India - Oil and Gas Sector Development Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 14787 PERFORMANCE AUDIT REPORT INDIA OIL AND GAS SECTOR DEVELOPMENT LOAN (LOAN 3391-IN) JUNE 30, 1995 Operations Evaluations Department This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Currency Equivalent Currency Unit = Rupees (Rs) Rs 1 Paise 100 US$ 1 Rs 26.70 Rs 1 US$ 0.037 Measures and Equivalents 1 Metric Ton (mt) 1000 Kilograms (kg) 2204 Pounds (Ib) 1 Meter 3.28 Feet I Cubic Meter 35.3 Cubic Feet (cft) 1 Barrel (Bbl) 0.159 Cubic Meter 1 Metric Ton of Oil (37 API) 7.5 Barrels I Normal Cubic Meter(Ncu.m.) 33.42 Standard Cubic Feet of natural gas Bbl/d Barrels per day MMCMD Million Cubic Meters per Day toe Tons of Oil Equivalent tpy Tons per Year Principal Abbreviations and Acronyms GOR Gas-oil ratio GOI Government of India 2C Indian Oil Corporation locs International Oil Companies K-G Krishna Godavari Basin OIL Oil India Limited ONGC Oil and Natural Gas Commission Fiscal Year April 1 - March 31 FOR OFFICIAL USE ONLY THE WORLD BANK Washington, D.C. 20433 U.S.A. Office of Director-General Operations Evaluation June 30, 1995 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Performance Audit Report on India Oil and Gas Sector Development Loan (Loan 3391-IN) Attached is the Performance Audit Report (PAR) on the India: Oil and Gas Sector Development loan (Loan 3391-IN, approved in FY91) prepared by the Operations Evaluation Department. The principal objectives of the loan were to support policies that would attract significant levels of private foreign investment into the petroleum sector, and to make it politically more acceptable for the national petroleum company, the Oil and Natural Gas Commission (ONGC), to reduce production from wells where such production would cause reservoir deterioration and a subsequent reduction in the total amount of oil that could eventually be recovered from the reservoir. The loan was disbursed in one tranche and was fully disbursed and closed, five months from the date of Board approval. The project was successful in financing the purchase of about one million tons of crude oil and petroleum products. On the policy side, the project failed to meet its main policy objective of attracting a significant volume of foreign investment to participate in petroleum exploration. There was a weak international response to the "Fourth Round" of bidding for exploration acreage announced by the Government of India (GOI) in 1991, primarily because the acreage offered was of limited value and the terms were inadequate. There were subsequent "Fifth, Sixth and Seventh Rounds" but, as of the time of the Audit Mission in late 1994, the Government had not acted on most offers. India failed to establish any exploration or development joint ventures within two years after loan closing, which was one of its most important sectoral adjustment policy objectives. The Audit therefore rates the project outcome as unsatisfactory, the institutional development as negligible, and the sustainability as uncertain. These ratings are the same as those given at the time of the Project Completion Report (PCR). It should be noted, however, that in the last two years there has been a gradual strengthening of the foreign investors' interest in India's energy sector which has led to a number of new contracts being signed in 1995. Indeed, the Borrower considers that the Audit has failed to appreciate the determination of Indian authorities to provide competitive terms to international investors while, at the same time, adopting a deliberate and gradual approach to reform (Annex B). Attachment This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  1 FOR OFFICIAL USE ONLY Contents Preface...... ................................................... ........ 3 Basic Data Sheet....................................................... 5 Evaluation Summary .................................................... 7 1. Project Background.................................................. . 2. Project Objectives ................................................... 13 3. Project Design and Description ...................5...... ................15 4. Implementation Experience ......................7...... ...............17 5. Project Results ...................................................... 19 6. Project Issues and Lessons Learned .................................................21 7. Impact Assessment.......................................... .........25 8. Conclusions and Lessons Learned....................................... 27 Annexes A. Letters of Sector Policy............................................... 29 B. Comments from Borrower ...................... ................. 33 This report was prepared by Richard Berney (Task Manager) and Abdul El-Mekkawy (Consultant) who audited the project in October 1994. Administrative assistance was provided by Lorna Sibblies and Charles Strout. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed wiLhout World Bank authorization.  3 Preface This is a Performance Audit Report (PAR) for the Oil and Gas Sector Development Loan involving a Bank loan of US$150 million which was fully disbursed. The loan was a quick disbursing operation aimed at complementing the financing provided for the Gas Flaring Reduction Project approved by the Board on June 25, 1991 (with a loan amount of US$450 million). The PAR was written in the Operations Evaluation Department (OED). To prepare it, OED reviewed the Memorandum of the President (MOP), legal documents, the staff appraisal report (SAR) and the legal documents of the associated project (Gas Flaring Reduction Project), Bank files and held discussions with Bank staff associated with the project. An OED mission visited India in October/November 1994, where it held discussions with the Government officials and management and staff of India Oil Corporation (IOC) which was responsible for crude oil and products imports. Auditing of the project was necessary to evaluate the impact it had on the involvement of the private sector and to ascertain whether the nature of the contracted conditions offered by GOI were favorable and in line with ongoing industry practices. Following standard procedures, OED invited Borrowers comments on the draft PAR. Comments are attached as an Annex.  5 Basic Data Sheet Oil and Gas Sector Development (Loan 3391-IN) Project Timetable Original Loan Dates Actual or Re-estimated Initiating Memorandum July 2, 1991 Letter of Development Policy July 12, 1991 Negotiations July 12, 1991 July 12, 1991 Board Approval July 23, 1991 July 23, 1991 Loan Agreement July 24, 1991 July 24, 1991 Effectiveness July 29, 1991 July 29, 1991 Loan Closing June 30, 1992 December 20, 1991 Actual Completion December 20, 1991 Cumulative Loan Disbursement FY 92 (i) Planned 150.0 (ii) Actual 150.0 (iii) (ii) as % or (I) 100 Mission Data No missions were fielded. Related Bank Loans and/or Credits Status Project Name Purpose Year Approved Gas Flaring Reduction To eliminate the Flaring of associated 1991 Under Project (Ln. 3364-IN) gas in the Bombay High oil field; Implementation improve the management of the reservoir production and optimize ultimate recovery of hydrocarbons. Also to reduce energy shortages and improve efficiency of energy use in India's Western Region and to promote involvement of the private sector in the oil and gas industry in India.  7 Evaluation Summary Project Background I. Oil output from the Bombay High oil fields reached a plateau in 1984/85. High withdrawal rates from the reservoir coupled with delays in implementing measures to maintain the pressure led to significant pressure drop in the oil reservoirs which resulted in sharp increase in the output of associated gas. The Oil and Natural Gas Commission (ONGC) launched a huge investment program aimed at rationalizing the operations of the Bombay High field. As part of this program, they had adopted a policy under which oil wells whose output of associated gas exceeded a certain level would be closed. The Bank approved a loan of $450 million (Gas Flaring Reduction Project, Loan 3364-IN) in June 1991 to assist ONGC in their efforts. 2. The closing of some 40 wells for reasons of high gas-oil ratio led to a projected short-fall in the oil output from Bombay High oil field (estimated at 3.9 million tons for the year 1991/92). The general decline of oil production from other fields in India, coupled with world oil price hikes at the time of the Gulf war, had dramatically increased India's oil import bill by an estimated $1200 million, at a time when India was desperately short of foreign exchange. 3. The Gas Flaring Reduction Project (GFR) was approved by the Bank with conditionalities for encouraging participation of private companies and international oil companies (IOC) in the petroleum exploration efforts. Shortly after approving GFR project, the Bank had also received from the Government of India (GOI), on July 12, 1991, two "Policy Letters" describing a program of actions, objectives and policies designed to achieve adjustment of certain aspects of the Indian economy, declaring GOI commitment to the execution of the program and requesting a fast disbursing loan to finance urgently needed imports required during such execution and to complement the assistance provided under GFR. On the basis of these Policy Letters, the Bank prepared an Energy Sector Adjustment operation, the Oil and Gas Development Loan which is the subject of this PAR. Project Objectives 4. The principal objectives of the project were: (a) to provide financing for oil imports in order to reduce the pressure on ONGC to continue producing from high gas-oil ratio wells; and (b) to complement a previously approved project loan (GFR) in assisting ONGC in increasing oil output through the encouragement of private domestic and foreign investments in the petroleum sector. 5. The two "Policy Letters" received from GOI provided a general framework of the policy context in which the loan was approved. In addition to the policy issues related to the oil and gas industry, the "Policy Letters" covered areas such as realistic alignment of the exchange rate, reforms of trade policy, industrial policy, financial sector and the public sector undertakings (see Annex 1 for the full text ). The "Policy Letters" were referred to in the preamble of the Loan Agreement but they were not attached to the Loan Agreement as official documents. 8 Project Design and Description 6. The project was designed as a quick disbursing operation to complement the financing provided for the GFR project. The loan scheduled to be disbursed in one tranche and to finance 100 percent of the CIF cost in foreign currency of crude oil and oil products imports. Retroactive financing was provided in an amount of $30 million. The processing of the project took less than three weeks and it was approved on July 23,1991, one month after the GFR project. Implementation Experience 7. Procurement arrangement followed mostly the special procedures for adjustment operations and for procuring commodities traded in the international commodity market. The basic principle was to avoid introducing new procedures and to accept the importers procedures as long as they comply with the Bank's general guidelines. The Audit examined the procedures followed by the Indian Oil Corporation (IOC ) and found them conforming to the petroleum market international trading practices and the Bank procurement principles. The loan was fully disbursed within five months from the date of its approval and was closed on December 20, 1991. Project Results 8. The project succeeded in financing the purchase of about one million tons of crude oil and petroleum products. 9. On the policy side, GOI announced the "Fourth Round" of bidding for exploration acreage, but no bids were received by the time of loan closing in December 1991. During 1992, twenty four bids were received for 13 blocks (out of the 72 blocks offered). Up to the time of the preparation of the PCR in early 1993, GOI had not negotiated with any of the bidders nor did it announce which offers were acceptable. 10. Though the Government had complied with the letter of the loan conditionalities under GFR project, the results were disappointing. The project files are void of any reference to the implementation of non-sectoral policy initiatives which provided the rationale for the loan approval. To the extent that the project did not establish any exploration or development joint ventures, the Audit concludes that the project had failed to meet its most important sector policy objectives. Project Sustainability 11. The project had failed to meet one of its main policy objectives of attracting a significant volume of foreign investment to participate in petroleum exploration. The poor response of IOCs to the "Fourth Round" and to the subsequent "Fifth, Sixth and Seventh Rounds " of bidding, which were announced throughout the last two years, and the failure to date of the 1. Responses since this date are described in the comments prepared by the Ministry of Petroleum and Natural Gas (Annex B). 9 Government to act on most of the offers received makes the project sustainability, at best, uncertain. Project Issues and Findings 12. Loan Design, Rationale and Conditionalities: Most of the program elements and actions described in the "Policy Letters", used as the rationale for the loan, were related to macro policies in non-energy sectors. The "Letters" lacked specific targets, milestones and a timed action plan as regard to the implementation of all policies (sector and non-sector). Issues related to the oil and gas sector were mostly conditions of effectiveness of GFR project. The fact that the loan was fast disbursing (about a 3-month disbursement period) foreclosed any possibility of monitoring the implementation of these policies. Sector policy objectives were not achieved. 13. Participation of IOC in India's Petroleum Exploration Efforts: Since the early 1980's GOI adopted a policy of inviting IOC to explore for oil on a sole risk basis. IOC's interest to participate in petroleum exploration in India had been very low. Where exploration acreage was awarded, the amount of work committed by IOC was too minuscule (only twelve exploration wells were drilled over a ten-year period) to have any impact on India's petroleum industry. The outcome of the Fourth Round was equally disappointing. 14. In spite of the changing environment of the international petroleum industry, the Indian standard conditions and incentives for exploration by private parties had not changed since 1986. These conditions were not very attractive in 1986 and have become less so over the years in comparison with the better terms and greater incentives being offered by an increasing number of highly prospective countries. Many IOCs and other institutions have repeatedly commented to the Bank on the very low quality of the exploration acreage under the bidding rounds. GOI had kept the more prospective blocks for ONGC and IOL, the national oil companies. 15. The Bank encouraged the Government to make greater efforts to attract IOC explorationists but failed to assess the reasons for the previous poor response and the insignificant impact the previous bidding rounds had on the Indian petroleum sector. There were no significant changes for the conditions of the "Fourth Round" and the outcome was disappointing. Conclusions and Lessons Ratings 16. Conditions under which private companies were invited to bid for exploration acreage, while fulfilled by GOI, failed to attract companies. To the extent that the project did not establish any exploration nor any development joint ventures, it is concluded that the project had failed to meet one of the most important sectoral adjustment policy objectives. The Audit rates the project outcome as unsatisfactory, the institutional development as negligible and the sustainability as uncertain. 10 Lessons 17. The sector loan, which was disbursed in one tranche, did not have sector conditionality of its own, but it was meant to complement the financing under the GFR project. Sector and non-sector policy program, as presented by GOI, lacked specificities and a timed action plan for implementation. The fact that the loan was designed as a fast disbursing instrument made follow-up of policy implementation all the more difficult. i8. Sector loans should be designed with a view to promoting sector policies. Fast disbursing loans should not be viewed as a down-payment for good intentions, but rather as a recognition of and a support for the implementation of new policies and an incentive to continue with a well articulated and successful implementation of these policies. 19. Before putting the "Fourth Round" as a loan condition, the Bank should have assisted India in formulating contractual and operational criteria comparable to the on-going international practices. Only then, would the loan conditionalities have been meaningful. 11 1. Project Background 1.1 Oil output from the Bombay High oil fields reached a plateau in 1984/1985. High withdrawal rates from the reservoir coupled with delays in implementing measures to maintain the underground reservoir pressures (e.g. through water injection and/or gas re-injection) had lead to significant pressure drop and sharp increase in the output of the associated gas in certain parts of the oil reservoirs. To avoid permanent damage to the reservoirs from excessive gas production and flaring, the Oil and Natural Gas Commission (ONGC), the largest national petroleum company, launched a huge program aimed at improving the management of the Bombay High field, increasing the oil and gas production and recovering produced gas. As part of this program, oil wells whose output of associated gas exceeded a certain level were to be closed. On June 25, 1991, the Bank approved a loan ($450 million) for a Gas Flaring Reduction Project (GFR) which aimed at collecting the flared gas and assisting India in its program to improve the management of the reservoirs of the Bombay High oil fields. 1.2 The closing of some 40 oil wells for reasons of high gas/oil ratio led to a projected short fall in the oil output from Bombay High oil field, estimated at 3.9 million tons in 1991/92. The general decline of indigenous oil production coupled with the world oil price hikes around the time of the Gulf war had already increased India's oil import bill by about $1200 million in 1990/91. This increase, combined with poor macro-management of the Indian economy had led to the depletion of the foreign exchange reserves to $2.3 billion (equivalent to couple of weeks of imports) by the time the Government applied for the loan in July 1991. 1.3 The Gas Flaring Reduction Project was approved by the Bank with conditionalities for encouraging participation of private companies and international oil companies (IOC) in the petroleum exploration efforts. Shortly after approving GFR project, the Bank had also received from the Government of India (GOI), on July 12, 1991, two "Policy Letters" describing a program of actions, objectives and policies designed to achieve the adjustment of certain aspects of the Indian economy, declaring GOI commitment to the execution of the program and requesting assistance from the Bank in financing urgently needed imports required during such execution. The processing of the sector loan took only few weeks and, it was approved by the Bank on July 23, 1991, one month after the approval of the GFR project.  13 2. Project Objectives 2.1 The principal objectives of this project as stated in MOP were: (a) to provide financing for oil imports in order to reduce the pressure on ONGC to continue producing from high gas-oil ratio wells, and, (b) to encourage ONGC and Oil India (the two national petroleum companies) to enter into joint ventures with domestic and foreign private companies in order to accelerate the development of other oil fields 2.2 The "Policy Letters" received from GOI on July 12,1991 provided a general framework of the policy context in which the loan was approved. The Letters mentioned GOI's decision to implement a more rational gas pricing policy and to invite private companies for the "Fourth Round" of bidding for petroleum exploration. These policy initiatives were also conditions of effectiveness of the GFR project. In addition to the policy issues related to the oil and gas industry, the "Policy Letters" covered areas such as realistic alignment of the exchange rate, reforms of trade policy, industrial policy, financial sector and some public sector undertakings (see Annexes for text of the letters). The "Policy Letters" were referred to in the preamble of the Loan Agreement but they were not attached to the Loan Agreement as official documents.  15 3. Project Design and Description 3.1 The loan was designed to be a quick disbursing operation to complement the financing provided for the Gas Flaring Loan ($450 million) approved by the Bank on June 25, 1991. The Bank was informed of the formation of the gas coordinating committee and of GOI's approval of a "Fourth Round" of bidding and that Government's decision had been announced in the press. Accordingly, the Bank found that these announcements had substantially satisfied the conditions of effectiveness of the GFR project and the sector loan. The loan was declared effective on July 29, 1991, one month after the approval of GFR project. 3.2 The loan was expected to be disbursed in one tranche and to finance 100 percent of the CIF cost in foreign currency of crude oil and oil products imports. Retroactive financing was provided in an amount of $30 million for items contracted after March 31, 1991, that is within four months of the expected date of loan signing. Crude oil and petroleum products imported under then existing contracts were eligible for Bank financing, provided that such contracts had been awarded through procedures and under terms acceptable to the Bank. The processing of the project took less than three weeks. India Oil Corporation (IOC), being the only agency authorized by GOI to import crude oil and petroleum products, was the implementing agency.  17 4. Implementation Experience 4.1 Procurement arrangements under the project followed mostly the special procedures for procurement of commodities traded in international commodity markets. The basic principle was to avoid introducing new procedures and to accept the importers procedures as long as they comply with the basic norms of economy, efficiency, acceptable market and trade practices and accountability requirements. The Audit examined IOC procedures for importing crude oil and petroleum products and found them following internationally accepted petroleum trading standards. IOC used to import every year about $6 billion worth of crude oil and petroleum products-about 65 percent of which was normally procured through long term contracts while about 35 percent, on the average, was purchased through the spot market. Early in the project life, the Bank declined a request from GOI to finance long term contracts which were based on government to government agreements. 4.2 The Bank staff discovered that spot oil purchases by 1OG had been based on bid offers for supply with short term financing ranging from 120 to 180 days. That raised the issue within the Bank as to whether the terms of bidding, referring to short term financing, were counter to provisions of the loan which stipulated that bid invitation would be done on the basis of price alone. Bank management concurred that this was not the case because short term bridging loans, such as those sought by IOC, were not considered as "financing" as intended in the provisions of the loan agreement. 4.3 Over the years, IOC had established a roster of reliable suppliers which includes brokers as well as major international oil companies. Response to bid invitations would be normally telexed to IOC, and the bid price was normally in US dollars. Under the tight foreign exchange situation, LOC revised the payment terms to the suppliers in a way to have two options; the first, which IOC preferred, would provide short term credit of 150/180 days and the second was as per normal petroleum trading practices of providing credit of 30 days. All bidders were requested to quote their price on the 30 days payment basis which was the basis of bids evaluation. In the event IOC availed of short term credit (Banker's acceptance, supplier's credit, revolving commercial bank trade credits, etc.), the date of payment was reckoned as the date the oil suppliers were paid from the credit facility and not when the credit matured or was repaid by IOC. As soon as the suppliers were paid from the short-term credit, funds from the Bank loan were withdrawn. 4.4 One month after the loan was approved, the legal documents were amended to include the opening of a special account to serve the purpose of the loan. A special account in the amount of $70 million was deemed necessary for the quick disbursement of the loan, particularly since the Bank had accorded GOI a high threshold in awarding contracts (up to $5 million) without prior Bank approval. 4.5 The special account was fully utilized through eight withdrawal applications. The loan was fully disbursed within five months from the date of its effectiveness, and it was closed on December 20, 1991. t r 19 5. Project Results 5.1 The project was successful in financing the purchase of about one million tons of crude oil and petroleum products. 5.2 On the policy side, the Government continued the process of inviting private sector participation in the petroleum exploration efforts which it had started in 1980. The "Fourth Round" of bidding for exploration acreage was announced in September 1991 (two months after loan approval) with closure time in April 1992, and it comprised onshore and offshore blocks. No bids were received by the time of loan closing in December 1991. Twenty four bids were received for 13 blocks (out of the 72 blocks offered) during 1992. Up to the time of the preparation of PCR in early 1993, GOI had failed to act on any of these proposals. The Government did not negotiate with any of the bidders nor did it announce which offers were acceptable, nor did the Government invite ?rivate participation in the development of existing oil and gas fields up to the beginning of 1993. 5.3 Though the Government had complied with the letter of the loan conditional ities under GFR project, the results were disappointing. To the extent that the project did not establish any exploration nor any development joint ventures, the Audit concludes that the project has failed to meet its most important policy objectives. 2. Responses since this date are described in the comments prepared by the Ministry of Petroleum and Natural Gas (Annex B). I 21 6. Project Issues and Lessons Learned Production Shortfalls 6.1 The MOP greatly exaggerated the foreign exchange cost of stopping oil production from wells that produce too much gas. Estimates of production losses arising from shutting high gas- oil ratio wells, as stated in the MOP, was 2.1 million tons (para. 20) or 3.9 million tons (para. 26). It follows that the estimated daily loss was equivalent to about 45,000 to 80,000 barrels per day. The actual shut-in production averaged 22,000 barrels per day for 1992 and ranged from 9600 to 10900 for the years 1993 and 1994. 6.2 Conclusions: Ex ante estimates of shut in production in the Bombay High oil field arising from closing high gas-oil ratio wells exaggerated reality by a factor of two to four. This inaccuracy is too high considering that compensation for these losses was a major project rationale. Loan Rationale, Design and Conditionalities 6.3 Most of the GOI program elements and actions described in the "Policy Letters", used as the loan rationale, were related to macro policies in non-energy sectors. All of the policies (sector and non-sector) covered by the "Letters" lacked specific targets, milestones and a timed action plan for implementation. Issues related to the oil and gas sector were mostly conditions of effectiveness of GFR project. Whether loan conditionalities were for sector or non-sector policies, it appeared that the loan was a down-payment for good intentions. An example of the way the Bank dealt with the implementation of such policies was the declaration of effectiveness of the sector loan when the local press in Delhi published GOI intentions to invite a "Fourth Round" of bidding for exploration acreage. The Bank did not wait for the actual bidding process to be initiated nor did it examine the terms and the scope of the "Fourth Round". 6.4 The loan was designed as a fast disbursing instrument, and it could have been fully disbursed through the importation of some twenty to thirty shipments of crude oil and petroleum products. Considering the large volume of India's petroleum imports, the loan could have been disbursed in about three months. The reference in the Loan Agreement to keeping the Bank informed of the execution of the GOI program and exchanging of views on the progress achieved in policy implementation was, in fact, meaningless since the fast disbursing nature of the Loan foreclosed any possibility of follow-up. In addition to the above, the "Policy Letters" were mentioned in the preamble of the Loan Agreement but were not attached to the Loan Agreement as official documents. 6.5 Conclusions: Sector policy reform was not given the high priority it deserves in a sector adjustment operation. The vagueness of the terms in which the GOI program of sector and non- sector policies were stated in GOI's correspondence and the loose criterion used by the Bank in declaring loan effectiveness showed lack of commitment on the Bank side to bring about and follow-up on the implementation of the sector reform objective. 22 Participation of IOCs in India's Petroleum Exploration Efforts 6.6 India's efforts to attract IOCs have been at best half heated. The lack of success is primarily, in the Audit's opinion, a result of lack of commitment. In the early 1980s GOI adopted a policy of inviting international oil companies to explore for oil on a sole risk basis. The "First Round" of offerings for exploration acreage occurred in 1980 whereby the Government offered 32 blocks in onshore and in offshore areas. Only one contract was signed for one block; later the block was relinquished by the foreign company after drilling three unsuccessful wells and spending some $29 million. A "Second Round" of offerings took place in 1982 with no response whatsoever from the international oil companies. For the "Third Round", which took place in 1986, the Government slightly improved the contractual terms and offered 27 offshore blocks. Two contracts were signed with IOCs, one at the end of 1987 and the other by mid-1988 with a commitment to drill 9 wells if contractors opted to continue exploration through the three exploration phases and did not relinquish the concessions earlier. 6.7 Many IOCs had related to the Bank the very low quality of most of the blocks offered by GOI. There were many other blocks that were of interest to IOCs which India kept for ONGC and IOL, the two national companies. Over a ten year period from 1981 to 1991, the role IOC played in exploring for petroleum in India had been too insignificant to have any impact on the Indian petroleum industry (only twelve exploration wells were drilled by private financing). The outcome under the "Fourth Round" was disappointing (see para 5.2); in that sense it was not much different from previous rounds. Contractual Conditions for Exploration 6.8 According to information gathered by the Audit, GOI had not materially changed the conditions offered to IOC since 1986 (the "Third Round" of bidding). These conditions were not very attractive then and became less so over the years in comparison with the better terms and greater incentives being offered b an increasing number of highly prospective countries which are interested in attracting IOC's. The terms of the "Model Production Sharing Contract" published by GOI, and according to which IOCs and private companies were expected to bid for exploration acreage, did not compare favorably with model contracts issued by countries with more promising areas. One important example of the unresponsive terms can be found in the mode of sharing of the produced oil and gas. Instead of following the practice of many of the international model contracts which link sharing of production to a rising scale of production levels, GOI offers a cumbersome sharing formula tied either to the contractors' post tax rate of return or to an investment multiple of the contractor at the end of each year with royalties being paid. Another example is the manner by which the contractor is being compensated for natural gas used domestically. The "Model Contract" links, like many international contracts, the price of gas to the price of fuel oil, but it gives GOI the right to negotiate the gas price within a wide range (from $1.6 to $3.5 per thousand cubic feet). Any prospective contractor would shy away from drilling in gas prone areas since the only assurance they have is the lower end of the price range equivalent to an oil price of $10 per barrel. To put this in perspective, some countries, more prospective than India, have further improved the contractual conditions and linked the compensation for natural gas to a crude oil parity and not to the price of high sulfur fuel oil as it was previously done. 3. The Ministry of Petroleum and Natural Gas disagree with this assessment. See their comments (Annex B). 23 6.9 Conclusions: Though GOI had complied with the letter of the GFR loan agreement and invited IOCs to participate in the petroleum exploration efforts in India, the Fourth round of bidding did not improve on the dismal record of previous rounds. This poor outcome appears to have been due to the stringent terms of the model contract and to the low quality of the acreage offered to the private companies. Unless GOI introduces significant changes in the contractual terms in a way to conform to the general international norms and to the attractiveness, or lack of it, of the offered blocks, there is little hope that GOI will succeed in having any serious participation by private parties in the future. 6.10 Lessons Learned: The Bank encouraged the Government to make greater efforts to attract IOCs explorationists but failed to assess the reasons for the previous poor response and the insignificant impact the previous bidding rounds had on India's petroleum sector. Before putting the "Fourth Round" as a loan condition, the Bank should have assisted India in formulating contractual and operational criteria comparable to the on-going international practices. Only then, would the loan conditionalities have been meaningful.  25 7. Impact Assessment 7.1 In response to GOI invitation under the "Fourth Round" of bidding, IOCs made 24 offers covering 13 blocks out of the 72 blocks offered. Of the offers presented, GOI found only five offers worth negotiating. In the latter part of 1994 at the time of the Audit mission, three years after loan closing, GOI was in the process of finalizing two agreements (for one block each) with two small companies. The committed work program for each of the agreements was been spread over three phases with about five hundred kilometers of seismic surveys in the first phase, another five hundred kilometers of seismic and drilling of one exploration wells for the second phase and drilling of an additional exploration well for the third phase. The private companies in each case would have a "walk-out" option after any of the phases. The fate of the other blocks/offers is still in abeyance. 7.2 It is clear that the maximum work commitment which resulted from the "Fourth Round" of bidding has been extremely modest, particularly if compared to India's own national program, which calls for spending $2 billion on petroleum exploration for the next two years. 7.3 Subsequent to the preparation of the PCR in early 1993, GOI had made further invitations to IOCs for exploration acreage through a "Fifth, Sixth and Seventh Rounds"; the last "Eighth Round" was scheduled to close on December 30, 1994. However, GOI has yet (late 1994) to conclude any agreements for any rounds after the two potential agreements cited above (resulting from Fourth Round offers).4 7.4 Modest progress has been made to promote private participation in the development of oil and gas fields that have been discovered and evaluated by ONGC and IOL. In 1993 GOI requested bids from "capable private companies" to participate in the development of eight medium-size and thirty three small-size oil and gas fields in India, some of which were in Krishna-Godavari basin. The outcome of that effort was the signature of one agreement for the joint development of the Ravva field in the Krishna-Godavari basin. The Ravva field, which is a medium-size field containing an estimated 15 million tons of reserves, was discovered by ONGC and confirmed and further delineated under a Bank financed project (Krishna-Godavari Petroleum Exploration project). The poor response of IOCs and of local private companies (only one agreement concluded for one field out of 41 discoveries offered for bidding) suggests that GOI may have to improve the terms and incentives (see para. 6.8) in order to attract more significant participation of the private sector and to encourage it to take the risks of evaluating minor oil and gas discoveries. 4. The Ministry of Petroleum and Natural Gas in its comments on this report has brought up to date its improved success in attracting foreign investment, "Since the Report has brought out the position as of about a year ago, the current position is brought out here. Government has so far signed contracts for four exploration blocks and sixteen discovered fields. Negotiations of finalization and signing of seven more exploration contracts and two field development contracts are at an advanced stage. Government would also be taking a decision in respect of award of contracts for over twenty-five exploration blocks in the next few months and contracts for these are expected to be signed by the end of the year."  27 8. Conclusions and Lessons Learned Ratings 8.1 The PCR based ratings were: unsatisfactory outcome with no rating given to sustainability and institutional development impact. 8.2 Offering of exploration acreage took place, but the conditions under which private companies were invited failed to attract companies up to January 1993. As the project did not establish any exploration or development joint ventures, it failed to meet one of the most important sector policy objectives. The project outcome is therefore rated as unsatisfactory. 8.3 The alleviation of balance of payment problems can not be done in a sustainable way through fast disbursing loans unless such loans are accompanied by structural changes. Since the loan had no institutional impact and since the framework for contracting explorations acreage did not change, the sustainability of the project is, at best, uncertain. 8.4 The project has failed to meet one of its main policy objectives by failing to attract any significant volume of foreign investment to participate in petroleum exploration. The poor response of IOCs to the "Fourth, Fifth, Sixth and Seventh Round " of bidding and the subsequent failure of the Government to act on most of the offers received makes the project sustainability, at best, uncertain also, from the narrower objective of eliciting IOCs' involvement. 8.5 The sector loan, which was disbursed in one tranche, did not have sector conditionality of its own, but it was meant to complement the financing under the GFR project and attracting private sector to invest in exploration and development. Sector and non-sector policy program, as presented by GOI, lacked specifics and a timed action plan for implementation. The fact that the loan was designed as a fast disbursing instrument made follow-up of policy implementation the more difficult. Lessons 8.6 The Bank should have assessed more thoroughly the extent of the production losses (shut-in production), particularly when compensating for such losses was one of the project rationales. 8.7 The design of a sector loan should be fully supportive of sector policy objectives. Disbursement of sector loans should take place only after substantial reforms have been achieved. Fast disbursing loans should not be viewed as a down-payment against good intentions, but rather as a recognition of and support for the implementation of new policies and an incentive to continue with a well articulated and successful implementation of these policies. 8.8 To ensure that the "Fourth Round" of bidding for exploration acreage would not repeat the failures of previous ones, the Bank should have assisted India in formulating contractual and operational criteria comparable to prevailing international practices. Without the proper contractual framework, any requirement to open up acreage for international bidding would not be meaningful.  29 Annex A Letters of Sector Policy FINANCE MINISTER INDIA NEW DELHI July 12, 1991 Dear Mr. Conable, I write to you in continuation of my letter of July 1, 1991 and to thank you for your statement expressing confidence in our policies designed to impart long-term dynamism to the Indian Economic System. Over the past two weeks you may have noticed that bold initiatives taken by Government for a more realistic realignment of the exchange rate which will instill confidence in our system, check the flight of capital, secure outstanding export receipts and contribute to a sound management of the balance of payments situation. You may have also seen the adoption of far-reaching measures in the area of "Trade Policy Reforms" which lend greater transparency to our system by replacing a maze of regulation through a system by replacing a maze of regulation through a system of "EXIM Scrips" leading to a more open trade system. We would continue this process of policy reforms in other sectors covering the area of industrial deregulation, foreign investment, reforms of the financial and capital market and more realistic policy in respect of public sector undertakings. It is in this context that we greatly value your support by way of fast disbursing loans for various projects to meet out immediate needs. My senior officials are making a more specific request to the Bank in regard to a fast disbursing loan under the Gas Flaring Project in the nature of an "Oil Adjustment Loan", and I hope that this request would be processed as quickly as possible. With kind regards, Your sincerely, (MANMOHAN SINGH) Annex A 30 D. 0. No: FS/91 GOVERNMENT OF INDIA MINISTRY OF FINANCE FINANCE SECRETARY Department of Economic Affairs New Delhi July 12, 1991 Dear Mr. Qureshi, We are grateful to the World Bank, and to you, for the understanding shown for enabling us to tide over the present transitional difficulties and to implement policies designed to achieve stabilization and structural adjustment. I am sure, you would have noticed the far-reaching measures for stabilization and growth which have already initiated over the past few week covering the field of trade policy reforms including a more realistic alignment of our currency and other measures which will impart a long-term momentum to our export efforts. We do hope that in the near future further structural reforms measures would encompass other areas along with lines appended with this letter. During the transitional period, we greatly value fast-disbursing loan components from he World Bank, which would mitigate our present difficulties. In this context, a fast disbursing loan of US$150 million to compliment the assistance provided under the Gas Flaring Reduction Project would assume special significance. It would allow the oil industry to proceed with the implementation of its ongoing programme to increase the ultimate recovery of oil from the Bombay High oilfield by shutting-in oil wells whose gas output exceeds a certain maximum level. This results in a temporary decline in oil production, which exacerbates current balance of payments difficulties. As such, a fast disbursing loan in support of this program would ensure their continued implementation. In support of this program, we have also decided that ONGC and Oil India will take steps to enter into joint ventures with domestic and foreign private companies in order to accelerate the development of our oilfields; in addition, we are implementing a more rational gas pricing policy, and decided to invite the fourth round of bidding for exploration of oil and gas in selected onshore and offshore areas. With kind regards, Yours sincerely, (S.P. Shukla) 31 Annex A A. Industrial Policy Reforms: i) The process of deregulation of the industrial sector is expected to be intensified and deepened with the objects of freeing industrial growth from licensing subject to considerations such as environmental criteria, industrial safety and protection of small scale industry. ii) A liberalized regime for direct foreign investment would be initiated to overcome existing policy and procedural handicaps. B. Reforms in the Financial Sector: The financial institutions are proposed to be strengthened to enable them to play their part in a more competitive environment through greater flexibility in determining internist rates, more prudent lending policies, ending the consortium approach to investment activity and creating condition for greater functional autonomy. C. Reforms in the working of Public Sector Undertakings: i) Disinvestment of up to 20 percent of Government equity in selected public sector undertakings. ii) Progressively subjecting public enterprises to a hard budget constraint.  33 Annex B Comments from Borrower Vijay L Relkar Government of Indla Tel. : 383501 Ministry of ease Petroleum & Natural Gas Tax o. 335e New Delhi*1 10 001 SECRETARY D.O. June a, 1995 Dear Mr. Albouy, Please refer to your letter dated 7th.April, 1995 enclosing the draft Performance Audit Report on the Oil and Gas Sector Development Loan (Loan 3391-IN). 2. Our comments 'on the draft Report are enclosed herewith. Yours sincerely, (Vijay B ellkar) Mr. Yves Albouy, Chief, Infrastructure and Energy Division, Operations Evaluation Department, The World Bank, Washington, D.C. 20433, U.S.A. Fax No. 1 001-202-5223125 Annex B 34 NOTE GIVING COMMENTS OF MINISTRY OF PETROLEUM 4 NATURAL GAS ON THE DRAFT PERFORMANCE AUDIT REPORT ON THE OIL AND -AS SECTOA DEVELOPMENT LOAN FROM THE WORLD BANK (LOAN 3391-IN) The draft Report (hereinafter referred to as the I"Repo,rt"l) has been prepared based on information made availAble in 1993 and 1994. Subsequent developments in the upstream hydrocarbon sector which need to be taken into consideration are brought out in this note. The note also proviaes the response of the Ministry to certain other observattons made in the Report. I. 'Poor response from foreign investors to exploration roun6s : Since 1991, the Government of India has offered exploration blocks in six separate rounds of bidding. The Fourth Round was floated in September, 1991. Thereafter, the Government of India decided to go in for a continuous round the year bidding system. Under this system, blocks were offered twice a year, with the Fifth to Eighth Rounds of bidding being floated in 1993 and 1994. Recently, in March, 1995,- the Government of India has offered 28 blocks in onshdre and offshore areas under the Joint Venture Exploration Round. Over 30 foreign companies have bid for exploration blocks in the rounds floated since 1991. 12 foreign companies, either on their own or in consortium with Indian companies, have been awarded contracts under the Fourth and Fifth Rounds. This is considered to be a reasonable response considering that the past couple of years have seen fairly depressed oil price trends, with a consequent tendency of international companies to cut back on investment in exploration activities. Then again, India has been competing as a destination for exploration risk capital with a large number of other countries, which have offered exploration acreages and producing opportunities at the same time. Given these factors and the fact that international companies continue to show interest in evaluating opportunities for exploration in India, it is felt that a longer term perspective needs to be kept in view while analysing the response of international companies to exploration opportunities in India. 35 Annex B II. Ieasons attributed for poor respqnse i The Report has highlighted two factors that it feels are primarily responsible for what it terms the poor response to the offer of exploration blocks : i) The low quality of blocks offered by the Government of India; ii) the failure to offer attractive terms and conditions. As regards the quality of blocks, it may be pointed out that in the Fourth,to Eighth Rounds of bidding, over 125 blocks covering nearly 85% *to 90% of the area of the sedimentary basins of India have been offered. Highly prospective areas, particularly in the Gulf of Cambay and in Assam, have been put on offer in these rounds. The Government is also aware that there is need for substantial further geological inputs in order to get a better understanding of the geological prospectivity of the basins in India. With this objective in view, Government has approvad an Accelerated Exploration Programme (APEX) which would require an investment of the order of US$ 2 billion. Implementation of the various -components of APEX has been commenced. In fact, the recent offer of blocks under the Joint Venture Exploration Programme is an important part of APEX, whereby private sector and public sector investment would complement each other in ensuring that an aggressive explor tion strategy is implemented. With regard to the terms and conditions offered in the' exploration rounds, particularly the fiscal terms, we are nqt aware of the basis on which the conclusion has been reached in the Report that the Indian terms do not compare favoukably with those of other countries. Studies carried out by independent consultants show the Indian fiscal regime to be progressive and among the more attractive regimes in the world. The most attractive features of the Indian fiscal regime are the absence of uptront payments like signature and production bonuses and license fees. The Indian regime also does not require companies to pay royalty or other statutory levies and imports for petroleum operations are exempted from payment of customs duty. The Report wrongly mentions in para 6.8 at page 17 that royalty is payable : the correct position is that royalty is not payable by companies. It is not corre.ct either to say that increasingly it is the interoational practice to link production sharing to the level of production : in ract, our discussions with representatives of international companies and other Governments indicates that production sharing linked to production levels is a regressive form of extracting economic rent ind can seriously affect the development of marginal fieldi. It is not understood as to why the Report refers to the rate of return/investment multiple formula as cumbersome. In di6cussions with us, companies have been appreciative of Annex B 36 the fa4t that this method of production sharing is linked to the pr fitability of the project and enables the companies to set th ir threshhold level of return when negotiating the produc ion sharing tranches with the Government. As regards gas price, it is the accepted principle that gas price should be linked to the replacement costs of alternative fuels. In fact, in the recent exploration contracts signed, companies have been given the full right to market the gas with no restrijetions on the price that can be realised by them. Since this provides for a fully market determined price based on supply and demand, we feel that this gives substantial incentive to the producer to develop gas discoveries. The Government is continuously monitoring the terms and conditions offered elsewhere with a view to ensuring that the terms and conditions offered in India remaid internationally competitive. One example is the recent decision in the Joint Venture Exploration Round to offer blocks where the national oil companies would be taking a participating interest in exploration blocks right from the beginn;ng of the contract, bearing their share of exploration costs,1 in modification of the provision in earlier rounds where the national oil companies were being carried throuqh the exploration period and were not required to pay their share of exploration costs. Further improvements in terms and conditions would be considered whenever required in order to make the Indian regime attractive to international companies. III. Finalisation of contracts : current status : Since the Report has brought out the position as of about a year ago, the current position is brought out here. Government has so far signed contracts for four exploration blocks and sixteen discovered fields. Negotiations for finalisation and signing of seven more exploration contracts and two field development contracts-are at an;advanced stage. Government would also be taking a decision in respect of award of contracts for over twenty- five exploration blocks in the next few months and contracts for these are expected to be signed by the end of the year. It is true that initially the pace of finalisation of contracts was a little slow. This was because a number of contractual issues had to be settled with companies. The Ministry was also then in the process of setting up a suitable system for finalisation of these contracts. With most contractual issues now having been settled and with the creation of a specialised Contract Cell in the Ministry, the pace of finalisation of contracts will definitely speed up in the coming months. 37 Annex B IV. Conclusion i The various policy initiatives taken by the Government to open up the hydrocarbon sector have, in the view of Ithis Ministry, over time, brought home to companies the faclt that the reforms now being undertaken are of an irreversible nature. consequently, there has been considerably greater interest shown in recent months by international companies in exploration activities in India. The Eighth Round, which closed in end-December, 1994 attracted bids for as many as nineteen exploration blocks. There ;has also been substantial interest shown by internAtional companies in the Joint Venture Exploration Round currently in progress. In an international environment where there is still pessimism regarding oil price and where there is intense competition amongst countries for scarce exploration risk capital, an effort such as that undertaken by the dovernment of India would show results only over time. It is felt that with the continuous opening up of the hydrocArbon sector and the growing investment opportunities in this sector in India, there would be increasing involvement of international companies in the hydrocarbon sector, in India, including the upstream sector. The directional changes in policy in the hydrocarbon sector over the past three years are an indication of the commitment of Government to r forms in this sector, Given the importance of this sector to the national economy and the fact that there has been almost no private presence in this sector over the past two decades, changes in policy have to be introduced sequentially and over time in order to ensure that the consequent burden on the national economy and the consumer is kept to a minimum. It also needs to be kept in mind that the total assets and turnover of the public sector companies in the hydrocarbon sector are of the order of US$ 16 billion and US$ 18 billion respectively, of which US$' 6 billion and US$ 3 billion are the figures for total assets and turnover respectively in the upstream sector. Given the size of this sector, it needs to be appreciated that reforms in this sector have to be carefully planned keeping in view the requirements of the national economy and the need to evolve an environment where both the public and private sectors can play a role in meeting the future energy requirements of the country.   IMAGING Report No: 14787 Type: PPAR