If, as Petroleum Minister S Jaipal Reddy said yesterday, in two or three weeks, the Cairn-Vedanta deal comes up before the Cabinet committee on economic affairs, a particular clause in the production sharing contract (PSC) between the government, Cairn and ONGC may well be at the centre of discussions.
This clause in the contract says royalty is to be borne by the licensee. The royalty issue is the last stumbling block to clearance of the $9.6-billion deal, which has been hanging fire for six months. ONGC has consistently claimed that royalty payments for the Rajasthan oilfields are cost recoverable.
In simple terms, it means the levy can be deemed an expense that is compensated before profits are calculated. In other words, whatever royalty ONGC has to bear will be recovered from the profits of the project.
ONGC has even cited Clause 3.1.9 in the accounting procedure of the PSC to argue that both Cairn and the government must share the state-owned oil firm’s royalty payouts. But part sharing the royalty burden would impact valuations, as it would lead to a $ 1.8-billion revenue hit for Cairn. It would also mean a similar $2.6-billion hit in the government’s share of profit.
This issue may actually prove a deal breaker between Cairn and Vedanta.
But the same PSC also has an article that some legal experts say is the governing provision on the subject. Article 16.4(a) of the PSC, under the head ‘Taxes, Royalties, Rentals, etc’ states: “The company shall not be liable to the government or a state government for payment of... royalty, annual area rental charges or license fees under the rules, as amended, the cost of which shall be borne by the licensee.”
The question is, in case of a dispute, which of the two clauses will be decisive? The PSC also answers that.
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Article 34.5 – under the head ‘Entire Agreement, Amendments, Waiver and Miscellaneous’ — goes on to say: “In the event of any conflict between any provisions in the main body of this contract and any provision in the appendices, the provision in the main body shall prevail.”
“Article 16.4(a) has specific provisions and that’s the governing provision on royalty. So, specific provisions will govern over general provisions of Clause 3.1.9. Article 16.4 deals with royalty, which is not a tax, while Clause 3.1.9 only deals with tax and is general in nature,” said a Mumbai-based lawyer on condition of anonymity.
Both ONGC and Cairn did not want to comment on the matter. But one source following the development said, “ONGC does not see this as a dispute, as the provisions of the PSC are amply clear. However, since their financial implications are large, there appears to be hesitation with the other party to accept the fact.”
The source goes on to say that Section 3.1. 9 of the accounting procedure in the PSC provides for the following, inter-alia, to be cost recoverable: “Any duties, levies, fees, charges and any other assessments levied by the government, any state government, any government agency or taxing authority in connection with the contractor’s activities under the contract and paid directly by the contractor, except corporate income tax payable by the constituents of the contractor.”
However, a former official of the directorate-general of hydrocarbons (DGH), the regulator for the upstream oil & gas sector, said ONGC is obfuscating the entire issue. "The issue is between the government and ONGC. When the PSC was signed, ONGC was chosen to represent the government. So, the government should reimburse ONGC from the profit petroleum. Under the PSC, all customs duties, taxes, royalties and cesses are to be paid by the licensee, which is ONGC," the former official said.
"What ONGC is talking about with regard to article 3.1.9 relates to the accounting procedures. In all pre-NELP (New Exploration & Licensing Policy) blocks, ONGC and Oil India were made licensees by the government. Such tactics on the government's part will send out wrong signals to the international upstream community," he added.
Sources following the development from Cairn’s side agree that Section 3.1.9 is applicable with respect to sums paid directly by all the contractors, both ONGC and Cairn, and would only include any exploration & production costs and other field-development investments.
However, ONGC is not just a contractor. Under the PSC, ONGC has two roles. Firstly, as part of the pre-NELP, it is the licensee, but it is also a contractor, having been nominated by the government to have a 30 per cent participating interest in Cairn’s three Rajasthan blocks.
This is the policy that was framed to woo private oil companies before NELP became the policy for exploration. The PSU would remain the licensee, with the right to 30 per cent interest, if there was a discovery. This arrangement allowed a PSU to transfer the exploration risk to its private partner.
These sources pointed out that ONGC cannot blur its two roles. “Its obligations as a licensee should be treated separately from its obligations as a contractor,” said a New Delhi-based lawyer, who is involved in the process, in condition of anonymity. “Royalty is the liability of the licensee, not even as one of the constituents of the contractor,” he added.