July

2017

Oil and Gas Sector

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ALPHA – THE INVESTMENT AND RESEARCH CLUB
FMS DELHI

Contact us - alpha@fms.edu | Amol Deorukhakar | Senior Analyst | 8097250652

Contents
Evolution of Oil and Gas Industry ........................................................................................................... 3
The global story................................................................................................................................... 3
The Indian Story .................................................................................................................................. 4
Global Oil and Gas Business .................................................................................................................... 6
OPEC........................................................................................................................................................ 8
Indian Oil and Gas Business .................................................................................................................... 9
Value Chain ........................................................................................................................................... 11
Upstream Business................................................................................................................................ 13
What is upstream? ............................................................................................................................ 13
What is crude? .................................................................................................................................. 13
Benchmark Crudes ............................................................................................................................ 15
Exploration ........................................................................................................................................ 15
Exploration Risk................................................................................................................................. 15
Production......................................................................................................................................... 16
Primary Recovery .......................................................................................................................... 16
Secondary Recovery ...................................................................................................................... 16
Enhanced Oil Recovery ................................................................................................................. 16
Economics of Oil production ............................................................................................................. 17
Midstream Business .............................................................................................................................. 19
Pipeline ......................................................................................................................................... 19
Tankers.......................................................................................................................................... 19
Rail ................................................................................................................................................ 19
Trucking ........................................................................................................................................ 19
Downstream Business ........................................................................................................................... 21
Refining ............................................................................................................................................. 21
Major Refiners in India .................................................................................................................. 23
Economics of Refining ................................................................................................................... 24
Storage and Transportation .............................................................................................................. 24
Regasification Terminals ................................................................................................................... 25
Marketing .......................................................................................................................................... 26
Revenue and Cost Drivers ..................................................................................................................... 28
Unconventional Resources ................................................................................................................... 29
What is shale gas? ......................................................................................................................... 29
Challenges in Shale Gas................................................................................................................. 29
Economics of Shale gas ................................................................................................................. 30

1
 The Breakeven for Shale gas ......................................................................................................... 30
US story of shale gas boom and its impact ................................................................................... 31
Oil Price ................................................................................................................................................. 32
Crude Price Benchmarks ............................................................................................................... 32
Price Determinants ....................................................................................................................... 32
Production Cost............................................................................................................................. 32
Economic Growth.......................................................................................................................... 32
OPEC Policies ................................................................................................................................. 33
Geopolitical Factors ...................................................................................................................... 33
Correlation between price and Inventories .................................................................................. 33
US Shale gas .................................................................................................................................. 34
Reasons Behind 2014 price crash ................................................................................................. 34
Government Policies ............................................................................................................................. 35
NELP .................................................................................................................................................. 35
Price Regulations............................................................................................................................... 36
Current pricing Mechanism .............................................................................................................. 36
Subsidies ........................................................................................................................................... 37
Natural Gas Pricing Mechanism ........................................................................................................ 37
APM Gas Pricing ............................................................................................................................ 37
India’s move towards market based pricing regime ..................................................................... 38
Non-APM gas pricing..................................................................................................................... 38
Price of imported LNG................................................................................................................... 38
Impact of GST ........................................................................................................................................ 39
What’s under GST? ....................................................................................................................... 39
Why such exclusion? ..................................................................................................................... 39
How will it impact the sector? ...................................................................................................... 39
Road Ahead ........................................................................................................................................... 40
References ............................................................................................................................................ 41

2
 Evolution of Industry

Evolution of Oil and Gas Industry

The global story

Crude oil has been known and used since ancient times with reference to it made by most
historians since records of world history began. Egyptians used it to help preserve mummies
whilst Alexander the Great was known for his use of oil to create flaming torches to frighten
his enemies. Beyond its obvious application as a source of fire, the substance was also highly
valued by several civilizations for its medicinal properties; for the Chinese it served as a skin
balm; for Native Americans a treatment for frostbite. [1]
Yet the modern oil era almost certainly commenced in 1859 in Titusville, Pennsylvania, when
Colonel Edwin Drake struck oil some 69 feet underground. The commercial objective being
pursued was to extract ‘rock’ oil, which, it had been discovered, could be refined to produce
kerosene for illumination. At 15 barrels-a-day Drake’s discovery prompted a mad rush to drill
for ‘the black stuff’. Within a year Pennsylvania was producing almost 500,000 b/d; two years
later over 3m b/d was oozing out of the Pennsylvanian hills. The modern oil industry had been
born. [1]
This explosion in production, however, brought with it its own problems. Although demand
for kerosene also surged as copious supplies made it ever more affordable, the absolute lack of
discipline that surrounded both the supply of oil and its refining meant that the newly found
kerosene industry was extremely volatile. Into this arena emerged one particular businessman
who was intent on bringing structure, order and profit to the kerosene refining industry.
Through the Standard Oil Company, John D Rockefeller set about establishing a business that
was to have absolute influence over the US refining and oil producing industries. By 1890,
using business practices that invariably sought to eliminate competition, Standard Oil
controlled almost 90% of the refined oil flows in the United States. It determined the price at
which its products would be sold on the open market and it told the producers the price that
they would receive for their oil. In effect it was, to all extents and purposes, the US oil industry,
a position it largely retained until its dissolution under anti-trust legislation by the US Supreme
Court courts in 1911 into 34 independent companies. [1]
Yet Standard Oil’s dissolution was as much the beginning of an era as it was the end. For the
companies which were born as a result by and large proved those which would go on to shape
the industry as we know it today. Exxon, Chevron, Texaco, Conoco and much of BP, amongst
others, can all trace their roots back to Standard Oil. And in their desperate pursuit through
much of the 20th century to secure new sources of oil from across the globe, not least the
Middle East, they gave birth to the national oil companies that dominate today’s production.
Saudi Aramco, the National Iranian Oil Company, the Iraqi National Oil Company, the Kuwait
Oil Company, ADNOC and PDVSA were all established in large part by the ‘sisters’ that
emerged from the breakup of Standard Oil. [1]
Indeed, it is perhaps an irony that an industry whose sustainability is constantly in question
should be comprised of companies that have a history that is longer than that of several modern
day countries. Governments may come and go and wars may pass. Yet in pursuit of that life-
giving incremental barrel of reserves, the major oil companies have evolved into the industrial
behemoths that stand today and will, almost certainly, still stand tomorrow. [1]

3
 Evolution of Industry

Figure 1: Global Oil Production vs Consumption since 1965 [2]

The Indian Story

Barely seven years after Edwin L. Drake drilled the world's first oil well in 1859 at Titusville,
Pennsylvania, USA, in 1866, Mr. Goodenough of McKillop, Stewart and Company, Calcutta,
drilled a hand dug well of 102 feet at Nahorpung near Jaipur area of Upper Assam but failed
to establish satisfactory production. However, the first well dug at Digboi field in Assam in
September 1889 and completed in November 1890 at depth of 662 feet by Assam Railways
and Trading Company Limited (AR&T Co. Ltd.), is regarded as the first commercially
successful oil discovery (200 gallons per day). [3]
AR&T subsequently drilled 10 wells at Digboi producing 757.08 litres/day. AR&T established
Assam Oil Company (AOC) in 1899. In 1901, Asia's first oil refinery was set up in at Digboi.
It is still functional and world's oldest operating refinery. Later on UK based Burma Oil
Company (BOC) arrived in 1911 and acquired petroleum interests of AOC. The oil industry,
after independence, remained operated by foreign company for a considerable period. Burma
Oil Company (BOC) kept its position as largest company in India till end of its operation. [3]
With the intention of intensifying and spreading exploration to various parts of the country a
separate Oil and Natural Gas Directorate (ONGD) was set up in 1955. In October 1959 the
ONGC was made a statutory body by an act of parliament delegating it more power but it
remained under Ministry. ONGC systematically started its geophysical surveys on area
considered prospective on the basis of global analogy. Within a year of being formed, ONGC
discovered oil at Cambay. The giant Ankleshwar field in the state of Gujarat in 1960, Kalol in
1961, Lakwa in 1964, Geleki in 1968 and Gas discovery Manhar tibba in Rajasthan in 1969
were discovered subsequently. Offshore exploration was initiated by ONGC in the form of
experimental seismic survey in 1962 in Gulf of Cambay and later in western offshore. Detailed
seismic surveys in western offshore resulted in a discovery of large structure on Bombay
offshore in 1972-73 and drilling lead to India's biggest commercial discovery Bombay High.
[3]

4
 Evolution of Industry

After Independence, India made significant efforts for its refining capacity. In the first decade
immediately after independence, three coastal refineries were established by multinational oil
companies operating in India at that time. This included refineries by Burma Shell, and Esso
Stanvac at Mumbai, and by Caltex at Visakhapatnam. Indian government in order to increase
exploration activity approved the New Exploration Licensing Policy (NELP) in March 1997 to
ensure level playing field in the upstream sector between private and public sector companies
in all fiscal, financial and contractual matters. The policy ensued that there was no mandatory
state participation through ONGC/OIL nor there was any carried interest of the government.
Today to meet its growing petroleum demand, India is investing heavily in oil fields abroad.
India's State owned oil firms have stakes in oil and gas fields in Russia, Sudan, Iraq, Libya,
Egypt, Qatar, Ivory Coast, Australia, Vietnam and Myanmar.
The oil and gas industry is among the six core industries in India and plays a major role in
shaping the Indian economy. The Indian oil and gas industry was worth US$ 139.8 billion in
2015. India’s economic growth is related to energy demand; Hence the Indian oil industry is
one of the pivots of the country. The government has allowed 100 per cent Foreign Direct
Investment (FDI) in the oil sector. Backed by new oil fields, the Indian domestic oil output is
anticipated to grow to 1 MBPD by FY16. Gas consumption is likely to expand at a Compound
Annual Growth Rate (CAGR) of 21 per cent during FY0817.
India will overtake Japan to become the world’s third largest oil consumer behind the US and
China by 2025. In June 2015, total crude oil imports were valued at US$ 8.7 billion. Despite
being a net importer of crude oil, India has become a net exporter of petroleum products.

Figure 2: Indian Oil Production vs Consumption since 1965 [2]

As industry has grown it has seen changes in its inherent nature. Technologies have intensified
competition at global scale. With oil becoming rarer, thrust of efficient exploration and
optimum refining has increased. Today we have moved far ahead of crude oil petrol and diesel.
This era belongs to Shale Gas, EOR, LNG. Oil and Gas has been integral part of India’s growth
story. Handicapped upstream business has been shadowed by booming midstream business.

5
 Global Business

Global Oil and Gas Business

Importance of Oil and Gas business is highlighted by the shear domination of oil and gas as
source of our total energy demand. 55% global energy demand is fulfilled by this sector. Its
most convenient source of energy in terms of price, production and usage.

Global Energy Share

Other, Oil, 40%

35%

Natural
Coal, 10% Gas, 15%

Global oil production is about 97 million barrels per day. To this production OPEC contributes
the most. Among OPEC Saudi Arabia is the largest producer of crude oil. Russia and USA are
two major Non-OPEC oil producers. US contributes to about 12% of production and 20% of
consumption. Russian economy is heavily depended on oil exports as we can see a significant
difference between production and consumption. India has very limited reserves in terms of oil
and gas and hence majority of consumption is fuelled by imports which put a huge pressure of
economy. India’s per capita fuel consumption is still much below the level in US Europe and
China. [4]
On natural gas front US is both largest producer and largest consumer and producer. Total
global market size in terms of volume is about 3500 BCM, to which US production contributes
to about 20%. Russia is second major gas hub in global market followed by OPEC members.

Global Oil Production = 97 Million Barrels/Day Global Gas Production = 3500 Billion m3/Day

Major Oil Players Major Gas Players

50 43
1000 720 780 670
19 400
12 13 12
8
500 200
5
3.5 1 4.5 120
40 50
0 0
USA Russia China OPEC India USA Russia China India
Production Consumption Production Consumption

These huge figures in terms of production and consumption do not capture the scale of this
industry completely. There exists a very long value chain with many important aspects like
refining, transportation, processing etc. Most major global oil companies are IOCs or Integrated
Oil Companies which means they operate across all blocks of value chain that is Upstream-

6
 Global Business

Midstream-Downstream. Hence these companies are huge on the basis of the scale of their top
line. The table below shows top 10 biggest firms across globe and their top line.
Company Country of Origin Revenue

Sinopec China $ 438 Billion

Petrochina China $ 432 Billion
Royal Dutch Shell UK/Netherlands $ 421 Billion
ExxonMobil USA $ 411 Billion
Saudi Armaco Saudi Arabia $ 378 Billion
BP UK $ 358 Billion
Total S.A. France $ 236 Billion
Kuwait Petroleum Corp Kuwait $ 252 Billion
Chevron USA $ 211 Billion
OJSC Lukoil Russia $ 144 Billion
Table 1: Major Global Firms

Being a non-renewable rescore there is lot of speculation about future growth and challenges.
Given the high gestation period between discovery of oil reserve and production proven
reserves is an important permanent to consider while understanding future prospects.

World’s Proven Oil Reserves = 1660 Billion Barrels

Proven Reserves in Billion Barrels

Libya 47
Russia 80
UAE 97
Kuwait 104
Iraq 144
Iran 158
Canada 171
Saudi Arabia 268
Venezuela 298
0 50 100 150 200 250 300 350

7
 OPEC

OPEC
The Organization of Petroleum Exporting Countries (OPEC) is a group consisting of 12 of the
world's major oil-exporting nations. OPEC was founded in 1960 to coordinate the petroleum
policies of its members, and to provide member states with technical and economic aid. OPEC
is a cartel that aims to manage the supply of oil in an effort to set the price of oil on the world
market, in order to avoid fluctuations that might affect the economies of both producing and
purchasing countries.

Figure 3: OPEC Member Countries

As of January 2017, OPEC has 13 member countries: six in the Middle East, five in Africa,
and two in South America. According to the US Energy Information Administration, OPEC's
combined rate of oil production (including gas condensate) represented 42 percent of the
world's total in 2015, and OPEC accounted for 73 percent of the world's "proven" oil reserves,
including 48 percent from just the six Middle Eastern members
Approval of a new member country requires agreement by three-quarters of OPEC's existing
members, including all five of the founders. In October 2015, Sudan formally submitted an
application to join, but it is not yet a member. For countries with smaller reserves OPEC
membership often creates hurdles due to rigid regulations in terms of amount to be produced.
Hence some countries in past have given up OPEC membership. Latest in the series is
Indonesia which gave up membership in 2016.

The advent of new technology, especially fracking in the United States, has had a major effect
on worldwide oil prices and has lessened OPEC's influence on the markets. As a result,
worldwide oil production has increased and prices have dropped significantly, leaving OPEC
in a delicate position. As late as June 2016, OPEC decided to maintain high production levels,
and consequently low prices, in an attempt to push higher-cost producers out of the market and
regain market share.

8
 India Business

Indian Oil and Gas Business

Oil and Gas caters to about 30% of India’s energy demand. Dependence on coal is decreasing
slowly in view of environmental concerns and push for cleaner energy.

Indian Energy Sources

5% 2%
1%
7%

28% 57%

Coal Oil Natural Gas Hyro-Electric Renewables Nuclear Energy

Domestic Oil production is about 1 MBPD where as consumption is about 4.5 MBPD. Balance
is imported which puts a significant fiscal pressure on economy. Gas is gaining increasing
importance in domestic energy scenario. Current consumption and production levels are
significantly low, about 120 BCM consumption against a production of 60 BCM.

Oil Production = 1 MBPD Oil Consumption = 4.5 MBPD

Gas Production = 64 BCM Gas Consumption = 120 BCM

Oil: Production Vs Imports Gas Production Vs Imports

4 80

3 60
40
2
20
1
0
0
2010 2011 2012 2013 2014 2015

Oil Production Oil Imports Gas Production Gas Imports

9
 India Business

Growth in domestic production has been negligible for oil. There is significant potential for
growth in natural gas production but uncompetitive market prices have hampered production
from many blocks. Consumption for oil is steadily increasing for gas the trend is much steeper.
This consumption demand is being fuelled by imported LNG.

Indian companies mostly operate in specific area of value chain. Hence in terms of top line
these are much smaller compared to global firms. The table below summarizes top line size of
important market players.
Company Revenue (FY-2016) in $
Billion
Indian Oil 30.5
Reliance Industries 26
Bharat Petroleum 4.2
Hindustan Petroleum 15.4
ONGC 11.3
GAIL 43.8
OIL 1

10
 Value Chain

Value Chain

The oil & gas industry is massive. There are a multitude of different businesses & jobs that
must be performed to get the oil & gas from under the ground to the consumer. This massive
industry can be broken into three chronological sectors: Upstream, Midstream & Downstream,
each with its own set of challenges and opportunities.

Figure 4: Oil and Gas Value Chain

Upstream encompasses searching for, recovering, and producing crude oil and/or natural gas
from underground or underwater fields. Complex and risky, this segment is highly impacted
by political and economic realities. Plagued by regulation that drives technology change and
subsequent work force skill issues, the upstream is the most complex of the oil and gas
segments.
This segment is focused on managing volatility and risk. Change is constant in all aspects of
business operations. Rapid development, efficiently, and cost effectively are critical to return
on assets as well as customer satisfaction.

Midstream operations often include some elements of the upstream and downstream sectors.
This segment embodies the complete execution dilemma of Supply and Demand. Covering
transportation, processing, storage and distribution operations the objective is getting crude oil
and natural gas to refineries. Tasked with installing the infrastructure for getting product from
wellhead to processor; consolidating supply and demand channels is especially challenging in
the global economy.

11
 Value Chain

Challenges today are founded in the diversities of quality, location and quantity of supply’s
and demands. Mismatches foster asset utilization issues on both the oil and gas supply chains.
Disruptive/ destructive technologies like fracking “laser” focus on sustainable demand to
maintain price ultimately supporting infrastructure development and deployment.

Downstream operations include the Refining and Processing of Natural Gas and Liquid Natural
Gas which produces the by-product element sulphur (65% of world supplies). Distribution and
trading are vital and appropriate avenues are a constant struggle to balance. The need for better
results and creating alliances in the supply chain, is a growing focus in this sector. Supply
Chain performance is increasingly dependent on technologies that model, design and monitor
operational and engineering assets. In addition, rising cost of services is a challenge that cuts
across the oil & gas industry; exploration, production, refinement and transportation.

12
 Upstream

Upstream Business

What is upstream?

Upstream mainly includes exploration and production of crude oil and natural gas. The crude
oil was formed millions of years ago when organic life was buried deep inside earth subject to
extreme pressure and temperature. Finding these reserves in earth’s crust is challenging and
recovering crude from established reservoirs is even more challenging. However energy being
the lifeline of global economy massive technological progress has been achieved in the field of
exploration and production of crude that oil is today available at extremely cheap prices as
compared to its utility. Because of this todays crude oil is often called as cheap oil but that
picture is set to change real soon.
The upstream sector includes searching for potential underground or underwater crude oil and
natural gas fields, drilling exploratory wells, and subsequently drilling and operating the wells
that recover and bring the crude oil and/or raw natural gas to the surface. There has been a
significant shift toward including unconventional gas as a part of the upstream sector, and
corresponding developments in liquefied natural gas (LNG) processing and transport.
Before we get into the details of upstream let us just quickly understand the product at the
centre of this whole business – crude oil.

What is crude?

Crude oil is a mixture of thousands of hydrocarbons. These hydrocarbons when separated into
different groups based on their boiling points yield products well known to us such as Petrol,
Diesel, Kerosene, Lube Oils and many more. Crude oil found in all oil reservoirs formed in the
Earth's crust from the remains of once-living things. Crude oil is properly known as petroleum,
and is used as fossil fuel. Evidence indicates that millions of years of heat and pressure changed
the remains of microscopic plant and animal into oil and natural gas.
Composition of crude plays a major role in determining its price as composition directly affects
yields of final profitable products. There are number of ways to look at crude properties. One
common parameter is PONA analysis. Which is a measure of percentage of Paraffins, Olefins,
Naphthens and Aromatics. Depending upon which component is more final products yield
changes. The expected products yields are often called as crude assays.
Crude produced from different parts of the world has different properties and correspondingly
different price. Apart from competition an easier method to classify crude is based on two
parameters, Density of Crude and Sulphur Content of crude. Generally heavy crudes have
higher specific gravity (density) and a lower API. API is a density index for crude which is
inversely related to specific gravity. Also heavy crudes also have a higher sulphur content in
them. Sulphur is most undesired component on crude and has to be removed from final
products to the scale of PPM. The reason being that, sulphur present in fuels burns along with
it to yield SO2. Sulphur dioxide can create hazardous pollution problems.

13
 Upstream

Heavy crudes are difficult to refine hence are cheap. Light crudes are easy to refine and hence
are expensive. The figure below shows difference between properties of different crudes found
across globe.

Figure 5: Crude Properties by Types

Figure 6:Major Crude Types

14
 Upstream

Benchmark Crudes
A benchmark crude or marker crude is a crude oil that serves as a reference price for buyers
and sellers of crude oil. There are three primary benchmarks, West Texas Intermediate (WTI),
Brent Blend, and Dubai Crude. Other well-known blends include the OPEC Reference Basket
used by OPEC, Tapis Crude which is traded in Singapore, Bonny Light used in Nigeria, Urals
oil used in Russia and Mexico's Isthmus.
West Texas Intermediate is used primarily in the U.S. It is light (API gravity) and sweet (low-
sulphur) thus making it ideal for producing products like low-sulphur gasoline and low-sulphur
diesel. Brent is not as light or as sweet as WTI but it is still a high-grade crude. The OPEC
basket is slightly heavier and sourer than Brent. As a result of these gravity and sulphur
differences, before 2011 WTI typically traded at a dollar or two premium to Brent and another
dollar or two premium to the OPEC basket. Brent Crude is a mix of crude oil from 15 different
oil fields in the North Sea. It is the benchmark used primarily in Europe though it is also mixed
in with the OPEC reference basket which is used around the world.

Exploration

Exploration is the search for crude deposits beneath the Earth's surface by sophisticated
geophysical technologies. Areas thought to contain hydrocarbons are initially subjected to a
gravity survey, magnetic survey, and passive seismic or regional seismic reflection surveys to
detect large-scale features of the sub-surface geology. Features of interest are subjected to more
detailed seismic surveys which work on the principle of the time it takes for reflected sound
waves to travel through matter (rock) of varying densities and using the process of depth
conversion to create a profile of the substructure. Finally, when a prospect has been identified
and evaluated and passes the oil company's selection criteria, an exploration well is drilled in
an attempt to conclusively determine the presence or absence of oil or gas.
Oil exploration is an expensive, high-risk operation. Offshore and remote area exploration is
generally only undertaken by very large corporations or national governments. Typical shallow
shelf oil wells cost US $ 10 – 30 million, while deep water wells can cost up to US $ 100
million plus. Hundreds of smaller companies search for onshore hydrocarbon deposits
worldwide, with some wells costing as little as US $ 100,000.

Exploration Risk
Hydrocarbon exploration is a high risk investment and risk assessment is paramount for
successful project portfolio management. Exploration risk is a difficult concept and is usually
defined by assigning confidence to the presence of the imperative geological factors, as
discussed above. This confidence is based on data and/or models and is usually mapped on
Common Risk Segment Maps (CRS Maps). High confidence in the presence of imperative
geological factors is usually coloured green and low confidence coloured red. Therefore, these
maps are also called Traffic Light Maps, while the full procedure is often referred to as Play
Fairway Analysis. The aim of such procedures is to force the geologist to objectively assess all
different geological factors. Furthermore, it results in simple maps that can be understood by
non-geologists and managers to base exploration decisions on. [5]

15
 Upstream

Production

After an Oil reservoir is established as a proven reserve by exploration activities, the next step
is production. Start of exploration to start of production is a long process. Typically the cycle
takes about 20-30 years. Most of the large production sites in operation today were explored in
1980-90s.

The oil well is created by drilling a long hole into the earth with an oil rig. A steel pipe (casing)
is placed in the hole, to provide structural integrity to the newly-drilled well bore. Holes are
then made in the base of the well to enable oil to pass into the bore. Finally a collection of
valves called a "Christmas Tree" is fitted to the top, the valves regulate pressures and control
flow.
Primary Recovery
During the primary recovery stage, reservoir drive comes from a number of natural
mechanisms. These include: natural water displacing oil downward into the well, expansion of
the natural gas at the top of the reservoir, expansion of gas initially dissolved in the crude oil,
and gravity drainage resulting from the movement of oil within the reservoir from the upper to
the lower parts where the wells are located. Recovery factor during the primary recovery stage
is typically 5-15%.
While the underground pressure in the oil reservoir is sufficient to force the oil to the surface,
all that is necessary is to place a complex arrangement of valves (the Christmas tree) on the
well head to connect the well to a pipeline network for storage and processing. Sometimes
pumps, such as beam pumps and electrical submersible pumps (ESPs), are used to bring the oil
to the surface; these are known as artificial lifting mechanisms.

Secondary Recovery
Over the lifetime of the well, the pressure falls and at some point there is insufficient
underground pressure to force the oil to the surface. After natural reservoir drive diminishes,
secondary recovery methods are applied. They rely on the supply of external energy into the
reservoir in the form of injecting fluids to increase reservoir pressure, hence replacing or
increasing the natural reservoir drive with an artificial drive. Secondary recovery techniques
increase the reservoir's pressure by water injection, natural gas reinjection and gas lift, which
injects air, carbon dioxide or some other gas into the bottom of an active well, reducing the
overall density of fluid in the wellbore. Typical recovery factor from water-flood operations is
about 30%, depending on the properties of the oil and the characteristics of the reservoir rock.
On average, the recovery factor after primary and secondary oil recovery operations is between
35 and 45%.

Enhanced Oil Recovery

Enhanced, or Tertiary oil recovery methods, increase the mobility of the oil in order to increase
extraction.

16
 Upstream

Thermally enhanced oil recovery methods (TEOR) are tertiary recovery techniques that heat
the oil, reducing its viscosity and making it easier to extract. Steam injection is the most
common form of TEOR, and it is often done with a cogeneration plant. This type of
cogeneration plant uses a gas turbine to generate electricity, and the waste heat is used to
produce steam, which is then injected into the reservoir. This form of recovery is used
extensively to increase oil extraction in the San Joaquin Valley, which yields a very heavy oil,
yet accounts for ten percent of the United States' oil extraction.[citation needed] Fire flooding
(In-situ burning) is another form of TEOR, but instead of steam, some of the oil is burned to
heat the surrounding oil.
Occasionally, surfactants (detergents) are injected to alter the surface tension between the water
and the oil in the reservoir, mobilizing oil which would otherwise remain in the reservoir as
residual oil. Another method to reduce viscosity is carbon dioxide flooding.
Tertiary recovery allows another 5% to 15% of the reservoir's oil to be recovered. In some
California heavy oil fields, steam injection has doubled or even tripled the oil reserves and
ultimate oil recovery. For example, see Midway-Sunset Oil Field, California's largest oilfield.
Tertiary recovery begins when secondary oil recovery is not enough to continue adequate
extraction, but only when the oil can still be extracted profitably. This depends on the cost of
the extraction method and the current price of crude oil. When prices are high, previously
unprofitable wells are brought back into use, and when they are low, extraction is curtailed.

Economics of Oil production

Oil production costs vary from geography to geography. Within each production plant as well
there are different cost heads. The figure below gives a typical breakup of onshore drilling
and completion.

Cost Breakdown

15%
23%

11%

12%

24%
14%

Rig & Drilling Fluid Casing and Cement Equiments

Proppant Completion fluids and flowback Other

Figure 7: Percentage breakdown of cost shares for U.S. onshore oil and natural gas drilling
and completion

17
 Upstream

Some geographies have been blessed with easy reserves and production from these is cheaper.
Most of the oil wells in Gulf region breakeven at about 10 dollars a barrel. This region is
densely populated with rich oil reserves which are located at lesser depths. Costs go up as we
look at other regions. In North American and Russian regions wells breakeven at about 30
dollars a barrel. The figure below shows breakeven costs for various regions. [6]

Cost in $/Barrel
50
45
40
35
30
25
20
15
10
5
0

Cost in $/Barrel

Figure 8: Conventional Oil Production Costs Comparison

18
 Midstream

Midstream Business

The midstream sector involves the transportation, storage, and wholesale marketing of crude
or refined petroleum products. Pipelines and other transport systems can be used to move crude
oil from production sites to refineries and deliver the various refined products to downstream
distributors. Natural gas pipeline networks aggregate gas from natural gas purification plants
and deliver it to downstream customers, such as local utilities.
The midstream operations are often taken to include some elements of the upstream and
downstream sectors. For example, the midstream sector may include natural gas processing
plants that purify the raw natural gas as well as removing and producing elemental sulphur and
natural gas liquids (NGL) as finished end-products.
Midstream is all about taking the crude oil retrieved in the upstream sector and getting it to the
downstream processing facilities so that it can be turned into the various finished products in
consumers’ daily lives. This may seem simple enough; however, there are quite a few logistical
hurdles involved in this process which the midstream must successfully navigate. Let’s take a
look at an overview of how the oil is transported.
Pipeline
Pipeline is the most common way that the oil begins the process of being transported and
distributed. To accomplish this, vast networks of pipelines need to be constructed and
maintained. There are many potential obstacles involved in the piping of oil because it typically
needs to travel long distances. Some of the most common hurdles are boosting stations, cross
country geographies, terrain and theft.
Tankers
Often the oil will be transported by tankers or other seafaring vessel. This can be a very time
consuming process, but it is the most efficient way for the oil to travel over oceans and other
large bodies of water.
Rail
Oil is often transferred over land by rail providing a cost effective and efficient option of
transporting a large amount of oil quickly.
Trucking
The oil may be trucked over highways and roads to various facilities and processing plants.
One advantage of trucking is that it allows the oil to travel to nearly any destination even if
there is not a port or rail line nearby.

Which is the best route?

In terms of shear economics pipelines is way cheaper than any other method. But Pipeline
projects are difficult to execute and maintain. In terms of practical feasibility rail are best for
intra-national transfer whereas tankers are best for international transport.
Fact-based analysis says that transportation by tanker or barge from port to port is both safe
and efficient. Large quantities of transported crude oil provide efficient use of rugged vessels

19
 Midstream

that transport without issues for years. Moving oil from where it is produced to ports for
transport is clearly safest and efficient when it is transported by pipelines designed fit for
purpose for the task at hand. Pipelines are undeniably the lowest risk and most efficient means
of transport onshore for point-to-point movement. They require both regulation and ongoing
inspection and maintenance and should be replaced based on predetermined age and risk
factors.
Trains and trucks work when the distance is short and the volumes not so large. Trains can also
provide a temporary longer-distance, higher-volume solution until the costs of a pipeline are
justified. Facts are facts, and crude oil in tankers weighs a lot; its contents are volatile under
certain conditions; rails are thin, as are train-car wheels, and possibly brittle, depending on age,
construction, wear and tear, and weather. Tracks are constantly exposed to breakdown. Trucks
are exposed to the same risks, including traffic and other highway conditions. Trucks are also
higher risk, being subject to human factors, more so than other transport infrastructure.

The Midstream sector of the oil industry has a major economic impact on a varied array of
people, companies, and even countries worldwide. It is a huge, vital sector which successfully
handles one of the most difficult logistical challenges in the world. In addition to the economic
contribution of the business itself it is also important to keep in mind what the midstream sector
is actually accomplishing.
Ultimately the midstream sector provides an integral link between the upstream and
downstream sectors. This in turn makes it possible for the end consumers to purchase the goods
and utilize the services that they are dependent upon. Given the far reaching nature of the oil
industry, and the vast number of different products that it contributes to, it is obvious why the
industry continues to grow and consumption is at an all-time high.

20
 Downstream

Downstream Business
The Upstream sector involves the initial discovery and pumping of oil. The Midstream sector
involves the transportation and shipping of oil. The last stage of the process, the downstream
sector, involves the actual processing, and selling and distribution of natural gas and oil based
products.
The Downstream sector of the oil industry is actually the one that provides the closest
connection to everyday consumers. As such it is also perhaps the easiest of the three for many
people to relate to. In the Downstream sector crude oil arrives at processing plants where it is
refined and eventually turned into various products which will then be sold and distributed.
Major types of downstream business segments are refining, petrochemicals, retail bulk
marketing, storage and transportation. From an Indian perspective refining is a huge. We not
just have huge refining capacity today but also advanced and complex infrastructure today in
country. With huge population and booming industries oil and gas retail and commercial
marketing has also become a critical part of Indian oil and gas industry. We shall now look at
each domain of downstream in detail.

Refining
Crude is a mixture of various hydrocarbons and the mixture as it is, is not efficiently usable to
derive maximum energy in safe manner. Hence this mixture is refined. Refining has three
important steps, primary separation, secondary processing and Blending. Crude is separated
into different components these components are then further processed to enhance properties
or remove impurities. Final processes separated components are mixed in various proportions
to give different final products such as Petrol, Diesel, Kerosene etc.

Figure 9: Typical Layout of Refinery Processes

21
 Downstream

The figure presented above is a rough flow chart of processing in a typical refinery. Many
refineries do not have all these units and some have even more processes. Secondary and
tertiary processing is important to maximize yield of profit making products.
Refining began with simple separation of crude, but with advent of technology and increasing
demand for this non-renewable energy source effective separation of crude started gaining
importance. Along with primary separation in atmospheric distillation column new
technologies came for secondary processing. Secondary processing is aimed at maximizing
yield of profitable products like Gasoline and Diesel. Secondary processing involves carrying
out chemical changes in composition of separated fractions. Cracking for example is a typical
technology used for heavy long chain hydrocarbons into smaller chains which fit into gasoline
pool.
Many tertiary processing technologies have become common in past three decades such as
LOBS, Delayed Coker, CCR, ISOM etc. Degree to which crude can be processed and
converted into valuable products is measured by an Index called as Nelson’s complexity index.
Reliance’s Jamnagar refinery is second most complex refinery in the world. It has a complexity
index of 14. Most of the state owned refineries under HPCL, IOCL, and BPCL have complexity
index in the range of 7-10.
Figure 9 represents overall refinery operation in a very simplistic diagram. Neglecting all
secondary processing this how crude components end up as products.

Figure 10: Crude Split into Different Products

22
 Downstream

Major Refiners in India

India has developed some really good refining infrastructure over the years. Today we are a
net petroleum products exporter even though we are net crude importer. India's current refining
capacity is 230 MMTPA, including the just commissioned 15 MMTPA IOC refinery at
Paradip. The public sector accounts for 66 per cent of the total capacity while the private sector
accounts for the rest 34 per cent or 80 MMTPA.

Net Importer of Crude but Net Exporter of Petroleum Products

Refining Capacity = 230 MMTPA Domestic Demand = 190 MMTPA Export = 40 MMTPA

RIL held the largest refining capacity with its 60 MMTPA Jamnagar refinery complex until
April 2015 when IOC pipped the private refiner by commissioning the 15 MMTPA Paradip
facility, taking IOC's total capacity to 69 MMTPA. India is a net exporter of petroleum products
but rising domestic demand and lower global rates have slowed exports. Petroleum product
exports dipped 11 per cent in April-December 2015 while domestic consumption grew 9.5 per
cent during this period.

CPCL
4%
MRPL
7%

Essar IOCL
9% 30%

HPCL
11%

BPCL
13%
RIL
26%

IOCL RIL BPCL HPCL Essar CPCL MRPL

Figure 11: Refining Share across major players

23
 Downstream

Economics of Refining

Refining is a capital intensive business to set up and margin intensive business to run. Hence
setting up a good project and running it in a cost effective manner are both equally important
for a profitable business. Gross Refining Margin (GRM) is most common metric to judge or
compare the performance of a refining companies.

Table 2: Gross Refining Margin Comparison

A key reason for high GRMs of private players is the variety of crude they can process, based
on their refinery’s complexity. A complex refinery is one with an ability to process heavy or
very low quality crude that can be sourced cheaper than light or good quality crude and be
processed into fuel. They buy low and sell the refined products at international benchmark
prices. Also most PSU refineries are old and less energy-efficient, which makes a big difference
to their operational metrics.

Storage and Transportation

Once crude oil has been refined into transportation fuels, heating oil, lubricants and other
products, it must be marketed and distributed to commercial and retail customers. Refined
products make their way to terminals, service stations and other outlets via pipelines, road or
rail transport. The profits are being made in this downstream sector of the industry.

24
 Downstream

Petroleum Product Pipeline Network

Transporter Length in Kms GAIL
IOCL 7451 15%

BPCL 1648 HPCL

19% IOCL
HPCL 2553
54%
GAIL 2042
Total = 12307 Km BPCL
12%

OIL Others
5% 1%
Natural Gas Pipeline Network
Transporter Length in Kms GSPL
16%
GAIL 11077 RGTIL
RGTIL 1469 9% GAIL
GSPL 2600 69%
OIL 811
Total = 16121 Km

Large-scale transportation of natural gas by tanker truck or rail is not feasible. Pipelines are
more cost-effective than the alternative transportation options. They require significantly less
energy to operate than operating trucks or rail and have a much lower carbon footprint.
Underground pipelines are safer as well. [7]

Regasification Terminals

Transportation of natural gas presents the challenge of volume. In order to make long distance
transport economically feasible gas has be compressed to liquid form. Unlike LPG which can
be liquefied at room temperature, Natural gas cannot be liquefied at room temperature. Hence
it is cooled to low temperatures and then liquefied by increasing pressure. This liquefied natural
gas or LNG is then transported via ships to customers. At point of receipt Regasification
infrastructure is required to convert liquid gas to gaseous state in an economical operation.
India has limited reserves of natural gas. Domestic gas production is hindered due to regulatory
pricing barriers. And domestic demand is picking up fast as a result of India’s push for
utilization of cleaner fuels. This has created big market for LNG Regasification projects.
Country’s liquefied natural gas (LNG) regasification capacity expected to more than double by
2025. India has four regasification plants with a total capacity of 25 million tonnes per annum
(mtpa). Already, with a gas consumption of 51 billion cubic metres (bcm), India is the world’s
15th largest consumer and the fourth largest importer of LNG, sourcing 18 bcm. ICRA projects
the regasification capacity to significantly increase to around 47 mtpa (approximately 165
mscmd) by FY20 and around 55 mtpa (approximately 190 mmscmd) by FY25. [8]
A key challenge for the new terminals is their ability to tie up LNG supplies through long-term
contracts at competitive prices and the competition faced by RLNG from liquid fuels. The risk
related to tie up of LNG is partly mitigated by the fact that the global LNG supply demand

25
 Downstream

balance is expected to ease from FY16 onwards. The graph below indicates how new projects
are expected to bridge gap between supply and demand of natural gas in India.

Figure 12: Projected Natural Gas Demand-Supply in India

Marketing

Refined product markets are different from crude oil markets in a number of ways. The scale
is much smaller: a typical crude oil transaction involves 500,000 or even one million barrels of
oil, while a typical refined product sale may involve only 5,000 to 10,000 bbls. Product quality
is more stringent as well – crude oil, by nature, has a wide variation in quality, while refined
products must meet stringent specifications or else be considered off-spec and a breach of
contract or a regulator violation. Finally, there are many opportunities for arbitrage in the
products market, because price differentials between grades of refined products are constantly
changing at a given location or between locations many miles apart. This offers traders the
opportunity to blend grades at one location or move cargoes around the world to achieve better
prices or margins.
No refinery or marketer has a fully balanced product system so a major aspect of the product
markets is to redistribute surpluses and deficits that arise at each location. Although patterns
change over time, there are regular flows of products from one region to another and price
levels are set according to this trade. For example, European traders regularly export gasoline
to the US and gasoil to the Far East.
The retail marketing of petroleum products in India is done by the Public Sector Oil Marketing
Companies (OMCs) i.e. Indian Oil Corporation Ltd (IOCL), Hindustan Petroleum Corporation
Ltd, Bharat Petroleum Corporation Ltd., Numaligarh Refinery Ltd., Mangalore Refinery &
Petrochemicals Ltd. (MRPL) and Private Companies such as Reliance, Essar, Shell. There are
320 Terminal/Depots, 186 LPG Bottling Plants, 52248 Retail Outlets, 13896 LPG
Distributorships, 6582 SKO/LDO Dealers in the country. The prices of sensitive petroleum
products such as SKO, LPG are controlled by Government. All other products are deregulated

26
 Downstream

and are subject to market forces. The Ministry regulates the distribution policies of the sensitive
petroleum products including petrol (MS). [9]

Petroleum Prodcuts marketed in 2015-16

Petroleum Coke
Furnace Oil Bitumen 6%
4% 2%
Lube Oil
1%
ATF
6%

Naphtha
Diesel
8%
47%
LPG
5%

keresene Petrol
4% 17%

Figure 13: Petroleum Products sold in Indian Market 2015-16 [10]

27
 Revenue and Cost Drivers

Revenue and Cost Drivers

The largest upstream cost is the "spread rate" or daily cost to operate oil rigs. That includes the
rig lease itself and the cost of personnel, fuel, food, and so forth. Rig rates can change whenever
the lease is renewed, so there is a strong supply and demand component to rig cost.
Capital expenses such as well tubulars and production facilities are usually a large slice of the
pie. Exploration/development costs like seismic data acquisition (to find new prospects) can be
expensive. But not as expensive as failed wells -- dry exploratory wells impose an enormous
cost, about half of all wells drilled are a waste of time -- so risk-management absolutely must
be considered in upstream economic models. Employee compensation is a relatively small part
of the total cost breakdown, I've heard 20% is considered high.
Upstream revenue is the sales price of whatever comes out of the ground: oil, gas, and
condensate. That is sometimes spot prices (the quoted price of oil that day) but more often is
based on a fixed-rate production contract to reduce volatility. Higher oil/gas prices mean more
revenue.

Midstream costs are driven by installation/repair/maintenance of pipelines and pumps, as well

as personnel. Revenue is linear with volume of oil/gas moved through the pipeline. Generally,
higher oil consumption across the board increases profits.

Downstream costs are driven by the price of oil, the price of hedging against changes in the
price of oil, and repair/maintenance. Personnel are also a significant component. Revenues are
tied primarily to the price of gasoline/diesel, but since these track the price of oil very closely,
the inputs and outputs trend together. So the meaningful metric for refinery profitability is the
crack spread, or the difference in value between crude oil and a basket of refined products
(gasoline, diesel, jet fuel, etc).

28
 Unconventional Resources

Unconventional Resources

For long world has enjoyed the benefits of cheap oil. Many believe that this cheap oil peaked
in production somewhere about 2012. That means the production of conventional oil and gas
would now keep dropping. As oil gets rarer it becomes more difficult to extract and hence more
expensive. As world slides on the slope of diminishing cheap oil it is now exploring
unconventional resources like shale gas. In terms of actual product obtained these are pretty
much the same as cheap oil but the way they are extracted make their economics interesting.
Shale gas, Tight Oil and Gas hydrates are most potent unconventional resources for future use.
Among them Shale gas industry has already taken a big leap and made a huge impact on
Industry.
What is shale gas?

Conventional Oil Field Shale Gas Field

In a conventional Oil Field rock structure is porous. Hence if we drill a single vertical well we
can extract most of the material inside. But in a shale gas field, rock structure is non-porous.
Hence drilling a single vertical well is useless. To explore a shale gas field economically we
need to drill a horizontal well beneath the ground and then create cracks in the rock structure
by a process called as “Fracking”.
Drilling horizontally is a challenging and expensive task. Fracking is again an expensive
process. Because of these costs involved exploring a shale gas field is economically
constrained. Consistently high prices throughout the early 2000s encouraged heavy investment
in shale gas technology in US. Many such fields are now active and have contributed to surplus
in global oil market.
Challenges in Shale Gas

1) Horizontal drilling and Hydrualic Fracking: As highlighted before it is much costly

compared to a conventional oil well drilling. Along with cost there are number of
environmental concerns related to fracking, as it can potentially affect ground water
2) Seismic side effects: It has been observed that shale gas extraction often causes
Induced seismicity from shale flow back water disposal and chemical disclosure of
fracture fluid additives

29
 Unconventional Resources

3) Fresh Water: Shale gas extraction consumes a huge quantity of fresh water. This
water post usage is unfit for most human activities
4) Short lived wells: Average first year production decline in US is 70-90% [11]

Economics of Shale gas

Due to complicated technology involved in shale gas extraction, shale gas production is
expensive and it cannot compete with conventional oil and gas when crude prices are low.
Apart from expensive technology there are multiple challenges involved with shale gas which
makes its economics tricky. The technology even though complex has existed since 1970s but
lower crude prices never allowed this industry to take off. It was in first decade of 21st century
that constantly high crude oil prices incentivized investments in shale exploration.

The Breakeven for Shale gas

There are two most common basis on which shale economic profitability is related to; i) Prices
of conventional crude oil ii) Prices of natural gas in market. However latter is less common and
mostly used only in USA as its domestic production and consumption both are high.
The breakeven price for shale exploration depends upon the geography of reserve and reserve
characteristics. Some fields can breakeven at prices as low as $35/barrel whereas some
breakeven at $90/Barrel. Most typically the average breakeven range is $ 60-80/Barrel. Hence
in current economic situation where oil prices are lower shale economy is super strained. USA
has seen record rate of well production discontinuation in past two years.
In USA other common parameter to assess the profitability of shale gas is its cost of production
per mmbtu. Million Metric British Thermal Unit is an energy unit commonly used in natural
gas pricing. Typically the breakeven price for shale gas for US production fields is 3 to 6
$/mmbtu.

The Bottom Line

There is no doubt that shale oil costs more than conventional oil to extract. Beyond that, there
is a lot of variability in the cost of extracting shale oil, meaning that every well has a different
level of cost-per-barrel of production from as low as $40 a barrel to over $90 a barrel. With
these costs paid upfront for a comparatively short production life compared to a conventional
well, it makes sense for the shale oil industry to suspend new wells when world oil prices dip
and ramp up when the prices are strong. That means there are a lot of shale oil deposits sitting
idle when crude oil prices are hovering around $50 a barrel.

30
 Unconventional Resources

US story of shale gas boom and its impact

With the surge in fracking and horizontal drilling, oil and gas production in the US has
increased dramatically during the last decade. Annual shale gas production in the US grew
from about 1 trillion cubic feet (Tcf) in 2006, to about 9.7 Tcf in 2012, and is expected to
grow to about 19.8 Tcf by 2040; shale gas in 2014 comprises more than 40% of total US
natural gas production.
This boom was one the important factor that lead 2014 oil price crash to $ 30/Barrel. US
shale created a surplus in global market. OPEC has been raging a price war to drive US shale
business out of market by making it uneconomical. But US upstream segment has shown
strong fight in these days of low crude price.

Figure 14: Shale Gas Potential across globe

31
 Oil Pricing

Oil Price

Crude Price Benchmarks

Before we talk about crude oil prices it is important to understand how prices are benchmarked.
Since there are different types of crudes and each has different price, overall price trends are
monitored in terms of price certain crudes which are known as benchmark crudes. Most
common benchmark crudes are Brent (North British Sea) and WTI (USA).
Price Determinants
Like any other commodity prices for Crude Oil are driven by supply demand dynamics. Higher
demand would lead to higher cost whereas higher supply will reduce prices. How this supply
demand dynamics is driven by many complex factors.
Production Cost
Cost of production of crude directly reflects in the price of crude. But in short term prices are
not driven by costs. Rather they are driven by supply demand gap. Prices across the world are
well above production costs, ensuring a hefty margin for producers. But it is important to
consider production costs in future because as oil becomes rarer and its extraction becomes
expensive margins would diminish and production cost would play an important role in price
determination.
Economic Growth
Demand side dynamics are closely governed by economic growth. Historically a very close
relationship has been observed between crude oil consumption vs GDP growth. The figure
below shows the correlation between growth and oil consumption over past two decades. A
higher growth often results in stronger process for crude because of higher consumption.
Slower economic growth drives down demand and in turn pushes the prices down on account
of oversupply. China in recent years has seen significant slump in its economic growth, being
a major consumer of crude (roughly 10% of global demand) it resulted in a supply surplus in
markets contributing to drop in prices.

Figure 15: Fuel Prices Vs GDP

32
 Oil Pricing

OPEC Policies
OPEC by and far dominates crude oil markets on account of its huge share in global production
and huge amount of reserves that it holds. Majority of OPEC policies are targeted towards
maintaining market leadership in terms of production and recent past we have seen that
objective being prioritized over profits which caused huge drop in prices.
OPEC’s Production targets are monitored closely by speculators and affect prices significantly.
In November 2016 OPEC announced its first production cut plan in 8 years. That resulted in
strengthening of crude oil process above $ 50/Barrel Mark. [12]
Geopolitical Factors
Being primary source of energy across globe crude oil has been an important factor in
geopolitical tensions. Wars, Financial crisis, Economic slowdowns have had major impact on
oil prices in past. The figure below captures major such incidents and marks them to
corresponding peaks/dips in crude oil prices. [13]

Figure 16: Oil Price History and Major Geopolitical Events

Correlation between price and Inventories

Crude one of the most speculated and hedged commodity globally. Given the scale of
business and the sensitivity of price it is also a commodity that is stocked and heavily. The
chart below indicates how closely crude inventories levels are related to crude prices. [14]

33
 Oil Pricing

Figure 17: Crude Price vs Inventories

US Shale gas
USA’s shale gas flooded the global markets with excess capacity in recent past. US is the
largest consumer of crude globally contributing to roughly 20% of total consumption. USA
also has been largest importer of crude. Changes in domestic crude production affects its
imports in turn affecting global supply demand balance.
Reasons Behind 2014 price crash
One of the latest price disruption observed in crude market was in 2014. More than one of the
above mentioned factor contributed to that drop in varying proportion. It was a combined
effect of following factors.
i) Between 2010 and 2014 USA’s crude oil production increased by more than 60%,
majorly on account of improved drilling technologies and shale gas field
development
ii) OPEC responded to surplus in global market by maintaining its production levels
casing a sustained global oil surplus. OPECs objective was to create economic
pressure on US shale Industry
iii) Globally growth slowed down including major economies like China and Europe
resulting in wider supply demand gap
iv) Improved geopolitical conditions in gulf countries like Syria further increased
output from these countries
Overall there was sustained oversupply in market because of which prices plummeted in the
fourth quarter of 2014. After reaching monthly peaks of $112/bbl and $105/bbl in June, crude
oil benchmarks Brent and West Texas Intermediate (WTI) fell to $62/bbl and $59/bbl in
December, respectively.

34
 Government Policies

Government Policies

NELP

New Exploration Licensing Policy (NELP) was formulated by the Government of India, during
1997-98 to provide a level playing field to both Public and Private sector companies in
exploration and production of hydrocarbons with Directorate General of Hydrocarbons (DGH)
as a nodal agency for its implementation. Government of India’s commitment to the
liberalization process is reflected in NELP, which has been conceptualized keeping in mind the
immediate need for increasing domestic production. To attract more investment in oil
exploration and production, NELP has steered steadily towards a healthy spirit of competition
between National Oil Companies and private companies. This has been a landmark event in
the growth of the upstream oil sector in India. The foreign and Indian private companies are
invited to supplement the efforts of National Oil Companies in the discovery of hydrocarbons.
The development of E&P sector has been significantly boosted through this policy of
Government of India, which brought major liberalization in the sector and opened up E&P for
private and foreign investment, where 100% Foreign Direct Investment (FDI) is allowed.
Under NELP, which became effective in February 1999, acreages are offered to the
participating companies through the process of open competitive bidding. The terms and
conditions of this open and transparent policy rank amongst the most attractive in the world.
Under NELP, blocks were awarded to Indian, private and foreign companies through
International Competitive Bidding process where NOCs viz. ONGC and Oil are also competing
on equal footing. [15]

The Government has taken number of measures to bring in healthy competition and public
participation by the way of NELP for exploration & production of Oil & gas in the country.
NELP has not only accelerated the quest for hydrocarbon exploration, but has also brought the
state of the art technology and efficiency of operations /management to the country.
There have been 9 NELP rounds till date:
NELP Year Deep Water Shallow On land Total
Water
I 1999 7 16 1 24
II 2000 8 8 7 23
III 2001 9 6 8 23
IV 2003 10 0 10 20
V 2004 6 2 12 20
VI 2005 21 6 25 52
VII 2007 11 7 23 41
VIII 2009 8 11 13 32
IX 2010 1 3 15 19
Total 81 59 114 254
Table 3: NELP Allocation Details [15]

35
 Government Policies

Price Regulations
India has seen complete price regulated oil market till 2000s. Many products were sold at
subsidy incurring huge pressure of government budget. Aviation Turbine Fuel was first product
that was deregulated in 2002. Petrol was deregulated in 2010 and diesel was deregulated in
2014. Although refiners were given pricing freedom on paper, what this meant in government-
speak was that prices of these fuels would be recalibrated periodically to market prices, the key
benchmark for which is the price of their raw material—crude oil.
In 2014, prices of India’s crude oil basket tumbled 45%, from $105 per barrel to $58. But the
only fuel whose price has declined proportionately is the non-subsidized cooking gas. For three
other fuels—ATF, petrol and diesel—the fall in price has been significantly less: notably, 14%
in petrol (a deregulated fuel in this period) and 7% in diesel (a regulated fuel for most of this
period).
For petrol and diesel, the government has hiked excise duty thrice since 13 November. And the
oil marketing companies—all of them—chose not to absorb this and instead passed it on to the
consumer. Even if they had absorbed the duty hike, the differential in the volume of the fall
would still be significant.
It appears the government is keeping some cushion for itself to manage a transition, in this
roundabout way, of India’s oil sector from ‘regulated deregulation’ to full and true
deregulation. Diesel is the latest fuel to be finally primed for true deregulation, leaving
kerosene and subsidized LPG as the only fuels in the subsidy basket.
The market appears to be expecting a move to full deregulation. With diesel prices in India
finally pegged to their true cost of production, stocks of state oil refiners have outperformed
the market in the past year.
To sum up it can be said that it is still a regulated deregulation in Indian Oil market.

Current pricing Mechanism

Figure 18: Petrol/Diesel Pricing Components

36
 Government Policies

Subsidies

Petroleum subsidy was 10% of government subsidy bill in 2016-17. Total subsidy granted
was 29,000 crores. Majority of this subsidy was on domestic LPG. Other components are
kerosene and subsidy for new LPG connections. The chart below depicts breakup of
petroleum subsidy. [16]

Petroleum Subsidy 2016-17

25%

7%

68%

Domestic use LPG LPG Connections to Poor Kerosene

Figure 19: Petroleum Subsidy Split

Natural Gas Pricing Mechanism

There are multiple natural gas pricing regimes in India. These can be divided into the following:
 Administrative Pricing Mechanism
 Non-APM

APM Gas Pricing

Natural gas produced from existing blocks of Indian state owned companies like OIL India,
ONGC Caters to fertilizer and power plants, court mandated customers and those requiring less
than 50 thousand standard cubic meters per day at APM rates. The price of APM has been set
by Indian government of India on cost plus basis and is $ 4.2 per mmbtu currently. The price

37
 Government Policies

in northeast is 60% of APM prices balance 40% is paid by government to Oil companies as
subsidies.

India’s move towards market based pricing regime

In June 2013 the cabinet committee of economic affairs (CCEA) approved market based
pricing formula for natural gas produced India. The revised prices are based on
recommendations made by Rangarajan committee. The pricing formula valid for next 5 years,
pegs the base price of natural gas at around USD 8.4 per mmbtu, up from $ 4.2 per mmbtu.
The upward revision in prices is based on the weighted average of netback price at wellhead
of countries exporting LNG to India and gas prices in trading hubs of North America, Europe
and Japan. These are calculated on trailing 12 months basis. Prices are revised every quarter.
Non-APM gas pricing
Non – APM gas pricing is divided in to 2 categories. i) Imported LNG, for which prices are
determined by market, ii) domestically produced gas from the new exploration licensing policy
(NELP) and pre NELP fields.
 Pre-NELP PSC Pricing: This is applicable for gas produced from Panna-Mukta, Tapti
and Rava fields. Gas prices are determined on the basis of formula specified in
production sharing contract. All the gas produced is sold to GAIL. Currently Pre-NELP
pricing is $3.5 - $5.7 per mmbtu.
 NELP gas pricing: This applies to gas fields awarded under NELP rounds. The price
of gas is determined on the basis of arm’s length prices (market prices), subject to
government’s approval, and is controlled by PSC terms. This pricing regime was valid
until March 2014. After this new pricing mechanism has come into force, based on the
Rangrajan committee’s recommendations. Currently NELP gas price is priced between
$ 4.2- $4.7 per mmbtu.
Price of imported LNG
The price of long term LNG imported from Qatar has been linked to Japanese custom cleared
prices and varies on a monthly basis for Petronet LNG. However India’s dependence on
expensive on spot LNG to meet bulk of its demand sees limited growth from this source. [17]

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 Impact of GST

Impact of GST

What’s under GST?

Five petroleum products viz. crude oil, natural gas, motor spirit, high-speed diesel and aviation
turbine fuel have been excluded from the GST, while other products such as LPG, naphtha,
kerosene, fuel oil etc. are included.
Why such exclusion?
Biggest reason because of which these products have been excluded from GST is to get state
governments on board with GST implementation as early as possible. Petroleum taxes majorly
charged via VAT are under the preview of state government and forms major chunk of their
revenue streams. States have been unwilling to let these products go under GST. Thus these
exclusion is temporary compromise on behalf of central government. Once GST
implementation is complete and system gets used to it, it is most likely that these products will
also come under regime of GST.
How will it impact the sector?
The oil and gas industry would have to comply with both the current tax regime as well as the
GST regime leading to double compliance cost. Besides, it will result in non-creditable tax
costs where an oil and gas company will pay the GST on procurement of plant, machinery and
services, and will be unable to get credit on sale of the finished products (which are out of the
purview of GST) as the input GST would not be credible against the excise duty and value
added tax levied on these fuels.
Additionally, as services contribute a significant proportion to the upstream companies' capex
and opex, the increase in tax rate from 15 per cent to 18 per cent would impact the upstream
companies adversely. In the gas utilities segment, gas marketers will face complexities as they
will pay the GST on transmission tariffs, while sale of natural gas is outside the purview of
GST.

Overall GST would impact Oil and gas sector negatively. However, given the fact that majority
of players in this segment are state owned companies, its repercussions would not be felt
significantly. Also this is expected to be a temporary situation, and whole set of petroleum
products is expected to come under GST in near future.

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 Future Prospects

Road Ahead

Worldwide, the oil and gas industry sector remains incredibly lucrative. Falling prices, job
instability and a battle to position oil and gas as a viable option compared to renewables have
certainly impacted the oil and gas industry over the past decade, but we believe the sector is
better placed than ever to move into the next 40 years with confidence and success. So how do
the next four decades shape up?
Globally, the need for oil is still growing and companies have to balance this demand for more
oil with potentially diminishing supplies. It’s likely that in future oil fields will be designed to
be used for longer and their longevity will be boosted by an injection of water or gas into the
oil supply to enhance its pressure.
The heavy oil contained in oil sands has recently become part of the estimation when global
oil reserves are reported on. It is likely that as exploration into this kind of oil begins in earnest,
the extraction of it will become less labour intensive, more environmentally friendly and cost
effective.
Fracking has certainly received its fair share of negative press, intensified by misinformed
comments about the potential risks it poses, but remains a vital part of our oil and gas industry
future. Fracking is commonplace in the US, where it is responsible for around half of the oil
and gas produced in the industry.
Iran and Iraq’s potential to increase their output could impact the market moving forward, and
touched on the impact of a global move towards shale technology in an April 2016 report. Shale
oil and gas industry developments have transformed the US market.
Oil and gas firms are trying to avoid arbitrary cost cutting, and pursue a way to balance the
production of competitively priced oil with carbon footprint reductions. New technologies can
help to minimise costs and reduce emissions. The next 40 years will be decades shaped by
change and new challenges. If the oil and gas industry sector can achieve the balance between
competitive pricing, investment in new technology and a defined business focus, there’s no
doubt it move forward and continue to prosper.

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 References

References

[1] “Oil and Gas for Beginners,” Deutsche Bank, 2013.

[2] “BP Statistical Review of World Energy,” 2013.

[3] “Evolution of Indian Oil and Gas Industry | Directorate General of Hydrocarbons (DGH),” 2017.

[4] US Energy Information Administration, 2015.

[5] “Exploration and Production Geology,” [Online]. Available: http://www.epgeology.com/risk-

and-play-mapping-f48/assigning-exploration-risks-t157.html.

[6] “Barrel Breakdown by WSJ News graphics,” [Online]. Available: http://graphics.wsj.com/oil-

barrel-breakdown/.

[7] “Petroleum and Natural Gas Regulatory Board,” 2017. [Online]. Available:
http://www.pngrb.gov.in/data-bank.html.

[8] ICRA, “Crowding of regasification terminals could put pressure on,” ICRA, 2015.

[9] M. o. P. a. N. Gas. [Online]. Available: http://petroleum.nic.in/docs/mktact.pdf. [Accessed

2017].

[10] M. o. P. a. N. Gas, “Indian Petroleum and Natural Gas Statistics,” 2015-16.

[11] M. G. Salameh, “Impact of U.S. Shale Oil Revolution on the Global Oil,” International
Association for Energy Economics, 2015.

[12] EIA, “WHAT DRIVES CRUDE OIL PRICES?,” [Online]. Available:

http://www.eia.gov/finance/markets/crudeoil/index.php.

[13] T. R. U.S. Energy Information Administration. [Online].

[14] I. G. I. U.S. Energy Information Administration. [Online].

[15] I. DGH, “New Exploration Licensing Policy (NELP),” Directorate General of Hydrocarbons, 2017.

[16] M. o. P. a. N. Gas, “Oil and Natural Gas Statistics,” Goverment of India, 2015-16.

[17] EY, “Natural gas pricing in India,” EY,PHD Chamber.

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