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Why ONGC should pay nothing to buy a stake into GSPC’s KG block path

Soon after the Gujarat State Petroleum Corporation discovered gas in its Krishna Godavari block in 2005, Prime Minister Modi announced that this would contribute to India’s energy security. Not just Gujarat; Andhra Pradesh set up a gas corporation to produce gas from the KG Basin. RIL, ONGC and Cairn were already in the KG Basin.

Why ONGC should pay nothing to buy a stake into GSPC’s KG block path

The estimated discovery of GSPC originally plugged at 20 TCF, has been downgraded to 2 TCF. GSPC has spent $3 billion and has yet to reach even a commercial production of a measly 2 billion cubic metres per year. GSPC should have started production in Aug 2014. Instead of forcing GSPC into bankruptcy, the NDA is forcing unwilling ONGC to buy a stake into GSPC and rescue it from bankruptcy. 

It is useful to study what value ONGC can pay GSPC to get a stake in its investment in KG basin.

The table shows that, under most likely scenarios, reserves held by GSPC in KG basin are unlikely to give any positive returns. 

GSPC’s KG basin discovery followed a similar one by Reliance in 2002. Like GSPC, RIL had also claimed that the discovery was huge at 14 TCF. Since then, it too was downgraded to 2.4 TCF. ONGC had also discovered gas reserves adjacent to RIL and had first estimated it to be 10 TCF and later downgraded it to 1.7 TCF. 

While many have blamed ONGC, RIL and GSPC for their over-estimation, these might have been honest mistakes on the part of the oil companies. Even large MNC oil companies face similar problems. When oil and gas reserves are discovered in virgin territory, there is always the risk of going wrong by a wide margin.

What is different in the Indian context is the unusual step taken by the NDA to “force” ONGC to buy into GSPC reserves, apparently to save it from bankruptcy. After spending more than Rs 20,000 crore in the KG basin to develop its reserves, GSPC has failed to produce any significant quantity of gas. To estimate what ONGC can buy into these reserves, I developed a computer simulation model incorporating five different variables. They are:

1. Reserves (between 2 TCF and 4 TCF)

2. Initial production (assuming 8, 10, 15 and 20 years to deplete the field)

3. Depletion rate (5% and 10% per year)

4. Gas price ($3.58/mmbtu, $4.50/mmbtu, and $6.00 mmbtu)

5. Cost of production ($1.50/mmbtu, $2.00/mmbtu, and $2.50/mmbtu)

By combining different values of these variables, one can simulate 144 scenarios to study the economic viability of ONGC buying a stake in GSPC. However, I have run just seven illustrative scenarios from the most pessimistic to most optimistic (see Table-1). In the case of most pessimistic scenario, the net present value (NPV) is $0.60 billion, resulting in a loss of $ 3.07billion to GSPC. In the most optimistic case, NPV is $12.42 billion and the profit is $8.75 billion. This is too good to be true.

It is highly unlikely that ONGC has the needed expertise to help GSPC. Let us learn from the disappointment of BP. A company like BP, which has operated in just about every part of the world and has extensive experience in offshore production, could not help RIL increase production in its KG-D6 block.

Given the failure of BP so far, what chance will ONGC have? In fact, it was because of this reason that ONGC did not invest to develop its own reserves in the blocks adjacent to RIL. This was a wise decision. On the other hand, it stood quietly for years when gas migrated to RIL’s block and was taken by RIL. That was dereliction of duty. It is a different story that this has now reached the stage of being a national level scam. 

There is every possibility that the government may convince ONGC to accept a scenario like Case-7 (most optimistic case) and ask ONGC to offer a high value to GSPC. By such an act of irresponsibility, the government will also result in causing injustice to other shareholders of ONGC. The only recourse would be to move the court to prevent ONGC from paying a high price to GSPC to save it from bankruptcy. But who will bell the cat? 

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