Shell sold its entire stake in the Barmer block to Cairn Plc, then a small company even globally. But Mike Watts, then the exploration in-charge at Cairn and a legendary figure in Rajasthan’s oil history, and his team found reserves of 1.1 billion barrels of oil in Barmer, a discovery that quadrupled the company’s share price and catapulted it into the FTSE 100 index.
As former ONGC chairman and managing director R S Sharma pointed out, “Cairn Plc’s success in Barmer changed the perception of global oil and gas companies
about the Indian sedimentary basins. It also explains the impressive participation of global players in the initial rounds of New Exploration and Licensing Policy (NELP) bidding.”
Sharma headed ONGC when Cairn Plc sold its India arm Cairn India
to Anil Agarwal’s Vedanta
group in 2011 to cash in on the value it created at Barmer. He also presided over some hard bargaining with the new buyers on an arbitration case involving cess payment. The Union government sided with ONGC, which holds a 30 per cent interest in the block, and asked for the withdrawal of arbitration by Cairn India
as one of the conditions to approve the sale.
Cairn India was created by its British owners and listed on the Bombay Stock Exchange in 2007. Just before that, Cairn UK’s holdings in nine subsidiaries were transferred to the Indian entity. Information of this transfer formed part of the initial public offer document when regulatory approvals were taken. But, the tax department in January 2014 sent Cairn a notice to file its return on these transactions. That was because the law on capital gains involving transactions by foreign entities on assets in India has been amended in 2012.
Much before the amendment, however, the tax department had asked British telecom giant Vodafone
to pay Rs 11,000 crore for the transaction with Hong Kong-based Hutchison Whampoa to buy the Essar-promoted telecom company then known as Hutchison Essar. This tax claim did not stand the test of courts even in 2013 when the Supreme Court struck down the demand.
The capital gains tax demand on Cairn Plc was made under this infamous retrospective amendment around the time it was struggling to sell its India business to Vedanta.
The tax assessment asked for a principal tax of Rs 10,200 crore due on the 2006 transactions with applicable interest and penalties. This claim sounded the death knell for foreign interest in India’s oil and gas sector.
“Such tax amendments and unreasonable arm-twisting by the Indian tax regime turned away such major players from the subsequent NELP rounds,” said Sharma. But despite Sharma’s assertion, it is also a fact India is low on investment priority when it comes to the upstream sector because the geological challenges in deep waters of some basins make the task difficult.
Barmer, in fact, did have its share of technical challenges that were compounded by differing interpretations of contract terms. Shell gave up because it could not see viable reserves; when the block was finally developed under Cairn, the crude oil was of superior sweet quality but also “waxy”, making transportation a technical challenge. A specialised pipeline was put in place to transport it but a long battle with the government ensued on whether the investment in the pipeline should be allowed as a cost recovery under the production sharing contract.
The oil exploration and production business involves a high degree of risk capital because of the geological uncertainties of blocks, so reserves are only best-guess estimates. Under NELP and pre-NELP blocks, the government’s take from these blocks — a term known as profit petroleum — is derived after costs are deducted. These costs, in the form of number of wells to be drilled, were defined at the bidding stage, making returns uncertain. This inherent uncertainty in the oil business only becomes more slippery if policy changes hound critical risk capital retrospectively.