Sector regulator says production sharing contract allows companies to revise plans, costs
Reliance Industries (RIL) as well as the oil ministry and sector regulator, the Directorate General of Hydrocarbons (DGH) today gave a detailed point-by-point reply to the observations of the Comptroller and Auditor General (CAG) on the country's largest gas field, KG-D6.
Besides Reliance, Cairn India and the UK's BG Group have also replied to audit observations on the Rajasthan oilfields and the Panna/Mukta and Tapti fields, respectively, at the Exit Conference called by the CAG before it finalises its report, PTI quoted sources privy to the meetings as saying.
DGH director-general SK Srivastava in a separate session with the CAG said the production sharing contract (PSC) allowed companies to revise costs and plans for developing oil and gas finds. This is by incorporating new inputs like the one done by Reliance for its KG-D6 fields where costs went up from $2.4 billion initially, to $8.8 billion, in two phases ($5.2 billion in phase-1 and $3.6 billion in phase-II).
The initial cost produced in 2004 was for producing a maximum of 40 million standard cubic metres per day (mmscmd), but in the revised plans Reliance doubled output to 80 mmscmd. "Financial estimates were best estimates at that point of time for the broad work programme considered in development plan and were used for techno economic evaluation only," DGH said.
The CAG had in its draft report accused the oil ministry and the DGH of turning a blind eye to the cost increase which would lower the government's profit take from the field.
Sources said that the DGH disagreed with CAG's assumption of adverse impact on government's financial take from the project, saying "cost for the purpose of computation of government take is determined based on actual expenditure incurred and duly validated by audit, and is not based on development plan estimates".
"Any expenditure qualified by audit will be disallowed as contract cost," it said, and added that RIL's actual expenditure on phase-1 of KG-D6 gas field development was $5.6 billion till March 2011. The second phase of drilling is scheduled to commence shortly.
A Reliance team headed by its executive director PMS Prasad pointed out that "the draft CAG report had found nothing to suggest that Reliance indulged in gold-plating, that is Reliance placed orders on its own affiliates at inflated costs or that payments made to vendors came back to Reliance."
According to sources, RIL stated that "using the benefit of hindsight, CAG cannot question the technical and operational judgements of the operator that were in effect the best possible judgements at that time, based on the best information available. Benchmarking the project with similar ones the world over validates the fact that KG-D6 remains the most cost-effective project."
Reliance said there was "no malafide intent" on its part in making any "economic, commercial or operational decisions". The company said "reasonableness of costs incurred cannot be established on the basis of hindsight. Any increase in investment only increases the risk exposure of the operator without giving any additional benefits."
The company presented a nearly 250-page reply to the CAG draft audit, while DGH's response was nearly 180 pages long.
Sources said that the private operators criticised the CAG for exceeding its brief and converting the special audit into a performance audit. Any audit has to be done under the production sharing contract which provides for the legal regime under which the companies have to operate. If audits like that done by the CAG were to go beyond the contract, there would be no legal protection left for the companies, they said.
The sources said that while RIL officials took almost 100 minutes to explain their point of view, Cairn representatives gave their explanation in less than 30 minutes. BG also took a similar amount of time.
The CAG had in its draft report of 7th June stated that the oil ministry and its technical arm, the DGH, had favoured private firms like RIL and Cairn India by allowing them to retain entire exploration acreage, turning a blind eye to the increase in capital expenditure and giving additional area in violation of the production sharing contract.
Sources said DGH urged CAG to focus in its final report on accounting issues with quantification, so as to ensure that revenue and expenditure reported in the books of accounts reflect a true and fair view in line with the accounting principles.
Also, procurement of goods and services should be viewed in the light of the common commercial practices prevailing in the private sector that distinguishes the performance of private sector and may not be unduly shadowed by the systems and procedures of a PSU, it said.
On pure technical issues, the CAG audit should rely on the judgement of the technical arm of the oil ministry for drawing conclusions in view of the fact that exploration and production complexity is not easily comprehensible. "The CAG's final comment should encourage enhanced inflow of private and foreign capital and technology," the DGH stated.
CAG may take two months to finalise its final report which would be tabled in parliament.
Global markets slide on fears of debt default spreading to Italy, Spain; warning signals were available some months ago
Global markets today suffered one of their worst beatings in recent months on mounting fears of a likely default by Greece and that the debt crisis is spreading to Italy and Spain. Shares across Europe dropped nearly 3% to two-year lows, Asian markets were also hit earlier in the day, and it appeared likely that the story would be repeated in the US markets too.
While to some the IMF has been surprisingly silent on bailouts for these debt-ridden European economies and Euro zone finance ministers are now talking about a rescue fund to help Greece but have fixed no timing, it seems that early warnings about this developing situation that could devastate financial markets all over again have been ignored.
Over a month ago, Porter Stansberry, financial advisor, warned that Italy was the next big global problem. In an article headlined "This is the biggest threat to your financial future" published on The Daily Crux web site, Mr Stansberry wrote, "Credit default swaps on Italian sovereign debt are at record levels and moving higher. Currently it costs €250,000 per year to insure €10 million worth of Italian bonds. I expect these prices to continue to increase, making it much harder for Italy to get the estimated €250 billion it needs to finance its annual deficit and roll over the €170 billion in principal that will come due in the second half of this year."
"And... none of these debt estimates includes the growing likelihood of a major bailout for UniCredit, Italy's largest bank. UniCredit is Europe's largest lender to Eastern Europe, where JPMorgan estimates credit losses will total €40 billion this year. When you see in the news that Hungary's currency is plummeting, you can bet UniCredit's losses are growing," Mr Stansberry elaborated.
Today, on the Italian bourses, UniCredit fell by over 7% before turning higher aided by a ban on short-selling by Italy's regulator and news that the government had sold its targeted €6.75 billion of 12-month bills in a bond auction.
UniCredit is the successor bank of Kredit-Anstalt, whose failure in 1931 overwhelmed European governments, forcing Austria, Germany, and England off the gold standard.
Mr Stansberry stated emphatically: "As I told my subscribers in March, I think history is about to repeat itself: Roughly 75 years after its collapse set off the banking crisis that ended the gold standard and destroyed the world's financial system, Kredit-Anstalt (now known as UniCredit) is once again the largest bank in Eastern Europe. I believe it will soon fail again, setting off another global banking crisis."
The investment advisor explained that one aspect about European sovereign debt that most investors around the world failed to understand is that Europe's banking regulators have allowed the banks to own European sovereign debt with zero reserves because the banks argued these were "risk-free" assets. The easiest way for European banks to "lever up" and increase their returns on equity was to borrow large amounts of slightly higher-yielding sovereign debt, from places like Greece, Spain, Portugal, and Italy. This allowed nations privileged access to credit, and it also allowed banks to take on much more leverage than they could have otherwise afforded. "Now, with credit default swap prices rising on these sovereign credits, the truth of these credit risks is coming out," he wrote.
In another note to investors on 20th June, Mr Stansberry wrote that he expected the Spanish and Italian economies to collapse in the next six months. "I expect this next 'down leg' in the world's markets to be more severe than the crisis of 2008, because the balance sheets of the Western democracies are now less prepared to manage the losses.
Describing the history of UniCredit again, and how the failure of its predecessor Oesterreichische Credit-Anstalt—the largest bank in Eastern Europe before World War II—was responsible for kicking off the Great Depression, Mr Stansberry said he was convinced that the failure of UniCredit now would presage the next global monetary collapse.
Today, as the UniCredit stock continues to weaken, there could be a run on the bank and the losses would be too large for Italy to manage without a huge international bailout. "UniCredit has borrowed $300 billion from other European banks. And Italy's government already owes creditors more than 120% of GDP. There aren't any easy solutions to this problem," the investment advisor wrote.
Nifty may stage a rally till 5,600, but this may be short-lived
Domestic markets were severely mauled today by the deepening Euro debt crisis and a couple of negative domestic factors such as poor Infosys results and a decline in the manufacturing index. After opening lower, the indices were knocked down through the day and lost more than 1.5% by the close of trading.
The European sovereign-debt crisis threatened to pass on to Italy and Spain, and prompted a surge in bond yields. Eurogroup finance ministers said late Monday they are ready to adopt further measures to ensure that Greece's sovereign-debt crisis does not spread to other parts of the European Union. However they didn't take any concrete steps.
The yield on 10-year Italian government bonds rose more than 0.2% percentage points to around 5.8% and the cost of insuring the debt against default also hit a record high.
The Sensex opened 187 points down at 18,534, while the Nifty opened at 5,557, lower by 59 points from its previous close.
The drop in the indices was worsened by the first quarter results of Infosys Technologies that were below expectations. The company announced a 15.72% increase in consolidated net profit to Rs1,722 crore for the first quarter ended 30 June 2011 over the Rs1,488 crore recorded in the corresponding period a year ago. However, net profit dipped 5.2% from the Rs1,818 crore in the previous quarter ended 31 March 2011, hurt by wage hikes and intense competition from rivals. The company maintained its full-year dollar revenue forecast of 18%-20%, which too was a disappointment for the market and the stock price slipped over 5% in early trade. The Infosys stock was the worst performer in the pack of Sensex stocks today, closing with a loss of 4.27%.
Slower-than-expected industrial output numbers for May that were announced around noon, dampened sentiments further. Industrial output, measured by the Index of Industrial Production (IIP) rose by just 5.6% from a year earlier. April's industrial output growth was also revised downwards to 5.8% from the earlier 6.3%, the government said. The growth in April-May was just 5.7% compared to 10.8% a year ago.
The weak market appeared to revive briefly on the news of the much-awaited Cabinet reshuffle, a little before noon. While the prime minister was expected to make changes that would address the problem of corruption and remove ministers who have not performed, there weren't any major changes apart from the induction of a few new faces. At about this time, the indices hit their intra day high, the Sensex at 18,589 and the Nifty at 5,580.
The market did not revive after that and as the European markets re-opened weak, the Sensex hit an intra-day low at 18,326 and the Nifty fell back to 5,497. At the close the Sensex had lost 310 points to 18,412 and the Nifty 90 points to 5,526.
Yesterday, we mentioned that the Nifty may find support at 5,525. Today, the Nifty broke this support but ended above it. We could see a pullback rally if the US market ends with minor losses.
Today, among the pack of 30 stocks in the Sensex, ONGC and Hindustan Unilever were the only stocks which were marginally positive. Other major losers besides Infosys were DLF (down by 3.84%), Mahindra & Mahindra (down by 3.02%), Jindal Steel (down by 2.99%) and Reliance Infrastructure (down by 2.89%). Only five stocks were positive in the Nifty.
The advance decline ratio on the National Stock Exchange (NSE) was a poor 427:1295.
Among the top gainers on the NSE were Weizmann Forex (up 20.03%), Savita Oil (up 12.92%), whereas the top losers were Jumbo Bag (down by 10.42%) and Vijay Shanthi Builders (down by 9.68%).
The European crisis had its effect on Asian markets across the board. The Hang Seng dropped the maximum (down by 3.06%), followed by the Seoul Composite (down by 2.20%) and the Taiwan Weighted (down 2.02%). The others dropped between 1.79% and 0.11%.