Economy

What Went Wrong with Gujarat’s KG ‘Deen-Dayal’ Gas Reserve Discovery?

From ballooning costs to technological challenges, the Gujarat State Petroleum Corporation has spent nearly Rs. 20,000 crore on the Deen Dayal gas fields with little to show for it.

Out of its depth: The Gujarat State Petroleum Company has spent nearly Rs. 20,000 crore on the Deen Dayal field with little to show for it. Credit: Skmaircon

Out of its depth: The Gujarat State Petroleum Corporation has spent nearly Rs. 20,000 crore on the Deen Dayal field with little to show for it. Credit: Skmaircon

New Delhi: It was a discovery that dwarfed all other discoveries. On June 26, 2005, Narendra Modi, the then-Chief Minister of Gujarat, announced that the Gujarat State Petroleum Corporation (GSPC) had discovered “the country’s largest reserve of natural gas in the Krishna-Godavari Basin.”

The announcement was surprising for two reasons: Firstly, the discovery of an estimated 20 trillion cubic feet (TCF) of gas was even bigger than the 14 TCF discovery by Reliance in 2002.

Modi referred to the finding as a “historic moment for India’s hydrocarbon sector”. Christened the Deen Dayal West (DDW) area, it was widely thought that the discovery would bring down India’s import bill.

The second reason why many were taken aback by the announcement was because of the low-profile nature of GSPC. What made matters more interesting is that the state-run corporation had just barely avoided disqualification for the bidding of the KG basin block that had now given it such a dramatic finding. Modi was forced to engage in some twelfth hour financial wrangling — through which the net worth of GSPC was increased by Rs. 300 crore — in order to win over competitors such as ONGC and Reliance. An India Today article lauded this decision, dubbing GSPC as “a company with the golden touch”.

All downhill from there

Fast-forward to the present, a little over decade after Modi announced the discovery, and to say that GSPC’s discovery hasn’t lived up to its potential would be putting it mildly. A Comptroller and Auditor General report, released last week, reaches a scathing conclusion: Even after an investment of Rs. 19,576 crore, commercial production is yet to start (as of November, 2015), resulting in “uncertainty regarding the future prospects from the block”.

What then, went so wrong? The CAG report –which talks of underestimation of costs, technical difficulties and poor contractors — breaks it down into three major categories:

1) Viability of the Field Development Plan (FDP): Every company that engages in deep water gas exploration has to factor in the government’s gas pricing policy. According to the report, when starting out, GSPC assumed a gas price of $5.7 per million british thermal unit (MMBTU) even though the prevailing government-approved formula was $4.20 per MMBTU.

This means that at the time the field development plan was written and proposed, it wasn’t economically viable.

However, amongst oil and gas companies this is normal practice. GSPC assumed, rightly, that the government would kick off gas price deregulation and that there would be an increase in global crude and gas prices. In fact, during a price discovery process carried out by the state-run company, it received offers above the floor price of $8.50 per MMBTU, subject of course to the approval of the government.

The problem, however, as the report notes, is that the price of $8.50 per MMBTU was not approved by the government. Furthermore, even under the 2014 natural gas pricing guidelines, which linked domestic prices to a weighted average of global prices, the price of gas was revised from $5.05 per MMBTU (effective November 2014) to $3.81 per MMBTU (October, 2015).

“The fact remained that prices were below the FDP estimate of $5.70 per MMBTU, based on which the project was considered financially viable. Thus the viability of the project even after commercial production of gas is doubtful,” the report says.

2) Technological Risks & Poor Planning: Out of all the concerns and risks that the CAG has flagged, the technological challenges of extracting gas out of DDW are the largest hurdles that GSPC still has to surmount.

The DDW field falls under what the oil and gas industry refers to as “high pressure, high temperature (HPHT) conditions”. A HPHT gas field has low permeability, which means that reservoir fluid cannot move out or flow within the rock into the well very easily. This essentially means that the production rate of a HPHT zone can be severely impacted if you don’t have the right technology strategy.

To its credit, as the CAG notes, GSPC believed that it could achieve a production target of 200 mmscfd by using “well bore designs and completion techniques” — proven operational and technological means that had been used elsewhere to develop other HPHT reservoirs. However, the efforts of GSPC in using technological techniques such as multilateral wells and hydraulic fracturing met with very little success from 2011 to 2014.

“The successive changes in approach for resolving the issue of low permeability and their outcome indicate that the Company [GSPC] is still not clear on how to obtain the proposed production rate from the wells. [The] audit noticed that the [GSPC] Board was apprised that it had not developed suitable drilling technology during the exploration phase..,” the CAG report says.

The report soberly notes that the technological issues are still unresolved: during trial production, which happened in August, 2014, average production reached only 19.45 mmscfd — the total targeted commercial production from the DDW field was around 200 mmscfd, which is indicative of these continuing problems.

3) Unqualified Contractors: In order to implement the FDP that had been laid out, after a tender process, GSPC awarded the contract in 2010 to Tuff Drilling (A consortium of Tuff Drilling Private Limited and Spartan Offshore Drilling).

The audit conducted by the CAG brought up the fact that Tuff Drilling “had not designed, engineered or constructed a modular platform rig on its own.” During the tender process, when a clarification was sought by GSPC, Tuff Drilling replied that its subcontractor had relevant experience; which was accepted by GSPC.

The CAG report notes that the “technical qualification of Tuff Drilling was not according to tender conditions.” One particular mistake by Tuff Drilling, which it failed to mobilize a platform rig by a stipulated time, proved to be costly, resulting in an additional expenditure of Rs. 34 crore.

       §

The longest running thread throughout the CAG’s assessment of GSPC’s performance is one of avoidable expenditure and overshooting of costs. The cost of constructing one subsea pipeline, for instance, increased from $160 million to $420 million because the state-run company had not obtained the required forest and wildlife clearances.

In another instance, the actual cost of creating an offshore facility was $1,057 million — 93% higher than what the company’s FDP estimated.

At times, the difference between what GSPC projected in its FDP and what something actually costed affected the overall economics of the project as well as resulting in production delays. For example, because the cost of the offshore facilities were underestimated, its capacities had to be realigned in order to reduce costs. This realignment pushed back commercial gas production from March, 2012 to May, 2013.

Much of these issues could have been avoided if GSPC decided to rope in a strategic, third-party partner. Indeed, it was even discussed during a company board meeting in 2010. However, as the CAG report notes, “no action was taken on this at an appropriate time”.

From 2010 onwards, GSPC got a little more frantic. Letters released by Arvind Kejriwal in 2014 showed that GSPC officials wrote to the government in 2013, proposing a new formula for the pricing of gas that would vary from $8.5 per MMBTU to $14.2 per MMBTU. This proposal, however, went against a 2010 Supreme Court decision that strongly reaffirmed the government’s right to set gas prices.

        §

The oil and gas industry is no stranger to issues of underestimation, overestimation and government interventions gone wrong. A classic example is the case of Reliance and its issues with the KG basin, which was either an instance of technical incompetence or malicious corporate intent.

The Gujarat story, if one goes by the CAG report,  is of company that appears to be simply out of its depth. Should the company have rushed in bidding for the opportunity back in 2003? And after realizing that it needed more experience, should it have called in a strategic partner? These are questions that remain to be answered. In the meantime, the opposition has been quick to jump on the CAG report, with former Commerce and Industry Minister Anand Sharma demanding an inquiry into what he called “a waste of public money and Rs. 20,000 crore.”

When GSPC first announced its discovery, a number of officials, including the then-Hydrocarbons Director-General V.K. Sibal, were very skeptical of the company’s claim. In an India Today story, Sibal was quoted as saying “it appears to be a tall claim based on the result of just one well.”

The Minister of State for Energy and Petrochemicals at the time, Saurabh Patel, didn’t take these comments lightly. Hitting back at Sibal, he said “we have done things professionally. We acquired advise [sic] at a price and took a decision. We have hit the jackpot.”

As any lottery winner will tell you though, the future isn’t automatically rosy.