Many of the issues raised by the Ambani dispute are common across the developing world, as jockeying for natural resources – and the wealth their exploration and production create – occurs often between businesses and governments.

But the history of successful nations also suggests that the rule of law is enforced by governments unhindered by corruption or political-favoritism. India has experienced dynamic growth, but its government must clearly establish rules for market participation. Moreover, the Indian government must enact a practical energy policy without interfering unduly in the nation’s economy. This will be critical to India’s long-term economic development.

Mukesh and Anil Ambani’s ongoing disagreement has major consequences for India’s future. Successful governance requires that private actors not be allowed to undermine the integrity of government policies as it creates uncertainty among other market participants about which rules will govern their investments. The history of the global energy sector proves this conclusively.

Introduction

India is one of the fastest-growing countries on earth. India is the second most-populous nation in the world and, by 2030, is expected to be home to the world’s third-largest economy. Secure energy development is integral to continue this dynamic growth.

Currently, Indians use only about 2.6 barrels of oil equivalent per person a year compared with a world-wide average of 13 barrels. Yet, India must import approximately 70% of the energy resources needed to meet total domestic demand.

The mix of energy resources India uses is also unfavorable compared to the rest of the world. Coal accounts for a highly-antiquated 70 percent of electricity generation, and 50 percent of India’s total non-residential energy demand is met by coal. Oil provides for more than 30 percent of its energy needs while natural gas accounts for only 9 percent. By comparison, natural gas meets on average 23 percent of the world’s energy demand. In fact, the United States meets 25 percent of its total energy demand through the use of natural gas.

The recent economic downturn further unsettled India’s already delicate energy balance. For example, skyrocketing commodity prices lifted India’s oil import bill to nearly $80 billion last year. This in turn further increased the government’s deficit, the shortfall ballooning to account for larger energy and fertilizer subsidies.

Despite all of this, 400 million Indians remain without what is considered a basic necessity in most developed countries – electricity. So many Indians live without this necessity due to a lack of power availability and prohibitive cost. A large majority of Indians, therefore, must rely on less efficient and less environmentally-friendly energy sources. Indeed, 87 percent of India’s rural population uses biomass to meet their cooking needs.

India’s energy development is vital to not only its energy security, but also to international security. Currently, though, the natural gas dispute between Mukesh and Anil Ambani over the memorandum of understanding (MoU) brokered by the brothers’ mother in June 2005 is marring efforts to expand India’s clean energy reserves, to the detriment of consumers, businesses and investors alike.

India’s Energy Development Policy

To bring clean power to India, the government must increase energy supplies and improve energy delivery at affordable prices. To accomplish this, the government has made acquiring energy supplies, both through imports and domestic development, a high priority. It also has engaged in a massive effort to improve the nation’s energy infrastructure.

The Indian government recognized the need for a comprehensive approach to meet its energy security needs in the 1990s. Thus, it drafted a competitive fiscal regime, the New Exploration Licensing Policy (NELP), in 1995. NELP was formed to accelerate the development of its offshore oil and natural gas reserves.

Under NELP, the government has granted licenses to some 63 blocks off its east and west coasts. One of the most successful licenses by far was granted to Reliance Industries, Ltd. (RIL) for the D-6 block of the Krishna Godavari (KG) basin in 1999.

RIL’s development efforts are a direct result of ambitious energy-production objectives. That led to its seeking licenses for oil and gas development during the first NELP round in the late 1990s and the subsequent discovery of a massive deepwater natural gas reservoir in the D-6 block in 2002.

The initial estimate of that find was for a reserve of 5.32 trillion cubic feet (tcf) of natural gas. It was estimated it would deliver peak production of 40 million standard cubic meters per day (mmscmd). The development cost for the project was $2.47 billion.

In 2006, though, additional development led to revised reserve estimates, increasing to 11.3 tcf, enough for 11 years at a new estimate peak production of 80 mmscmd. However, the development costs also went up at an even greater rate than the reserves, to $8.8 billion. That sharply higher cost was a direct result of skyrocketing prices that hit the world’s offshore oil development industry. Between 2000 and 2008, steel prices increased more than 250 percent. Consequently, the price of an offshore production rig has nearly quintupled, among various other sharp price increases.

Still, a 2008 report by Goldman Sachs of 32 deepwater projects globally has found RIL’s development costs for D-6 among the lowest in the world. This D-6 project also ranks among the fastest in moving from discovery to production worldwide. Goldman Sachs even goes on to recommend RIL to its investors, “We prefer Reliance Industries within the refining space given its increasing exposure to the natural gas business in India, with the company expecting the commencement of production from the KG D-6 block in January 2009. With gas prices fixed for the first five years, this business will increase the proportion of RIL’s annuity earnings and, in fact, will become its largest business division in terms of operating profits by FY11E, in our view.”

At full production, the KG basin discovery would effectively double India’s current domestic natural gas production. This expansion would enable India to increase electricity generation, reduce power shortages, and rely less on other nations to meet its burgeoning energy needs. The natural gas in the KG basin – complete with its production’s important economic and security implications – is essential to the modernization of India’s energy landscape.

The successful development of the KG D6 block also demonstrates the existence of potential commercially viable reserves in the East Coast of India. The KG Basin may soon earn the reputation of being India’s Gulf of Mexico with other oil and gas discoveries made by state owned ONGC and Gujarat State Petroleum Corporation (GSPC).

Energy Modernization in India

To fully understand India’s critical need to modernize its energy sector, there is no need to look further than the variety and complexity of the domestic energy projects recently launched. Just last month, state-owned utility Gas Authority of India, Ltd. (GAIL) – keen on sourcing natural gas supplies – signed an agreement with New Delhi-based South Asia Gas Enterprise Pvt. Ltd (SAGE). This deal marks the initial stages for the construction of a 2000-km deep-sea natural gas pipeline from Qatar, via Oman, to the Indian states of Gujarat or Maharashtra.

Official sources say that GAIL signed the deal because it foresees possibilities that the pipeline will be fully-implemented soon, given the delays in the Iran-Pakistan-India (IPI) natural gas pipeline and the rise in India’s natural gas demand. This new demand will not be met even with new natural gas supplies from KG fields off India’s eastern coast.

Currently, Qatar supplies the bulk of India’s rising natural gas imports. Imported liquefied natural gas (LNG) – gas that will continue to increase its market share in the future – is slated to double this year.

If all goes well, the SAGE energy corridor is expected to be completed by 2014. At least two deepwater pipeline specialists have confirmed that the pipeline project is technically feasible. The pipelines would reach a depth of 3,500 meters and the terrain has been extensively surveyed over the last two decades. In the first phase, 31 million cubic meters per day (1.1 bcf per day) could be transported from Qatar to India’s west coast.

Unfortunately, both the financial and technical issues are overwhelming. There has never been a pipeline anywhere in the world that has traversed such deep waters.

This is why India’s development of its own large reserves of offshore oil and natural gas can play an important role. Sadly, this is also why the feud between the Ambani brothers over their pricing agreement has become a national problem.

Exploration and Production in the Developing World, Global Energy Pricing

India’s natural gas consumption presently is 180 million standard cubic meters per day (6.4 bcf per day) while domestic production is 80 million standard cubic meters (2.8 bcf per day.) Clearly, India needs to increase its production of natural gas to better meet its own energy needs. Nations across the developing world face the same challenges.

Exploration and production costs vary widely from across the world. Developed and developing energy-producing states in other parts of the world give testament to the diversity of global development costs. For example, Norwegian and British energy companies face much higher costs for producing oil and natural gas compared to competitors in places such as Mexico and Saudi Arabia. Depth of exploration, labor requirements and rate of investment return, among many other considerations, make global energy exploration and production across the developed and developing worlds anything but “one-size-fits-all.”

However, the KG basin affords India some of the world’s most cost-effective energy development opportunities. At the equivalent of about $5, RIL’s development costs are about half that of the global average. Deutsche Bank, for example, estimates that the KG D-6 development could increase India’s gross domestic product (GDP) by $103 billion.

Additionally, Goldman Sachs estimates India will save $9 billion on imports and lower its current account deficit by $2.6 billion. Citibank estimates India will cut that deficit by as much as $10 billion. The government likewise will benefit with a fiscal deficit reduction of more than $3 billion, according to Citibank. All of this promises to make India economically more vibrant, safer and more secure, especially in dealing with the behavior of some of its current energy partners.

The relative pricing of natural resources worldwide is another important component of the natural gas stand-off in India. Some in India point to the Henry Hub price – the pricing point on the New York Mercantile Exchange (NYMEX) for natural gas futures contracts – when making the case for lower prices. This is a flawed pricing mechanism, however, especially when discussing India’s natural gas reserves.

As IHS Cambridge Energy Research Associates (CERA) reports, Henry Hub is an increasingly unreliable benchmark for the world market. North American gas is now developed predominantly in the western parts of the continent, far from the actual commodity trading on the NYMEX. Obviously, the KG basin’s D-6 block off of India’s east coast is even farther away.

Henry Hub pricing for India’s natural gas is problematic because the world’s various natural gas markets all behave differently. The idea of choosing a single price based on a market in New York and a pipeline in Louisiana makes little sense for a developing economy such as India’s. For example, in other Asian markets, the natural gas market typically indexes its prices to crude oil. Moreover, Europeans maintain several different pricing centers throughout their continent.

This insight into the pricing of global natural gas markets is important for India’s government to acknowledge. If the pricing mechanism does not hold the promise of being fair and attractive it will inhibit the full development of India’s vast energy resources – the government will pay a heavy price, namely less foreign investment in the country and a continued energy supply deficit.

Government’s Role in Energy Markets, the Ambani Feud

New Delhi is now confronted with a very fragile situation, one in which the nation’s future economic development and energy security depend.

Foreign firms looking to invest in the Indian market and promote its energy development are concerned about the additional risk they would incur if different sets of rules are cut out for special players rather than one set of rules for all.

Indeed, India now has had to delay its licensing of a new set of oil and natural gas leases because foreign firms are worried about whether they should currently enter India’s energy markets. Orderly markets demand transparency. Otherwise, businesses may find the investments they make undermined by collusion among other market players.

Government officials are working to ensure that the fair, government approved pricing mechanism is followed, though. Oil Minister Murli Deora stated last week that the government will take all steps necessary to protect the state’s legal right to regulate the utilization allocation of natural gas reserves.

When the Supreme Court hears the Ambani court case next month, if it affirms the family-brokered contract, the court would essentially endorse collusion in other energy ventures at the expense of the government’s energy policies and India’s national security.

In short, a ruling in favor of the family agreement would grant the rights to trade and arbitrage the price differentials in markets for private profit without any advantage to India’s economic development.

The Future of Energy Security

India’s current energy sector is vulnerable, and the best way to strengthen it is to produce domestic oil and natural gas resources, at affordable prices, under the rule of law.

There is concern that, if India becomes overly dependent on Iran, it may be induced to share its nuclear technology with it and become inhibited in joining global efforts to deter Iran’s nuclear ambitions and support for terrorism. This would affect not only Western security interests, but also India’s and other Asian nations, as well.

There is already reason for worry. India’s Oil and Natural Gas Corp. discovered natural gas in Iran’s Farsi block, with reserves estimated at 10 trillion cubic feet, and it discovered about 1 billion barrels of oil within 50 miles of where Iran is constructing its first nuclear reactor. No one in the international community wants to see India more reliant on such a hostile nation to meet its growing energy demand.

India’s growing energy appetite has also sparked interest from Russia. For example, President Pratibha Patil and Prime Minister Vladimir Putin met last week in Moscow and agreed to strengthen their bilateral energy cooperation, with a special focus on hydrocarbons. This has given some in the international community pause, as well.

It is in the best interest of India, the United States and other Western nations for India to diversify its energy resources.

Conclusion

In sum, the Indian government owns the natural gas resources at stake in the Ambani dispute. The government must maintain as its number one priority the advancement of its citizens’ welfare by ensuring a smoothly functioning market. Thus, the government-set price must prevail to continue to provide an attractive domestic business environment, increase domestic energy supply, and strengthen global energy security.