Sunil Jain: Golden and other rules

The Director General of the Directorate General of Hydrocarbons has taken offence to Reliance Natural Resources Limited (RNRL) chief Anil Ambani’s statements that Reliance Industries Limited (RIL) has goldplated its costs. VK Sibal has said inflating expenses does not benefit either the contractor or the government. In his words, “No company would like to increase its investment unproductively. Every addition dollar of wasteful investment dents the profit of the contractor. For a business enterprise, there is no motivation to goldplate its investment. Due to the higher share of profit generally earned by the contractors, the loss to the contractors due to inefficiency or gold plating is higher than to the government.” He has also cited various studies, including a CAG audit, to say the cost are fine. And they may well be. But Sibal’s point about the contractor (in this case, RIL) having no incentive to inflate costs is simply not correct.

According to the Production Sharing Contract (PSC) between the government, RIL and its partner Niko Resources Limited, till such time that RIL recovers 1.5 times its total costs, the government gets just 10 per cent of profits — the first thing that is recovered is the costs. After RIL recovers 2.5 times its costs, the government gets to keep 85 per cent of profits. So, if RIL inflates costs, Sibal is right, it will get a lower level of profits. But since the company also gets to recover the inflated costs, it makes a net gain. Whether RIL is inflating costs is a different matter, but the incentive to do so exists.
 

Oily economics
(RIL’s cost-recovery versus capital costs)

Investment
Multiple

Govt Share
of profit
% RIL Share
of profit
% Less than 1.51090 1.5 to 21684 2 to 2.52872 2.5 to 38515 3 and above8515 Investment Multiple: RIL revenues from KG Basin divided by costs
Source: RIL-Niko PSC with Government of India