ASIAN DEVELOPMENT BANK PPA: IND 25363 PROGRAM PERFORMANCE AUDIT REPORT ON THE HYDROCARBON SECTOR PROGRAM LOAN (Loan 1148-IND) IN INDIA January 2001 CURRENCY EQUIVALENTS Currency Unit – Rupee/s (Re/Rs) At Appraisal At Project Completion At Operations Evaluation (November 1991) (September 1997) (September 2000) Rs1.00 = $0.0386 = $0.0276 = $0.0219 $1.00 = Rs25.90 = Rs36.18 = Rs45.67 ABBREVIATIONS ADB – Asian Development Bank APM – administered price mechanism BOP – balance of payments DGH – Directorate General of Hydrocarbons HSP – Hydrocarbon Sector Program IMF – International Monetary Fund IOC – Indian Oil Company LPG – liquefied petroleum gas MMT – million metric tons MOF – Ministry of Finance MOPNG – Ministry of Petroleum and Natural Gas NELP – New Exploration Licensing Policy OECF – Overseas Economic Cooperation Fund OIL – Oil India Limited ONGC – Oil and Natural Gas Corporation PSE – public sector enterprise TA – technical assistance NOTES (i) The fiscal year (FY) of the Government ends on 31 March. (ii) In this Report, "$" refers to US dollars. Operations Evaluation Office, PE-566 CONTENTS Page BASIC DATA i EXECUTIVE SUMMARY ii I. BACKGROUND 1 A. Rationale 1 B. Formulation 1 C. Objectives and Scope at Appraisal 2 D. Financing Arrangements 2 E. Donor Coordination 3 F. Program Completion Report 4 G. Evaluation 4 II. IMPLEMENTATION EXPERIENCE AND RESULTS 4 A. Effectiveness of Design 4 B. Implementation of Policy and Institutional Measures 5 C. Management of the Program 12 D. Assessment of Program Results 13 III. PROGRAM IMPACT 15 A. Macroeconomic Impact 16 B. Social Impact 17 C. Institutional Impact 17 D. Environmental Impact 17 E. Sustainability 18 IV. KEY ISSUES FOR THE FUTURE 18 A. Issues Related to Sectoral Improvement 19 B. Issues Related to Program Loan Formulation 19 V. CONCLUSION 21 A. Overall Performance 21 B. Lessons Learned 22 APPENDIXES 23 BASIC DATA Hydrocarbon Sector Program Loan (Loan 1148-IND) Program Preparation/Institution Building Person- Approval TA No. TA Project Name Type Months Amount Date 1645-IND Examination of Public Sector Oil A&O 7 $200,000 2 Jan 1992 Refining, Distribution and Marketing Activities 1646-IND Promotion of Private Sector A&O 13 $400,000 2 Jan 1992 Investment in Downstream Activities Key Program Data ($ million) As Per ADB Loan Documents Actual Total Program Cost 500.0 375.0 ADB Loan Amount/Utilization 250.0 125.0 ADB Loan Amount/Cancellation 125.0 Key Dates Expected Actual Appraisal 3-10 October 1991 31 Oct-9 Nov 1991 Loan Negotiations 16-17 Nov 1991 17-19 Nov 1991 Board Approval 12 Dec 1991 17 Dec 1991 Loan Agreement 13 Dec 1991 18 Dec 1991 Loan Effectiveness 16 Dec 1991 20 Dec 1991 Loan Closing 30 Jun 1995 18 Sep 1997 Months (effectiveness to completion) 42.5 60.5 Borrower Government of India Executing Agencies Ministry of Finance Ministry of Petroleum and Natural Gas Mission Data Type of Mission No. of Missions No. of Person-Days Fact-Finding 1 80 Appraisal 1 60 Program Administration Disbursement 1 3 Aid Coordination 1 2 Consultation 1 4 Special Contact 1 15 Review 3 29 Program Completion 1 20 Operations Evaluation 1 51 A&O = advisory and operational, TA = technical assistance. 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 for structural reforms, promotion of competition, and private sector participation. The Hydrocarbon Sector Program (HSP) loan was consistent with this strategy. It was also part of international donor efforts to support India to diffuse its balance-of-payment crisis caused by the drying-up of short-term credits and the surge of oil import costs due to the sharp oil price increases caused by the Gulf crisis. On 17 December 1991, the Board approved the program loan for $250 million to be disbursed in two tranches. In addition, cofinancing of $250 million from the Overseas Economic Cooperation 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 promoting private sector investment in downstream activities. The main objective of the Program was to promote accelerated exploration and development of domestic hydrocarbon resources through increased participation of the private sector and enhanced operational efficiency of public sector enterprises (PSEs). Specifically, the Program aimed to contain the share of oil imports in total oil consumption at the 1991 level (45 percent). The Government considered the objective of long-term oil import substitution as important from the viewpoint of reducing pressure on the foreign currency reserve as well as the country’s strategic self-reliance. The scope of HSP was to cover major areas including sectoral policy and institutional reforms, attracting private sector investments, improving public sector operational and financial efficiency, and promoting energy conservation and efficiency. The first tranche of $125 million was disbursed in two installments in December 1991 and February 1992. The Government proceeded to implement most of the reform measures prescribed by the Program. The process, however, stalled with what was considered a key covenant, namely the divestment of 20 percent of the Government’s equity in the country’s leading oil company, the Oil and Natural Gas Corporation (ONGC). The scheduled loan closing date 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 the cancellation of the second tranche ($125 million). The loan was actually closed on 18 September 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 or not 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 a Directorate General of Hydrocarbons to provide a level playing field for private sector, introduction of a New Exploration Licensing Policy, phased dismantling of the administered price mechanism, and establishment of the common carrier company Petronet. As a result, the general regulatory and business environment has undoubtedly grown much more market oriented. iii However, the Program suffered from a number of failed assumptions, which were partially responsible for the fact that a key covenant was not achieved. First, the time-bound target of divesting 20 percent Government equity in ONGC failed to take into account the scale and complexities of the divestment and necessary regulatory and market conditions for the divestiture. Second, the Program’s heavy emphasis on divestment, as a means to raise additional capital and enhance management efficiency, was very uncertain as sales of government shares at heavy discounts would have caused substantial financial losses for the Government without really achieving much since the majority of the stake would have remained with the Government even if the sales succeeded. Other alternatives such as forming joint ventures, devising attractive policies to encourage foreign direct investment, and allowing more management autonomy for the PSEs could have been more effective. Third, the Program’s time frame was too tight and no explicit consideration was given to proper sequencing of the reform measures prescribed. In addition, other factors such as the Government’s slow movement to market reforms and reluctance to open up the market also played a role in the cancellation of the second tranche. In this regard, the Government must accelerate the reform process and pursue private and 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 private sector is yet to be realized with the PSEs, notably ONGC and Oil India Limited, still dominating activity. Major foreign oil companies have been reluctant to make large investments in this inherently risky business due to the administered prices and the difficulties in obtaining marketing rights. Some believe that the multinational oil companies may hold the key for acceleration of successful exploration due to their better resources and technology in certain key areas, such as deep water exploration. The proportion of crude oil production from private or joint ventures under production-sharing contracts remains insignificant, e.g., 4 million out of 37 million metric tons in FY1999/2000. Total private sector investment in exploration is also far from 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 on an upward trend with the oil self-sufficiency rate reduced to 37 percent in FY1998/99, much lower than the targeted 45 percent. Recent high crude oil prices have once again brought urgency to the sector’s reforms as oil imports continue to drain the country’s foreign currency reserve and the deficit on the oil pool accounts (a cross-subsidy mechanism) deficit has reached a very high level. The situation in the refining sector is somewhat better. Since the beginning of the Program, a total of 12 refineries have been approved, five for operation by the private sector, six by joint ventures, and one by the public sector. However, all the prospective foreign companies including Exxon, Shell, KPC, etc. withdrew from the initial agreement due to concerns over marketing rights, administered prices, and anticipated refining overcapacity in the country. Only two domestic private companies, Reliance Petroleum, Ltd.