Brinkmanship in an oil deal

Brinkmanship in an oil deal

The government’s decision to impose stiff terms for Scottish explorer Cairn Energy to sell a majority stake in its Indian operations to mining major Vedanta Resources smacks of brinkmanship. As a precondition to approving the deal, it insisted on Thursday that Cairn Energy indirectly bear a part of the royalty burden in the most valuable asset in its Indian portfolio, an oil-producing field in Rajasthan.

Currently, the burden is being taken entirely by its minority partner, state-owned ONGC Ltd. Secondly, Cairn must forgo its arbitration rights against its partner and consequently drop an ongoing case where it is seeking either reversal of the cess paid on the oil produced or better fiscal terms on the outflow.

Rather than meddle with the contract arrangements, the author of the contract and owner of the oil reserves—the government—should have directed ONGC to work within the contract and proceed for arbitration to redress its grievance. After all, no one is disputing that there are conflicting provisions in the contract on the above issues.

Arm-twisting Cairn seems to be working so far, given the manoeuvres in the marketplace over the last few months —Cairn has lowered the transaction value, while Vedanta has been shoring up equity from other stakeholders in Cairn India. However, regardless of whether the sale goes through or not, the government’s decision has brought upon the country significant collateral damage. Investors will be wary of engaging with the government or its agencies such as public sector companies—this will translate to private firms seeking higher returns to compensate for the additional risk. In turn, it means higher consumer prices.

The argument, however, can be moderated on the grounds that globally, the oil exploration production business has a decades-long tradition of “rude" interventions by the state. Companies have come to live with the fact that contracts are not sacred. The genesis of this behaviour is the fact that it is not merely a business of profits and losses arising out of production of goods or offering services. It is about rent sought for a resource owned by the state, more so triggered when the contractor makes large discoveries.

However, the strength to extract a larger share of the natural resource is derived from a fact that has eluded India thus far: Prospects of finding oil and gas. Surely, the country cannot afford to scare away oil and gas explorers.

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