendment in the production sharing contract, i.e., to cancel the 10 percent participating interest held by GGR and increase GSPC's share to 90 percent. GSPC also informed GGR that its participating interest has been forfeited. As of today, GGR has no interest in the KG block.
The Tehelka piece also arrived at the conclusion that GGR's share towards these exploded costs is being funded by us taxpayers. That is far from the truth. In fact, GSPC has relied on its own internal reserves and surplus, credit line and borrowings.
GSPC's venture into the KG basin has not been without its problems. Hindsight may indicate that perhaps GSPC should have done things differently. It is important, however, to reflect on whether GSPC's decisions were reckless with these basic questions:
Could GSPC have insisted that GGR get a flat fee for its services? Theoretically, yes. But the market realities at that time and the fast approaching deadline were factors that guided the decision to agree to some kind of participating interest. Moreover, GSPC had to agree to a minimum of 10 percent due to the government's bidding policy.
Could GSPC have known that Jean Paul Roy's estimates would need significant revision? Indeed, if it had, it would have taken corrective measures right then. The truth is that the KG Basin has not been a smooth ride for anyone. Even giants such as Reliance and ONGC have faced serious problems with their exploration activities.
Did GGR have an incentive to be reckless with its estimates because it did not have to worry about paying a dime towards costs? Logically, the answer has to be no. It must be repeated here that GGR was not entitled to a single dime until (a) the gas discovered was monetised; (b) mandatory payments/disbursements including royalties were made; and (c) GSPC reimbursed itself of GGR's 10 percent liability out of the revenues. If GGR would get paid only if the project is successful, why would it be reckless?
Would GGR have a greater incentive to cautiously estimate had it been given a flat fee? The answer is, no. A flat fee means you have no real interest tied in the project for it to be successful. This is not to say that, because GGR was getting paid anyways, it would not have bothered to double check the veracity of its findings and estimates. The simple point is that GGR would not have any greater incentive to estimate more accurately had it been given a flat fee.
Yes, the entire process did have a lapses. For example, the agreements could have been drafted more tightly leaving no scope for a lingering dispute on interpretation. But, it is fairly obvious that GSPC did not hand over a sweet deal to GGR without thinking it through and without an honest appreciation of the circumstances prevalent at that time.
In rushing with delicious allegations and insinuations, however, Tehelka and Kejriwal have jumped several deductive dots without thinking it through.
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