ASIAN DEVELOPMENT BANK

PPA: IND 25363

PROGRAM PERFORMANCE AUDIT REPORT

ON THE

HYDROCARBON SECTOR PROGRAM LOAN (Loan 1148-IND)

IN

INDIA

January 2001

CURRENCY EQUIVALENTS Currency Unit Rupee/s (Re/Rs) At Appraisal (November 1991) Rs1.00 $1.00 = = $0.0386 Rs25.90 At Project Completion (September 1997) = = $0.0276 Rs36.18 At Operations Evaluation (September 2000) = = $0.0219 Rs45.67

ABBREVIATIONS ADB APM BOP DGH HSP IMF IOC LPG MMT MOF MOPNG NELP OECF OIL ONGC PSE TA Asian Development Bank administered price mechanism balance of payments Directorate General of Hydrocarbons Hydrocarbon Sector Program International Monetary Fund Indian Oil Company liquefied petroleum gas million metric tons Ministry of Finance Ministry of Petroleum and Natural Gas New Exploration Licensing Policy Overseas Economic Cooperation Fund Oil India Limited Oil and Natural Gas Corporation public sector enterprise technical assistance NOTES (i) (ii) The fiscal year (FY) of the Government ends on 31 March. In this Report, "$" refers to US dollars.

Operations Evaluation Office, PE-566

CONTENTS Page BASIC DATA EXECUTIVE SUMMARY I. BACKGROUND A. Rationale B. Formulation C. Objectives and Scope at Appraisal D. Financing Arrangements E. Donor Coordination F. Program Completion Report G. Evaluation IMPLEMENTATION EXPERIENCE AND RESULTS A. B. C. D. III. Effectiveness of Design Implementation of Policy and Institutional Measures Management of the Program Assessment of Program Results i ii 1 1 1 2 2 3 4 4 4 4 5 12 13 15 16 17 17 17 18 18 19 19 21 21 22 23

II.

PROGRAM IMPACT A. B. C. D. E. Macroeconomic Impact Social Impact Institutional Impact Environmental Impact Sustainability

IV.

KEY ISSUES FOR THE FUTURE A. B. Issues Related to Sectoral Improvement Issues Related to Program Loan Formulation

V.

CONCLUSION A. B. Overall Performance Lessons Learned

APPENDIXES

BASIC DATA Hydrocarbon Sector Program Loan (Loan 1148-IND)

Program Preparation/Institution Building TA No. 1645-IND TA Project Name Examination of Public Sector Oil Refining, Distribution and Marketing Activities Promotion of Private Sector Investment in Downstream Activities Type A&O PersonMonths 7 Amount $200,000 Approval Date 2 Jan 1992

1646-IND

A&O

13

$400,000

2 Jan 1992

Key Program Data ($ million) As Per ADB Loan Documents Total Program Cost ADB Loan Amount/Utilization ADB Loan Amount/Cancellation 500.0 250.0 Actual 375.0 125.0 125.0

Key Dates Expected Appraisal Loan Negotiations Board Approval Loan Agreement Loan Effectiveness Loan Closing Months (effectiveness to completion) 3-10 October 1991 16-17 Nov 1991 12 Dec 1991 13 Dec 1991 16 Dec 1991 30 Jun 1995 42.5 Actual 31 Oct-9 Nov 1991 17-19 Nov 1991 17 Dec 1991 18 Dec 1991 20 Dec 1991 18 Sep 1997 60.5

Borrower Executing Agencies

Government of India Ministry of Finance Ministry of Petroleum and Natural Gas

Mission Data Type of Mission Fact-Finding Appraisal Program Administration Disbursement Aid Coordination Consultation Special Contact Review Program Completion Operations Evaluation

No. of Missions 1 1 1 1 1 1 3 1 1

No. of Person-Days 80 60 3 2 4 15 29 20 51

A&O = advisory and operational, TA = technical assistance.

EXECUTIVE SUMMARY The operational strategy for India of the Asian Development Bank (ADB) in much of the 1990s was to assist the Government achieve increased economic efficiency through support for structural reforms, promotion of competition, and private sector participation. The Hydrocarbon Sector Program (HSP) loan was consistent with this strategy. It was also part of international donor efforts to support India to diffuse its balance-of-payment crisis caused by the drying-up of short-term credits and the surge of oil import costs due to the sharp oil price increases caused by the Gulf crisis. On 17 December 1991, the Board approved the program loan for $250 million to be disbursed in two tranches. In addition, cofinancing of $250 million from the Overseas Economic Cooperation Fund of Japan was solicited and obtained, and two technical assistance (TA) grants were provided to support the design and implementation of the Program. The first TA, for $200,000, examined the performance of the public sector in oil refining, distribution, and marketing activities, and the second TA, for $400,000, aimed to identify ways of promoting private sector investment in downstream activities. The main objective of the Program was to promote accelerated exploration and development of domestic hydrocarbon resources through increased participation of the private sector and enhanced operational efficiency of public sector enterprises (PSEs). Specifically, the Program aimed to contain the share of oil imports in total oil consumption at the 1991 level (45 percent). The Government considered the objective of long-term oil import substitution as important from the viewpoint of reducing pressure on the foreign currency reserve as well as the countrys strategic self-reliance. The scope of HSP was to cover major areas including sectoral policy and institutional reforms, attracting private sector investments, improving public sector operational and financial efficiency, and promoting energy conservation and efficiency. The first tranche of $125 million was disbursed in two installments in December 1991 and February 1992. The Government proceeded to implement most of the reform measures prescribed by the Program. The process, however, stalled with what was considered a key covenant, namely the divestment of 20 percent of the Governments equity in the countrys leading oil company, the Oil and Natural Gas Corporation (ONGC). The scheduled loan closing date was 30 June 1995, but it was extended three times to allow more time for compliance. Finally, the Government indicated that it was unable to meet the requirement and requested the cancellation of the second tranche ($125 million). The loan was actually closed on 18 September 1997. The Operations Evaluation Mission (OEM), which visited the country during the period 6-22 September 2000, confirmed that among the 26 loan covenants, three were still pending or not complied with, two were partially complied with, and all the others had been implemented. The covenants implemented included, among others, corporatization of ONGC, creation of a Directorate General of Hydrocarbons to provide a level playing field for private sector, introduction of a New Exploration Licensing Policy, phased dismantling of the administered price mechanism, and establishment of the common carrier company Petronet. As a result, the general regulatory and business environment has undoubtedly grown much more market oriented.

iii However, the Program suffered from a number of failed assumptions, which were partially responsible for the fact that a key covenant was not achieved. First, the time-bound target of divesting 20 percent Government equity in ONGC failed to take into account the scale and complexities of the divestment and necessary regulatory and market conditions for the divestiture. Second, the Programs heavy emphasis on divestment, as a means to raise additional capital and enhance management efficiency, was very uncertain as sales of government shares at heavy discounts would have caused substantial financial losses for the Government without really achieving much since the majority of the stake would have remained with the Government even if the sales succeeded. Other alternatives such as forming joint ventures, devising attractive policies to encourage foreign direct investment, and allowing more management autonomy for the PSEs could have been more effective. Third, the Programs time frame was too tight and no explicit consideration was given to proper sequencing of the reform measures prescribed. In addition, other factors such as the Governments slow movement to market reforms and reluctance to open up the market also played a role in the cancellation of the second tranche. In this regard, the Government must accelerate the reform process and pursue private and foreign direct investment with greater vigor and speed if it wants the Indian economy to succeed in a region where competition is fierce for limited investment resources. In the area of exploration and development, the anticipated competition from the private sector is yet to be realized with the PSEs, notably ONGC and Oil India Limited, still dominating activity. Major foreign oil companies have been reluctant to make large investments in this inherently risky business due to the administered prices and the difficulties in obtaining marketing rights. Some believe that the multinational oil companies may hold the key for acceleration of successful exploration due to their better resources and technology in certain key areas, such as deep water exploration. The proportion of crude oil production from private or joint ventures under production-sharing contracts remains insignificant, e.g., 4 million out of 37 million metric tons in FY1999/2000. Total private sector investment in exploration is also far from the program target of $5.2 billion. The production of domestic crude oil remained largely stagnant over the program period. Consumption/demand, on the other hand, was continually on an upward trend with the oil self-sufficiency rate reduced to 37 percent in FY1998/99, much lower than the targeted 45 percent. Recent high crude oil prices have once again brought urgency to the sectors reforms as oil imports continue to drain the countrys foreign currency reserve and the deficit on the oil pool accounts (a cross-subsidy mechanism) deficit has reached a very high level. The situation in the refining sector is somewhat better. Since the beginning of the Program, a total of 12 refineries have been approved, five for operation by the private sector, six by joint ventures, and one by the public sector. However, all the prospective foreign companies including Exxon, Shell, KPC, etc. withdrew from the initial agreement due to concerns over marketing rights, administered prices, and anticipated refining overcapacity in the country. Only two domestic private companies, Reliance Petroleum, Ltd. and Mangalore Refinery and Petrochemicals, Ltd. are already in production. The operational efficiency of the PSEs in the sector significantly improved during the program period. Exploration and production per capita productivity increased by 23 percent, and that for refining by 45 percent during the period between FY1991/92 and FY1997/98. However, between FY1993/94 and FY1998/99, the Indian economys energy intensity, measured by hydrocarbon (oil and gas) consumption per unit of gross domestic product, increased marginally by 1.8 percent, signaling that the economy might not have become more energy efficient, even

iv after allowing for some natural fluctuation of data. Waste in energy consumption, particularly that associated with illegal or overuse of subsidized fuels such as kerosene, diesel, and liquefied petroleum gas, is still evident. In view of the foregoing, the OEM rated the Program as less than successful.

I.

BACKGROUND

A.

Rationale

1. The operational strategy for India of the Asian Development Banks (ADB) in much of the 1990s was to assist the Government, in its strive for industrialization, achieve increased economic efficiency through support for structural reforms, promotion of competition, and private sector participation. The Hydrocarbon Sector Program (HSP) Loan was consistent with this strategy. It was also part of international donor efforts to support India to diffuse its balance of payments (BOP) crisis caused by the drying-up of short-term credits and the surge of oil import costs due to the sharp oil price increases caused by the Gulf crisis. The Government that took office in June 1991 acted swiftly to avert the crisis and prevent default in payments. A program of macroeconomic stabilization was set in place consisting of structural reforms to trade, and market-oriented industrial and trade policy frameworks. The Government negotiated a standby arrangement with the International Monetary Fund (IMF) in October 1991 for $2.3 billion and a Structural Adjustment Loan with the World Bank for $500 million. 2. HSP targeted market-oriented reforms in the hydrocarbon sector because petroleum and petroleum products accounted for a significant share of imports (22 percent in FY1990/91). The reforms aimed to contain the country's dependence on oil imports by increasing domestic production and promoting energy conservation through, among others, attracting private sector investments as well as enhancing financial, technical, and managerial efficiencies. B. Formulation

3. On 8 November 1990 a small-scale technical assistance (TA) grant was approved to review the hydrocarbon sector operations in India.1 In January 1991, a policy dialogue between the Government and ADB on hydrocarbon sector policy was held in the context of a Special Assistance Project.2 A broad framework of HSP emerged during the consultation mission held on 15-19 April 1991. The policy framework included sector reorganization, private sector involvement in exploration and development, market-oriented hydrocarbon pricing, energy conservation, and resource mobilization. Following a government request for a program loan to support the reforms for the sector, a fact-finding mission was fielded in September 1991 to assess the Governments proposal and to further discuss government policy actions and strategies in the sector. Policy dialogues continued during the appraisal mission in November 1991 during which the content and timing of the policy reforms, and the implementation arrangements of the proposed loan, were discussed. The Board approved the Program on 17 December 1991.

TA 1416-IND: Undertaking a Review of the Hydrocarbon Sector Operations, for $100,000, approved on 8 November 1990. Loan 1081-IND: Special Assistance Project, for $150 million, approved on 4 April 1991. The primary objective of the project was to provide foreign currency financing for importing diesel fuel with no conditionalities attached.

2 4. The six-week period from loan appraisal to approval was a near record speed for a program loan addressing such complex reform issues, notwithstanding the emergencyassistance nature of the loan. Not surprisingly, many of the design problems revealed later are partially attributable to the hastened program preparation process. The Government, which was strongly motivated to push through market-oriented reforms as well as in urgent need of a cash injection, also appeared to have underestimated the complexities of implementing the program measures. C. Objectives and Scope at Appraisal

5. HSP aimed to maintain the share of oil imports in total oil consumption at the 1991 level, as well as to support the Governments overall economic policies of macro-stabilization and increased use of market-based instruments in allocating resources. HSP covered five major areas that together aimed at complementing the Governments drive to improve the sectors production potential and efficiency: (i) (ii) (iii) (iv) undertaking sectoral adjustment through a program comprising appropriate policy and instrument reforms and increased investment over the medium-term; encouraging private sector participation in the oil and gas sectors through joint ventures, leasing, contracting, build-operate-transfer, and other schemes; mobilizing resources for financing medium-term investment in the sector involving greater external cofinancing and raising additional private sector resources; improving the operational and financial efficiency of public sector organizations engaged in oil and gas exploration and development, through greater managerial autonomy, decentralization, and divestment; and promoting increased energy efficiency and conservation through promotion of appropriate pricing and related policies.

(v)

6. The policy matrix under HSP covered 26 policy measures. Of these, 20 were to be implemented prior to the release of the second tranche and six before the end of the program period. D. Financing Arrangements

7. The loan in an amount of $250 million was from ADB's ordinary capital resources, to be disbursed in two equal installments of $125 million. The release of the tranches was conditional on the implementation of agreed measures. The loan proceeds were to be utilized by the Government to finance the foreign exchange costs of eligible imports. HSP was also cofinanced by the Overseas Economic Cooperation Fund of Japan (OECF) with a loan of $250 million equivalent. To support the Program, two TA grants totaling $600,000 were provided.3

TA 1645-IND: Examination of Public Sector Oil Refining, Distribution and Marketing Activities, for $200,000, approved on 2 January 1992; and TA 1646-IND: Promotion of Private Sector Investment in Downstream Activities, for $400,000, approved on 2 January 1992.

3 E. Donor Coordination

8. ADB actively coordinated with the other donors, IMF, and the World Bank, who agreed that efficiency in the sector needed to be improved; they supported ADBs proposed program. While ADB cancelled the second tranche of the loan as the Government could not fulfill a loan covenant regarding divesting the Oil and Natural Gas Corporation (ONGC), OECF released its second tranche, after obtaining a "no objection" from ADB, on the basis that the Government was committed to divestment but the actual completion of the divestiture was contingent upon market conditions. Similarly, IMF had also stipulated several conditions while granting emergency assistance to India, and considered that India had met all the major conditions satisfactorily and waived, what it considered to be, minor deviations.

F.

Program Completion Report

9. The loan was closed on 18 September 1997. The program completion report (PCR) was circulated on 30 September 1998. The PCR concluded that, although the second tranche of $125 million was cancelled despite three extensions to the loan closing date, the Program could take credit for a number of policy reforms, improvement in the regulatory environment, and the foundation for market-oriented reforms. The PCR classified the Program as partially successful. It further concluded that, had ADB not insisted on the full compliance of the divestment covenant relating to ONGC and released the second tranche of $125 million, the Program would have been considered successful. The PCR also concluded that the two accompanying TAs achieved their objectives within budget. G. Evaluation

10. This program performance audit report (PPAR) focuses on overall impact and design aspects of the Program and presents the findings of the Operations Evaluation Mission (OEM) which visited the country during the period 6-22 September 2000. The PPAR also presents an assessment of the Program's effectiveness in achieving its objectives and in generating a sustainable development impact. 11. The PPAR is based on a review of the PCR, Report and Recommendation of the President (RRP), and material in ADB files; and on discussions with staff at ADB, the Executing Agencies, and other government agencies, and with representatives of aid agencies, research organizations, and the private sector. II. IMPLEMENTATION EXPERIENCE AND RESULTS

A.

Effectiveness of Design

12. While the majority of the 26 measures stipulated as loan covenants (Appendix 1) were appropriate and served effectively to advance market-oriented reforms in the sector, others, as will be argued below, were less appropriate and effective. 1. Divestment Target

13. A loan covenant regarded as key by ADB was the divestiture by the Government of 20 percent of its equity in ONGC. This was considered essential to pave the way for privatization, enhancing efficiency of the sector, and raising additional resources for the Government. However, the target proved to be unrealistic relative to the size of the domestic capital market and limited interest in the stock from prospective investors. At the time of formulation, no

5 analysis of market realities was made to judge whether this condition was practical, in spite of the fact that the transactions were potentially worth billions of dollars. 14. ONGC's authorized share capital, after it was converted into a company from a statutory body under the Indian Companies Act as required by the Program, was Rs150 billion (about $3.3 billion) comprising 15 billion shares with a face value of Rs10 each. Under the Program, the Government attempted to divest its share in installments. The first was the sale of 2 percent to domestic financial institutions in October 1994, at a Rs1,533 per share. With the earnings per share for FY1994/95 standing at Rs58.1, the price/earnings ratio was 26.4:1 or the return was only 3.7 percent for investors.4 This was followed by the sale of another 2 percent to ONGC employees at Rs270 per share (after dilution of the original shares in the ratio of 3.08:1).5 Subsequently, according to the Government, when it tried to auction 35.6 million shares, the response was insignificant (bids for only 192,310 shares were received). The Government therefore consulted industry experts and was advised that such divestment should only be attempted after full deregulation of the sector, including the dismantling the administered price mechanism (APM), a proposition the Government accepted. 15. The Government was, and is still, of the view that had it tried to sell 16 percent of its equity to satisfy the remaining condition for the release of the second tranche of $125 million, it would have suffered huge losses several times greater than the second tranche. The Ministry of Petroleum and Natural Gas (MOPNG) still harbors strong negative sentiments about ADB's decision to cancel the second tranche to such an extent that, initially, it refused to meet with the OEM. The Government argued that such a sale would not have assisted in redressing the Government's budget deficit situation as envisaged under the Program. 2. Reform Time Frame and Sequencing

16. The Program envisaged the reform measures to be carried out within three years, which proved to be over optimistic. The Program period was extended three times to six years. In addition, the sequencing of related reform measures was not carefully thought through. With hindsight, price liberalization for major petroleum products should have been made as a prerequisite for divestment of ONGC as private investors demonstrated little interest in acquiring ONGC shares as long as the prices of major petroleum products, i.e., gasoline, diesel, kerosene, and liquefied petroleum gas (LPG) were administered by the Government. B. Implementation of Policy and Institutional Measures

17. The measures envisaged under the Program covered a wide range of areas, namely, regulation, exploration and production, refining, transportation, distribution and marketing, pricing, divestment, efficiency improvements, and indirectly, environmental impact in the hydrocarbon sector. The policy matrix providing the summary of planned actions, the timetable
4

The share price appeared to be too high relative to the returns, and though no evidence indicates that the Government was imposing these shares on the financial institutions, many of them are wholly or partially owned by the Government. In comparison, according to the Annual Report of the Oil and Natural Gas Corporation for FY1999/2000, the share prices traded on the national stock exchange have averaged Rs200 per share and the earnings per share for FY1999/2000 was Rs25.45.

6 as envisaged during appraisal, and the implementation status at the time of the PCR and OEM, is attached as Appendix 1. Appendix 2 provides background information on the major players in the sector. 1. Regulation

18. Under the Program, a Directorate General of Hydrocarbons (DGH) was established under MOPNG in April 1993 to administer the regulatory functions hitherto carried out by ONGC. DGH oversees exploration and production activities; develops data packages for areas offered for exploration; provides technical advice to the Government on related issues, particularly development, conservation, and reservoir management; and advises MOPNG on maintaining oil-field safety and environmental standards. 19. The establishment of DGH represented the first step to create a level playing field for the public and private sectors. The public sector enterprises (PSEs)ONGC and Oil India Ltd. (OIL)are required to compete on equal terms with the PSEs (para. 22). In addition, data on exploration acreage on offer are now available to the private sector on the same basis as to the public sector. 6 20. Based on the recommendations under a subsequent ADB-financed TA7 for regulatory framework for the gas industry, the Government had earlier initiated steps for creating an autonomous gas regulatory body, which would operate in a transparent manner. However, the initiative experienced some bureaucratic and procedural delays and now the Government is considering the establishment of a single regulatory body for the entire hydrocarbon sector because of the close linkages between oil and gas. 2. Exploration and Production

21. Prior to the Program, the entire responsibility for oil and natural gas exploration and development was vested with two PSEs, i.e., ONGC and OIL. However, government statistics indicate that the private sector is becoming increasingly active in the development of new oil and gas fields. Contracts have been signed with private firms under the Program for the development of six medium-sized and 24 small fields. Under the New Exploration Licensing Policy (NELP),8 which, according to the Government, is one of the most favorable in the world, the Government in January 1999 invited bids for 48 blocks (10 onshore blocks, 26 shallow water blocks, and 12 deep water blocks). By the bid closing date of 18 August 1999, 45 bids for 27 blocks were received, of which 25 blocks were awarded. Of the 25 blocks, three were awarded to Enron and eight to a consortium of major domestic private sector corporations i.e., Tata and Reliance.

7 8

TA 2775-IND: Hydrocarbon Exploration and Production Database and Archive System, for $600,000, approved on 3 April 1997, assisted the Directorate General of Hydrocarbons in designing a national archive of exploration and production database. TA 2008-IND: Regulatory Framework for the Gas Industry, for $600,000, approved on 7 December 1993. Under this policy, the Oil and Natural Gas Corporation and the Oil India Limited are offered the same fiscal and contract terms as private companies.

7 22. However, subsequent interviews with the World Bank and private sector representatives revealed a somewhat less optimistic scenario. They stated that the interest of foreign companies in exploration activities is greatly inhibited by two factors: (i) a perception that the blocks open to bidding are generally those with higher risks, and (ii) a government requirement of Rs20 billion or $435 million minimum investment in the sector before a company is granted the right to market oil products in India. 23. The production statistics also support the less optimistic view. Crude oil production from existing wells decreased from 30.35 million metric tons (MMT) in FY1991/92 to 27.17 MMT in FY1993/94. With the additional production by ONGC and production from the private sector and joint ventures (about 4 MMT in FY1999/2000), the domestic production of crude oil in FY1999/2000 increased to about 36.55 MMT. In comparison, the Program envisaged that crude oil production would reach 45 MMT per annum by the end of the program period (1997) in order to contain the import share at the 1991 level of 45 percent.

3.

Refining

24. Under the Program, domestic and foreign private firms were allowed to enter the oilrefining sector in 1991. The Government has approved 12 new refineriesfive for operation by the private sector, six by joint ventures, and one by the public sector. Of these, twoReliance Petroleum, Ltd. and the Mangalore Refinery and Petrochemicals, Ltd.are already in operation while three private firms have already withdrawn, and commissioning of the others has been delayed. The current status of the private and joint venture refineries is given in Appendix 3. Two principal causes for the withdrawal and delays in the implementation of the others were the possibly overbuilt refining capacity in the country as anticipated by some industry analysts and the preconditions for obtaining marketing rights. 25. In a separate move not related to the Program to prepare the PSEs for greater competition from the private sector, the Government recently announced a restructuring of the oil sector whereby all standalone refineries in the public sector are to be converted into subsidiaries of marketing PSEs. Bharat Petroleum Company (BPC) will buy out the entire government stake in Cochin Refineries and it will take over Indo Burma Petroleum's stake in Numaligarh Refinery in Assam. Meanwhile, market leader Indian Oil Corporation (IOC) will buy out the entire stake in both Bongaigon Refinery and Chennai Refinery. The detailed timetable was not available at the time of the OEM. 4. Pipeline Transportation

26. One of the major recommendations of a TA9 under the Program was related to the establishment of an independent common carrier company which would own and operate all the transport and storage facilities in the hydrocarbon sector to which all the stakeholders in the sector would have open access. In line with this recommendation, Petronet India Ltd. was established in 1998 as a financial holding company with the specific objective of rapidly developing a national network of pipelines for transporting petroleum products to which all producers in both the private and public sectors could have open access. Fifty percent of the equity in Petronet is held by five PSEs, i.e., IOC, BPC, Hindustan Petroleum Corporation (HPC), the Gas Authority of India, Ltd., and ONGC (each with 10 percent). The remaining 50 percent is held by financial institutions and private companies, with no individual entity holding more than 10 percent of the total. 5. Marketing and Distribution

27. The Program stipulated that new refineries under private or joint venture ownership would be allowed to market oil products. This covenant was only partially complied with since the refineries have been permitted to market only minor products such as lubricants. The right to market the top five petroleum productsgasoline, diesel, kerosene, LPG, and aviation turbine fuelis still held by four PSEs i.e., IOC, BPC, HPC, and Indo Burma Petroleum. Recently, the
9

TA 1645-IND: Examination of Public Sector Oil Refining, Distribution and Marketing Activities, for $200,000, approved on 2 January 1992.

9 Government agreed to let private companies engage in retailing provided that they invested at least Rs20 billion in the upstream sector. Only the Reliance Petroleum Refinery Ltd., a private Indian company, has fulfilled this condition. The Government is expected to approve its request to market its refinery products. The PSEs have developed extensive retail outlets, which new entrants may have difficulty matching. Foreign companies have tried to get a slice of this market through joint venture arrangements with PSEs, but have not been successful. As stated earlier, this has been an effective barrier to entry for private investors in the upstream sector that view the retail sector as a cushion against the inherently risky exploration and production activities. 28. In the case of LPG, the Government introduced a parallel marketing system in February 1993 enabling private sector participation in bottling and retailing of LPG to industrial and commercial consumers. Virtually all the major multinational oil and gas companies present in India are confined to this market. However, the commercial and industrial segment of the LPG market is relatively insignificant at approximately 0.5 MMT, compared with the household segment of 5.5 MMT, which is still controlled by the top PSEs under APM (para. 30). Further, with commercial and industrial consumers illegally tapping subsidized LPG from household consumers, even this limited market available to private companies has been adversely affected. 6. Pricing

29. Prior to HSP, the pricing system was fully under government control, and was known as the APM. At the heart of APM are the oil pool accounts, created to insulate domestic crude oil producers from volatile international crude oil prices and to provide for a mechanism for crosssubsidizing certain petroleum products, such as kerosene and LPG for the household sector, without government budgetary support.10 Under the Program, the Government started to align petroleum prices with market prices, subject to maximum and minimum price constraints, from the previous cost-plus formula, namely, cost of production plus a fixed profit margin. However, a formal plan to phase out APM by 2002 was not announced until November 1997, two months after the loan officially closed. Meanwhile, total subsidies have decreased from Rs186 billion in 1997 to Rs83.6 billion in 1999 (Table 1). Table 1: Subsidies on Major Petroleum Products (Rs billion)
Item KeroseneDomestic Use Diesel LPGDomestic Use Naptha for Fertilizer BitumenPacked Paraffin Wax Total
10

1993 33.04 1.20 11.76 8.15 1.52 1.19 56.86

1994 37.73 5.75 12.61 7.72 1.26 0.89 65.96

1995 37.40 4.30 14.10 8.50 1.10 0.20 65.60

1996 41.90 21.80 16.30 12.00 1.20 0.40 93.60

1997 65.40 80.90 22.20 15.20 2.00 0.30 186.00

1998 58.20 0 16.60 0 0 0 74.80

1999 57.90 0 25.70 0 0 0 83.60

Through the oil pool accounts, inflows from surcharges on the sales of petroleum products (mix of domestically produced and imported) and outflows for meeting the claims by domestic oil producers and refineries, are adjusted. When the world oil price is low, the surcharges will be high enough to meet the claims while still contributing a surplus to the fund, which will then be used to pay for the claims when the world crude price is high. Over an extended period of time, the pool accounts are supposed to balance.

10

Source: Ministry of Petroleum and Natural Gas.

30. It should be noted that government revenues from customs and excise duties from oil products far exceed subsidies. For instance, in FY1999/2000 (the latest year for which data are available) the Government earned Rs222.3 billion from customs and excise duties whereas the subsidies were only about Rs83.6 billion, i.e., about 38 percent of the revenues. In addition, the state governments collect a substantial portion of their revenues from the hydrocarbon sector through a sales tax.11 However, the prices of petroleum products in India are still some of the lowest in the region, with the exception of oil- and gas-rich countries, as may be seen from Table 2 below.12 Table 2: Consumer Retail Prices of Selected Petroleum Products in the Region (as of 1 January 1998)
LPG No. 1 2 3 4 5 6 7 8 Country Singapore Thailand Malaysia Philippines Korea, Rep. of Taipei, China Indonesia India 26.95 13.00 13.84 26.19 24.58 17.89 17.10 78.57 22.61 24.20 35.72 77.37 61.36 8.10 57.99 Gasoline Aviation Fuel Kerosene (US cents per liter) 38.38 36.20 4.05 33.20 30.11 23.42 11.11 20.49 9.92 50.23 2.70 10.39 Diesel

39.36 20.83 14.32 23.12 47.17 47.00 3.66 26.38

= data not available, LPG = liquefied natural gas.

7.

Restructuring and Divestment

31. As agreed under the Program, ONGC was changed from a statutory body to a corporation under the Indian Companies Act in September 1993. However, most board directors of the PSEs in the oil sector are government appointees, and some are appointed as board members for multiple PSEs at the same time. As a result, although some progress has been made compared to the situation prior to the Program, the PSEs are far from being granted full autonomy. 32. As stated earlier (para. 13), divestment of PSEs in the sector was given paramount importance in the reform package prescribed by the Program. However, the Government was only able to divest about 4 percent of ONGC to financial institutions and employees under the Program. In 1999, after the loan closed, an additional 12 percent of government equity was sold to other PSEs under a cross-shareholding scheme. Cross-shareholding, a common practice in India, effectively consolidates the horizontal alliance of PSEs in the same sector and has drawn

11

For example, in Maharashtra the sales tax as of 1 April 1999 was 13 percent on natural gas, 27 percent on gasoline, and 30 percent on diesel. 12 The Government has raised the prices for major petroleum products shortly after the Operations Evaluation Mission.

11 much criticism as no real divestment has taken place and the stakes still remain with the Government. 33. Despite the difficulties with ONGC, the Government was more successful in divesting equity in other PSEs and has in fact exceeded the targets set under the Program (Table 3).13

13

Sale of 20 percent of government equity in one of the integrated or two nonintegrated refining and marketing companies.

12 Table 3: Divestment in the Hydrocarbon Sector

Share Capital (Rs Crore) Authorized Paid-Up 15,000 250 2,500 250 200 75 200 200 1,000 1,425.92 142.67 389.31 225.58 150.00 68.94 47.10 99.82 845.65 Divestment (%) 15.89 2.00 8.86 48.94 33.80 44.96 48.20 25.53 3.37 Government Holding (%) 84.11 98.00 91.14 51.06 66.20 55.04 51.80 74.47 96.63

Company ONGC OIL IOC HPC BPC CRL MRL BRPL GAIL

Crore = 10 million. ONGC = Oil and Natural Gas Corporation, OIL = Oil India Limited, IOC = Indian Oil Corporation, HPC = Hindustan Petroleum Corporation, BPC = Bharat Petroleum Company, CRL = Cochin Refineries Limited, MRL = Madras Refineries Ltd., BRPL = Bongaigaon Refinery and Petrochemicals Limited, GAIL = Gas Authority of India Limited.

34. More recently, the move to divestment and privatization of PSEs appears to have gained some momentum. A minister has been appointed in charge of divestment and a Department of Divestment has been created. The Government presently owns 240 central PSEs, with a total investment of Rs2,301 billion, over half of these incurring losses. Progress, though, has been relatively slow in the hydrocarbon sector. Unlike nonprofitable PSEs, the companies in the hydrocarbon sector have traditionally been regarded as Navaratna (Nine Gems) as they contribute a significant share of government revenue. The total revenue from major oil PSEs in FY1999/2000 was Rs289 billion, of which only little over Rs2.1 billion (or 0.7 percent) was in the form of dividends and the rest as excise tax and duty. The implication is that the Governments revenue will not be significantly reduced after divestment since only the dividend portion would be relinquished. Aside from economics, there are security and strategic concerns as the oil sector is viewed as the lifeline of the economy. All these factors have contributed to the very slow motion of divestment. C. Management of the Program

35. The EA for loan withdrawals was the Ministry of Finance while the EA for implementing the Program and the TA was MOPNG. The dual EA structure has, to a certain extent, created an incentive problem as MOPNG had no direct financial incentive to implement all the reform measures on time and many measures such as the privatization of PSEs may even have been viewed as harming its own short-term interests. 36. Despite the incentive problem, monitoring of compliance with loan covenants was successfully carried out by MOPNG. Dialogue during the program period, in the form of reports, memos, and through other channels, between ADB and the Government was intense, resulting in three extensions of the Program and ultimately the cancellation of the second tranche. During the OEM, MOPNG pointed out the need for continuing such a policy dialogue, which would help improve the understanding of each others objectives and constraints, as well as development in the sector.

13

37. The Program included two TA grants (Footnote 3). The PCR reported that MOPNG did not encounter any difficulties in recruiting two consulting firms under ADBs guidelines, and rated the performance of the consultants as satisfactory. The OEM also confirmed that some of the TA recommendations had been implemented, such as the establishment of a common carrier company (Petronet) and market-oriented reforms. D. Assessment of Program Results

1.

Choice of Indicators and Limitations

38. In order to measure the Programs results, a set of indicators is identified against the objectives that the Program set out to achieve. A caveat is in order that these indicators at best may be used to measure the before and after program scenarios, which may not be conclusive of the cause-effect relationship, or lack thereof, between the Program and the observed differences. Multiple factors have contributed to the implementation of the policy and institutional reforms in the hydrocarbon sector. What the OEM observed is the combined effects of various initiatives taken by the Government14 and supported by the World Bank, IMF, and ADB. 2. Achievement of Objectives

Containment of Share of Oil Imports to the 1991 Level. Table 5 shows that the crude 39. oil production increase envisaged by the Program did not materialize due to lack of exploratory breakthroughs and the fact that the existing oil fields are running dry. Several factors have contributed to this outcome, e.g., low investment, technological constraints of the PSEs, or simply lack of prospective oil reserves. While the production level remained largely stagnant over the program period, consumption and demand were continually on the increase and the economy became more reliant on imported oil with the self-sufficiency rate reduced to 37 percent in FY1998/99. Table 5: Crude Oil Production and Consumption
Domestic Production (MMT) 33.02 30.35 26.95 27.17 32.24 35.20 Private and Joint Venture Fields (MMT) Consumption/ Demand (MMT) 55.04 56.97 58.90 61.50 67.40 74.67 Percentage SelfSufficiency 55.6 49.3 42.4 40.9 44.3 47.1

Year 1990/91 1991/92 1992/93 1993/94 1994/95 1995/96

14

0.65

In fact, during the OEM, several government officials repeatedly stressed that the reforms were implemented because of the Governments strong commitment, not because of the Hydrocarbon Sector Program conditionalities. They also pointed out that the sector reforms are being pursued vigorously despite the cancellation of the second tranche and closure of the loan.

14
1996/97 1997/98 1998/99 a 1999/2000 32.90 33.86 32.72 36.55 1.35 2.51 3.04 4.00 79.17 84.29 89.36 95.00 41.6 40.2 36.6 38.4

MMT = million metric tons. a Estimated by the OEM based on published information and interviews.

40. Undertaking Sectoral Adjustment through Policy and Instrumental Reforms. Most of the loan covenants have been implemented or partially implemented, namely, conversion of ONGC into a corporate entity (para. 14), creation of DGH aimed to provide a level playing field for the private sector (para. 18), introduction of NELP (para. 21), phased dismantling of APM (para. 29), and establishment of a common carrier company, Petronet (para. 26). As a result, the general regulatory and business environment has undoubtedly grown much more marketoriented. 41. Encouraging Private Sector Participation. While the reforms have made the hydrocarbon sector more conducive to private sector participation, the anticipated competition from the private sector is yet to be realized. In the area of exploration and development, ONGC and OIL do not face any major competition. Major foreign oil companies have been reluctant to make large investments in this inherently risky venture due to the administered prices and the difficulties in obtaining marketing rights. As a result, the proportion of crude oil production from private or joint ventures under production-sharing contracts, as an indicator for measuring private sector participation, remains insignificant, e.g., four out of 37 MMT in FY1999/2000 (Table 5). 42. In the refining sector, the situation is somewhat better. Appendix 3 shows that private and joint ventures dominated the 12 newly approved refineries. However, all the prospective foreign companies including Exxon, Shell, KPC, etc. withdrew from the initial agreement due to concerns over marketing rights, administered prices, and anticipated refining overcapacity in the country. Only two domestic private companies, Reliance Petroleum, Ltd. and Mangalore Refinery and Petrochemicals, Ltd., are already in production. Despite its new ultra-modern refinery, Reliance alone will not be big enough to influence the market dominated by the PSEs. 43. Mobilizing Resources for Medium-Term Investments. The RRP estimated that a total of $10 billion would be needed in exploration and production to boost the production level, of which $4.8 billion would come from PSEs and $5.2 billion from private sectors. Existing government statistics on the amount of investment in the sector include only those by PSEs, and no information is available on total private and joint venture investments. However, private sector participation in exploration and production appears to be very limited and far from the target level due to concerns over high risks and marketing rights. Compared with exploration, refining received more substantial private investment, principally for one multibillion-dollar projectReliances 27 MMT per annum ultra-modern refinery in Jamnagar. 44. Improving Operational and Financial Efficiency of PSEs. Government statistics indicate that the total numbers of employees in India in exploration and production, and in refining have declined from 58,627 and 29,856 in FY1991/92 to 52,909 and 25,294 in FY1998/99, respectively. Over this period, the domestic crude oil production increased slightly from 30.35 MMT per annum to 33.86 MMT per annum, and the countrys refinery throughput increased from 54.254 MMT per annum to 66.672 MMT per annum. This resulted in a net per capita productivity gain, as a measure of the sectors efficiency, of 23 percent for exploration and production, and 45 percent for refining.

15

45. ONGC has been converted into a limited liability company and the PSEs have been granted considerable autonomy in their operations, including forming joint ventures with domestic and foreign private enterprises. Before 1997, there were 892 government "guidelines" which controlled the operations of the PSEs. Of these, 696 guidelines were removed in 1997. Also, in anticipation of the full dismantling of APM and industry deregulation (both scheduled to be completed by 2002), the hydrocarbon sector PSEs are striving to restructure, modernize, and streamline their technical, financial, and managerial operations and form strategic alliances with suitable domestic and foreign partners. IOC, for example, is moving upstream by entering the exploration and production of crude oil with the award of one onshore block under NELP. The sector has taken several steps to keep abreast of international technical standards in refining, e.g., Euro IV standards, and in storage and transportation. 46. The gains in efficiency, albeit moderate, can hardly be attributed to divestment as thus far divestment has not taken place in a substantial way. The reluctance to sell the family jewels, though unjustified, is very much evident (para. 35). Instead, the improvement is likely the result of the Governments initiative to streamline its PSEs to prepare them for the greater competition expected from the private sector. This was also evidenced by the recent government announcement regarding upward integration of marketing PSEs through acquisition of the standalone refineries in the public sector (para. 25). 47. Promotion of Energy Conservation and Efficiency. Between FY1993/94 and FY1998/99, Indias real gross domestic product (GDP) grew from Rs7,813.13 billion to Rs10,818.34 billion, while hydrocarbon (petroleum and natural gas) consumption increased from 78.35 MMT oil equivalent to 110.41 MMT oil equivalent. This represents a marginal increase in the economys energy intensity of 1.8 percent, measured by hydrocarbon consumption per unit of GDP. Even after allowing for data fluctuation, it is clear that the economy did not become more energy efficient over the six-year period. Wasteful use of energy is evident, particularly in areas associated with illegal or overconsumption of subsidized fuels such as kerosene, diesel, and LPG. It is widely known that nonhousehold consumers use subsidized kerosene and LPG intended for household users. The disproportionately large number of diesel-powered and inefficient taxis is also partially the result of previous subsidies on diesel (Table 1). Early dismantling of APM would obviously be desirable from the viewpoint of energy conservation and efficiency. 48. In sum, the degree to which the objectives have been achieved is characterized as a mixture of both progress and inadequacy. Real but marginal progress has been made in allowing competition, introducing of better technology, and making available resources to the sector. However, more needs to be done in the areas of productivity and efficiency. III. PROGRAM IMPACT

49. A similar caveat as used earlier should also be applied in this section: it is virtually impossible to pinpoint the exact impacts of this particular Program loan due to the multifaced nature of the reform processes. Even in terms of donor support programs, ADBs contribution was relatively modest.

16 A. Macroeconomic Impact

50. An immediate benefit expected from HSP was to assist the country in overcoming BOP difficulties. The financial assistance provided by IMF, World Bank, ADB, and OECF helped the Government meet India's import obligations and stabilize the economic situation. More importantly, the cash injection also helped improve confidence of foreign investors, which led to larger than expected inflows of foreign private capital in subsequent years. As a result, India achieved macroeconomic stability and sustained economic growth. Real GDP growth increased from 0.4 percent in FY1991/92 to 6.4 percent in FY1999/2000 (Table 6). 51. However, while the BOP support clearly succeeded, private sector participation in the hydrocarbon sector did not materialize enough to accelerate exploration and development. For much of the 1990s, the increasing dependence on imported crude oil did not put undue pressure on Indias BOP position. The surge in exports and the weak crude oil price were more than sufficient to cover the import bill such that the foreign exchange reserve reached a high of $38 billion (equivalent to 7.6 months of imports) at the end of FY1999/2000 (March 2000). The current account deficit was at its lowest in the period under discussion at 0.5 percent of GDP in FY1993/94 (Table 6). 52. The recovery may have led the Government to become complacent about the urgency to reduce the oil import dependency. As such, recent crude oil price increases have caught the Government by surprise. If the crude oil prices average $30 per barrel during the rest of the financial year, the total oil import bill for FY2000/2001 will double from FY1999/2000 level to $20 billion. This will threaten to drain the countrys foreign currency reserve, which had already declined to $32.7 billion by August 2000. The surging oil imports have also widened the yearon-year trade deficit by $300 million so far and put more pressure on the rupee, which has dropped by 3.5 percent against the dollar since April 2000 as of November 2000. 53. Another key indicator in this regard is the oil pool accounts deficit. Table 6 indicates that it reached Rs150 billion in FY1999/2000 and is likely to reach Rs236 billion ($5.1 billion) in FY2000/2001. The Government has also recently announced that it will raise the price of gasoline, kerosene, LPG, diesel, and aviation fuel to reduce the widening oil pool deficit. Table 6: Key Economic Indicators
Item Real GDP Growth (%) Oil Import ($ million) % of total imports Current Account/Balance/GDP (%) Average Price of Crude Oil ($/barrel) Foreign Exchange Reserves ($ million) Months Worth of Total Imports Oil Pool Account Deficit (Rs billion)
= data not available.

1990/91 5.7 6,028 21.6 -3.8 23.0 2,338 1.0

1991/92 0.4 5,364 25.5 -0.7 16.34 5,721 3.3

1993/94 6.0 5,650 21.1 -0.5 15.6 15,176 6.8

1995/96 7.3 7,526 17.2 -1.7 17.2 17,044 4.7 57

1997/98 5.0 8,164 15.9 -1.3 19.1 25,975 6.1 182.7

1999/00 6.4 10,482 18.9 -0.9 18.1 38,036 7.6 a 150

17
a

The OEMs estimate based on published information and interviews. The figure for FY2000/2001 is likely to reach Rs236 billion.

B.

Social Impact

54. The Program did not aim for any specific social impact. However, it supported macroeconomic stability and sustained economic development that would potentially benefit all sectors of society. The positive impacts of macroeconomic stability may have been particularly well received by the poor as they would be most vulnerable to high inflation. On the other hand, the removal of subsidies on petroleum products like kerosene and LPG for household use, an important component of the market-oriented reforms, would, in the near term at least, adversely affect the poor. However, on several occasions, the OEM learned that the subsidized fuels often do not reach poor households for which they are intended due to problems with the distribution chain, and it is often comparatively wealthy people who benefit more from the subsidy. C. Institutional Impact

55. The policy and institutional reforms had a positive impact on the institutions in the hydrocarbon sector. The creation of DGH was instrumental in attracting foreign and domestic private investment in the upstream sector. PSEs now enjoy considerable autonomy in their operations as a result of the policy reforms. Also, because their shares are traded on the national stock exchange, there is now more transparency in their financial reporting requirements compared with when they were wholly under government ownership and control. D. Environmental Impact

56. The hydrocarbon sectors operations have strong environmental implications through both the production and consumption of its products. The environment was not directly considered by HSP at its design stage. However, energy conservation and improvement of efficiency of the sector, two explicit goals of HSP, would have had indirect positive impacts on the environment, even though these objectives were not fully achieved. In addition, one of the key loan covenants of HSP was to dismantle APM and remove subsidies on petroleum products. From the environmental point of view, subsidized diesel was probably responsible for the disproportionately large number of diesel cars in major cities like Delhi and Mumbai. Diesel engines without emission controls tend to emit much higher amounts of air pollutant, e.g., particulate, than gasoline-powered engines. To that extent, the removal of subsidies on diesel since 1998 (Table 1) is beneficial for the environment, although many of the diesel-powered taxis will remain in the fleet for a few more years to come. On the other hand, subsidies for cooking gas and kerosene are perceived to be environmentally beneficial as these fuels have led to widespread displacement of coal and wood for domestic cooking and heating. Therefore, measures should be taken in the future to ensure that the complete removal of subsidies on cooking gas and kerosene do not force households to switch back to coal or fuelwood.

18 E. Sustainability

57. It appears that the economy-wide privatization, pricing, and institutional reforms which began in 1991 in India following the Gulf crisis have gained considerable momentum and become increasingly irreversible. The Government has announced the details of a phased dismantling of APM by 2002,15 it will face a major loss of credibility if it reverses this course. Further, due to the deterioration of the public infrastructure like telecommunications, power, and water, a public consensus is emerging that the private sector would do a better job than the PSEs. This is evidenced by the fact that despite several changes in the political parties in power at the center, the direction of reform has been maintained, albeit at different speeds. IV. KEY ISSUES FOR THE FUTURE

58. The OEM has identified a set of issues related to the sectors performance and formulation of program loans, which require ADBs attention in its future operations.

15

As this report was being reviewed, the Government, sensing greater urgency for reform, just announced its intent to move up this date to 2001.

19

A.

Issues Related to Sectoral Improvement

59. HSP aimed to support the Governments market-oriented reforms in the hydrocarbon sector with a clear objective containing the total share of oil imports in total oil consumption at the 1991 level. Almost 10 years have elapsed and the gap between domestic production and consumption is as wide as ever. Given the importance of the hydrocarbon sector to Indias economy and the highly volatile nature of the international oil market, it is imperative that the country continues with deregulation and pricing reforms. India must pursue private sector participation, particularly from foreign investments, with greater vigor and speed if it wants to succeed in a region where there is much competition for limited investment resources. B. Issues Related to Program Loan Formulation

60. Quick-Disbursing Loans vs. Long-Term and Complex Reforms. Like many other program loans, HSP was designed for dual purposes: BOP support (to stabilize the economy) and support for sectoral reforms. BOP support called for the quick disbursing of the loan, whereas the reforms it stipulated needed a much longer time to accomplish. Future policybased lending may consider severing the link between short-term crisis management and support for long-term market reforms. ADB-Imposed Reforms vs. ADB-Government Joint Initiatives. The Government had 61. initiated the market-oriented reforms before HSP began. One can argue that, even without the Program, the Government would still have carried out the reforms and, therefore, that the real value added of the Program was limited. However, the issue can be viewed from a different angle: if the reforms were purely ADBs initiative, the chances of their success would have been even smaller. A growing body of evidence, accumulated both within ADB and the international development community at large points to the fact that the political commitment of governments to reform is the fundamental reason for the success (or otherwise) of policy-based lending. To that extent, future policy-based lending should continue seeking a partnership with governments on their reform initiatives as this will increase the likelihood of their success or broaden the scope of existing reforms, even though it poses technical difficulties for evaluating the value added of the program, as evidenced in this case. This does not mean that ADB can play only a passive role by financing the costs of the reforms, which is very important, but can assist the Government in a variety of waysincluding providing TA, preparing reform packages, offering policy dialogues, and financing follow-up investment needs. 62. Use of Loans vs. Implementation of Reforms. The EA for loan withdrawal was the Ministry of Finance (MOF) while the EA for implementing the reform measures was MOPNG. There was no direct financial incentive for MOPNG to implement all the prescribed measures on schedule, as many reform measures could have hurt its own short-term interests. This should have been a cause for concern. Future policy-based lending should explicitly take into account proper incentives for all stakeholders through, for example, follow-up investments or other measures. 63. Market-Oriented Reforms vs. Poverty Reduction Goals. Market-oriented reforms are a common feature of all program loans aimed at improving the economic efficiency of a sector or an economy. While such efficiency improvement will eventually benefit all segments of

20 society, some reform measures, such as the removal of fuel subsidies in this case, may hurt the poor in the short term. Consequently, particular attention should be paid to assessing the impacts of economic reforms on the poor when formulating future program loans and, whenever

21 necessary, measures should be taken to protect the poor from drastic negative impacts, e.g., by allocation of a minimum amount of subsidized fuel oil to the poorest households when necessary. 64. Compliance with Loan Covenants vs. Achieving Program Goals. The decision to cancel the second tranche was based on noncompliance with a loan covenant stipulating the divestment of 20 percent of ONGC. However, even with the full compliance of this covenant at a discounted price, it would have not led to better achievement of the program goals, e.g., raising additional capital and improving accountability (paras. 15-16). Conversely, nominal divestment was carried out through, for example, cross-shareholding among different PSEs, but it did little to raise additional capital and increase private sector participation. Thus, in administering as well as evaluating future program loans, more attention should be paid to assessing to what extent the program objectives are achieved rather than on simply monitoring the compliance status of covenants. V. CONCLUSION

A.

Overall Performance

65. Program Relevance, Appropriateness, and Sustainability. The market-oriented policy and institutional reforms envisaged under HSP were highly relevant, timely, and most of them were appropriate. However, the reforms aimed at improving the sectors efficiency do not necessarily validate import substitution as the primary motivation of the Program. The issue of the relative economic competitiveness of domestic crude oil production against imports was not extensively addressed during the Programs formulation. Instead, a reduction in spending from a limited amount of foreign currency available on oil imports and, more implicitly, long-term oil supply security, were regarded as the primary rationale for the Program. Although currently high world crude oil prices appear to reinforce the rationale, the long-term economic viability of domestic oil production competing against imports remains to be seen. The OEM also observed that many of the reform measures, including establishment of DGH, phased dismantling of APM, and devising favorable policies and incentives to attract foreign investment in the sector, have been or are being implemented. Many of the reform measures implemented, and indeed the general (but slow) trend of greater economic liberalization are increasingly irreversible. 66. Program Efficacy and Rating. Despite the positive observations, the OEM rates the Program less than successful. Several factors have contributed to this assessment. First, as stated earlier, it is inappropriate to attribute the new developments wholly to HSP. In fact, the Government continued to press ahead with the reforms despite the cancellation of the second tranche by ADB. Second, arguably the most important goal of the Program, i.e., to contain the share of oil imports at the 1991 level of 45 percent, was not realized, as the present level of selfsufficiency is only 37 percent. Third, the loan covenant of divesting 20 percent of Government equity in ONGC was found to be not only unrealistic but also ineffective from the viewpoint of achieving the Programs objectives. Lastly, a less than successful instead of an unsuccessful rating reflects the substantial progress that has been made in market oriented-reforms with the anticipation that greater progress will be made in the near future.

22 67. Borrower and ADB Performance. Both MOF and MOPNG registered satisfactory performance in terms of administering the Program and monitoring progress. MOPNG, despite several changes of government and the Programs lack of explicit consideration for its financial incentive, demonstrated commitment to implementing the reform measures stipulated by the Program. However, ADBs performance was deemed less than satisfactory on several fronts. The Program was not well conceived, despite the fact that the broad framework was consistent with ADBs country operating strategy, and the loan preparation was rushed. As a result, the chances of a successful Program were compromised by the various design deficiencies. The problems were further aggravated by the inflexible manner in which implementation was handled. B. Lessons Learned

68. Realistic Goals Based on In-Depth Sector Analysis. Success of program loans depends on the formulation of realistic policy and institutional reforms. For HSP, the target of 20 percent divestment of the Government's equity in ONGC was unrealistic. No analysis was conducted regarding what regulatory and market preconditions for such a large and complex divestment should take place without jeopardizing shareholder value. The RRPs analysis on program risks did not even mention that potentially poor market response could adversely affect compliance. In addition, the target for additional domestic crude oil production was unrealistic as it ignored the fact that the investments alone were no guarantee of finding and producing oil. 69. Flexibility in Loan Conditions. ADB sent mixed signals to the Government when it allowed OECF to release the second tranche while canceling its own second tranche. In the implementation of program loans, ADB should adopt a flexible approach. Flexibility and willingness to adapt will be a crucial factor for the success of ADBs future operations in India.

23

APPENDIXES Cited on (page, para.) 3,12 4,17 6,24

Number 1 2 3

Title Compliance Status of Policy Matrix Hydrocarbon Sector in India Status of Approved Refinery Projects

Page 19 24 31

COMPLIANCE STATUS OF POLICY MATRIX

Condition
A. 1. Prior to Second Tranche Release Restructuring and Divestment of State Enterprises Submission of report by the Committee appointed by the Government (April 1992) to examine all aspects of ONGCs existing organization and activities. Incorporation of new companies based on the recommendation of the Committee (July 1992). Complied with. The Kaul Committee was set up on 24 January 1992, and the Committees Report was submitted to the Government in December 1992. Delayed Compliance. By an Act of Parliament, ONGC was converted from a statutory body to a public limited company under the Companies Act in September 1993. This provided for the transfer and vesting of the undertaking of the Commission into a corporation. Complied with. There are no further acquisitions by ONGC of oil rigs or of supply and support vessels including crews for seismic surveys from FY1993. Well drilling, workovers, and other services related to oil and gas production have been outsourced from private sector companies. Partially complied with. Close to 4 percent has been divested to employees and domestic financial institutions. Same as PCR.

PCR Status

OEM Status and Remarks

Same as PCR. ONGC is now a full commercial entity.

Divestiture of ONGCs selected activities to new companies to the extent that such divestiture is recommended by the Committee (January 1993).

Same as PCR.

20

20 percent of government equity in ONGC or its equivalent in the new corporate structure (including the new structure for oil field equipment and services) recommended by committee. Implementation of measures identified to increase the managerial and financial autonomy and accountability of public sector enterprises in the hydrocarbon sector (January 1993).

Additional 12 percent was divested in 1999 through a cross-shareholding scheme by different oil and gas PSEs, but the Government remains the majority shareholder for these PSEs. Same as PCR. It was noted during the OEM that some governmental officials and industry executives are board members for different PSEs within the sector at the same time. This structure could potentially compromise their capability of taking independent views to best represent the interests of any single PSE.

Complied with. Major measures include: (i) an increase in the approval authority of the board of directors for capital expenditure of approved projects; (ii) simplified appraisal procedures where capital investments require the Governments approval; and (iii) access to capital markets. The conversion of ONGC from a statutory body to a corporation under the Companies Act provides it with much greater flexibility and managerial autonomy to five public sector enterprises in the hydrocarbon sector. Delayed compliance. After completion of TA 1645 in January 1994, discussions were held between the Government and ADB on the findings of the

Appendix 1, page 1

Commencement of policy dialogue between the Government and ADB to implement the study (January 1993).

MOPNG expressed the desire to continue policy dialogue between ADB and the Ministry of Finance on new development in the sector.

Condition
study. 2. Encourage Increased Private Sector Participation Confirmation of Governments decision to divest shares in selected public sector enterprises engaged in oil refining and marketing (February 1992). Sale of 20 percent of Governments equity in one integrated or two nonintegrated public sector oil refining/marketing companies to mutual funds, financial institutions, general public, and workers (June 1993). Government to allow new refineries in the private sector or as joint ventures and to allow them to market petroleum products (July 1992).

PCR Status

OEM Status and Remarks

Complied with. An announcement was made by the Government in February 1992.

Same as PCR.

Complied with. The Government has divested its holdings as follows since 1992: IOC, 8.74 percent; BPC, 33.80 percent; HPC, 48.84 percent, and IBP, 40.40 percent. Complied with. The Government has approved the establishment of 11 new refineries (five by private and six by public-private joint ventures).

Same as PCR.

Government to allow private sector franchising, joint ventures, etc. for LPG bottling (June 1993).

Complied with. As a result of implementation of parallel marketing system introduced in February 1993, LPG bottling and marketing is open to private sector companies. Delayed compliance. After completion of TA 1646IND in October 1993, policy dialogue was held between the Government and ADB on the findings of the study. Complied with. Contracts were signed for five medium-sized fields as a result of the first offering in August 1992 and one medium-sized field was awarded during the second offering in September 1993. Complied with. Contracts for 13 small fields were signed as a result of the first offering in August 1992 and 11 small fields were awarded during the second offering in September 1993. Complied with. Twenty-two contracts have been signed out of 35 exploration blocks awarded to private companies since Fourth Round bidding in 1991.

Partially complied with. But out of the 11 newly approved refineries, only two have been commissioned, schemes for three have been shelved and the others have been delayed. All the original foreign partners have withdrawn. Marketing of the top five petroleum products is still done by PSEs and only the lubricants and part of the LPG market is open to private companies. Same as PCR. The market segment open to private sectors, i.e., industrial and commercial customers, is relatively insignificant, 0.5 MMT in the entire market of 6 MMT. Same as PCR.

21

Commencement of policy dialogue between the Government and ADB to discuss the study (July 1992).

Finalization of initial agreements for development of a few medium-sized oil and gas fields (June 1993).

Same as PCR.

Appendix 1, page 2

Finalization of initial agreements for development of some small oil and gas fields (June 1993).

Same as PCR.

Finalization of agreements with local/foreign companies for exploration on production sharing basis under the Fourth Round offering made in August 1991 (January 1993).

Same as PCR. Some private and joint ventures have formed productive capacity. In FY1999/2000, the total crude output from these ventures was approximately 4 MMT.

Condition

PCR Status

OEM Status and Remarks

3. Institutional and Regulatory Framework Agreement Establishment of a DGH within MOPNG for regulatory oversight of exploration and production activities (June 1993). Creation of a cell within MOPNG to actively seek local and foreign private investment in hydrocarbon operations (July 1992). Complied with. DGH was established in April 1993. Same as PCR. The DGH now plays a vital role in providing a fair and open mechanism for all companies interested in entering the exploration and production sector. Not complied with.

Delayed compliance. A team was formed to handle local and foreign private investment in 1992. A contract cell for hydrocarbon development was created in 1995. After staffing, this will be changed to an investment cell.

4. Pricing and Marketing Allocation Finalization of review of the pricing structure for oil refining and distribution companies with the objective of enhancing operational efficiency (June 1992). Complied with. Review completed. Consumer price increased by 5-22 percent and producer price increased by 55 percent in September 1992. Deregulation of APM reviewed since January 1995. Complied with. The import of naphtha, kerosene, LPG, and lubricants has been deregulated and parallel marketing allowed in 1993. The pricing structure was revised in 1994. Complied with. A gas policy encompassing market-based allocation of gas supplies has been in place since January 1993. Within this framework, the marketing of gas may be undertaken by public and private sector companies. Public, private, and joint public-private utilities are active in gas distribution. Gas produced by the private sector is free of any marketing or price controls. Complied with. Domestic private sector companies are at par with international oil companies. With the change in the basis of calculating domestic crude oil prices, the net return to the national oil companies and the terms agreed upon with the private companies are comparable. Some of the concession areas have been relinquished by the national oil companies and are included under the areas offered to the private sector. Same as PCR.

22

Implementation of revised pricing structure for oil refining and distribution companies (June 1993).

Same as PCR.

Formulation of a gas policy (including a policy for allocation) and allowing gas marketing by the utility companies in accordance with the policy (January 1993).

Same as PCR. However, the current two-tiered market characterized by a dual pricing mechanism, i.e., households marketed by PSEs under APM and industrial and commercial customers marketed by private and joint ventures at market prices, prevents private and joint ventures from gaining market share.

Domestic hydrocarbon exploration and production companies in the private/public sectors be allowed to operate on the same basis as foreign companies, including terms of pricing, profit sharing, relinquishment of concession areas, and work programs (June 1993).

More blocks have been awarded to private companies including major multinational oil and gas companies.

Appendix 1, page 3

Condition

PCR Status

OEM Status and Remarks

B. Before the End of the Program Period 1. Restructuring and Divestment of State Enterprises Further divestment of Government equity in public sector oil refining and marketing companies.

Pending. First stage divestment only partially complied with.

No further divestment can be expected until 2002 when APM is scheduled to be fully dismantled.

2. Encourage Increased Private Sector Participation Further divestment of Government equity in public sector oil refining and marketing companies. Complied with. The Government has already divested from two integrated oil companies beyond the stipulated 20 percent and has undertaken action for further divestments in the sector for the target of 51 percent of the Governments shareholdings in the hydrocarbon sector of public companies. No further divestment can be expected until 2002 when APM is scheduled to be fully dismantled.

3. Institutional and Regulatory Framework Enhancement Adoption of the regulatory framework, as required, to reflect the increased role of the private sector as well as the increased utilization of market forces in allocating resources within and between the hydrocarbon sector and the economy as a whole. Partially complied with. The Government has approved in principle the legislative framework for creation of a regulatory authority in the upstream sector. The Parliamentary Committee on Subordinate Legislation has taken up for consideration the exact scope of work of the authority to be created for regulation. Pending. The Government is now considering a single regulatory agency for the entire hydrocarbon sector, i.e., oil and gas.

23

4. Pricing and Marketing Allocation Further deregulation of administrative pricing of petroleum products in line with the development of more competitive market structure. Complied with. The Government began dismantling APM in a phased manner from 1 April 1998. Five petroleum products are now administered by the Government. Subsidies for liquid fuels, except kerosene and LPG, were removed on 1 April 1998 and subsidies are expected to be phased out by 2002. From 2002, all prices will be fully deregulated. Complied with. The price of natural gas is linked to the international price of a basket of fuel oils, the linkage increased from 5 percent in FY1998/99 to 65 percent in FY1999/2000 and 75 percent in FY2000/01. The pricing structure will be reviewed Same as PCR.

Appendix 1, page 4

Review of consumer pricing policies for hydrocarbon products to determine how efficiency of the pricing structure can be improved.

The current price parity for most petroleum products is above 80 percent of international prices, subject to floor and ceiling prices.

Condition

PCR Status
in March 2000 to move toward 100 percent parity with the international price of fuel oil.

OEM Status and Remarks

V. Energy Conservation Programs to promote energy conservation in energy-intensive industries, including a program of energy audits, to be actively pursued. An Energy Management Center set up by the Government carried out energy audits and helped conserve energy. In the corporate reporting system in India, companies must report on energy conservation measures undertaken. There are also many active NGOs engaged in energy conservation. An Energy Conservation Week is observed every year with the help of state governments to spread awareness of conservation of energy. In addition, various measures have been undertaken including introduction of new technologies by the refineries to conserve energy. The Government has recently banned leaded gasoline and has reduced the permissible sulfur content in high speed diesel to 0.25 percent. The Indian economys energy intensity exhibited a marginal increase (i.e., became less efficient) during the program period. Waste associated with use of subsidized fuels are still evident.

ADB = Asian Development Bank, APM = administered price mechanism, BPC = Bharat Petroleum Company, DGH = Directorate General of Hydrocarbons, HPC = Hindustan Petroleum Corporation, IBP = Indo Burma Petroleum, IOC = Indian Oil Company, LPG = liquefied petroleum gas, MMT = million metric tons, OEM = Operations Evaluation Mission, MOPNG = Ministry of Petroleum and Natural Gas, ONGC = Oil and Natural Gas Corporation, NGO = nongovernment organization, PCR = project completion report, PSE = Public Sector Enterprise.

24 Appendix 1, page 5

25 HYDROCARBON SECTOR IN INDIA

Appendix 2, page 1

1. The hydrocarbon sector in India is presently undergoing profound changes that may have far-reaching impacts on the sectors long-term performance. The following is a snapshot overview of the sector covering major players, and the regulatory and economic environment in which they operate, as of the Operations Evaluation Mission (OEM) period 5 to 23 September 2000. As the Governments efforts in market-oriented reforms deepen, the roles of various players in the sector may vary. A. Government Agencies with Responsibility for the Sector

2. The Ministry of Petroleum and Natural Gas (MOPNG) annual report defines its mandate as The Ministry is concerned with exploration and production of oil and natural gas, and refining, distribution and marketing, import, export and conservation of petroleum product. At present, MOPNG plays a central role in all key aspects of the sectors policy and strategic decision making, as well as in some operational issues. As market reforms deepen, it is expected that MOPNG may gradually withdraw from its day-to-day involvement in business decision making and focus more on its supervisory and regulatory responsibilities 1. Oil Industry Development Board

3. The Oil Industry Development Board (OIDB) was created in 1975 under Oil Industry (Development) Act, 1974. As a financing arm of MOPNG, its primary objective is to render financial and other assistance for promotion of all such measures that are conducive to the development of the oil industry. The main functions of OIDB are to provide concessional loans for high-risk exploration and grant assistance for research and development (R&D) in the hydrocarbon sector. This includes:
(i) (ii) (iii) (iv)

advancing loans to oil industrial companies; disbursing loans and grants for the implementation of research and development programs conducive to the development of the oil industry; refinancing oil industrial loans granted by the oil companies to industrial units; and funding expenditure of various study groups, consultancy cells, scientific advisory committees, task forces, project monitoring cells, etc.

4. OIDB has received Rs90.2 billion from the cess levied and collected by the Government on domestic crude oil. The targeted recipients of OIDB funding have been predominantly oil and gas public sector enterprises (PSEs). The significance of OIDB is somewhat uncertain amid the ongoing sectoral reforms, anticipated greater private sector participation, and greater competition from commercial financial institutions. 2. Directorate General of Hydrocarbons

5. The Directorate General of Hydrocarbons (DGH) was established in April 1993 as an advisory body to MOPNG in matters relating to oil exploration and development, and to assemble and integrate all data pertinent to the concessional areas leased for oil-and-gas related activities. It advises the Government on the offering of areas for exploration as well as on matters relating to relinquishing of areas, reviews the adequacy of exploration and development programs, and advises the Government on oilfield safety and environmental issues. The establishment of DGH was stipulated as one of the key loan covenants of the

26

Appendix 2, page 2

hydrocarbon sector program on institutional and regulatory framework reform which will set the stage for creating a level playing field for all players in exploration and production, public or private, foreign, or domestic. 6. The establishment of DGH has created this more level playing field as far as the public and private sectors are concerned. Under the new exploration-licensing scheme, the Oil and Natural Gas Corporation (ONGC) and Oil India Limited (OIL) are required to compete on equal terms with private parties. In addition, data on exploration acreage on offer are now available to the private sector on the same basis as to the public sector. At the time of the OEM, five blocks had been opened for bidding under the New Exploration Licensing Policy (NELP). They consist of a cross-section of high-risk and low-risk fields. 3. Oil Coordination Committee and Oil Pricing

7. The Oil Coordination Committee (OCC) was set up on 14 July 1975 through a Government of India Resolution on the recommendation of the Interim Report of the Oil Prices Committee (OPC). The secretary, MOPNG, is the Chairman of OCC, and the committee comprises an additional secretary, joint secretaries, and a financial adviser of MOPNG, chief executives of oil companies, and the executive director of the Oil Industry Safety Directorate. The day-to-day functions are handled by the OCC secretariat under the executive director of OCC. 8. The main functions of OCC are as follows: (i) (ii) (iii) (iv) (v) (vi) (vii) monitoring the performance of the oil industry to achieve optimality; preparing estimates for supply/demand and import plans; assisting MOPNG in the preparation of Oil Economy Budget (OEB); coordinating supply of crude oil to the refineries; operating and maintaining pool accounts; coordinating major marketing activities of the oil industry; coordinating with various government departments/agencies to facilitate coordination with the railways on optimizing tank wagon movements and the movements of petroleum products, etc.; and assisting MOPNG in the management of crisis and special situations such as strikes, floods, elections, etc., for uninterrupted supplies of petroleum products.

(viii)

9. The pricing, subsidy, and tariff levels are administered by OCC through a mechanism called the oil industry pool accounts. Under such a mechanism, inflows from collection of surcharges on the sale of petroleum products and outflows for meeting the claims for variation in the elements included in the price build-up are adjusted. The difference between inflows and outflows represents the surplus or deficit position of the pool accounts. The main objectives of the pool accounts are to: (i) maintain stable and uniform prices throughout the country in recognition of the need to import crude oil for refineries and for finished products to meet the deficit in domestic production; and provide subsidies or cross-subsidies on some petroleum products.

(ii)

10. Oil pool accounts are supposed to balance over a period of time and there is no need for government budgetary support. The pool accounts were generating a surplus up to FY1988/89.

27

Appendix 2, page 3

However, due to high crude oil prices, the accounts deficit by the end of FY2000/01 is expected to reach Rs150 billion. 11. The Government took steps to align the petroleum prices with open market prices and gradually phase out administered price mechanism (APM). In November 1997, it announced the details of a phased dismantling program of APM and of the duty structure from April 1998 until 2002 as follows: (i) cost-plus formula for indigenous crude oil producers has been withdrawn and gradual import parity established, currently standing at 82 percent of imported crude oil prices subject to ceiling and floor constraints; retention pricing for all refineries has been abolished (except refinery gate prices of controlled productsgasoline, diesel oil, kerosene, liquefied petroleum gas (LPG), and aviation fuelwhich are fixed in accordance with the principles of adjusted import parity price for the existing refineries during the transition period); consumer prices of gasoline, diesel oil, kerosene, aviation fuel and LPG (for domestic use) will continue to be administered; and prices of other petroleum products like naphtha, fuel oil, bitumen, and paraffin wax have been decontrolled since 1 April 1998.

(ii)

(iii) (iv) B.

Exploration and Production

12. Presently, two major PSEs in exploration and production are ONGC and OIL, which together provided little less than 33 million metric tons (MMT) of crude oil in FY1999/FY2000, with ONGCs share estimated at over 29 MMT. Additionally, private and joint venture companies produced approximately 4 MMT, bringing the total to 36.55 MMT for the year. 13. The net production of natural gas was 27.428 billion cubic meters (m3), including 2.87 billion m3 from private and joint venture companies, in FY1999/2000, a marked increase from 18 billion m3 in FY1991/1992 at the start of HSP. 1. Oil and Natural Gas Corporation

14. ONGC was formed by an Act of Parliament to take over the activities of the Oil and Natural Gas Directorate set up by the Government in 1956. It was a statutory body until it was corporatized under HSP in September 1993. As the countrys dominant upstream oil company, it carries out geological and geophysical surveys, exploratory drilling, development drilling, and exploitation of hydrocarbon resources. Until recently, ONGC had the virtual monopoly of all offshore and most onshore exploration and production activities. 15. Presently ONGC has about 40,000 employees, down from 47,000 at the beginning of HSP in 1991. It is envisaged that the total workforce will be further reduced to 35,000 in five years through voluntary retirement. The company is in a relatively healthy financial situation. In FY1998/99, the company produced 27.55 MMT crude oil and 23.97 billion m3 natural gas for a net profit (after tax) of Rs27.545 billion. 16. Despite the relatively healthy financial picture, the future of ONGCs production capacities allows for no optimism. Its existing oil fields are running dry, and its exploration activities have made no major findings of oil and gas fields. As such, ONGC, and the entire upstream exploration and production system, has been targeted by MOPNG as a priority area for attracting foreign direct investment and technological collaboration, particularly in the areas

28

Appendix 2, page 4

of deep-sea exploration and technology related to prolonging the productive lives of existing wells. 17. Under the NELP (which the Government claims is one of the most favorable in the world), a total of 48 blocks have been offered. By the bid closing date of 18 August 1999, a total of 45 bids were received from both foreign and Indian companies including public sector undertakings, of which 25 blocks were awarded, including three to Enron and eight to a consortium formed by major domestic private corporations, i.e., Tata and Reliance. In addition, ONGC is actively seeking foreign partners for the exploration of the six blocks that it has been awarded. A total of 17 foreign firms expressed interest including Total of France and BG International of the United Kingdom. In addition to collaborating with foreign companies in domestic exploration and production, ONGC is also looking to provide drilling services to secure production contracts overseas including Bangladesh and Oman. ONGC has established ONGC Videsh Limited (OVL), a wholly subsidiary, to enter into joint ventures for exploration and production in other countries. OVL, in partnership with BP-Amoco and Statoil, has already discovered offshore gas in Viet Nam. 18. The latest international crude oil price increases have generally weighed in favor of the upstream companies like ONGC. This is because prices of the domestically produced crude have been pegged to international prices on an increasing-proportion basis since 1998 (when the old cost-plus pricing formula was abolished). The proportion started at 75 percent and has been increasing gradually to the present 82.5 percent of the international crude oil price, subject to a ceiling of $25 per barrel. The ceiling crude oil price is imposed to curtail excessive costs to the downstream companies and consumers during severe international crude oil price increases, and to compensate for the floor prices when there is a sharp decrease in prices. 2. Oil India Limited

19. OILs origins date back to the time when oil was first discovered in Assam in 1889. The Government of India, which was a joint venture partner with Burmah Oil Company, took over the latters shareholding in full in 1981. As with ONGC, although on a much smaller scale, OILs primary activities are exploration, production, and transportation of hydrocarbons, with a rough breakdown of sales as follows: crude oil (90 percent), natural gas (5 percent), transportation charges (3 percent), and LPG (2 percent). OILs operations are very much confined to northern India including Assam, Arunachal Pradesh, Orissa, Rajasthan, the Mahanadi basin, and several offshore areas. C. Private and Joint Venture Companies

20. At present, private and joint venture companies contribute approximately 4 MMT to total domestic production of crude oil (about the same as OILs production). Most of these private companies, including ESSAR, HOEC, Okland, and Shell are operating under production sharing contracts (PSCs) with ONGC operating on existing known oil fields. The proportion of crude oil production from private companies and joint ventures is expected to rise in the coming years as more and more private (domestic and foreign) companies are awarded blocks for exploration under the Governments NELP. D. Refining

21. The refining subsector has been delicensed since 1998. The Government has opened oil refining to the domestic and foreign private sector. During the Program, the Government

Appendix 2, page 5 29 approved 12 new refineries. Of these, twoReliance Petroleum Refinery Ltd. and the Mangalore Refinery and Petrochemicals, Ltd.are already in production while three private firms have already withdrawn. 22. With the commissioning of several large modern refineries, Indians refining capacities have increased from 69.14 MMT per annum as of 4 January of 1999 to 109.04 MMT per annum as of 1 January 2000, making the country almost self-sufficient in the refining sector. Total capacity is expected to further increase to 126 MMT per annum by the end of the Ninth Plan (1997-2002). There are currently 17 refineries in the country, of which seven are owned by the Indian Oil Corporation, Ltd. 1. Indian Oil Corporation Limited

23. The Indian Oil Corporation Limited (IOCL) was established on 1 September 1964 with the merger of Indian Refineries Ltd. and the Indian Oil Company Limited with the main objective of coordinating and controlling the refining and distribution activities of these two oil companies effectively. 24. With a total workforce of 32,000, IOCL is the largest commercial undertaking and only Fortune 500 company in India. IOCL is both a refining and marketing company. With seven refineries and 35.6 MMT per annum combined capacity, its refining capacity accounts for roughly one third of Indias total. It also owns and operates a 6,543 km network of pipelines with an installed capacity of 43.45 MMT per annum. 25. The refineries of IOCL achieved a crude throughput of 30.36 MMT during FY1998/99. Against the contracted target of 31.80 MMT for FY1999/2000, the throughput achieved up to December 1999 was 23.86 MMT. In FY1998/99, IOCL achieved a turnover of Rs6,943 billion for an after-tax profit of Rs221 billion. 2. Hindustan Petroleum Corporation Limited

26. The Hindustan Petroleum Corporation Limited (HPCL) is a PSE (with the Government holding 51.06 percent) and the second largest integrated oil company in India. It has two refineries producing a variety of petroleum productsfuels, lubricants and specialty products, one in Mumbai (on the west coast) having a capacity of 5.5 MMT per annum and the other in Visakhapatnam (on the east coast) with a capacity of 4.5 MMT per annum (being expanded to 7.5 MMT per annum). HPCL also operates the only joint venture refinery in the country in association with the Aditya Birla Group of Companies (an Indian private conglomerate). 27. During FY1998/99, the two refineries of HPCL achieved a combined crude oil throughput of 9.07 MMT, or a little less than one third of IOCLs level. The sales turnover increased to Rs2,599.46 billion in FY1998/99 for a net profit of Rs90 billion. 3. Bharat Petroleum Corporation Limited

28. The Bharat Petroleum Corporation Limited (BPCL) is an integrated oil company in the downstream sector engaged in refining crude oil and marketing petroleum products. It has also diversified into the manufacture and marketing of petrochemical feedstocks. The Governments holding in BPCL is 66.2 percent.

30

Appendix 2, page 6

29. During FY1998/99, BPCL oil refinery achieved a throughput of 8.94 MMT. The sales turnover in FY1998/99 was Rs2,565 billion, compared with Rs2,070 billion the year before, for a profit after tax of Rs70 billion. E. Standalone Refineries

30. Major standalone refineries in India include Cochin Refineries, Chennai Refineries, Mangalore Refineries, and Reliance Petroleum. The crude oil throughput for these companies for FY1999/2000 were 7.8 MMT, 7.0 MMT, 5.2 MMT, and 9.9 MMT, respectively. 31. In a move to pave the way for the PSEs to meet anticipated competition, the Government has recently announced consolidation of the oil sector whereby all the standalone refineries in the public sector will be converted into subsidiaries of larger PSEs. While BPCL will buy out the entire government stake in Cochin Refineries, it will take over Indo Burma Petroleums (IBP) stake in Numaligarh Refinery in Assam. Market leader IOCL will buy out the entire stake in both Bongaigaon Refinery and Chennai Refinery. IOCL and BPCL are expected to spend nearly Rs20 billion to acquire stakes in these oil refineries. 32. The rise of Reliance Petroleum represents major progress in private sector participation in the sector. Through vertical integration, Reliance has gradually moved upstream from textile to petrochemical, to refineries and to oil exploration and production. With its recently commissioned ultra modern refining facility with an installed capacity of 27 MMT per annum, Reliance will be a major force in the refining sector. F. Marketing

33. Unlike the refining sector, the retail sector is virtually controlled by four PSEs, i.e., IOCL, BPCL, HPCL, and IBP, which have, over the years, developed an extensive network of storage, transportation, and retail outlets nationwide. IOCL currently controls over 54 percent of the market with BPCL and HPCL controlling approximately 20 percent each. Any company, foreign or domestic, that wishes to engage in marketing activities has to invest a minimum of Rs20 billion in oil and gas infrastructure. The first domestic private company that met this criterion was Reliance Petroleum Refinery Ltd., which is currently applying for, and is expected to obtain, rights to market petroleum products. 34. The existing natural monopoly, as well as the requirement of investment in upstream activities, has served to deter some potential investors in the hydrocarbon sector as a whole. Very few risk-averse foreign oil and gas companies are willing to invest millions of dollars in exploration and refineries without first being guaranteed marketing rights. G. Gas Distribution and Marketing

35. The total net production and consumption of natural gas was 25.71 billion m3 for FY1998/99. Prior to 1984, ONGC and OIL handled the production, transmission, and distribution of natural gas. Since 1984, distribution and marketing have been largely taken over by Gas Authority of India Limited (GAIL). 36. Gas Authority of India Limited. The Gas Authority of India Limited (GAIL), set up in 1984, is the largest natural gas transmission company in India. The company owns and operates a network of over 4,000 km of pipelines. GAIL primarily targets large industrial and commercial customers including those PSEs in the power and fertilizer industries for its natural

31

Appendix 2, page 7

gas. Total gas sales for FY1998/999 were 21 billion m3. GAIL also operates six natural gas processing plants with an installed capacity to produce 961,000 tons of LPG per year. H. Private Sector Involvement in LPG

37. At present, the total market size for LPG is about 6 MMT, of which approximately 5.5 MMT is sold to domestic households by four major PSEs, i.e., IOCL, GAIL, BPCL and HPCL, at a subsidized price under APM. The remaining 0.5 MMT is sold to industrial and commercial customers at market prices. As part of industry deregulation the Government has, since 1993, allowed private sector participation in importing and retailing LPG to cater to this small segment of the market. This has led to the establishment of a number of private sector units for importing and marketing LPG and kerosene in the private sector. Most major multinational oil and gas companies currently operating in India, including Shell, Caltex, ELF Gas, Mobil, and SHV, are now limited to this small segment of the market. I. Oil Pipeline Transmission

38. Petronet India Limited. Petronet India Ltd. was established in 1998 as a financial holding company with the specific objective of rapidly developing a national network of pipelines for transporting petroleum products to which all producers in the private and public sectors will have open access. Half of the equity in the company is held by five PSEs including IOCL, BPCL, and HPCL. The remaining 50 percent is held by financial institutions and private companies, with no individual entity holding more than 10 percent of the total. The creation of Petronet was in line with a key recommendation by TA 1645-IND for the creation of a new independent common carrier company to manage all pipelines and associated terminals and ensure open access by all oil companies. 39. Individual pipeline projects are undertaken as joint ventures wherein Petronet holds 26 percent of the equity, oil companies and private companies up to 26 percent, while the balance is held by financing institutions and other investors. 40. Petronet has identified eight pipeline projects for implementation. Joint ventures for four have been incorporated, of which, one (Vadinar-Kandla) has been completed and three are under construction. Detailed feasibility studies for the other four projects are scheduled to be completed in 2001.

32 STATUS OF APPROVED REFINERY PROJECTS

Capacity (MMTPA) 27 Expected Completion Fiscal Year 1999/2000

Appendix 3

Name Reliance Petroleum Refinery Ltd.

Type Private

Status at OEM Commissioned in late 1999. Currently operating at 27 to 30 MMTPA.

Essar Refinery Central India Refinery

Private Joint

9 6

2001/02 2001/02 All government clearances have been obtained but physical work has not started. It will take another 48 months. This is a joint venture with Oman Oil Company at an estimated cost of Rs5,277 million crores. Commissioned. The project has been deferred because of too much capacity on the west coast. This is an HPC project. This is an IOC venture with KPC. KPC withdrew in December 1999. Expected capacity is 4 to 7.5 MMTPA. This was originally a joint venture between BPC and Shell. Shell has withdrawn from the project. It is unlikely that anything will happen before 2005. This was originally a joint venture between HPC and Exxon. Exxon withdrew from the project and HPC is in the process of selecting another partner. Withdrawn. Withdrawn. Withdrawn.

MRPL Expansion West Coast Refinery

Joint Joint

6 6

1999/2000 Uncertain

East Coast Refinery

Joint

2002/03

UP Refinery-Sultanpur

Joint

Uncertain

Punjab Refinery

Joint

2003/04

Soros Refinery N. Denro Ashok Leyland

Private Private Private

6 9 2

Uncertain Uncertain Uncertain

BPC = Bharat Petroleum Company; HPC = Hindustan Petroleum Corporation; IOC = Indian Oil Company; KPC = Kuwait Petroleum Corporation; MMTPA = million metric tons per annum; MRPL = Mangalore Refinery and Petrochemicals Ltd.; OEM = Operations Evaluation Mission; UP = Uttar Pradesh.