Reliance's latest KG Basin foray comes with its own set of risks

It remains to be seen if Reliance-BP partnership will benefit from new pricing policy

After meeting Prime Minister Narendra Modi and Petroleum Minister Dharmendra Pradhan, Reliance Industries CMD Mukesh Ambani and British Petroleum Group CEO Bob Dudley hosted a press conference in New Delhi last week. Before the conference, not a word had come out on what would be the announcements, though rumours trigged by a tweet from Pradhan indicated a joint investment in fuel retailing. Dudley broke the suspense by announcing that the two companies were ready with fresh investments in the Krishna-Godavari basin.
 

Together the partners will invest Rs 40,000 crore ($6 billion) in three projects comprising the R-Series, satellites and D55 discoveries. Although the first to take off will be R-Series, all three will be developed in an integrated manner, producing approximately 3 trillion cubic feet of gas. “We plan to submit development plans for the next two projects (satellites and D55) for government approval before the end of 2017,” Dudley said. The development of the three projects is expected to bring a total of 30-35 mmscmd (1 billion cubic feet of gas a day) of new domestic gas production, phased over 2020-2022.

Reliance’s current production from the D1 and D3 fields in KG-D6 is just 7.4 million standard cubic metre a day with price realisation at $2.52/MMBTU. Not surprisingly, the earnings before interest and tax for 2016-17 were in the red by Rs 1,584 crore.

The announcement, therefore, raised its own set of queries. Is it that the companies have got a signal from the government that they will be eligible for a higher gas price through a premium mechanism put in place for natural gas produced from high-pressure and high-temperature deep-water and ultra-deep-water discoveries? According to a March 2016 decision of the Union cabinet, the premium would be applicable to future discoveries as well as existing discoveries which commence commercial production after January 1, 2016. According to the Petroleum Ministry, the new pricing norms for difficult fields would help in the production of 6.5 trillion cubic feet of gas valued at Rs 180,000 crore, or $28.35 billion. Of this, Reliance has eight deep-water and ultra-deep-water discoveries with 2.53 trillion cubic feet of gas.

The caveat to the applicability of the decision to Reliance was: “If there is pending arbitration or litigation filed by the contractors directly pertaining to gas pricing covering such fields, this policy guideline shall be made applicable only on the conclusion/withdrawal of such litigation/arbitration and the attendant legal proceedings”. Reliance is involved in several arbitrations with the government, including one on the $1.55-billion penalty imposed on it and its partners, British Petroleum and Niko Resources, for producing natural gas from state-owned Oil and Natural Corporation’s share of gas flowing from an adjoining lease area. The company along with British Gas is also involved in a $1-billion price dispute with the government for the Panna-Mukta-Tapti fields, which it had recently lost in arbitration.

At the press conference, Ambani said: "We still have pending arbitrations with the government. We'll follow the normal course of law." Since his statement did not have any hint of a possible withdrawal of arbitration by the company, it is not clear what is it that has brightened the prospects of investment in the KG block.

According to a Moody’s report, the annual investment in these discoveries is disproportionately higher than the cash flows being generated by Reliance's upstream business. “This implies that the upstream business will drain cash from the rest of the business from fiscal 2018 until production begins from these blocks. This adds further drag on Reliance’s refining and petrochemical businesses which are already supporting the company’s Rs-300,000-crore ($47 billion) cap-ex over the last four years in its energy and telecom businesses,” says the Moody’s report.

The minimal investments in the year ending March 2018 and the annual investment will be about Rs 6,000 crore after that, which will increase borrowings and leverage. However, relative to Reliance's total EBITDA of Rs 56,800 crore in fiscal 2017, this amount will have little impact on its credit metrics, says the Moody’s report.

It further points out the companies will move forward only when the development plans are approved by the government and their boards. The rating agency sees Reliance’s exposure to the Indian gas business, which is “extremely challenging given the delays in regulatory approvals, retrospective changes in regulations and slow resolution of disputes, increasing”.

The revised pricing policy, effective for all gas production from fields that start producing after January 1 2016, allows pricing and marketing freedom subject to a price ceiling linked to the landed prices of LNG and other substitute fuels such as fuel oil. The price ceiling for gas from such blocks is currently $5.56 per MMBTU.

If the three new fields together manage to achieve production volumes of 30-35 mmscmd of natural gas, they could generate annual revenues of $2.2-2.5 billion, of which Reliance’s share will be $1.3-1.5 billion.

Two fields in the KG-D6 block have seen a sharp decline in production from 60 mmscmd in 2010 to 7.8 mmscmd in 2017. The company has attributed the decline to more-than-expected complexity of the reservoirs.

If the new fields also exhibit the same kind of complexity, the cash flows from the project could be much lower, says Moody’s.

A Morgan Stanley report, however, sees an overall estimated 12 per cent internal rate of return for the project. It says the upstream investment plan and collaboration with British Petroleum in expanding investment in conventional fuels, unconventional mobility solutions and addressing electrification, sets the tone for Reliance's growth plans.