New Delhi: One of the government’s top law officers has advised that the petroleum ministry should make the costs that Reliance Industries Ltd (RIL) can recover from its lucrative block in the Krishna-Godavari (KG) basin dependent on capacity utilization, thus protecting the exchequer’s share of future revenue from the sale of gas and oil from the area.

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The ministry’s action comes after RIL wasn’t able to achieve projected capacity utilization in the KG-DWN-98-3 block, even though the company had already recovered most of the costs associated; it had invested $5.69 billion (Rs 26,800 crore today) in the block as on 31 March and recovered $5.26 billion of this. The government’s share of profits is calculated after deduction of costs by the company.

In July, the petroleum ministry sought the opinion of the law ministry, which in turn passed on the request to solicitor general Rohinton F. Nariman. The legal opinion was reviewed by Mint.

“We are looking at the opinion in light?of the brief that was sent," Union law minister Salman Khursheed said in a phone text message. “There may be some important aspects inadequately covered. These matters are not based on decided cases, but on totality of relevant material. Once the file is completed with comprehensive material, we may seek further advice from SG (solicitor general). (We) shall take a decision when appropriate."

Nariman was not available for comment, his office said.

In his opinion, Nariman suggested that the government recover from the company the revenue share related to the excess costs it has already deducted. He also advised the government to opt for the dispute resolution mechanism as mentioned in its production-sharing contract (PSC) with RIL if the company didn’t agree to include these excess costs in its calculation of the government’s share.

Spokespersons for the ministry of petroleum and natural gas and RIL declined to comment.

The block in question is at the centre of a controversy after the Comptroller and Auditor General of India (CAG) said in a report released last week that RIL had breached some terms of the PSC with the government.

Significantly, CAG said in a general comment in its report that the current template of the contract encourages companies to front-load expenditure as it correspondingly reduced the share of the government in profit. According to this, the government’s share from hydrocarbon blocks, known as profit petroleum, comes only after the companies recover all their costs.

In his opinion given to the law ministry on 17 August, Nariman advised that “the costs/expenditure incurred in constructing production/processing facilities and pipelines that are currently underutilized/have excess capacity cannot be recovered against the value of petroleum" by the company and advised the government not to “allow cost recoveries on this account in future periods".

Nariman suggested that the government recover the cost related to excess and underutilized capacity and equipment by reversing RIL’s share.

“To the extent the contractor has already recovered expenditures incurred in the construction of production/processing facilities and pipelines and the contractor is not entitled to such recovery under the production-sharing contract, the cost entitlement of the contractor can be reversed," he said. The legal opinion also noted that RIL hadn’t met production commitments to which it had agreed. The amendment to the initial development plan submitted by RIL projects a gas production of 61.88 million standard cu. m per day (mscmd) from 1 July 2010 and 80 mscmd from 1 July 2011.

“I have been instructed that a production rate of 80 mscmd does not appear foreseeable in the work programme and production plan submitted by the contractor (RIL)," Nariman said in his opinion.

According to CAG, while RIL submitted an initial development plan involving expenditure of $2.4 billion in May, 2004, it made an addendum to the initial development plan in October 2006 with an estimated capex of $5.2 billion for phase-I and $3.6 billion for phase-II.

“Typically, cost recovery is not linked to the production pattern or performance of the field, albeit the PSC does have provision to deal with entitlement issues when based on provisional production quantities," said Gokul Chaudhri, partner at audit and consulting firm BMR Advisors Pvt. Ltd. “Cost recovery aspects are significant for both the contractor and the government given the amounts can materially impact the sharing of the petroleum and natural gas inter-se the parties."