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Financial Times: Unease grows over an upstream blockage

By Joe Leahy
Published: June 18 2007 04:50 | Last updated: June 18 2007 04:50

Every year the Indian government invites global oil companies to bid for exploration blocks in a process called Nelp – the New Exploration Licensing Policy.

This year, Nelp, which is expected to kick off in the coming months, is in danger of being overshadowed by disputes embroiling foreign and domestic operators, particularly one involving the country’s only major foreign onshore operator, Cairn India.

India imports more than two-thirds of its oil needs – a figure expected to rise if the country’s economy continues to grow at its current rate of more than 8 per cent a year.

The government has had success in attracting domestic private sector operators to explore for oil and gas, but so far, with a few exceptions, most of the global majors, such as Shell, BP, Chevron and Exxon, remain absent from the country’s upstream oil industry.

These majors are training a keen eye on the progress of Cairn India.

The company, controlled by its London parent, Cairn Energy, raised $1.9bn in an initial public offering in Mumbai in January with a promise to begin delivering the first oil from its remote fields in the deserts of Rajasthan, north-western India, in 2009.

In its prospectus, the company also promised to quickly ramp up output from Rajasthan to a plateau of 150,000 barrels of oil per day, a level equivalent to about 20 per cent of India’s total production now.

Cairn says it remains committed to these targets, but people familiar with the issue say the company is facing growing uncertainty from a dispute with the government over how the oil should be delivered from Rajasthan to the market.

Under the original agreements, the issue of delivery was the government’s obligation, but following complications on the government side, Cairn offered to take responsibility by building a pipeline to take the oil to the coast, from where it could be delivered to existing state-run refineries.

As part of the deal, Cairn would front the $800m cost of the 580-km pipeline and recover part of this later from the field’s profits.

In recent weeks, however, these proposals have hit an unexpected snag.

The government is concerned that the particular type of crude produced in Rajasthan would require the pipeline to be heat-treated, making it expensive.

As a possible alternative, the government is considering a proposal to build a so-called “mini-refinery” at the field. If the crude is refined onsite, it could then be distributed using a normal, cheaper pipeline.

To make the refinery viable, it has been suggested that the government could elongate the life of the field by cutting its plateau production in half, to 75,000 barrels of oil a day.

“We do realise that if you truncate the production schedule, it impacts on the project, but then it may obviate the need to set up an expensive pipeline,” said AK Jain, joint secretary of the ministry of petroleum and natural gas, adding that nothing was yet final.

This proposal has caused alarm at Cairn because it would delay first oil by several years while the refinery is being built, and would impose an arbitrary cap on production.

People familiar with the issue believe the proposal would also represent a violation by the government of various agreements with Cairn and would force the company to compromise its commitments to shareholders and to its borrowers.

At an oil price of $50 a barrel, delaying the project would also cost the Indian central government and the government of Rajasthan, one of the country’s most impoverished states, up to $1bn a year.

On top of this would be the cost to India in the form of increased political risk. As one person familiar with the issue said: “In financial terms, you would have just added several hundred basis points to your cost of capital for the industry.”

Some analysts are not yet alarmed.

“While the associated political overtones of recent developments could delay first oil, there is unlikely to be a complete overhaul,” said Citigroup analyst Rahul Singh in a report.

But others say such issues point to the longer-term need to set up an independent regulator if the sector is to prosper. “There’s strictly speaking no regulator for the oil and gas sector,” said one analyst, who declined to be named. “You need to have that to facilitate a feeling of a level playing field.”

Copyright The Financial Times Limited 2007

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