INTERNATIONAL ASSOCIATION OF DRILLING CONTRACTORS P.O. Box 4287 • Houston, Texas 77210-4287 USA 15810 Park Ten Place, Suite 242 • Houston, Texas 77084-5139 USA Phone: 1/281 578-7171 • Fax: 1/281 578-0589 • www.iadc.org

M.K. Zutshi 26 February 2003 Chairman Central Board of Excise & Customs & Ex-officio Special Secretary to the Government of India North Block New Delhi 110002 INDIA

Dear Mr. Chairman, I am sure you recall our meeting this past November in your office, when we discussed various concerns shared by India’s contract drilling community about certain policies of India Customs involving drilling rig equipment valuation and other matters. I was very pleased and encouraged that you expressed a desire that the problems our members of the International Association of Drilling Contractors (IADC) have encountered in India be addressed and remedied. The most pressing problem we brought to you was the apparent disconnect between the positive intent of the Government’s policies and the subjective interpretations of same by individual customs officials, probably owing to certain ambiguities in the wording and procedures laid down in the statute to implement the policies. We brought to your attention examples of customs levies imposed by local customs authorities on drilling rigs at the time of import which were then repudiated by central customs authorities, often very long after the subject rigs were well established in operations in the Exclusive Economic Zone of India. The resulting confusion and litigation have served to interrupt drilling operations and discourage international companies from bringing rigs to work in Indian waters. Foreign drilling companies have found it difficult to deal with the extensive and repeated interrogations at customs house about the legality or correctness of certain imports, long after the import formalities were completed and the rigs were procedurally out of the charge of India Customs. IADC sincerely welcome your initiative and commitment to bring professionalism, courtesy, and a congenial atmosphere in interactions of the customs officials with international drilling contractors. This surely will go a long way in making those companies forthcoming, and in encouraging them to do business in India. I made the case to you that India might consider dealing with the difficult issue of ascertaining the value of a rig for customs purposes by simply excluding rigs as a class of equipment from the customs regime. This can be done by considering the rigs as “tools of the trade” engaged in temporary construction activity: in this case, the construction of a well bore. This approach is being discussed in Geneva at the World Trade Organisation for construction activities in international markets. It also dispenses with the problem of judging how much of a

HOUSTON • WASHINGTON D.C. • UNITED KINGDOM • THE NETHERLANDS • OMAN

drilling rig is new or used, as it is repaired and modified throughout its normal working life which can be decades long. The “tools of the trade” approach is used in many places in the world involving specialised equipment that enters and leaves a given country frequently, but is not in fact “imported”, which would give rise to a customs levy. You asked me to provide you examples of how other offshore oil and gas nations handle these issues as applied to drilling rigs. We have examined eight countries outside the U.S. and Europe which have active offshore programs, and whose experience may more closely approximate that of India:

Representative Rig Import Procedures Angola - Rig enters as temporary importation. - Exempted from paying duty. - Have to submit a customs invoice identifying the rig and stating the value, as determined by the contractor. - Contractor can be the importer. - Must pay 2% of value to a clearing agent. - Treat rigs as "vessels in transit," therefore not technically imported. Bangladesh - Similar to Malaysia. - Have to keep detailed records of spare parts imported, consumed and remaining. Brazil - Contractor is importer. - All companies operating rigs in Brazil must be registered under the "Repetro" license system, with annual license renewal.

- Under this system, all imports are classified as either (a) consumables, and therefore subject to the full duty as per the tariff code (e.g. spare parts); or (b) temporary admission, and therefore exempt from duty (e.g. rigs). - On receipt of documents and once the tariff has been determined, separate licenses will be issued for consumables and for all temporary admission items.

Gabon - Have to submit a customs invoice identifying the rig and stating the value, as determined by the contractor. - A "duty” amount is assessed, but does not have to be paid. Instead, contractor posts a bond or obtains a letter of guarantee from the oil company client. - Have to pay a customs fee of 3% of the duty amount per month plus interest, but it's a matter of negotiation between the contractor and the client who pays this fee. Indonesia - Import rig on behalf of the operator. - Submit detailed master list of equipment imported, including spare parts needed for duration of the contract. - Rig and other items on the master list are duty free. - If not on the master list, must post a bond in the amount of the customs duty, which is about

10% of the value of the item imported. - Upon completion of work, the bond is returned if you show the customs authorities you are exporting everything you brought in; otherwise pay duties and penalties for permanent importation. Malaysia - Rig enters Malaysia under the "umbrella" of the operator. - There are no duties assessed against the drilling rig or associated equipment. - There are also no duties on spare parts, so long as they are on the "master list" maintained by the operator. - If spare parts not on master list, import duty is levied at approximately 10% of value. Mexico - Mobile rigs - Treated as "vessels".

- Temporary 10-year import. - No customs duties. - Import documentation, declare fair market value of rig. - Upon export, submit documents, but no fees.

- Platform rigs - Considered permanent import. - Detailed list of every item of equipment imported, giving fair market value. - Import fees and duties amount to about 10% of fair market value.

- In addition there is a VAT of 15% that has to be paid upon import, but is refundable upon export.

Nigeria - Rig enters as temporary importation for 24 months, must be renewed every 12 months. - Exempt from paying duty. - Have to submit a commercial invoice, simply identifying the rig and stating the value. - Contractor can be the importer. - Must post bond in the amount of 20% of value of the rig to secure export of the rig.

We think the above list is a useful point of comparison for India Customs, especially as it includes several neighboring countries. Another key issue raised with you in our meeting in November was the often bizarre implications of “Re-Export” requirements derived from the terms of “Essentiality Certificates” issued by the Director General of Hydrocarbons. For a drilling contractor to move its rig from one offshore block to another involving different operators sometimes requires that the rig be “exported” from Indian territory, just to be brought immediately back in. This transit is wholly unnecessary, extremely expensive and poses unnecessary danger to the rig and its crew. Such rig moves from block-to-block within the Exclusive Economic Zone of India should be facilitated as are similar moves everywhere else in the world. The technical designation of rigs as subject to “Re-Export” has dubious foundation in law and makes utterly no sense in the real world of offshore operations. I was gratified that you acknowledged such a system is illogical, and hope

that in future Customs might simply deem these technical requirements as satisfied, and thus avoid rig journeys “out” of India just to turn around and re-enter to begin another contract on another block. I have attached a detailed longer note on these and related issues. IADC sincerely hope you and CBEC can find the administrative means to remedy many of the problems illustrated in the note. As I emphasised in our meeting, many offshore drilling contractors have become reluctant to engage in work in India because of the uncertainties associated with rig valuations and customs levies, and those contractors that do consider working in India often choose not to send their newest and most technically advanced equipment for work there, for fear that it will be embroiled in endless disputes over its value. Absent a reliable objective recognized authority for setting the value, India Customs could hold the rig or stop its work pending resolution of valuation disputes. Many new generation offshore rigs are unique, especially those now exploring the deepwater areas around the world. India needs these rigs to harvest its deepwater hydrocarbon resources, and the establishment of a reliable system of rig valuation with the certainty of a final customs levy would go a long way to giving drilling contractors confidence they can perform their contracts expeditiously and to the highest industry standards. We look forward to your reply to this submission, and are available to you if you or your staff have any questions or need of clarification. I have indicated my full postal address and other contact information below my signature. We look forward to improving the business climate for offshore oil and gas exploitation in India with your assistance and guidance. Yours sincerely,

Brian T. Petty Senior Vice President – Government Affairs IADC 1901 L St., NW Suite 702 Washington, DC 20036 U.S.A. Tel: 202-293-0670 Fax: 202-872-0047 E-mail: brian.petty@iadc.org c: Mr. Vijay Kelkar, Ministry of Finance Attachment

Note on Customs Issues related to Offshore Drilling Rigs Background The Exploration & Production of Petroleum has been undoubtedly a priority for India. In order to carry out the petroleum operations in the offshore areas falling within the exclusive economic zone of India, various petroleum operators including ONGC, Reliance and others have to charter hire the Mobile Offshore Drilling Units commonly known as Offshore Drilling Rigs from the Drilling Contractors all around the world. Although the offshore drilling rigs are entitled for customs duty exemptions under the Indian Statute, while operating in most of the Petroleum Exploration License / Mining Lease Areas (PEL / ML Areas), the drilling contractors face difficulties while completing the Import / Export Formalities. The major issues faced by the drilling contractors are as follows:

• Importability of the offshore drilling rigs

• Valuation of the offshore drilling rigs and equipment, which are brought in to India on Charter hire basis without involving any sale or purchase transaction.

• Transfer of imported offshore drilling rigs and equipment from a PEL / ML area operated by one operator to that operated by another operator, within the EEZ of India, in view of the Re-Export condition imposed by the Director General of Hydrocarbons while issuing an Essentiality Certificate.

The above issues are elaborated in details below: 1. "Importability" of the Offshore Drilling Rigs The offshore drilling rigs, charter hired by the petroleum operators, are required to be brought to Indian waters, only for the purpose of rendering the drilling services, for the duration of the contracts. These rigs are returned to the agreed demobilization point, as soon as the obligations under the drilling contract are fulfilled. The drilling rigs, which are available throughout the world for charter hire by the petroleum operators, are generally not “new". These rigs are generally "used" and are in most of the cases older than 10 years. Most of the petroleum operators do not want to take the role of an importer. They prefer the drilling contractor to import the Drilling Rig & Associated Goods and deploy the same for the petroleum operation carried out by them. Hence the drilling contractors become "Importers" of goods although they are not the "Actual Users". As a first step in the importation process the Drilling Contractors have to face an important question from the Customs Authorities:

Whether the Offshore Drilling Rigs are considered to be "freely importable" under the Indian Export & Import Policy? And if so, under what section? Although it appears to be the intent of the Government of India that the offshore drilling rigs should be "freely importable" when brought in to India on charter hire basis, the current Export & Import Policy 2002-2007 does not seem to have an absolutely clear answer to this question. Section 2.16 of the Export Import Policy provides that Capital goods, raw materials, intermediates, components, consumables, spare parts, accessories instruments and other goods which are importable without any restriction may be imported by any person. However if such imports require a license / certificate / permission the actual user alone may import such goods unless specifically dispensed with by the licensing authority. Section 2.17 of the Export Import Policy provides that all second hand goods shall be restricted for imports and may be imported only in accordance with the provisions of the policy, ITC(HS), Handbook (Vol. 1), Public Notice or a license / certificate / permission issued in this behalf. Section 2.21 of the Export Import Policy provides that New or Second Hand Capital Goods, equipment components. parts and accessories, containers meant for packing of goods for exports may be imported for export without a license / certificate / permission on execution of legal undertaking / bank Guarantee with the Customs Authorities. Section 2.32 of the Handbook of Procedures under the current Export Import Policy provides a list of second hand goods that may be imported without a license / certificate / permission. However this list does not specifically cover offshore drilling rigs and equipment. Section 2.33 of the Handbook of Procedures under the current Export Import Policy provides that import of second hand capital goods. which are not more than 10 years old shall be allowed freely. However the same shall not be transferred sold or otherwise disposed off within a period of two years from the date of import except with prior permission of the Director General of Foreign Trade. The word "Second Hand Goods" is not specifically defined in the Customs Law or the current Export Import Policy. However in common parlance it is considered synonymous to "old" or "used" or "not new". The drilling rigs of all types are covered under ITC(HS) Number 8905.20. (Refer Explanatory Notes of the ITC (HS) Volume 4, Chapter 89). As per the Import Export Policy, Handbook of Procedures Volume 3, the offshore drilling rigs covered under ITC (HS) Number 8905.20 are allowed to be imported in to India freely without an import license. However as per the interpretation by most of the officers of customs this provision is applicable only for new rigs and not to the second hand, old or used rigs. It may be noted that there are hardly any instances of new rigs being imported for carrying out the petroleum operations in India.

It appears to be a general practice followed by the Customs Officials in Western Region to consider the second hand offshore drilling rigs. as "freely importable" under section 2.21 of the Export Import Policy, when imported for rendering drilling services under a charter hire contract. However applicability of this section is also questioned by many customs officials owing to its ambiguous language. While examining the applicability of the section 2.21, in the context of offshore drilling rigs, being imported under charter hire contracts, following lacunae are observed: Section 2.21 does not specifically cover the drilling rigs being imported on charter hire basis, and the importer or his agent seem to take umbrage under the expressions such as "second hand capital goods" and "imported for export" while struggling to convince the customs authorities that the old and used rigs are "freely importable" under the Section 2.21 of the Export Import policy. Although the imported rigs may be exported after completing the drilling work (if the contractor fails to secure another charter hire contract for the rig to work in Indian offshore areas), to say that those rigs have been "imported for export" does not appear to be entirely correct. From the foregoing one can appreciate that the question "whether old and used charter hired rigs are freely importable in India without a license?" is debatable and the views taken by a particular customs officer could be subjective. Suggestion: A specific mention may be made in the Export Import Policy to the effect that "All goods, "new" or "old" or "used", when brought in to India under charter hire contracts for rendering services required for petroleum operations. may be freely imported without a license / certificate / permission". 2. "Valuation of the offshore drilling rigs and equipment", which are brought into India on Charter hire basis without involving any sale or purchase transaction. The drilling rigs and associated equipment have been exempted from payment of customs duty when imported in to India, for the operations under the specified contracts as per Customs Notification 21 / 2002 dated 1st March 2002. Section 14, Sub Section (1) of the Indian Customs Act provides that for the purpose of the Customs Tariff Act, or any other law for the time being under force, whereunder a duty of customs is chargeable on any goods by reference to their value, the value of such goods shall be deemed to be the price at which such or like goods are ordinarily sold, or offered for sale, for delivery at the time and place of importation or exportation, as the case may be, in the course of international trade, where the seller and buyer have no interest in the business of each other and the price is the sole consideration for the sale or offer for sale.

Although no duty is chargeable on the offshore drilling rigs and equipment which qualify for the duty free import under the Duty Exemption Scheme as per Notification 21 / 2002, and although there is no sale or an offer of sale involved in importation of the offshore rigs under charter hire contracts, the customs authorities insist on assessing the value of the imported rigs while processing the "Bill of Entry" document. The Section 14 Sub Section (1A) of the Indian Customs Act further provides that subject to the provisions of Sub Section (1), the price referred to in that Sub Section shall be determined in accordance with the rules made in this behalf. The Government of India has made the "Customs Valuation (Determination of Price of Imported Goods) Rules, 1988" which are relied upon by the Customs Authorities, while assessing the value of the rig. As per Rule 10 of the above-mentioned valuation rules, the Importer has to declare the value of the Rig and also has to furnish the full and accurate details relating to the value and any other information or document in support thereof, as considered necessary by the Customs Authorities for determination of the value under these rules. The provisions related to confiscation, penalty and prosecution applies to the cases where wrong declaration, information statement or documents are furnished. When the Authorities have reason to doubt the truth or accuracy of the declared value, they can ask the importers to furnish further information or other evidence. As per the valuation rules (Rule 4) the assessable value for computation of Customs Duty is derived from the transaction value (price actually paid or payable). However, if this is not possible the assessable value is to be determined by proceeding sequentially through the rule number 5 to 8, wherein other methods have been prescribed under the following heads: Rule 5: Transaction Value of Identical Goods Rule 6: Transaction Value of Similar Goods Rule 7: Deductive Value Rule 7A: Computed Value Rule 8: Residual Method A careful study of these methods reveal that most of them are based on processing the information about an actual monetary transaction between the buyer and seller of the goods in question, or that of the "Identical Goods" or "Similar Goods". Even the deductive value is based on the unit price at which the imported goods or identical or similar goods are sold under certain laid down conditions in the greatest aggregate quantity, subject to certain laid down deductions.

The computed value is based on the sum of cost of materials, fabrication, etc., the profit and general expenses reflected in sales in the country of exportation and the cost of all other expenses such as freight, insurance, landing charges, etc. Whereas the residual method or the fall back method provides for using reasonable means consistent with the four earlier methods, and based on the data available in India. This rule 8 also lists some of the forbidden methods, which are not to be used. None of these methods actually take in to account the nature of drilling business, where there is no sale or purchase transaction between the contractor and the operator. The contractor is asked by the customs authorities to submit a "commercial invoice" depicting the CIF value of the rig, indicating the FOB value, and the components of freight and insurance. The concept of charter hire of the rigs for the duration of the drilling contracts is neither acknowledged nor recognized by the customs authorities or the customs valuation rules as they are written today. This leads to a lot of ambiguity and subjectivity in the process of valuation by the customs authorities. The valuation problem is further compounded owing to the fact that the actual sale and purchase transactions of the used drilling rigs also takes place around the globe, when the drilling contractors acquire or disposes of these assets. The sale or purchase price in such acquisition / disposal is generally not dependent on the computed value of the rig. It is normally determined by the rig's potential to earn revenue while being used for rendering the drilling services. In a fluctuating market this can vary drastically. A jack-up rig for example may earn anything between 25,000 US $ per day to 80,000 US $ per day depending on market conditions. This is indeed a function of many complicated factors including supply and demand situation, the prevailing oil prices, petroleum production commitments etc. The market value of the rig, which is dependent on its potential to earn revenue, at any given time, therefore also fluctuates drastically and has no relation with the computed value or the depreciated book value. Similarly the drilling contractors insure the rig at a certain value taking in to account the balance between the risk of replacing / repairing the rig in case of an incident and the high insurance premiums. The insurance value also does not necessarily have a definite relation with the extremely fluctuating market value or even with the computed value. In India, normally the value declared in the "commercial invoice" supported by a "valuation certificate" from the approved Valuation Agencies such as SGS, BV, DNV etc. is acceptable to the customs authorities. (A detailed list of the approved agencies is given in the Handbook of Export-Import Procedures). The valuation agencies, while issuing the certificate, carry out a visual inspection of the rig, verify the rig certificates including the insurance certificate and issue the valuation certificate indicating the residual life and endorsing the reasonability of the value declared by the Importer in the Commercial Invoice. Since these agencies carry out only a visual inspection before issuing a certificate, they make statements to the effect that the value may not be accurate and in any case they do not take responsibility for the correctness of the certificate. From the foregoing one can appreciate that the question of valuation of the rigs is also debatable and the views taken by a particular customs officer could be subjective.

3. "Transfer of imported offshore drilling rigs and equipment from a PEL /

ML area operated by one operator to that operated by another operator, within the EEZ of India."

For several years the task of exploration and development of petroleum was Entrusted by the Indian Government to only two National Oil Companies: ONGC and Oil India Ltd. However the exploration and exploitation of petroleum received a great thrust after the commencement of the reform process in the last decade which encouraged a number of foreign investors as well as private sector Indian companies to actively participate in the Indian campaign to enhance the energy security of the country. As a result, a number of operators are engaged today in exploration and development of various offshore blocks on both east as well as west coast of India. Some of the major operators are:

• Oil & Natural Gas Corporation Ltd. (ONGC) • Reliance Industries Ltd. (RIL) • British Gas India Ltd. (BG) • Cairn Energy India Pty Ltd. (Cairn) • Niko Resources (Niko) • Gujarat State Petroleum Corporation Ltd. (GSPCL) • Hardy Exploration and Production (India) Inc. (Hardy) • SNP Petrom SA (Petrom) • Hindustan Oil Exploration Company (HOEC) • Premier Oil Pacific UK (Premier) • Oil India Ltd. (OIL) • Gas Authority Of India Ltd. (GAIL)

Some of these operators have made great discoveries in recent past and their success is attracting more companies to invest in the Indian Upstream Petroleum Industry. The above list of operators is therefore expected to grow further with the new rounds of NELP blocks being offered by the Indian Government to the foreign as well as domestic investors. Recognizing the crucial need for India to reduce its dependence on the other oil producing and exporting countries to meet the domestic demand of petroleum, the Indian Government has offered several concessions to the investors in the upstream petroleum sector, customs duty exemption being one of them. The offshore drilling rigs as well as specified goods required in connection with petroleum operations undertaken under specified contracts (Production Sharing Contracts) as well as under the petroleum exploration license or mining lease issued or renewed after 1st April 1999 by the Government of India or any State Government to the national oil companies (ONGC and all), are completely exempted from the payment of any customs duty as per notification 21 / 2002 dated 1st March 2002 (Refer Sr. No. 214, 216 and 217 of the table, conditions 29,31 & 32 as well as List 12 of the notification)

In order to realize the benefit of the customs duty exemptions under the above referred notification the operators have to obtain Essentiality Certificates from the Director General of Hydrocarbons (DGH). The DGH while issuing an Essentiality Certificate, imposes a condition namely "Subject to Re-Export" stipulating that the goods cleared under the duty exemption must be re-exported on completion of the particular project for which the goods were imported. As a matter of fact, imposing such a "Re-Export" condition by DGH on the Essentiality Certificate is completely arbitrary and finds no basis whatsoever in the statute. In view of the Re-Export condition imposed by the DGH, the customs authorities insists that a re-export bond be submitted by the importer, equivalent to the value of the rig. It may be noted that the various petroleum operators, while engaged in the petroleum exploration and exploitation activities in India, need various services from various service contractors, including the drilling contractors. The Drilling Rigs and other equipment imported for rendering services to one operator are often required for rendering similar services to other operators. Hence the contractors are required to transfer the imported goods after the completion of one contract from one operator to work under another similar charter hire contract with another operator who also enjoys the same customs duty exemption benefits as the previous operator under Notification21 / 2002 dated 1st March 2002. As a matter of fact the Section 2.43 of the Handbook of Procedures under the current export Import Policy inter alia provides that "goods which are importable without restrictions can be transferred by sale or otherwise by the importer freely". However the re-export condition imposed by the DGH makes it extremely difficult to transfer the goods from one petroleum operations to another. It is also relevant to note that by the Notification S.O. 189 (E) dated 7th February 2002, the Government of India has extended the Customs Act and the Customs Tariff Act to the continental shelf of India and to the Exclusive Economic Zone of India for the purpose of prospecting or extraction or production of mineral oils and of supply of goods in connection with any such activities. This notification came in to force on the 11th February 2002. It may also be noted that all the Offshore Petroleum Blocks are situated within the Exclusive Economic Zone of India and therefore for the purpose of Customs Act and Customs Tariff Act, these blocks are situated in "India". It is therefore completely impracticable to re-export drilling rigs or other goods out of India and re-import the same before they can be deployed to serve the petroleum operations being carried out in another block within the EEZ of India, just for the sake of fulfilling the re-export conditions imposed by DGH in an arbitrary manner.

To cite the instances of operators’ and contractors’ sufferings on account of difficulties to transfer the drilling rigs and equipment, attention is drawn to the following cases:

• Transfer of Rig CE Thornton from British Gas to Cairn Energy. • Transfer of Rig F G McClintock from Petrom to Niko Resources. • Transfer of Rig CE Thornton from Cairn energy to ONGC.

Although the Customs authorities have agreed in principle to the concept of transfer of rigs, they have not regularized the paperwork for want of a clear procedure and the Re-Export bonds submitted separately by British Gas, Cairn, Petrom and Niko have not yet been returned to them although their respective charter hire contracts with drilling contractors for deployment of the rigs to work in their blocks have been completed for over six months. It is therefore necessary that the issues related to Transfer of rigs and other equipment required for petroleum operations by various operators are resolved and a proper procedure in this respect is formulated.