Mumbai/New Delhi: Reliance Industries Ltd (RIL) has begun arbitration proceedings in anticipation of the government’s reported move to restrict the cost recoverable by the firm for developing the D6 field in the Krishna Godavari (KG) basin depending on the level of utilization, the company said in a statement on Monday.

RIL’s statement said that it sought clarification from the oil ministry about such a move, but received no response. An RIL official said the letter was sent in September. He declined to be identified.

A file sea exploration equipment KG-D6 basin

RIL, India’s most valuable company, said it will seek a hearing at the earliest and expects that the government “will seek to do likewise in the interests of the energy sector in India and the investments therein".

An oil ministry spokesperson declined comment.

This is RIL’s first official statement on the matter after Mint reported on 14 September that India’s solicitor general Rohinton F. Nariman had given an opinion to the oil ministry stating RIL should only be allowed to recover the cost incurred in developing D6 proportionate to the level of utilization of the field.

On 9 November, oil minister S. Jaipal Reddy accepted Nariman’s opinion. Mint reported on 21 November that law minister Salman Khurshid said that he was “on the same page" as the oil minister. “We feel ambiguities are best cleared by arbitration," he had said.

The oil ministry had sought the law ministry’s views, which in turn passed on the request to Nariman, after RIL failed to meet its own target for gas generation in the D6 offshore block despite having claimed associated costs as deductions before estimating the profit to be shared with the government. Such front-loading of the costs means the revenue to be shared with the government drops correspondingly. RIL had invested $5.69 billion in the block as of 31 March and recovered $5.26 billion.

Most commercial contracts, as the one in this case, have clauses to invoke arbitration. This is aimed at speedy dispute resolution since the courts usually take much longer, and commercial contracts are time-sensitive. RIL and the government may opt for ad hoc or institutional arbitration, depending on the nature of the clause.

Gas production at D6, India’s largest gas reservoir located off the eastern coast of India, has been falling over the months. 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 the firm projects a gas production of 61.88 million standard cubic metres per day (mscmd) from 1 July 2010 and 80 mscmd from 1 July 2011. For the first half of fiscal 2012, gas output averaged 46.6 mscmd, according to an RIL investor presentation.

In his opinion given to the law ministry on 17 August, Nariman said: “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".

“In the event the contractor does not agree to reverse cost recoveries already made, the government will have to take recourse to the dispute resolution provisions set forth in Article 33 of the PSC (production-sharing contract)," Nariman said.

“We sent an arbitration notice to the government last week, but they are yet to get back to us," the aforementioned RIL official said. “We need to invest further money in the oil and gas business and need clarity on what the terms and conditions are since the PSC says one thing and the solicitor general’s opinion is different."

“All investments in the exploration, development and production of hydrocarbons from KG D6 were made by RIL and its foreign partners at their own risk, and not the government of India," the RIL statement said. “RIL and its partners are entitled under the PSC with GoI to recover their full costs from the revenues generated by production from the block." RIL further stated that its investment at D6 has only been “partly recovered" and “the return on investment so far is less than the cost of capital".

The D6 block is also at the centre of a controversy after CAG said in a report that RIL had breached some terms of its contract with the government.

Nikhil Kanekal in New Delhi contributed to this story.