THE SQUABBLE OVER THE SPOILS OF KG BASIN

So much has been written about the squabble between the Ambani brothers over the gas being produced from the KG Basin that I cannot resist putting in my two cents on the issue.

For the uninitiated, at the heart of the issue is the memorandum of understanding (MOU) executed between Mukesh and Anil at the time of their family settlement in 2005 whereby Mukesh agreed to cause Reliance Industries Limited (RIL) to sell to Anil’s Reliance Natural Resources Ltd (RNRL) 27 MMSCMD  (million standard cubic meters per day) of gas to be produced from RIL’s block in KG Basin at a fixed price of USD 2.34 per mmbtu (million british thermal units) (approximately USD 0.10 per standard cubic meter) for use by Anil at his proposed power plant in Dadri. As things unraveled post settlement, Anil did not put up the plant at Dadri citing Mukesh’s retracting from the commitment and Mukesh cited the government’s fixing a higher price of USD 4.2 per MMBTU as his reason for not being able to honour the commitment under the MOU which had predicated the supply on the approval of the sale price by the Government.

In typical Anil fashion, the matter has been escalated in Courts and while he has gotten a favourable judgement from the Bombay High Court, RIL has petitioned the Supreme Court with special leave to have the judgement of the Bombay High Court set aside.

Now for my two cents…

At the outset, let me state that this matter is, in my view one of the most interesting case studies for any student of management, political science, law or corporate governance in the present day, not just in the Indian context but globally. It is a matter which is matched in its complexity only by the far reaching implications it will have for all the parties involved. What makes this matter even more prestigious is that it is a test of the Reliance group’s abilities to maneuver the dispensation and regulatory framework yet again, and Mukesh has to prove his worth as the heir of his father by doing something that Dhirubhai never had to do, go up against one of his own.

To better appreciate the matter, one has to take a step back to 2002 when Dhirubhai died leaving behind the vast Reliance empire comprising of diverse business interests and convoluted holding structure. The shareholding of the Reliance group companies and more specifically the flagship RIL was held by over a hundred investment companies which found their genesis in the law changing tax manipulations of Dhirubhai. They say that Dhirubhai died intestate. But I don’t agree. He was too shrewd a person to leave such a huge empire without a succession plan. He was deliberate in not leaving a will. For he very well knew that the devolution of the Reliance empire would be atypical, insofar as it would not turn on transfer of shareholdings (something which was even otherwise a daunting task considering the large cross holdings between the various companies). Dhirubhai, in his charateristic fashion had esconced the succession and control of the Reliance empire in the holding structure whereby the voting rights of all the holding companies were vested with the chairman of RIL. He gave effect to the succession plan during his lifetime by making Mukesh (and not Anil) the Chairman of RIL thereby giving him the unfettered control over the entire group.

Of course this did not go down well with the younger brother and we all bore witness to the dirty laundry being aired in public with similar gusto and mass appeal as Dhirubhai’s path breaking equity issues in the 80’s. The matter was settled in 2005 with the intervention of the matriarch and Mukesh agreeing to part with his baby, Reliance Infocomm, as also pretty much all of the other assets, except for RIL as part of the infamous family settlement and the MOU which is at the centre stage of the litigation now.

It would of course be unduly gratuitous to Mukesh to say that he made the supreme sacrifice for his brother in this settlement. No. He played it astutely and gave his brother the small fish and kept the big catch for himself.

Every decade since the                 70’s, the Ambanis have made some game changing moves. Whether it be the import of the PFY (polyester filament yarn) and setting up the country’s largest textile facilities in the 1970’s, or the massive equity offerings over the widest ever shareholder base in the 80’s, or setting up the largest privately owned refinery in Jamnagar in the 90’s or launching their telecom venture in the first decade of the 21st century, they have always been ahead of the curve in conceptualizing and delivering on the initiative which leverages the huge potential of the Indian consumer base. The next big play which was planned by Dhirubhai and Mukesh was on the upstream oil & gas exploration and production side. They had won the ‘bid’ for the KG basin block in NELP and by the time the settlement of the brothers came about, it was evident that this block was prolific on a scale which would overshadow everything Reliance had done so far.

To put it in perspective, by 2012, just one field (D6) from this block alone would be responsible for the production of over 40% of the country’s total projected domestic gas production of 190 MMSCMD and oil production of over a billion barrels. In terms of value, this production would be worth over Rs. 100,000 crores annually, which is more than the combined turnover of all Reliance group entities that were alloted to Anil in the settlement. The annual projected cash flow to RIL from D6 alone would be in excess of 50,000 crores with a net profit well over the profits generated by its entire refining business and other businesses combined. 

Hence Mukesh gladly gave away Reliance’s power, capital and telecom business units to Anil and kept the refining as well as the upstream initiatives with himself.  

Of course, amputating the power business from the RIL organization, did dislodge the master plan of the Ambanis, which had been to sell the gas to their private power business at a subsidized price and to produce power and sell the same at open market prices thereby capturing the entire cream in their power ventures. This plan had been conceived by Dhirubhai and Mukesh since under the terms of the PSC (production sharing contract) of KG Basin blocks, the owner of the gas remained the sovereign government and RIL was merely a contractor. The sale price of the gas was to be determined by the government and alloted to priority sectors such as power & fertilizers which account for the bulk of the gas consumption in the country. This in effect meant that the bulk of the revenues would be captured by the Government and there would be a natural inclination to pass the gas to priority sectors at subsidized rates, thereby making RIL’s profits subordinate to the National energy policy. Furthermore, even if the gas was to be transferred to priority sectors at higher rates, it would not benefit RIL tremendously as the incremental share of RIL in the gas revenues would be diminished owing to the ‘investment multiple’ concept in the PSC (under the investment multiple concept the contractor’s share in profits is inversely proportional to the cumulative cash flow of the contractor). Hence the scheme which was developed by the Ambanis was to transfer the gas to their power business at subsidized rates, thereby prolonging the period and proportion they would have in the gas produced under the investment multiple concept. The sale of power would be done at merchant rates as well as favourable rates under PPA’s (power purchase agreements) with state governments and unlike the upstream business, in power they would not have to share any profit with the government.

Well all of this fell apart when Anil decided to split and take away the power business for himself. Of course, being privy to the entire plan, Anil insisted on the continuation of the scheme (except that now the entire cream would belong to him as the sole holder of the power business). Accordingly the MOU provided for supply of 27 MMSCMD of gas to Anil’s RNRL for use by him for power generation. Hence Anil was also shrewd in trying to capture a piece (and a large one at that) of the upstream action, through the MOU. However, he made the mistake that he did not go ahead and construct the Dadri plant for which the gas was contracted in the first place. In any case, it would have been too simplistic had he succeeded in such a plan, for Mukesh, from the very inception had no intention of sharing this booty with Anil. Accordingly he had inserted in the MOU a caveat that the supply of gas by RIL to RNRL under the MOU would be subject to approval of the Government.

True to his father’s legacy, Mukesh has since denied Anil the gas using the various legal, strategic and political machinations at his disposal. He has obfuscated the authorities and juxtaposed new variables in the equation at opportune times to suit his end goal. The result has been that while the gas production commenced earlier this year, zero quantity has been delivered to Anil and RIL has secured approval of the Court to sell the gas to the users at the higher price of USD 4.2 per MMBTU pending final resolution of the dispute.

Now that Anil has gotten relief at the High Court level, RIL has moved the SC and not surprisingly, with the new government firmly in place (with RIL loyalists such as Pranab and Deora and the Gandhis themselves), the MOPNG has been persuaded to assert its rights by filing a separate petition to the SC that the MOU be declared null and void. Of course this sounds but logical since the gas belongs to the government and it is not for one brother to contract to sell it to another at any arbitrary price set between themselves in a private settlement. It is a fundamental legal principle that one cannot contract to sell that which one does not own himself. This will be a point laboured hard and long by the Government and the end result will be that the Government will sell the gas to the priority users at the price it sets and RIL will get its profit share under the PSC. Hence Anil cannot hope to get the gas under the MOU.

What he can only hope to get is damages from his brother for breach of the clause by way of difference between the price he will have to pay to buy the gas from the market and the price he would have had to pay under the MOU. However, law of contracts in India does not recognize notional damages. Damages have to be proven and quantified. Hence before Anil can even think of claiming damages, he will have to set up the 10,000 MW dadri power plant which has been on the drawing board for years (much like many other ADAG group projects), commission the plant, get the gas from Government under allocation to the power sector and then claim the differential from Mukesh. Any of this will not happen before the next 3-4 years and in the mean time RIL would have ramped up production from its KG Basin assets to even higher levels, in excess of 100 MMSCMD. At this point, RIL would be producing hydrocarbons worth over 2-3% of the country’s GDP and at that point of time there will be enough gas to be allocated to ADAG as well. Of course by such time, I am sure Mukesh will get the Government to assent to the supply of the gas to RNRL at USD 2.34 per MMBTU as a lower price will actually give him a larger share of the profit gas under the investment multiple concept!!!

To conclude my ‘two cents’ I will only say that there is much more to this drama than meets the eye, and there will be lot more twists and turns going forward. But by the time the dust settles over the next five years, few things will definitely be clear:

a.            RIL would have emerged as the country’s largest producer of natural gas, single handedly contributing over 50% of the production;

b.            RIL’s profitability would have quadrupled from current levels (also helped by the fact that budget 2009 was a single point agenda of granting a tax holiday to RIL for its natural gas production, tantamounting to a tax saving of over 3,000 crores per annum – no wonder Pranabji was made the FM in place of PC);

c.             Anil will get some share of the pie, but it will be a case of too little too late.

 

Either way, it’s a case study which will be written about for many years hence and shall go on to become folklore for the generations to follow.