Hydrocarbon Sector Program Loan (Loan 1148-InD)

7/31/2019 Hydrocarbon Sector Program Loan (Loan 1148-InD)

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ASIAN DEVELOPMENT BANK PPA: IND 25363

PROGRAM PERFORMANCE AUDIT REPORT

ON THE

HYDROCARBON SECTOR PROGRAM LOAN(Loan 1148-IND)

IN

INDIA

January 2001


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CURRENCY EQUIVALENTSCurrency Unit Rupee/s (Re/Rs)

At Appraisal(November 1991)

At Project Completion(September 1997)

At Operations Evaluation(September 2000)

Rs1.00 = $0.0386 = $0.0276 = $0.0219$1.00 = Rs25.90 = Rs36.18 = Rs45.67

ABBREVIATIONS

ADB Asian Development BankAPM administered price mechanismBOP balance of paymentsDGH Directorate General of Hydrocarbons

HSP Hydrocarbon Sector ProgramIMF International Monetary FundIOC Indian Oil CompanyLPG liquefied petroleum gasMMT million metric tonsMOF Ministry of FinanceMOPNG Ministry of Petroleum and Natural GasNELP New Exploration Licensing PolicyOECF Overseas Economic Cooperation FundOIL Oil India LimitedONGC Oil and Natural Gas CorporationPSE public sector enterpriseTA technical assistance

NOTES

(i) The fiscal year (FY) of the Government ends on 31 March.(ii) In this Report, "$" refers to US dollars.

Operations Evaluation Office, PE-566


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CONTENTS

Page

BASIC DATA iEXECUTIVE SUMMARY ii

I. BACKGROUND 1A. Rationale 1B. Formulation 1C. Objectives and Scope at Appraisal 2D. Financing Arrangements 2E. Donor Coordination 3F. Program Completion Report 4G. Evaluation 4

II. IMPLEMENTATION EXPERIENCE AND RESULTS 4

A. Effectiveness of Design 4B. Implementation of Policy and Institutional Measures 5C. Management of the Program 12D. Assessment of Program Results 13

III. PROGRAM IMPACT 15

A. Macroeconomic Impact 16B. Social Impact 17C. Institutional Impact 17D. Environmental Impact 17E. Sustainability 18

IV. KEY ISSUES FOR THE FUTURE 18

A. Issues Related to Sectoral Improvement 19B. Issues Related to Program Loan Formulation 19

V. CONCLUSION 21

A. Overall Performance 21B. Lessons Learned 22

APPENDIXES 23


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BASIC DATAHydrocarbon Sector Program Loan (Loan 1148-IND)

Program Preparation/Institution Building

TA No. TA Project Name TypePerson-Months Amount

ApprovalDate

1645-IND Examination of Public Sector OilRefining, Distribution and MarketingActivities

A&O 7 $200,000 2 Jan 1992

1646-IND Promotion of Private SectorInvestment in Downstream Activities

A&O 13 $400,000 2 Jan 1992

Key Program Data ($ million)As Per ADB

Loan Documents Actual

Total Program Cost 500.0 375.0ADB Loan Amount/Utilization 250.0 125.0ADB Loan Amount/Cancellation 125.0

Key DatesExpected Actual

Appraisal 3-10 October 1991 31 Oct-9 Nov 1991Loan Negotiations 16-17 Nov 1991 17-19 Nov 1991Board Approval 12 Dec 1991 17 Dec 1991Loan Agreement 13 Dec 1991 18 Dec 1991Loan Effectiveness 16 Dec 1991 20 Dec 1991Loan Closing 30 Jun 1995 18 Sep 1997Months (effectiveness to completion) 42.5 60.5

Borrower Government of India

Executing Agencies Ministry of FinanceMinistry of Petroleum and Natural Gas

Mission DataType of Mission No. of Missions No. of Person-Days

Fact-Finding 1 80Appraisal 1 60Program Administration

Disbursement 1 3

Aid Coordination 1 2Consultation 1 4Special Contact 1 15Review 3 29Program Completion 1 20

Operations Evaluation 1 51

A&O = advisory and operational, TA = technical assistance.


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EXECUTIVE SUMMARY

The operational strategy for India of the Asian Development Bank (ADB) in much of the

1990s was to assist the Government achieve increased economic efficiency through support forstructural reforms, promotion of competition, and private sector participation. The HydrocarbonSector Program (HSP) loan was consistent with this strategy. It was also part of internationaldonor efforts to support India to diffuse its balance-of-payment crisis caused by the drying-up ofshort-term credits and the surge of oil import costs due to the sharp oil price increases causedby the Gulf crisis.

On 17 December 1991, the Board approved the program loan for $250 million to bedisbursed in two tranches. In addition, cofinancing of $250 million from the Overseas EconomicCooperation Fund of Japan was solicited and obtained, and two technical assistance (TA)grants were provided to support the design and implementation of the Program. The first TA, for$200,000, examined the performance of the public sector in oil refining, distribution, and

marketing activities, and the second TA, for $400,000, aimed to identify ways of promotingprivate sector investment in downstream activities.

The main objective of the Program was to promote accelerated exploration anddevelopment of domestic hydrocarbon resources through increased participation of the privatesector and enhanced operational efficiency of public sector enterprises (PSEs). Specifically, theProgram aimed to contain the share of oil imports in total oil consumption at the 1991 level (45percent). The Government considered the objective of long-term oil import substitution asimportant from the viewpoint of reducing pressure on the foreign currency reserve as well as thecountrys strategic self-reliance. The scope of HSP was to cover major areas including sectoralpolicy and institutional reforms, attracting private sector investments, improving public sectoroperational and financial efficiency, and promoting energy conservation and efficiency.

The first tranche of $125 million was disbursed in two installments in December 1991and February 1992. The Government proceeded to implement most of the reform measuresprescribed by the Program. The process, however, stalled with what was considered a keycovenant, namely the divestment of 20 percent of the Governments equity in the countrysleading oil company, the Oil and Natural Gas Corporation (ONGC). The scheduled loan closingdate was 30 June 1995, but it was extended three times to allow more time for compliance.Finally, the Government indicated that it was unable to meet the requirement and requested thecancellation of the second tranche ($125 million). The loan was actually closed on 18September 1997.

The Operations Evaluation Mission (OEM), which visited the country during the period

6-22 September 2000, confirmed that among the 26 loan covenants, three were still pending ornot complied with, two were partially complied with, and all the others had been implemented.The covenants implemented included, among others, corporatization of ONGC, creation of aDirectorate General of Hydrocarbons to provide a level playing field for private sector,introduction of a New Exploration Licensing Policy, phased dismantling of the administered pricemechanism, and establishment of the common carrier company Petronet. As a result, thegeneral regulatory and business environment has undoubtedly grown much more marketoriented.


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However, the Program suffered from a number of failed assumptions, which werepartially responsible for the fact that a key covenant was not achieved. First, the time-boundtarget of divesting 20 percent Government equity in ONGC failed to take into account the scaleand complexities of the divestment and necessary regulatory and market conditions for thedivestiture. Second, the Programs heavy emphasis on divestment, as a means to raiseadditional capital and enhance management efficiency, was very uncertain as sales of

government shares at heavy discounts would have caused substantial financial losses for theGovernment without really achieving much since the majority of the stake would have remainedwith the Government even if the sales succeeded. Other alternatives such as forming jointventures, devising attractive policies to encourage foreign direct investment, and allowing moremanagement autonomy for the PSEs could have been more effective. Third, the Programs timeframe was too tight and no explicit consideration was given to proper sequencing of the reformmeasures prescribed.

In addition, other factors such as the Governments slow movement to market reformsand reluctance to open up the market also played a role in the cancellation of the secondtranche. In this regard, the Government must accelerate the reform process and pursue privateand foreign direct investment with greater vigor and speed if it wants the Indian economy to

succeed in a region where competition is fierce for limited investment resources.

In the area of exploration and development, the anticipated competition from the privatesector is yet to be realized with the PSEs, notably ONGC and Oil India Limited, still dominatingactivity. Major foreign oil companies have been reluctant to make large investments in thisinherently risky business due to the administered prices and the difficulties in obtainingmarketing rights. Some believe that the multinational oil companies may hold the key foracceleration of successful exploration due to their better resources and technology in certainkey areas, such as deep water exploration. The proportion of crude oil production from privateor joint ventures under production-sharing contracts remains insignificant, e.g., 4 million out of37 million metric tons in FY1999/2000. Total private sector investment in exploration is also farfrom the program target of $5.2 billion. The production of domestic crude oil remained largely

stagnant over the program period. Consumption/demand, on the other hand, was continually onan upward trend with the oil self-sufficiency rate reduced to 37 percent in FY1998/99, muchlower than the targeted 45 percent. Recent high crude oil prices have once again broughturgency to the sectors reforms as oil imports continue to drain the countrys foreign currencyreserve and the deficit on the oil pool accounts (a cross-subsidy mechanism) deficit hasreached a very high level.

The situation in the refining sector is somewhat better. Since the beginning of theProgram, a total of 12 refineries have been approved, five for operation by the private sector, sixby joint ventures, and one by the public sector. However, all the prospective foreign companiesincluding Exxon, Shell, KPC, etc. withdrew from the initial agreement due to concerns overmarketing rights, administered prices, and anticipated refining overcapacity in the country. Only

two domestic private companies, Reliance Petroleum, Ltd. and Mangalore Refinery andPetrochemicals, Ltd. are already in production.

The operational efficiency of the PSEs in the sector significantly improved during theprogram period. Exploration and production per capita productivity increased by 23 percent, andthat for refining by 45 percent during the period between FY1991/92 and FY1997/98. However,between FY1993/94 and FY1998/99, the Indian economys energy intensity, measured byhydrocarbon (oil and gas) consumption per unit of gross domestic product, increased marginallyby 1.8 percent, signaling that the economy might not have become more energy efficient, even


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after allowing for some natural fluctuation of data. Waste in energy consumption, particularlythat associated with illegal or overuse of subsidized fuels such as kerosene, diesel, andliquefied petroleum gas, is still evident.

In view of the foregoing, the OEM rated the Program as less than successful.


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I. BACKGROUND

A. Rationale

1. The operational strategy for India of the Asian Development Banks (ADB) in much of the1990s was to assist the Government, in its strive for industrialization, achieve increasedeconomic efficiency through support for structural reforms, promotion of competition, and privatesector participation. The Hydrocarbon Sector Program (HSP) Loan was consistent with thisstrategy. It was also part of international donor efforts to support India to diffuse its balance ofpayments (BOP) crisis caused by the drying-up of short-term credits and the surge of oil importcosts due to the sharp oil price increases caused by the Gulf crisis. The Government that tookoffice in June 1991 acted swiftly to avert the crisis and prevent default in payments. A programof macroeconomic stabilization was set in place consisting of structural reforms to trade, and

market-oriented industrial and trade policy frameworks. The Government negotiated a standbyarrangement with the International Monetary Fund (IMF) in October 1991 for $2.3 billion and aStructural Adjustment Loan with the World Bank for $500 million.

2. HSP targeted market-oriented reforms in the hydrocarbon sector because petroleum andpetroleum products accounted for a significant share of imports (22 percent in FY1990/91). Thereforms aimed to contain the country's dependence on oil imports by increasing domesticproduction and promoting energy conservation through, among others, attracting private sectorinvestments as well as enhancing financial, technical, and managerial efficiencies.

B. Formulation

3. On 8 November 1990 a small-scale technical assistance (TA) grant was approved toreview the hydrocarbon sector operations in India.1 In January 1991, a policy dialogue betweenthe Government and ADB on hydrocarbon sector policy was held in the context of a Special

Assistance Project.2 A broad framework of HSP emerged during the consultation mission heldon 15-19 April 1991. The policy framework included sector reorganization, private sectorinvolvement in exploration and development, market-oriented hydrocarbon pricing, energyconservation, and resource mobilization. Following a government request for a program loan tosupport the reforms for the sector, a fact-finding mission was fielded in September 1991 toassess the Governments proposal and to further discuss government policy actions andstrategies in the sector. Policy dialogues continued during the appraisal mission in November

1991 during which the content and timing of the policy reforms, and the implementationarrangements of the proposed loan, were discussed. The Board approved the Program on17 December 1991.

1TA 1416-IND: Undertaking a Review of the Hydrocarbon Sector Operations, for $100,000, approved on 8 November1990.

2Loan 1081-IND: Special Assistance Project, for $150 million, approved on 4 April 1991. The primary objective ofthe project was to provide foreign currency financing for importing diesel fuel with no conditionalities attached.


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4. The six-week period from loan appraisal to approval was a near record speed for aprogram loan addressing such complex reform issues, notwithstanding the emergency-assistance nature of the loan. Not surprisingly, many of the design problems revealed later arepartially attributable to the hastened program preparation process. The Government, which wasstrongly motivated to push through market-oriented reforms as well as in urgent need of a cashinjection, also appeared to have underestimated the complexities of implementing the program

measures.

C. Objectives and Scope at Appraisal

5. HSP aimed to maintain the share of oil imports in total oil consumption at the 1991 level,as well as to support the Governments overall economic policies of macro-stabilization andincreased use of market-based instruments in allocating resources. HSP covered five majorareas that together aimed at complementing the Governments drive to improve the sectorsproduction potential and efficiency:

(i) undertaking sectoral adjustment through a program comprising appropriate policyand instrument reforms and increased investment over the medium-term;

(ii) encouraging private sector participation in the oil and gas sectors through jointventures, leasing, contracting, build-operate-transfer, and other schemes;

(iii) mobilizing resources for financing medium-term investment in the sector involvinggreater external cofinancing and raising additional private sector resources;

(iv) improving the operational and financial efficiency of public sector organizationsengaged in oil and gas exploration and development, through greater managerialautonomy, decentralization, and divestment; and

(v) promoting increased energy efficiency and conservation through promotion ofappropriate pricing and related policies.

6. The policy matrix under HSP covered 26 policy measures. Of these, 20 were to beimplemented prior to the release of the second tranche and six before the end of the programperiod.

D. Financing Arrangements

7. The loan in an amount of $250 million was from ADB's ordinary capital resources, to bedisbursed in two equal installments of $125 million. The release of the tranches was conditionalon the implementation of agreed measures. The loan proceeds were to be utilized by theGovernment to finance the foreign exchange costs of eligible imports. HSP was also cofinanced

by the Overseas Economic Cooperation Fund of Japan (OECF) with a loan of $250 millionequivalent. To support the Program, two TA grants totaling $600,000 were provided.3

3TA 1645-IND: Examination of Public Sector Oil Refining, Distribution and Marketing Activities, for $200,000,approved on 2 January 1992; and TA 1646-IND: Promotion of Private Sector Investment in Downstream Activities,for $400,000, approved on 2 January 1992.


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E. Donor Coordination

8. ADB actively coordinated with the other donors, IMF, and the World Bank, who agreedthat efficiency in the sector needed to be improved; they supported ADBs proposed program.While ADB cancelled the second tranche of the loan as the Government could not fulfill a loan

covenant regarding divesting the Oil and Natural Gas Corporation (ONGC), OECF released itssecond tranche, after obtaining a "no objection" from ADB, on the basis that the Governmentwas committed to divestment but the actual completion of the divestiture was contingent uponmarket conditions. Similarly, IMF had also stipulated several conditions while grantingemergency assistance to India, and considered that India had met all the major conditionssatisfactorily and waived, what it considered to be, minor deviations.


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F. Program Completion Report

9. The loan was closed on 18 September 1997. The program completion report (PCR) wascirculated on 30 September 1998. The PCR concluded that, although the second tranche of

$125 million was cancelled despite three extensions to the loan closing date, the Program couldtake credit for a number of policy reforms, improvement in the regulatory environment, and thefoundation for market-oriented reforms. The PCR classified the Program as partially successful.It further concluded that, had ADB not insisted on the full compliance of the divestmentcovenant relating to ONGC and released the second tranche of $125 million, the Program wouldhave been considered successful. The PCR also concluded that the two accompanying TAsachieved their objectives within budget.

G. Evaluation

10. This program performance audit report (PPAR) focuses on overall impact and designaspects of the Program and presents the findings of the Operations Evaluation Mission (OEM)which visited the country during the period 6-22 September 2000. The PPAR also presents anassessment of the Program's effectiveness in achieving its objectives and in generating asustainable development impact.

11. The PPAR is based on a review of the PCR, Report and Recommendation of thePresident (RRP), and material in ADB files; and on discussions with staff at ADB, the Executing

Agencies, and other government agencies, and with representatives of aid agencies, researchorganizations, and the private sector.

II. IMPLEMENTATION EXPERIENCE AND RESULTS

A. Effectiveness of Design

12. While the majority of the 26 measures stipulated as loan covenants (Appendix 1) wereappropriate and served effectively to advance market-oriented reforms in the sector, others, aswill be argued below, were less appropriate and effective.

1. Divestment Target

13. A loan covenant regarded as key by ADB was the divestiture by the Government of 20percent of its equity in ONGC. This was considered essential to pave the way for privatization,enhancing efficiency of the sector, and raising additional resources for the Government.However, the target proved to be unrealistic relative to the size of the domestic capital marketand limited interest in the stock from prospective investors. At the time of formulation, no


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analysis of market realities was made to judge whether this condition was practical, in spite ofthe fact that the transactions were potentially worth billions of dollars.

14. ONGC's authorized share capital, after it was converted into a company from a statutorybody under the Indian Companies Act as required by the Program, was Rs150 billion (about$3.3 billion) comprising 15 billion shares with a face value of Rs10 each. Under the Program,

the Government attempted to divest its share in installments. The first was the sale of 2 percentto domestic financial institutions in October 1994, at a Rs1,533 per share. With the earnings pershare for FY1994/95 standing at Rs58.1, the price/earnings ratio was 26.4:1 or the return wasonly 3.7 percent for investors.4 This was followed by the sale of another 2 percent to ONGCemployees at Rs270 per share (after dilution of the original shares in the ratio of 3.08:1). 5Subsequently, according to the Government, when it tried to auction 35.6 million shares, theresponse was insignificant (bids for only 192,310 shares were received). The Governmenttherefore consulted industry experts and was advised that such divestment should only beattempted after full deregulation of the sector, including the dismantling the administered pricemechanism (APM), a proposition the Government accepted.

15. The Government was, and is still, of the view that had it tried to sell 16 percent of its

equity to satisfy the remaining condition for the release of the second tranche of $125 million, itwould have suffered huge losses several times greater than the second tranche. The Ministry ofPetroleum and Natural Gas (MOPNG) still harbors strong negative sentiments about ADB'sdecision to cancel the second tranche to such an extent that, initially, it refused to meet with theOEM. The Government argued that such a sale would not have assisted in redressing theGovernment's budget deficit situation as envisaged under the Program.

2. Reform Time Frame and Sequencing

16. The Program envisaged the reform measures to be carried out within three years, which

proved to be over optimistic. The Program period was extended three times to six years. Inaddition, the sequencing of related reform measures was not carefully thought through. Withhindsight, price liberalization for major petroleum products should have been made as aprerequisite for divestment of ONGC as private investors demonstrated little interest in acquiringONGC shares as long as the prices of major petroleum products, i.e., gasoline, diesel,kerosene, and liquefied petroleum gas (LPG) were administered by the Government.

B. Implementation of Policy and Institutional Measures

17. The measures envisaged under the Program covered a wide range of areas, namely,

regulation, exploration and production, refining, transportation, distribution and marketing,pricing, divestment, efficiency improvements, and indirectly, environmental impact in thehydrocarbon sector. The policy matrix providing the summary of planned actions, the timetable

4The share price appeared to be too high relative to the returns, and though no evidence indicates that theGovernment was imposing these shares on the financial institutions, many of them are wholly or partially owned bythe Government.

5In comparison, according to the Annual Report of the Oil and Natural Gas Corporation for FY1999/2000, the shareprices traded on the national stock exchange have averaged Rs200 per share and the earnings per share forFY1999/2000 was Rs25.45.


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as envisaged during appraisal, and the implementation status at the time of the PCR and OEM,is attached as Appendix 1. Appendix 2 provides background information on the major players inthe sector.

1. Regulation

18. Under the Program, a Directorate General of Hydrocarbons (DGH) was establishedunder MOPNG in April 1993 to administer the regulatory functions hitherto carried out byONGC. DGH oversees exploration and production activities; develops data packages for areasoffered for exploration; provides technical advice to the Government on related issues,particularly development, conservation, and reservoir management; and advises MOPNG onmaintaining oil-field safety and environmental standards.

19. The establishment of DGH represented the first step to create a level playing field for thepublic and private sectors. The public sector enterprises (PSEs)ONGC and Oil India Ltd.(OIL)are required to compete on equal terms with the PSEs (para. 22). In addition, data on

exploration acreage on offer are now available to the private sector on the same basis as to thepublic sector. 6

20. Based on the recommendations under a subsequent ADB-financed TA7 for regulatoryframework for the gas industry, the Government had earlier initiated steps for creating anautonomous gas regulatory body, which would operate in a transparent manner. However, theinitiative experienced some bureaucratic and procedural delays and now the Government isconsidering the establishment of a single regulatory body for the entire hydrocarbon sectorbecause of the close linkages between oil and gas.

2. Exploration and Production

21. Prior to the Program, the entire responsibility for oil and natural gas exploration anddevelopment was vested with two PSEs, i.e., ONGC and OIL. However, government statisticsindicate that the private sector is becoming increasingly active in the development of new oiland gas fields. Contracts have been signed with private firms under the Program for thedevelopment of six medium-sized and 24 small fields. Under the New Exploration LicensingPolicy (NELP),8 which, according to the Government, is one of the most favorable in the world,the Government in January 1999 invited bids for 48 blocks (10 onshore blocks, 26 shallow waterblocks, and 12 deep water blocks). By the bid closing date of 18 August 1999, 45 bids for 27blocks were received, of which 25 blocks were awarded. Of the 25 blocks, three were awardedto Enron and eight to a consortium of major domestic private sector corporations i.e., Tata and

Reliance.

6TA 2775-IND: Hydrocarbon Exploration and Production Database and Archive System, for $600,000, approved on3 April 1997, assisted the Directorate General of Hydrocarbons in designing a national archive of exploration andproduction database.

7TA 2008-IND: Regulatory Framework for the Gas Industry, for $600,000, approved on 7 December 1993.

8Under this policy, the Oil and Natural Gas Corporation and the Oil India Limited are offered the same fiscal andcontract terms as private companies.


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22. However, subsequent interviews with the World Bank and private sector representativesrevealed a somewhat less optimistic scenario. They stated that the interest of foreigncompanies in exploration activities is greatly inhibited by two factors: (i) a perception that theblocks open to bidding are generally those with higher risks, and (ii) a government requirementof Rs20 billion or $435 million minimum investment in the sector before a company is grantedthe right to market oil products in India.

23. The production statistics also support the less optimistic view. Crude oil production fromexisting wells decreased from 30.35 million metric tons (MMT) in FY1991/92 to 27.17 MMT inFY1993/94. With the additional production by ONGC and production from the private sector and

joint ventures (about 4 MMT in FY1999/2000), the domestic production of crude oil inFY1999/2000 increased to about 36.55 MMT. In comparison, the Program envisaged that crudeoil production would reach 45 MMT per annum by the end of the program period (1997) in orderto contain the import share at the 1991 level of 45 percent.


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Government agreed to let private companies engage in retailing provided that they invested atleast Rs20 billion in the upstream sector. Only the Reliance Petroleum Refinery Ltd., a privateIndian company, has fulfilled this condition. The Government is expected to approve its requestto market its refinery products. The PSEs have developed extensive retail outlets, which newentrants may have difficulty matching. Foreign companies have tried to get a slice of this marketthrough joint venture arrangements with PSEs, but have not been successful. As stated earlier,

this has been an effective barrier to entry for private investors in the upstream sector that viewthe retail sector as a cushion against the inherently risky exploration and production activities.

28. In the case of LPG, the Government introduced a parallel marketing system in February1993 enabling private sector participation in bottling and retailing of LPG to industrial andcommercial consumers. Virtually all the major multinational oil and gas companies present inIndia are confined to this market. However, the commercial and industrial segment of the LPGmarket is relatively insignificant at approximately 0.5 MMT, compared with the householdsegment of 5.5 MMT, which is still controlled by the top PSEs under APM (para. 30). Further,with commercial and industrial consumers illegally tapping subsidized LPG from householdconsumers, even this limited market available to private companies has been adverselyaffected.

6. Pricing

29. Prior to HSP, the pricing system was fully under government control, and was known asthe APM. At the heart of APM are the oil pool accounts, created to insulate domestic crude oilproducers from volatile international crude oil prices and to provide for a mechanism for cross-subsidizing certain petroleum products, such as kerosene and LPG for the household sector,without government budgetary support.10 Under the Program, the Government started to alignpetroleum prices with market prices, subject to maximum and minimum price constraints, fromthe previous cost-plus formula, namely, cost of production plus a fixed profit margin. However, a

formal plan to phase out APM by 2002 was not announced until November 1997, two monthsafter the loan officially closed. Meanwhile, total subsidies have decreased from Rs186 billion in1997 to Rs83.6 billion in 1999 (Table 1).

Table 1: Subsidies on Major Petroleum Products(Rs billion)

Item 1993 1994 1995 1996 1997 1998 1999

KeroseneDomestic Use 33.04 37.73 37.40 41.90 65.40 58.20 57.90Diesel 1.20 5.75 4.30 21.80 80.90 0 0

LPGDomestic Use 11.76 12.61 14.10 16.30 22.20 16.60 25.70Naptha for Fertilizer 8.15 7.72 8.50 12.00 15.20 0 0

BitumenPacked 1.52 1.26 1.10 1.20 2.00 0 0Paraffin Wax 1.19 0.89 0.20 0.40 0.30 0 0

Total 56.86 65.96 65.60 93.60 186.00 74.80 83.60

10Through the oil pool accounts, inflows from surcharges on the sales of petroleum products (mix of domesticallyproduced and imported) and outflows for meeting the claims by domestic oil producers and refineries, are adjusted.When the world oil price is low, the surcharges will be high enough to meet the claims while still contributing asurplus to the fund, which will then be used to pay for the claims when the world crude price is high. Over anextended period of time, the pool accounts are supposed to balance.


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Source: Ministry of Petroleum and Natural Gas.

30. It should be noted that government revenues from customs and excise duties from oilproducts far exceed subsidies. For instance, in FY1999/2000 (the latest year for which data areavailable) the Government earned Rs222.3 billion from customs and excise duties whereas the

subsidies were only about Rs83.6 billion, i.e., about 38 percent of the revenues. In addition, thestate governments collect a substantial portion of their revenues from the hydrocarbon sectorthrough a sales tax.11 However, the prices of petroleum products in India are still some of thelowest in the region, with the exception of oil- and gas-rich countries, as may be seen fromTable 2 below.12

Table 2: Consumer Retail Prices of Selected Petroleum Products in the Region(as of 1 January 1998)

LPG GasolineAviation

Fuel Kerosene Diesel

No. Country (US cents per liter)

1 Singapore 26.95 78.57 30.11 39.362 Thailand 13.00 22.61 23.42 20.833 Malaysia 13.84 24.20 11.11 14.324 Philippines 26.19 35.72 38.38 20.49 23.125 Korea, Rep. of 24.58 77.37 9.92 47.176 Taipei, China 17.89 61.36 36.20 50.23 47.007 Indonesia 8.10 4.05 2.70 3.668 India 17.10 57.99 33.20 10.39 26.38

= data not available, LPG = liquefied natural gas.

7. Restructuring and Divestment

31. As agreed under the Program, ONGC was changed from a statutory body to acorporation under the Indian Companies Act in September 1993. However, most board directorsof the PSEs in the oil sector are government appointees, and some are appointed as boardmembers for multiple PSEs at the same time. As a result, although some progress has beenmade compared to the situation prior to the Program, the PSEs are far from being granted fullautonomy.

32. As stated earlier (para. 13), divestment of PSEs in the sector was given paramountimportance in the reform package prescribed by the Program. However, the Government wasonly able to divest about 4 percent of ONGC to financial institutions and employees under the

Program. In 1999, after the loan closed, an additional 12 percent of government equity was soldto other PSEs under a cross-shareholding scheme. Cross-shareholding, a common practice inIndia, effectively consolidates the horizontal alliance of PSEs in the same sector and has drawn

11For example, in Maharashtra the sales tax as of 1 April 1999 was 13 percent on natural gas, 27 percent ongasoline, and 30 percent on diesel.

12The Government has raised the prices for major petroleum products shortly after the Operations EvaluationMission.


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much criticism as no real divestment has taken place and the stakes still remain with theGovernment.

33. Despite the difficulties with ONGC, the Government was more successful in divestingequity in other PSEs and has in fact exceeded the targets set under the Program (Table 3).13

13Sale of 20 percent of government equity in one of the integrated or two nonintegrated refining and marketingcompanies.


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Table 3: Divestment in the Hydrocarbon Sector

Share Capital(Rs Crore) Divestment

GovernmentHolding

Company Authorized Paid-Up (%) (%)ONGC 15,000 1,425.92 15.89 84.11OIL 250 142.67 2.00 98.00IOC 2,500 389.31 8.86 91.14HPC 250 225.58 48.94 51.06BPC 200 150.00 33.80 66.20CRL 75 68.94 44.96 55.04MRL 200 47.10 48.20 51.80BRPL 200 99.82 25.53 74.47GAIL 1,000 845.65 3.37 96.63

Crore = 10 million.ONGC = Oil and Natural Gas Corporation, OIL = Oil India Limited, IOC = Indian OilCorporation, HPC = Hindustan Petroleum Corporation, BPC = Bharat Petroleum Company,CRL = Cochin Refineries Limited, MRL = Madras Refineries Ltd., BRPL = Bongaigaon

Refinery and Petrochemicals Limited, GAIL = Gas Authority of India Limited.

34. More recently, the move to divestment and privatization of PSEs appears to have gainedsome momentum. A minister has been appointed in charge of divestment and a Department ofDivestment has been created. The Government presently owns 240 central PSEs, with a totalinvestment of Rs2,301 billion, over half of these incurring losses. Progress, though, has beenrelatively slow in the hydrocarbon sector. Unlike nonprofitable PSEs, the companies in thehydrocarbon sector have traditionally been regarded as Navaratna (Nine Gems) as theycontribute a significant share of government revenue. The total revenue from major oil PSEs inFY1999/2000 was Rs289 billion, of which only little over Rs2.1 billion (or 0.7 percent) was in theform of dividends and the rest as excise tax and duty. The implication is that the Governmentsrevenue will not be significantly reduced after divestment since only the dividend portion would

be relinquished. Aside from economics, there are security and strategic concerns as the oilsector is viewed as the lifeline of the economy. All these factors have contributed to the veryslow motion of divestment.

C. Management of the Program

35. The EA for loan withdrawals was the Ministry of Finance while the EA for implementingthe Program and the TA was MOPNG. The dual EA structure has, to a certain extent, createdan incentive problem as MOPNG had no direct financial incentive to implement all the reformmeasures on time and many measures such as the privatization of PSEs may even have been

viewed as harming its own short-term interests.

36. Despite the incentive problem, monitoring of compliance with loan covenants wassuccessfully carried out by MOPNG. Dialogue during the program period, in the form of reports,memos, and through other channels, between ADB and the Government was intense, resultingin three extensions of the Program and ultimately the cancellation of the second tranche. Duringthe OEM, MOPNG pointed out the need for continuing such a policy dialogue, which would helpimprove the understanding of each others objectives and constraints, as well as development inthe sector.


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37. The Program included two TA grants (Footnote 3). The PCR reported that MOPNG didnot encounter any difficulties in recruiting two consulting firms under ADBs guidelines, andrated the performance of the consultants as satisfactory. The OEM also confirmed that some ofthe TA recommendations had been implemented, such as the establishment of a commoncarrier company (Petronet) and market-oriented reforms.

D. Assessment of Program Results

1. Choice of Indicators and Limitations

38. In order to measure the Programs results, a set of indicators is identified against theobjectives that the Program set out to achieve. A caveat is in order that these indicators at bestmay be used to measure the beforeand afterprogram scenarios, which may not be conclusive

of the cause-effect relationship, or lack thereof, between the Program and the observeddifferences. Multiple factors have contributed to the implementation of the policy and institutionalreforms in the hydrocarbon sector. What the OEM observed is the combined effects of variousinitiatives taken by the Government14 and supported by the World Bank, IMF, and ADB.

2. Achievement of Objectives

39. Containment of Share of Oil Imports to the 1991 Level. Table 5 shows that the crudeoil production increase envisaged by the Program did not materialize due to lack of exploratorybreakthroughs and the fact that the existing oil fields are running dry. Several factors have

contributed to this outcome, e.g., low investment, technological constraints of the PSEs, orsimply lack of prospective oil reserves. While the production level remained largely stagnantover the program period, consumption and demand were continually on the increase and theeconomy became more reliant on imported oil with the self-sufficiency rate reduced to 37 percentin FY1998/99.

Table 5: Crude Oil Production and Consumption

Year

DomesticProduction

(MMT)

Private and JointVenture Fields

(MMT)

Consumption/Demand(MMT)

PercentageSelf-

Sufficiency

1990/91 33.02 55.04 55.6

1991/92 30.35 56.97 49.31992/93 26.95 58.90 42.41993/94 27.17 61.50 40.91994/95 32.24 67.40 44.31995/96 35.20 0.65 74.67 47.1

14In fact, during the OEM, several government officials repeatedly stressed that the reforms were implementedbecause of the Governments strong commitment, not because of the Hydrocarbon Sector Programconditionalities. They also pointed out that the sector reforms are being pursued vigorously despite the cancellationof the second tranche and closure of the loan.


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1996/97 32.90 1.35 79.17 41.61997/98 33.86 2.51 84.29 40.21998/99 32.72 3.04 89.36 36.61999/2000

a36.55 4.00 95.00 38.4

MMT = million metric tons.a

Estimated by the OEM based on published information and interviews.

40. Undertaking Sectoral Adjustment through Policy and Instrumental Reforms. Mostof the loan covenants have been implemented or partially implemented, namely, conversion ofONGC into a corporate entity (para. 14), creation of DGH aimed to provide a level playing fieldfor the private sector (para. 18), introduction of NELP (para. 21), phased dismantling of APM(para. 29), and establishment of a common carrier company, Petronet (para. 26). As a result,the general regulatory and business environment has undoubtedly grown much more market-oriented.

41. Encouraging Private Sector Participation. While the reforms have made thehydrocarbon sector more conducive to private sector participation, the anticipated competitionfrom the private sector is yet to be realized. In the area of exploration and development, ONGC

and OIL do not face any major competition. Major foreign oil companies have been reluctant tomake large investments in this inherently risky venture due to the administered prices and thedifficulties in obtaining marketing rights. As a result, the proportion of crude oil production fromprivate or joint ventures under production-sharing contracts, as an indicator for measuringprivate sector participation, remains insignificant, e.g., four out of 37 MMT in FY1999/2000(Table 5).

42. In the refining sector, the situation is somewhat better. Appendix 3 shows that privateand joint ventures dominated the 12 newly approved refineries. However, all the prospectiveforeign companies including Exxon, Shell, KPC, etc. withdrew from the initial agreement due toconcerns over marketing rights, administered prices, and anticipated refining overcapacity in thecountry. Only two domestic private companies, Reliance Petroleum, Ltd. and Mangalore

Refinery and Petrochemicals, Ltd., are already in production. Despite its new ultra-modernrefinery, Reliance alone will not be big enough to influence the market dominated by the PSEs.

43. Mobilizing Resources for Medium-Term Investments. The RRP estimated that a totalof $10 billion would be needed in exploration and production to boost the production level, ofwhich $4.8 billion would come from PSEs and $5.2 billion from private sectors. Existinggovernment statistics on the amount of investment in the sector include only those by PSEs,and no information is available on total private and joint venture investments. However, privatesector participation in exploration and production appears to be very limited and far from thetarget level due to concerns over high risks and marketing rights. Compared with exploration,refining received more substantial private investment, principally for one multibillion-dollarprojectReliances 27 MMT per annum ultra-modern refinery in Jamnagar.

44. Improving Operational and Financial Efficiency of PSEs. Government statisticsindicate that the total numbers of employees in India in exploration and production, and inrefining have declined from 58,627 and 29,856 in FY1991/92 to 52,909 and 25,294 inFY1998/99, respectively. Over this period, the domestic crude oil production increased slightlyfrom 30.35 MMT per annum to 33.86 MMT per annum, and the countrys refinery throughputincreased from 54.254 MMT per annum to 66.672 MMT per annum. This resulted in a net percapita productivity gain, as a measure of the sectors efficiency, of 23 percent for explorationand production, and 45 percent for refining.


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45. ONGC has been converted into a limited liability company and the PSEs have beengranted considerable autonomy in their operations, including forming joint ventures withdomestic and foreign private enterprises. Before 1997, there were 892 government "guidelines"which controlled the operations of the PSEs. Of these, 696 guidelines were removed in 1997.

Also, in anticipation of the full dismantling of APM and industry deregulation (both scheduled to

be completed by 2002), the hydrocarbon sector PSEs are striving to restructure, modernize, andstreamline their technical, financial, and managerial operations and form strategic alliances withsuitable domestic and foreign partners. IOC, for example, is moving upstream by entering theexploration and production of crude oil with the award of one onshore block under NELP. Thesector has taken several steps to keep abreast of international technical standards in refining,e.g., Euro IV standards, and in storage and transportation.

46. The gains in efficiency, albeit moderate, can hardly be attributed to divestment as thusfar divestment has not taken place in a substantial way. The reluctance to sell the family

jewels, though unjustified, is very much evident (para. 35). Instead, the improvement is likelythe result of the Governments initiative to streamline its PSEs to prepare them for the greatercompetition expected from the private sector. This was also evidenced by the recent

government announcement regarding upward integration of marketing PSEs through acquisitionof the standalone refineries in the public sector (para. 25).

47. Promotion of Energy Conservation and Efficiency. Between FY1993/94 andFY1998/99, Indias real gross domestic product (GDP) grew from Rs7,813.13 billion toRs10,818.34 billion, while hydrocarbon (petroleum and natural gas) consumption increasedfrom 78.35 MMT oil equivalent to 110.41 MMT oil equivalent. This represents a marginalincrease in the economys energy intensity of 1.8 percent, measured by hydrocarbonconsumption per unit of GDP. Even after allowing for data fluctuation, it is clear that theeconomy did not become more energy efficient over the six-year period. Wasteful use of energyis evident, particularly in areas associated with illegal or overconsumption of subsidized fuelssuch as kerosene, diesel, and LPG. It is widely known that nonhousehold consumers use

subsidized kerosene and LPG intended for household users. The disproportionately largenumber of diesel-powered and inefficient taxis is also partially the result of previous subsidieson diesel (Table 1). Early dismantling of APM would obviously be desirable from the viewpointof energy conservation and efficiency.

48. In sum, the degree to which the objectives have been achieved is characterized as amixture of both progress and inadequacy. Real but marginal progress has been made inallowing competition, introducing of better technology, and making available resources to thesector. However, more needs to be done in the areas of productivity and efficiency.

III. PROGRAM IMPACT

49. A similar caveat as used earlier should also be applied in this section: it is virtuallyimpossible to pinpoint the exact impacts of this particular Program loan due to the multifacednature of the reform processes. Even in terms of donor support programs, ADBs contributionwas relatively modest.


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A. Macroeconomic Impact

50. An immediate benefit expected from HSP was to assist the country in overcoming BOPdifficulties. The financial assistance provided by IMF, World Bank, ADB, and OECF helped theGovernment meet India's import obligations and stabilize the economic situation. More

importantly, the cash injection also helped improve confidence of foreign investors, which led tolarger than expected inflows of foreign private capital in subsequent years. As a result, Indiaachieved macroeconomic stability and sustained economic growth. Real GDP growth increasedfrom 0.4 percent in FY1991/92 to 6.4 percent in FY1999/2000 (Table 6).

51. However, while the BOP support clearly succeeded, private sector participation in thehydrocarbon sector did not materialize enough to accelerate exploration and development. Formuch of the 1990s, the increasing dependence on imported crude oil did not put unduepressure on Indias BOP position. The surge in exports and the weak crude oil price were morethan sufficient to cover the import bill such that the foreign exchange reserve reached a high of$38 billion (equivalent to 7.6 months of imports) at the end of FY1999/2000 (March 2000). Thecurrent account deficit was at its lowest in the period under discussion at 0.5 percent of GDP in

FY1993/94 (Table 6).

52. The recovery may have led the Government to become complacent about the urgency toreduce the oil import dependency. As such, recent crude oil price increases have caught theGovernment by surprise. If the crude oil prices average $30 per barrel during the rest of thefinancial year, the total oil import bill for FY2000/2001 will double from FY1999/2000 level to $20billion. This will threaten to drain the countrys foreign currency reserve, which had alreadydeclined to $32.7 billion by August 2000. The surging oil imports have also widened the year-on-year trade deficit by $300 million so far and put more pressure on the rupee, which hasdropped by 3.5 percent against the dollar since April 2000 as of November 2000.

53. Another key indicator in this regard is the oil pool accounts deficit. Table 6 indicates that

it reached Rs150 billion in FY1999/2000 and is likely to reach Rs236 billion ($5.1 billion) inFY2000/2001. The Government has also recently announced that it will raise the price ofgasoline, kerosene, LPG, diesel, and aviation fuel to reduce the widening oil pool deficit.

Table 6: Key Economic Indicators

Item 1990/91 1991/92 1993/94 1995/96 1997/98 1999/00

Real GDP Growth (%) 5.7 0.4 6.0 7.3 5.0 6.4Oil Import ($ million) 6,028 5,364 5,650 7,526 8,164 10,482% of total imports 21.6 25.5 21.1 17.2 15.9 18.9

Current Account/Balance/GDP(%)

-3.8 -0.7 -0.5 -1.7 -1.3 -0.9

Average Price of Crude Oil($/barrel)

23.0 16.34 15.6 17.2 19.1 18.1

Foreign Exchange Reserves($ million)

2,338 5,721 15,176 17,044 25,975 38,036

Months Worth of Total Imports 1.0 3.3 6.8 4.7 6.1 7.6Oil Pool Account Deficit(Rs billion)

57 182.7 150a

= data not available.


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The OEMs estimate based on published information and interviews. The figure for FY2000/2001 is likely to reachRs236 billion.

B. Social Impact

54. The Program did not aim for any specific social impact. However, it supportedmacroeconomic stability and sustained economic development that would potentially benefit allsectors of society. The positive impacts of macroeconomic stability may have been particularlywell received by the poor as they would be most vulnerable to high inflation. On the other hand,the removal of subsidies on petroleum products like kerosene and LPG for household use, animportant component of the market-oriented reforms, would, in the near term at least, adverselyaffect the poor. However, on several occasions, the OEM learned that the subsidized fuels oftendo not reach poor households for which they are intended due to problems with the distributionchain, and it is often comparatively wealthy people who benefit more from the subsidy.

C. Institutional Impact

55. The policy and institutional reforms had a positive impact on the institutions in thehydrocarbon sector. The creation of DGH was instrumental in attracting foreign and domesticprivate investment in the upstream sector. PSEs now enjoy considerable autonomy in theiroperations as a result of the policy reforms. Also, because their shares are traded on thenational stock exchange, there is now more transparency in their financial reportingrequirements compared with when they were wholly under government ownership and control.

D. Environmental Impact

56. The hydrocarbon sectors operations have strong environmental implications throughboth the production and consumption of its products. The environment was not directlyconsidered by HSP at its design stage. However, energy conservation and improvement ofefficiency of the sector, two explicit goals of HSP, would have had indirect positive impacts onthe environment, even though these objectives were not fully achieved. In addition, one of thekey loan covenants of HSP was to dismantle APM and remove subsidies on petroleumproducts. From the environmental point of view, subsidized diesel was probably responsible forthe disproportionately large number of diesel cars in major cities like Delhi and Mumbai. Dieselengines without emission controls tend to emit much higher amounts of air pollutant, e.g.,particulate, than gasoline-powered engines. To that extent, the removal of subsidies on dieselsince 1998 (Table 1) is beneficial for the environment, although many of the diesel-powered

taxis will remain in the fleet for a few more years to come. On the other hand, subsidies forcooking gas and kerosene are perceived to be environmentally beneficial as these fuels haveled to widespread displacement of coal and wood for domestic cooking and heating. Therefore,measures should be taken in the future to ensure that the complete removal of subsidies oncooking gas and kerosene do not force households to switch back to coal or fuelwood.


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E. Sustainability

57. It appears that the economy-wide privatization, pricing, and institutional reforms whichbegan in 1991 in India following the Gulf crisis have gained considerable momentum andbecome increasingly irreversible. The Government has announced the details of a phased

dismantling of APM by 2002,15 it will face a major loss of credibility if it reverses this course.Further, due to the deterioration of the public infrastructure like telecommunications, power, andwater, a public consensus is emerging that the private sector would do a better job than thePSEs. This is evidenced by the fact that despite several changes in the political parties in powerat the center, the direction of reform has been maintained, albeit at different speeds.

IV. KEY ISSUES FOR THE FUTURE

58. The OEM has identified a set of issues related to the sectors performance andformulation of program loans, which require ADBs attention in its future operations.

15As this report was being reviewed, the Government, sensing greater urgency for reform, just announced its intentto move up this date to 2001.


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A. Issues Related to Sectoral Improvement

59. HSP aimed to support the Governments market-oriented reforms in the hydrocarbonsector with a clear objective containing the total share of oil imports in total oil consumption at

the 1991 level. Almost 10 years have elapsed and the gap between domestic production andconsumption is as wide as ever. Given the importance of the hydrocarbon sector to Indiaseconomy and the highly volatile nature of the international oil market, it is imperative that thecountry continues with deregulation and pricing reforms. India must pursue private sectorparticipation, particularly from foreign investments, with greater vigor and speed if it wants tosucceed in a region where there is much competition for limited investment resources.

B. Issues Related to Program Loan Formulation

60. Quick-Disbursing Loans vs. Long-Term and Complex Reforms. Like many other

program loans, HSP was designed for dual purposes: BOP support (to stabilize the economy)and support for sectoral reforms. BOP support called for the quick disbursing of the loan,whereas the reforms it stipulated needed a much longer time to accomplish. Future policy-based lending may consider severing the link between short-term crisis management andsupport for long-term market reforms.

61. ADB-Imposed Reforms vs. ADB-Government Joint Initiatives. The Government hadinitiated the market-oriented reforms before HSP began. One can argue that, even without theProgram, the Government would still have carried out the reforms and, therefore, that the realvalue added of the Program was limited. However, the issue can be viewed from a differentangle: if the reforms were purely ADBs initiative, the chances of their success would have beeneven smaller. A growing body of evidence, accumulated both within ADB and the international

development community at large points to the fact that the political commitment of governmentsto reform is the fundamental reason for the success (or otherwise) of policy-based lending. Tothat extent, future policy-based lending should continue seeking a partnership with governmentson their reform initiatives as this will increase the likelihood of their success or broaden thescope of existing reforms, even though it poses technical difficulties for evaluating the valueadded of the program, as evidenced in this case. This does not mean that ADB can play only apassive role by financing the costs of the reforms, which is very important, but can assist theGovernment in a variety of waysincluding providing TA, preparing reform packages, offeringpolicy dialogues, and financing follow-up investment needs.

62. Use of Loans vs. Implementation of Reforms. The EA for loan withdrawal was theMinistry of Finance (MOF) while the EA for implementing the reform measures was MOPNG.

There was no direct financial incentive for MOPNG to implement all the prescribed measures onschedule, as many reform measures could have hurt its own short-term interests. This shouldhave been a cause for concern. Future policy-based lending should explicitly take into accountproper incentives for all stakeholders through, for example, follow-up investments or othermeasures.

63. Market-Oriented Reforms vs. Poverty Reduction Goals. Market-oriented reforms area common feature of all program loans aimed at improving the economic efficiency of a sectoror an economy. While such efficiency improvement will eventually benefit all segments of


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society, some reform measures, such as the removal of fuel subsidies in this case, may hurt thepoor in the short term. Consequently, particular attention should be paid to assessing theimpacts of economic reforms on the poor when formulating future program loans and, whenever


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necessary, measures should be taken to protect the poor from drastic negative impacts, e.g., byallocation of a minimum amount of subsidized fuel oil to the poorest households whennecessary.

64. Compliance with Loan Covenants vs. Achieving Program Goals. The decision tocancel the second tranche was based on noncompliance with a loan covenant stipulating the

divestment of 20 percent of ONGC. However, even with the full compliance of this covenant at adiscounted price, it would have not led to better achievement of the program goals, e.g., raisingadditional capital and improving accountability (paras. 15-16). Conversely, nominal divestmentwas carried out through, for example, cross-shareholding among different PSEs, but it did littleto raise additional capital and increase private sector participation. Thus, in administering aswell as evaluating future program loans, more attention should be paid to assessing to whatextent the program objectives are achieved rather than on simply monitoring the compliancestatus of covenants.

V. CONCLUSION

A. Overall Performance

65. Program Relevance, Appropriateness, and Sustainability. The market-orientedpolicy and institutional reforms envisaged under HSP were highly relevant, timely, and most ofthem were appropriate. However, the reforms aimed at improving the sectors efficiency do notnecessarily validate import substitution as the primary motivation of the Program. The issue ofthe relative economic competitiveness of domestic crude oil production against imports was notextensively addressed during the Programs formulation. Instead, a reduction in spending from alimited amount of foreign currency available on oil imports and, more implicitly, long-term oil

supply security, were regarded as the primary rationale for the Program. Although currently highworld crude oil prices appear to reinforce the rationale, the long-term economic viability ofdomestic oil production competing against imports remains to be seen. The OEM also observedthat many of the reform measures, including establishment of DGH, phased dismantling of

APM, and devising favorable policies and incentives to attract foreign investment in the sector,have been or are being implemented. Many of the reform measures implemented, and indeedthe general (but slow) trend of greater economic liberalization are increasingly irreversible.

66. Program Efficacy and Rating. Despite the positive observations, the OEM rates theProgram less than successful. Several factors have contributed to this assessment. First, asstated earlier, it is inappropriate to attribute the new developments wholly to HSP. In fact, theGovernment continued to press ahead with the reforms despite the cancellation of the second

tranche by ADB. Second, arguably the most important goal of the Program, i.e., to contain theshare of oil imports at the 1991 level of 45 percent, was not realized, as the present level of self-sufficiency is only 37 percent. Third, the loan covenant of divesting 20 percent of Governmentequity in ONGC was found to be not only unrealistic but also ineffective from the viewpoint ofachieving the Programs objectives. Lastly, a less than successful instead of an unsuccessfulrating reflects the substantial progress that has been made in market oriented-reforms with theanticipation that greater progress will be made in the near future.


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67. Borrower and ADB Performance. Both MOF and MOPNG registered satisfactoryperformance in terms of administering the Program and monitoring progress. MOPNG, despiteseveral changes of government and the Programs lack of explicit consideration for its financialincentive, demonstrated commitment to implementing the reform measures stipulated by theProgram. However, ADBs performance was deemed less than satisfactory on several fronts.The Program was not well conceived, despite the fact that the broad framework was consistent

with ADBs country operating strategy, and the loan preparation was rushed. As a result, thechances of a successful Program were compromised by the various design deficiencies. Theproblems were further aggravated by the inflexible manner in which implementation washandled.

B. Lessons Learned

68. Realistic Goals Based on In-Depth Sector Analysis. Success of program loansdepends on the formulation of realistic policy and institutional reforms. For HSP, the target of 20percent divestment of the Government's equity in ONGC was unrealistic. No analysis was

conducted regarding what regulatory and market preconditions for such a large and complexdivestment should take place without jeopardizing shareholder value. The RRPs analysis onprogram risks did not even mention that potentially poor market response could adversely affectcompliance. In addition, the target for additional domestic crude oil production was unrealistic asit ignored the fact that the investments alone were no guarantee of finding and producing oil.

69. Flexibility in Loan Conditions. ADB sent mixed signals to the Government when itallowed OECF to release the second tranche while canceling its own second tranche. In theimplementation of program loans, ADB should adopt a flexible approach. Flexibility andwillingness to adapt will be a crucial factor for the success of ADBs future operations in India.


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APPENDIXES

Number Title PageCited on

(page, para.)

1 Compliance Status of Policy Matrix 19 3,12

2 Hydrocarbon Sector in India 24 4,17

3 Status of Approved Refinery Projects 31 6,24


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Condition PCR Status O

in March 2000 to move toward 100 percent paritywith the international price of fuel oil.

V. Energy Conservation

Programs to promote energy conservation in energy-intensiveindustries, including a program of energy audits, to beactively pursued.

An Energy Management Center set up by theGovernment carried out energy audits and helpedconserve energy. In the corporate reportingsystem in India, companies must report on energyconservation measures undertaken. There arealso many active NGOs engaged in energyconservation. An Energy Conservation Week isobserved every year with the help of stategovernments to spread awareness ofconservation of energy. In addition, variousmeasures have been undertaken includingintroduction of new technologies by the refineriesto conserve energy.

The Govegasoline acontent inIndian ecmarginal during theuse of su

ADB = Asian Development Bank, APM = administered price mechanism, BPC = Bharat Petroleum Company, DGH = Directorate General of Hydrocarb

BP = Indo Burma Petroleum, IOC = Indian Oil Company, LPG = liquefied petroleum gas, MMT = million metric tons, OEM = Operations Evaluation MissioGas, ONGC = Oil and Natural Gas Corporation, NGO = nongovernment organization, PCR = project completion report, PSE = Public Sector Enterprise.


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Appendix 2, page 1

HYDROCARBON SECTOR IN INDIA

1. The hydrocarbon sector in India is presently undergoing profound changes that mayhave far-reaching impacts on the sectors long-term performance. The following is a snapshotoverview of the sector covering major players, and the regulatory and economic environment inwhich they operate, as of the Operations Evaluation Mission (OEM) period 5 to 23 September

2000. As the Governments efforts in market-oriented reforms deepen, the roles of variousplayers in the sector may vary.

A. Government Agencies with Responsibility for the Sector

2. The Ministry of Petroleum and Natural Gas (MOPNG) annual report defines its mandateas The Ministry is concerned with exploration and production of oil and natural gas, andrefining, distribution and marketing, import, export and conservation of petroleum product. Atpresent, MOPNG plays a central role in all key aspects of the sectors policy and strategicdecision making, as well as in some operational issues. As market reforms deepen, it isexpected that MOPNG may gradually withdraw from its day-to-day involvement in businessdecision making and focus more on its supervisory and regulatory responsibilities

1. Oil Industry Development Board

3. The Oil Industry Development Board (OIDB) was created in 1975 under Oil Industry(Development) Act, 1974. As a financing arm of MOPNG, its primary objective is to renderfinancial and other assistance for promotion of all such measures that are conducive to thedevelopment of the oil industry. The main functions of OIDB are to provide concessional loansfor high-risk exploration and grant assistance for research and development (R&D) in thehydrocarbon sector. This includes:

(i) advancing loans to oil industrial companies;(ii) disbursing loans and grants for the implementation of research and development

programs conducive to the development of the oil industry;(iii) refinancing oil industrial loans granted by the oil companies to industrial units;

and(iv) funding expenditure of various study groups, consultancy cells, scientific advisory

committees, task forces, project monitoring cells, etc.

4. OIDB has received Rs90.2 billion from the cess levied and collected by the Governmenton domestic crude oil. The targeted recipients of OIDB funding have been predominantly oil andgas public sector enterprises (PSEs). The significance of OIDB is somewhat uncertain amid theongoing sectoral reforms, anticipated greater private sector participation, and greatercompetition from commercial financial institutions.

2. Directorate General of Hydrocarbons

5. The Directorate General of Hydrocarbons (DGH) was established in April 1993 as anadvisory body to MOPNG in matters relating to oil exploration and development, and toassemble and integrate all data pertinent to the concessional areas leased for oil-and-gasrelated activities. It advises the Government on the offering of areas for exploration as well ason matters relating to relinquishing of areas, reviews the adequacy of exploration anddevelopment programs, and advises the Government on oilfield safety and environmentalissues. The establishment of DGH was stipulated as one of the key loan covenants of the

25


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Appendix 2, page 3

However, due to high crude oil prices, the accounts deficit by the end of FY2000/01 is expectedto reach Rs150 billion.

11. The Government took steps to align the petroleum prices with open market prices andgradually phase out administered price mechanism (APM). In November 1997, it announced thedetails of a phased dismantling program of APM and of the duty structure from April 1998 until

2002 as follows:

(i) cost-plus formula for indigenous crude oil producers has been withdrawn andgradual import parity established, currently standing at 82 percent of importedcrude oil prices subject to ceiling and floor constraints;

(ii) retention pricing for all refineries has been abolished (except refinery gate pricesof controlled productsgasoline, diesel oil, kerosene, liquefied petroleum gas(LPG), and aviation fuelwhich are fixed in accordance with the principles ofadjusted import parity price for the existing refineries during the transition period);

(iii) consumer prices of gasoline, diesel oil, kerosene, aviation fuel and LPG (fordomestic use) will continue to be administered; and

(iv) prices of other petroleum products like naphtha, fuel oil, bitumen, and paraffin

wax have been decontrolled since 1 April 1998.

B. Exploration and Production

12. Presently, two major PSEs in exploration and production are ONGC and OIL, whichtogether provided little less than 33 million metric tons (MMT) of crude oil in FY1999/FY2000,with ONGCs share estimated at over 29 MMT. Additionally, private and joint venture companiesproduced approximately 4 MMT, bringing the total to 36.55 MMT for the year.

13. The net production of natural gas was 27.428 billion cubic meters (m3), including 2.87billion m3 from private and joint venture companies, in FY1999/2000, a marked increase from18 billion m3 in FY1991/1992 at the start of HSP.

1. Oil and Natural Gas Corporation

14. ONGC was formed by an Act of Parliament to take over the activities of the Oil andNatural Gas Directorate set up by the Government in 1956. It was a statutory body until it wascorporatized under HSP in September 1993. As the countrys dominant upstream oil company,it carries out geological and geophysical surveys, exploratory drilling, development drilling, andexploitation of hydrocarbon resources. Until recently, ONGC had the virtual monopoly of alloffshore and most onshore exploration and production activities.

15. Presently ONGC has about 40,000 employees, down from 47,000 at the beginning ofHSP in 1991. It is envisaged that the total workforce will be further reduced to 35,000 in five

years through voluntary retirement. The company is in a relatively healthy financial situation. InFY1998/99, the company produced 27.55 MMT crude oil and 23.97 billion m3 natural gas for anet profit (after tax) of Rs27.545 billion.

16. Despite the relatively healthy financial picture, the future of ONGCs productioncapacities allows for no optimism. Its existing oil fields are running dry, and its explorationactivities have made no major findings of oil and gas fields. As such, ONGC, and the entireupstream exploration and production system, has been targeted by MOPNG as a priority areafor attracting foreign direct investment and technological collaboration, particularly in the areas

27


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Appendix 2, page 4

of deep-sea exploration and technology related to prolonging the productive lives of existingwells.

17. Under the NELP (which the Government claims is one of the most favorable in theworld), a total of 48 blocks have been offered. By the bid closing date of 18 August 1999, a totalof 45 bids were received from both foreign and Indian companies including public sector

undertakings, of which 25 blocks were awarded, including three to Enron and eight to aconsortium formed by major domestic private corporations, i.e., Tata and Reliance. In addition,ONGC is actively seeking foreign partners for the exploration of the six blocks that it has beenawarded. A total of 17 foreign firms expressed interest including Total of France and BGInternational of the United Kingdom. In addition to collaborating with foreign companies indomestic exploration and production, ONGC is also looking to provide drilling services to secureproduction contracts overseas including Bangladesh and Oman. ONGC has established ONGCVidesh Limited (OVL), a wholly subsidiary, to enter into joint ventures for exploration andproduction in other countries. OVL, in partnership with BP-Amoco and Statoil, has alreadydiscovered offshore gas in Viet Nam.

18. The latest international crude oil price increases have generally weighed in favor of the

upstream companies like ONGC. This is because prices of the domestically produced crudehave been pegged to international prices on an increasing-proportion basis since 1998 (whenthe old cost-plus pricing formula was abolished). The proportion started at 75 percent and hasbeen increasing gradually to the present 82.5 percent of the international crude oil price, subjectto a ceiling of $25 per barrel. The ceiling crude oil price is imposed to curtail excessive costs tothe downstream companies and consumers during severe international crude oil priceincreases, and to compensate for the floor prices when there is a sharp decrease in prices.

2. Oil India Limited

19. OILs origins date back to the time when oil was first discovered in Assam in 1889. TheGovernment of India, which was a joint venture partner with Burmah Oil Company, took over the

latters shareholding in full in 1981. As with ONGC, although on a much smaller scale, OILsprimary activities are exploration, production, and transportation of hydrocarbons, with a roughbreakdown of sales as follows: crude oil (90 percent), natural gas (5 percent), transportationcharges (3 percent), and LPG (2 percent). OILs operations are very much confined to northernIndia including Assam, Arunachal Pradesh, Orissa, Rajasthan, the Mahanadi basin, and severaloffshore areas.

C. Private and Joint Venture Companies

20. At present, private and joint venture companies contribute approximately 4 MMT to totaldomestic production of crude oil (about the same as OILs production). Most of these privatecompanies, including ESSAR, HOEC, Okland, and Shell are operating under production sharing

contracts (PSCs) with ONGC operating on existing known oil fields. The proportion of crude oilproduction from private companies and joint ventures is expected to rise in the coming years asmore and more private (domestic and foreign) companies are awarded blocks for explorationunder the Governments NELP.

D. Refining

21. The refining subsector has been delicensed since 1998. The Government has openedoil refining to the domestic and foreign private sector. During the Program, the Government

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approved 12 new refineries. Of these, twoReliance Petroleum Refinery Ltd. and theMangalore Refinery and Petrochemicals, Ltd.are already in production while three privatefirms have already withdrawn.

22. With the commissioning of several large modern refineries, Indians refining capacitieshave increased from 69.14 MMT per annum as of 4 January of 1999 to 109.04 MMT per annum

as of 1 January 2000, making the country almost self-sufficient in the refining sector. Totalcapacity is expected to further increase to 126 MMT per annum by the end of the Ninth Plan(1997-2002). There are currently 17 refineries in the country, of which seven are owned by theIndian Oil Corporation, Ltd.

1. Indian Oil Corporation Limited

23. The Indian Oil Corporation Limited (IOCL) was established on 1 September 1964 withthe merger of Indian Refineries Ltd. and the Indian Oil Company Limited with the main objectiveof coordinating and controlling the refining and distribution activities of these two oil companieseffectively.

24. With a total workforce of 32,000, IOCL is the largest commercial undertaking and onlyFortune 500 company in India. IOCL is both a refining and marketing company. With sevenrefineries and 35.6 MMT per annum combined capacity, its refining capacity accounts forroughly one third of Indias total. It also owns and operates a 6,543 km network of pipelines withan installed capacity of 43.45 MMT per annum.

25. The refineries of IOCL achieved a crude throughput of 30.36 MMT during FY1998/99.Against the contracted target of 31.80 MMT for FY1999/2000, the throughput achieved up toDecember 1999 was 23.86 MMT. In FY1998/99, IOCL achieved a turnover of Rs6,943 billion foran after-tax profit of Rs221 billion.

2. Hindustan Petroleum Corporation Limited

26. The Hindustan Petroleum Corporation Limited (HPCL) is a PSE (with the Governmentholding 51.06 percent) and the second largest integrated oil company in India. It has tworefineries producing a variety of petroleum productsfuels, lubricants and specialty products,one in Mumbai (on the west coast) having a capacity of 5.5 MMT per annum and the other inVisakhapatnam (on the east coast) with a capacity of 4.5 MMT per annum (being expanded to7.5 MMT per annum). HPCL also operates the only joint venture refinery in the country inassociation with the Aditya Birla Group of Companies (an Indian private conglomerate).

27. During FY1998/99, the two refineries of HPCL achieved a combined crude oil throughputof 9.07 MMT, or a little less than one third of IOCLs level. The sales turnover increased toRs2,599.46 billion in FY1998/99 for a net profit of Rs90 billion.

3. Bharat Petroleum Corporation Limited

28. The Bharat Petroleum Corporation Limited (BPCL) is an integrated oil company in thedownstream sector engaged in refining crude oil and marketing petroleum products. It has alsodiversified into the manufacture and marketing of petrochemical feedstocks. The Governmentsholding in BPCL is 66.2 percent.

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29. During FY1998/99, BPCL oil refinery achieved a throughput of 8.94 MMT. The salesturnover in FY1998/99 was Rs2,565 billion, compared with Rs2,070 billion the year before, for aprofit after tax of Rs70 billion.

E. Standalone Refineries

30. Major standalone refineries in India include Cochin Refineries, Chennai Refineries,Mangalore Refineries, and Reliance Petroleum. The crude oil throughput for these companiesfor FY1999/2000 were 7.8 MMT, 7.0 MMT, 5.2 MMT, and 9.9 MMT, respectively.

31. In a move to pave the way for the PSEs to meet anticipated competition, theGovernment has recently announced consolidation of the oil sector whereby all the standalonerefineries in the public sector will be converted into subsidiaries of larger PSEs. While BPCL willbuy out the entire government stake in Cochin Refineries, it will take over Indo BurmaPetroleums (IBP) stake in Numaligarh Refinery in Assam. Market leader IOCL will buy out theentire stake in both Bongaigaon Refinery and Chennai Refinery. IOCL and BPCL are expectedto spend nearly Rs20 billion to acquire stakes in these oil refineries.

32. The rise of Reliance Petroleum represents major progress in private sector participationin the sector. Through vertical integration, Reliance has gradually moved upstream from textileto petrochemical, to refineries and to oil exploration and production. With its recentlycommissioned ultra modern refining facility with an installed capacity of 27 MMT per annum,Reliance will be a major force in the refining sector.

F. Marketing

33. Unlike the refining sector, the retail sector is virtually controlled by four PSEs, i.e., IOCL,BPCL, HPCL, and IBP, which have, over the years, developed an extensive network of storage,transportation, and retail outlets nationwide. IOCL currently controls over 54 percent of themarket with BPCL and HPCL controlling approximately 20 percent each. Any company, foreign

or domestic, that wishes to engage in marketing activities has to invest a minimum of Rs20billion in oil and gas infrastructure. The first domestic private company that met this criterion wasReliance Petroleum Refinery Ltd., which is currently applying for, and is expected to obtain,rights to market petroleum products.

34. The existing natural monopoly, as well as the requirement of investment in upstreamactivities, has served to deter some potential investors in the hydrocarbon sector as a whole.Very few risk-averse foreign oil and gas companies are willing to invest millions of dollars inexploration and refineries without first being guaranteed marketing rights.

G. Gas Distribution and Marketing

35. The total net production and consumption of natural gas was 25.71 billion m3

forFY1998/99. Prior to 1984, ONGC and OIL handled the production, transmission, and distributionof natural gas. Since 1984, distribution and marketing have been largely taken over by Gas

Authority of India Limited (GAIL).

36. Gas Authority of India Limited. The Gas Authority of India Limited (GAIL), set up in1984, is the largest natural gas transmission company in India. The company owns andoperates a network of over 4,000 km of pipelines. GAIL primarily targets large industrial andcommercial customers including those PSEs in the power and fertilizer industries for its natural

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gas. Total gas sales for FY1998/999 were 21 billion m3. GAIL also operates six natural gasprocessing plants with an installed capacity to produce 961,000 tons of LPG per year.

H. Private Sector Involvement in LPG

37. At present, the total market size for LPG is about 6 MMT, of which approximately 5.5

MMT is sold to domestic households by four major PSEs, i.e., IOCL, GAIL, BPCL and HPCL, ata subsidized price under APM. The remaining 0.5 MMT is sold to industrial and commercialcustomers at market prices. As part of industry deregulation the Government has, since 1993,allowed private sector participation in importing and retailing LPG to cater to this small segmentof the market. This has led to the establishment of a number of private sector units for importingand marketing LPG and kerosene in the private sector. Most major multinational oil and gascompanies currently operating in India, including Shell, Caltex, ELF Gas, Mobil, and SHV, arenow limited to this small segment of the market.

I. Oil Pipeline Transmission

38. Petronet India Limited. Petronet India Ltd. was established in 1998 as a financialholding company with the specific objective of rapidly developing a national network of pipelinesfor transporting petroleum products to which all producers in the private and public sectors willhave open access. Half of the equity in the company is held by five PSEs including IOCL,BPCL, and HPCL. The remaining 50 percent is held by financial institutions and privatecompanies, with no individual entity holding more than 10 percent of the total. The creation ofPetronet was in line with a key recommendation by TA 1645-IND for the creation of a newindependent common carrier company to manage all pipelines and associated terminals andensure open access by all oil companies.

39. Individual pipeline projects are undertaken as joint ventures wherein Petronet holds26 percent of the equity, oil companies and private companies up to 26 percent, while the

balance is held by financing institutions and other investors.

40. Petronet has identified eight pipeline projects for implementation. Joint ventures for fourhave been incorporated, of which, one (Vadinar-Kandla) has been completed and three areunder construction. Detailed feasibility studies for the other four projects are scheduled to becompleted in 2001.

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Appendix 3

STATUS OF APPROVED REFINERY PROJECTS

Name TypeCapacity(MMTPA)

ExpectedCompletionFiscal Year Status at OEM

Reliance Petroleum Refinery

Ltd.

Private 27 1999/2000 Commissioned in late 1999.

Currently operating at 27 to 30MMTPA.

Essar Refinery Private 9 2001/02

Central India Refinery Joint 6 2001/02 All government clearances havebeen obtained but physical work hasnot started. It will take another 48months. This is a joint venture withOman Oil Company at an estimatedcost of Rs5,277 million crores.

MRPL Expansion Joint 6 1999/2000 Commissioned.

West Coast Refinery Joint 6 Uncertain The project has been deferred

because of too much capacity on thewest coast. This is an HPC project.

East Coast Refinery Joint 9 2002/03 This is an IOC venture with KPC.KPC withdrew in December 1999.Expected capacity is 4 to 7.5MMTPA.

UP Refinery-Sultanpur Joint 7 Uncertain This was originally a joint venturebetween BPC and Shell. Shell haswithdrawn from the project. It isunlikely that anything will happenbefore 2005.

Punjab Refinery Joint 9 2003/04 This was originally a joint venturebetween HPC and Exxon. Exxonwithdrew from the project and HPCis in the process of selecting anotherpartner.

Soros Refinery Private 6 Uncertain Withdrawn.

N. Denro Private 9 Uncertain Withdrawn.

Ashok Leyland Private 2 Uncertain Withdrawn.

BPC = Bharat Petroleum Company; HPC = Hindustan Petroleum Corporation;

Hydrocarbon Sector Program Loan (Loan 1148-InD)

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