Upstream oil companies free to sell oil in open market

In a rather innocuous move, the government could change the operating platform for the upstream oil extraction companies. Going ahead, the oil extraction companies will have more freedom and leeway to market the oil they produce. This move is likely to be extremely beneficial for major crude oil producers in India like ONGC, Oil India Ltd etc. In addition, it is also likely to be positive for private sector upstream oil companies like Vedanta (which owns the Cairn Energy oil wells) and the upstream business of Reliance.

This is likely to be a move that would boost the Indian hydrocarbon industry and possibly bring more investments into the sector. The new policy has given more marketing freedom to domestic crude oil producers making it possible to sell petroleum to any company in the local market. As of now, this leeway is only limited to the Indian market. This could be a major incentive for Indian oil companies to explore more oil since India’s oil output has been and India still relies on imports for nearly 86% of daily crude sourcing requirements.

To begin with, this freedom would be restricted to the domestic market while the oil extraction companies will not be allowed to export crude oil. The old model was that, based on production sharing contracts (PSCs), the upstream oil companies were only permitted to sell crude to the government or government companies. By giving the upstream companies more freedom, it will be an incentive for such companies to produce more and sell to the customers of their choice within India. That was a major bottleneck in output till date.

Given that India is substantially a net oil importing nation, marketing freedom practically means no impact on the exchequer. That is because, the current freedom only applies to the local sales and not to export sales. Earlier the government determined how much crude would be sold to whom. Going ahead, the producers of oil will have the freedom to decided so one can expect more such long term arrangements. This will effectively ensure marketing freedom for all exploration and production (E&P) operators in India.

An important advantage of this move would be that it is likely to help attract investments into the sector and may even lead to the introduction of exchanges as well as e-auction of domestic crude in the longer run. Apart from the PSU oil companies, it will also benefit the private E&P players. In the past, pricing power to the seller was minimal, but now that will change in a big way. Even smaller players like Hindustan Oil Exploration Company or HOEC should be benefitting from this move.

There is a small subtlety that has to be understood here. For example, the Indian E&P sector already has marketing and pricing freedom under the Open Acreage Licensing Policy (OALP) and Discovered Small Field (DSF) regimes. However, this decision by the government also opens up free pricing for crude oil under the NELP (New Exploration Licensing Policy) as well as for the pre-NELP regime. However, it remains to be seen if the local production to import ratio of crude can really change drastically by this decision. Currently, India’s domestic crude oil production stands at 29.7 MT while the imports stand at around 212 MT.

That is a ratio of almost 88:12 in favour of crude oil imports and this ratio has only worsened in the last couple of years as the oil wells of ONGC have been ageing rapidly impacting production. At least, this move should be instrumental in incentivising investments in the upstream oil and gas sector.