EP is an inherently risky activity. It involves three interlocking uncertainties - the uncertainty that a given geologic structure contains hydrocarbons, the uncertainty that the hydrocarbons can be located and the uncertainty that once located, the hydrocarbons can be produced on a commercial basis. The gestation period between the search for hydrocarbons and first production (assuming, of course, exploration is a success) can be as long as a decade. It is because of such exposure that investors look for contract structures that balance fairly the risks ex ante discovery (which are borne entirely by the contractor) with the rewards ex post commercial production. They also look for an operating environment that assures contract sanctity. The "production sharing" framework is one such structure. It is an industry template and widely adopted because it not only achieves this balance but it also allows for a formula that gives the government (as the owner of the resource) increasing and disproportionately higher returns.India has 26 sedimentary basins which, according to ONGC/OIL, contain approximately 35 billion tonnes of oil and oil equivalent of gas (OE). This is less than 1% of the world's resources but it establishes that our geology contains hydrocarbons. The challenge is to locate them. This is a challenge that has become increasingly difficult to overcome. The reason is the end of the era of easy oil. The Mumbai High field, for instance, which was discovered in 1975, had well-defined structures and was in shallow waters. The more recent KG D6 gas find is in water depths exceeding 2,000 feet and in complex geology.Future discoveries will most likely be in terrain comparable to D6. They will not be easy to locate.
A compounding challenge is the consequential hike in costs and technical complexity. ONGC was able to bring a barrel of oil from Mumbai High into production at perhaps no more than $2-$3. Reliance, on the other hand, will have incurred a significant multiple of that number to get its D6 gas to flow. Costs have risen for many reasons but the surge in the price of essential inputs like drilling rigs, steel and cement is perhaps the most dominant. The capital cost index for setting up production facilities in 2000 was 100. It is now 220. The price of oil/gas has also, of course, risen, and internationally most companies have been able to more than offset these cost pressures and generate profits. But in India that has not always been the case. ONGC, for instance, is compelled to sell its crude oil to public sector refiners at a discount and the price of D6 gas has been administratively set at $4.20/million metric British thermal units which is less than half the LNG import price into India. The upshot is that whilst India does have hydrocarbons, it has to overcome significant geologic, technical and commercial obstacles to harness them.
The experience of other countries worldwide suggests that these are not insuperable obstacles. Most countries other than those in the Middle East are facing a similar challenge. For them too, the era of easy oil has ended. But the data suggests they are making good progress in meeting this challenge. The average size of new discoveries worldwide is increasing, and last year 60% of the discoveries were of giant fields containing reserves in excess of 500 million barrels/OE. Some countries have been particularly successful. The standout example is Brazil. It added 22 billion barrels/OE to its reserve base in 2010. But others like the US, Australia, Israel and Mozambique have also made notable discoveries. The common thread running through all of these successes is capital, operational excellence and technology. The latter has been particularly crucial. The application of innovative techniques like digital oilfields, horizontal wells and hydraulic fracturing has made all the difference.India imports more than 80% of its crude oil. With prices expected to stay in triple digits, this translates into a massive existing and emergent financial burden. The government recognises this reality and its annual NELP licensing round is testament to its determination to accelerate EP. However, to secure the required risk capital, operating best practice and technology, the government may now have to do more. It may have to proactively reaffirm to potential investors and partners its commitment to contract sanctity.
The writer is chairman of the Shell Group in India. Views expressed are personal.