Reliance’s Latest KG Basin Energy Foray

Reliance Industries Ltd.’s decision to invest afresh in the offshore Krishna Godavari (KG) basin after a gap of eight years has caught investors by surprise.

With RIL’s earlier investments of about $9 billion in the basin generating less than a tenth of the projected output of 80 million metric standard cubic metres per day (mmscmd) of gas and the refining-to-retail company still embroiled in arbitration over cases relating to alleged inflation of costs and under production, the announcement of a fresh investment commitment of $6 billion, along with BP Plc., into the KG basin has triggered a guessing game.

“Nothing has changed at the policy level’’ in the last couple of years, observed Madhu Nainan, executive editor of Petrowatch, an online platform for the oil industry. “I am as surprised as you are with this announcement. With $5 billion at stake on account of arbitration, I don’t understand what gives RIL the confidence to invest a further $6 billion in the block.”

While gas from the KG basin is currently sold at $2.48 per million metric British thermal units (mmbtu) by RIL under the gas pricing formula worked out by the NDA government, some analysts contend that the company is betting on significantly higher returns based on the new pricing formula that the Centre had proposed for operating difficult fields including high pressure, high temperature, deep-water and ultra deep-water areas.

Jal I countryi, head of research at Edelweiss Securities, wrote in a research note that RIL would be eligible for premium gas price under that policy, which currently stood at $5.6/mmbtu.

“The combined integrated project will benefit from premium gas price allowed under difficult field policy” and halving of deep-water rig costs since 2014. “Currently, the premium pricing for difficult fields stands at ~2x APM, which significantly enhances viability of these projects.,” wrote I countryi.

The Centre’s policy, however, has a categorical caveat. The new pricing formula won’t apply to blocks under arbitration.

Moody’s Investors Service has also cautioned that RIL’s proposed investment is fraught with risks.

“The planned investment will increase RIL’s exposure to Indian gas business, which is extremely challenging given the delays in regulatory approvals, retrospective changes in regulations and slow resolution of disputes. RIL is already in arbitration with the regulator for costs previously incurred in the KGD6 block,” Moody’s said on Tuesday.

“Two fields in the KGD6 block that are already producing have seen a sharp decline in production of 60 mmscmd in 2010 to 7.8 mmscd in 2017. The company has attributed the decline to more-than-expected complexity of the reservoirs. If the new fields also exhibit the same kind of complexity, the cash flows from the project could be much lower.”

Reliance’s billionaire chairman Mukesh Ambani, who recovered a substantial portion of the initial investment when the company sold a 30% stake to BP in 2011 for $7.2 billion, appears to be wagering that a resolution with the Centre is around the corner.

“RIL has recovered its investments from the block but what about BP? There is no logic unless there is an assurance from the government on higher gas prices,” Petrowatch’s Mr. Nainan said.

RIL and its partner BP expect to produce up to 12 mmscmd, with first production in 2020.

“If the three new fields together manage to achieve production volumes of 30-35 mmscmd of natural gas, they could generate annual revenues of $2.2-2.5 billion, of which RIL’s share will be $1.3-1.5 billion,” Moody’s said.