Type: Client Alerts
India’s ambitious drive to reduce dependence on foreign hydrocarbon imports is expected to spur almost US$30 billion of exploration and production investments including in the offshore sector. An increase in offshore exploration activities usually results in increased work opportunities for offshore support vessels (OSVs). However, the cabotage policy in India means that the odds are stacked against foreign OSV owners winning tenders. To improve their odds in the tender process, foreign OSV owners have to take certain measures including setting up an Indian entity to assume ownership of the relevant vessel and fly the Indian flag.
Introduction While demand for hydrocarbons in the world’s biggest economies is generally weak, India, fueled by relatively robust economic growth, is set for a rapid, sustained trajectory in energy demand.1 In 2015, India consumed an average of 4.1 million barrels per day (mb/d) of crude oil, overtaking Japan as the world’s third largest consumer of crude oil. It is anticipated that by 2040 not only will India’s energy use more than double to reach 1,900 million tonnes of oil equivalent (mtoe), but the demand for oil in India will also increase by 6 mb/d to reach 9.8 mb/d.2 At present, India imports about 75 per cent of its crude oil and around 40 per cent of its natural gas requirements.3
HELPing the Indian oil and gas sector However, in a bid to reduce India’s dependence on foreign oil and gas, Prime Minister Narendra Modi announced in February 2016 an ambitious plan to cut fuel imports by 10 per cent over the next six years and sought investments close to US$27 billion in domestic hydrocarbon exploration projects to achieve this objective.4 To this end, the Minister for Petroleum and Natural Gas, Dharmendra Pradhan announced the new Hydrocarbon Exploration Licensing Policy (HELP) on 10 March 2016, replacing the oft-criticised National Exploration Licensing Policy (NELP).
One of the major features of HELP was to prospectively replace the cost-recovery (or profit-sharing) arrangements with a revenue-sharing mechanism. Previously, production-sharing contracts were based on the principle of ‘profit sharing’ and until a profit was made, no share was given to the government, other than royalties. To enable the government to monitor a contractor’s costs, government approval had to be obtained at various stages and activities could not be commenced without such approval. Many projects were delayed due to disagreements as to what constituted a valid cost item and the amount to be apportioned for the item.
The revenue-sharing mechanism is intended to minimise such disputes as it operates on a ‘pay-as-you-go’ model where the operator sets aside an agreed percentage of the gross revenue generated for payment to the government. The government is not concerned with the cost incurred and receives a share of the gross revenue from the sale of oil and gas.5
Second, HELP also allows exploration and production companies to submit an expression of interest indicating the area in which they wish to operate. In contrast, under NELP, the exploration was confined to blocks that had been put on tender by the government. The other major reform was to free the pricing of gas extracted from new blocks and existing discoveries that were yet to commence production, especially in deep water and complex geological areas such as deep and ultra-deep water fields.
Major oil companies welcomed these reforms. In the first significant statement following the announcement of HELP, ONGC revealed its plans to invest as much as US$5 billion over the next three years to develop new oil and gas discoveries especially in the Krishna Godavari basin, off the eastern coast of India.6 BP, whose 30 per cent stake in Reliance Industries’ 21 offshore oil and gas blocks (amounting to US$7.2 billion) has been hit by production and a pricing dispute, welcomed the latest reforms as a “step change”.7
Indians first An increase in offshore exploration projects usually means there will be increased work opportunities for OSVs – music to the ears of OSV owners given that recent demand for OSVs has been parched at best. The reality, unfortunately, is somewhat different, at least in the case of foreign OSV owners. A major obstacle for foreign OSV owners wishing to participate in these projects is the Indian cabotage regulations. Cabotage refers to the restriction on the operation of vessels between sea ports within a particular country. In India, these regulations offer preferential treatment or right of first refusal to Indian flagged vessels; foreign flagged and/or foreign owned vessels are allowed only when no suitable Indian flagged vessel is available.8
Right of first refusal accrues to a technically qualified bidder in a tendering process. Therefore, where an Indian flagged vessel is available for charter and a foreign flagged vessel offers the lowest charter rate, the Indian flagged vessel would be given an opportunity to match the foreign flagged vessel’s charter rate and if it does so, would win the tender. The Indian Directorate General of Shipping has recently announced an intended further tightening of the right of first refusal rules and the following hierarchy of categories would have to be observed when contracts are awarded:9
i. Indian flagged vessels owned by Indian entities
ii. Indian flagged vessels chartered by Indian entities
iii. Indian flagged vessels chartered by foreign entities
iv. Foreign flagged vessels owned by Indian entities
v. Foreign flagged vessels chartered by Indian entities
vi. Foreign flagged vessels that are under construction at the time of a tender and are owned by Indian entities with a commitment to convert to the Indian flag at the start of the contract
vii. Foreign flagged vessels that are chartered by Indian entities with a commitment to convert to the Indian flag at the start of the contract
viii. Foreign flagged vessels that are under construction at the time of the tender and are chartered by Indian entities with a commitment to convert to the Indian flag at the start of the contract
ix. Bareboat charter-cum-demise vessels chartered by Indian entities
x. Foreign flagged vessels that are built in Indian shipyards and owned or chartered by Indian or foreign entities
xi. Foreign flagged vessels that are built in foreign shipyards and owned or chartered by Indian entities
If a preceding category is not available or the right of first refusal is not exercised by a qualified bidder in the preceding category, then the right of first refusal is given to a qualified bidder in the next category.
Reducing the odds for foreign OSV owners Given the above order of priorities, unless a foreign flagged vessel offers an exceptionally low rate, realistically, it has very little or zero chance of succeeding in any open tender. In fact, given the current state of the OSV market, most current tenders are filled up with category (i) vessels. It is also difficult to compete on rates, at least in the case of certain tenders, as the age restriction for the vessels is 21 years. This has meant stiff competition from older vessels, which can afford to offer much lower rates than newer and more advanced vessels.
In order to improve its chances, the foreign OSV owner has to take certain measures to leapfrog up the categories.
First, the foreign OSV owner may register its vessel under the Indian flag. For a vessel to be Indian flagged, it has to be owned by an Indian citizen, company or co-operative,10 which means that the foreign OSV owner has to set up an Indian company to assume ownership of the vessel. The current Indian foreign direct investment policy allows for 100 per cent foreign ownership of Indian companies in the oil and gas sector.
However, there are several important considerations that a foreign OSV owner should take into account when setting up an Indian company. These include: (i) registration of a mortgage under Indian law may not be acceptable to its lenders; (ii) the Reserve Bank of India does not allow a negative pledge of the shares in a single purpose vehicle, which is commonly set up to assume ownership of the vessel; (iii) the Indian company will be exposed to Indian tonnage tax; (iv) remitting profits out of India could be a challenge as dividends out of India are subject to a withholding tax of 23 per cent; and (v) managing currency fluctuations. Even if the contract is awarded in U.S. Dollars, the Indian banking system only allows the holding of U.S. Dollar amounts for one month, after which they are automatically converted into Indian Rupees.
Second, a foreign OSV owner may enter into an agreement with an Indian entity to charter its vessel to the Indian entity. The tender would be submitted by the Indian entity. If successful, the Indian entity would contract with the oil company and charter the vessel from the foreign OSV owner.
From experience, the foreign OSV owner in that situation should take certain measures to protect its interest. These include requiring payment of the charter hire to be remitted into a bank account nominated by the foreign OSV owner.
Alternatively, the foreign OSV owner could instead ask for a banker’s guarantee for up to three-month charter hire from the Indian entity. Being able to call on the banker’s guarantee would be useful where the Indian entity/charterer had been paid by the oil company but that payment was not passed through to the foreign OSV owner. The other advantage of this latter measure is that the foreign OSV owner has the flexibility to call on the banker’s guarantee even if the delay in charter hire payment arose as a result of the oil company’s delay in making payment: a common incident in this type of contract.
To prevent the Indian entity from ‘foreign owner shopping’, the foreign OSV owner should also stipulate in the pre-charter agreement that the Indian entity must only put forward the foreign OSV owner’s vessel in the tender. This prevents the Indian entity from picking and choosing a vessel which would provide it with the highest charter hire margin and minimises the risk of any future sharp negotiating practice by the Indian entity. In addition, it eliminates the risk of leaked commercial information being put forward for the tender.
There is hope yet… Therefore, while at first blush India appears promising, the odds, unfortunately, are stacked against foreign OSV owners given the prevailing right of first refusal rule.
To take full advantage of the opportunities India presents, foreign OSV owners have to take certain measures to give them a realistic chance of succeeding in these tenders. These measures, however, come with attendant risks and should be properly considered before taken.
- “International Energy Outlook 2016”, U.S. Energy Information Administration (EIA, 2016). Available at: http://www.eia.gov/forecasts/ieo/world.cfm (accessed on 25 July 2016).
- “India Energy Outlook – World Energy Outlook 2015”, International Energy Agency (IEA). Available at: http://www.worldenergyoutlook.org/media/weowebsite/2015/IndiaEnergyOutlook_WEO2015.pdf (accessed on 25 July 2016).
- Based on IEA, 2010a; “Global Energy Assessment: Toward a Sustainable Future”, GEA Writing Team (Cambridge University Press, 2012), at p.341.
- “India's $27b oil quest gives services firms a lifeline”, Saket Sundria, Dhwani Pandya and Debjit Chakraborty, The Jakarta Post (29 June 2016). Available at: http://www.pressreader.com/indonesia/the-jakarta-post/20160629/282127815784720 (accessed on 25 July 2016).
- “India approves HELP plan to spur investment, production”, Oil and Gas Journal (10 March 2016).
- “ONGC to Invest US$5 Billion in Two Krishna Godavari Basin Fields”, Gireesh Chandra Prasad, Livemint (24 July 2016).
- “India Targets $40bn of Untapped Oil and Gas”, Victor Mallet, Financial Times (15 March 2016).
- Part XIV of the Merchant Shipping Act 1958, sections 406 and 407.
- “Foreign Ships Could Lose Out on Indian Coastal Work”, Manoj Venunath, IHS Fairplay (10 May 2016).
- Section 21 of the Merchant Shipping Act.
Client Alert 2016-211