Abstract
Bundling means bringing many different activities into one set, and unbundling means dividing different activities into different sets. Unbundling helps to reduce the chances of monopoly and exploitation of consumers by the companies as well as it creates competition in the sector. In this article, we will discuss the unbundling of activities in the Indian oil and gas downstream sector which is divided into upstream, midstream, and downstream sectors. In the upstream sector, the companies explore and produce oil and gas, basically crude oil. In the midstream sector, the produced crude oil is sent to the factories where they extract gases and oil. In the downstream sector, the final good is sent to the consumer. In this article, the downstream sector has been discussed in depth and the author has attempted to suggest some amendments in its regulatory framework.
Keywords: Unbundling, Upstream, Midstream and Downstream
Introduction
Unbundling in layman language means dividing into two sectors. Unbundling involves the separation of natural gas supply from pipelines into transportation and distribution of natural gas markets in the oil and gas industry. Pipeline corporations can use non-price methods like unbundling to limit competition in the wholesale gas market by providing low-quality transportation services. It removes the distortion and offers a level playing field for all participants, allowing supply firms to flourish by purchasing natural gas in the wholesale market, reselling it downstream, and using pipeline and distribution companies’ transportation services. Competition among supply businesses drives down resale markups, allowing cost savings to flow from the manufacturers to the end-users. Natural gas storage now has a new role in natural gas and transportation markets, in addition to its traditional duty of load balancing, thanks to the unbundling of pipelines. The purchasing and selling of natural gas market circumstancesevolve as natural gas companies move towards unbundling and retail competition. Storage operators, too, become more engaged in the gas market which can be crucial in relieving pipeline congestion and lowering gas prices in local gas markets. The idea behind this concept is that shall not be a monopoly in the sector.
Unbundling in India
The concept of unbundling in oil and gas downstream sector has been introduced in the Indian legal regime in the proviso ofSection 21(1) of the Petroleum and Natural Gas Regulatory Board Act, 2006 (“Act, 2006”). This section makes, inter alia, provision for giving the right of first use for the personal requirement to an entity that has unbundled its distribution and transportation activities relating to natural gas on a common carrier or contract carrier basis. It also states that such entities should comply with the specified affiliate code of conduct and further provides transportation rates for the use of a common carrier to the authorized entity.
In 2006, the Government of India and the Ministry of Petroleum and Natural Gas had passed apolicy for developing natural gas pipelines and natural gas distribution networks. Its sixth paragraph addresses unbundling of operations, stating that any entity seeking Board approval for the construction, operation, or expansion of common or contract carrier gas pipelines must provide an undertaking if the entity works in gas marketing or the local or city natural gas distribution network, or has a related entity such as a group company, parent organization, joint venture company, affiliated company, etc. and the entity has to ensure that they follow arm’s length relationship with the activity they have opted for and other activities. The entity has to follow the affiliatecode of conduct which is drafted by the Petroleum and Natural Gas Regulatory Board (“the Board”). The Board has the authority to enquire about the authorized entity’s and associated entities’ managerial and organizational functioning and accounts, as well as to request related documents to determine if they are operating at arm’s length. The second point of this paragraph suggests that the authorized entity, in the long run, should work in the transportation activity of natural gas so that the Board may intervene at the correct stage. This paragraph ensures that the owner of the pipeline does not take any competitive advantage and does not abuse its dominant power while establishing an efficient gas grid and checks if there is open access for all players on a non-discriminatory basis.
The concept of affiliate code of conduct and separate accounts are explained in the Petroleum and Natural Gas Regulatory BoardRegulation, 2008 (“Regulations”). Regulation 5 deals with the degree of accounting separation. It states that authorized entity after unbundling should ensure that there is accounting and financial separation by maintaining different accounts.
Regulation 5A deals with the degree of legal separation. It states that when an authorized entity is engaged in marketing and transportation of natural gas on a common or contract carrier basis, they have to create a separate legal entity this means that two different entities should treat transportation of natural gas and marketing, and the right of first use will be available to the affiliate of separate legal entity.
Regulation 8 deals with non-discriminatory access to services and states that authorized entities engaged in the marketing of natural gas have to provide services on a non-discriminatory basis as the prices are decided by themselves. The authorized entity has to check its affiliates as well to ensure that they do not get involved with promotional material or market which is favorable to one buyer or a specific set of buyers. To avoid this, an entity has to take some measures for e.g., it should notify affected consumers of this kind of activities/violations, create awareness among the affiliates and when the authorized entity comes to know of such violation, they should inform the Board in writing as well as the measures taken by the entity to prevent the occurrence of this kind of situation in future. The entity shall be authorized to an affiliate in the same manner as applies to similarly placed non-affiliates. The authorized entity cannot assign or transfer to an affiliate its consumer to whom the authorized entity is providing the services unless the consumer gives its consent in writing.
On 11th September 2012, the Board issued a public notice where they explained the concept of unbundling and invited participants of the oil and gas downstream sector to share their views. The motive behind unbundling in this sector was that there shall be vertical splitting in the value chain. They wanted to split monopoly and non-monopoly activities offered. There are three types ofsuggestions which the paper suggests, they are:
1. Accounting segregation: This would help generate effective accounting statements from which regulation of entity can be done properly. This also helps analyze the cost, revenues, and capital of the major areas of the entity’s business. This creates various divisions under the entities, and they are obliged to maintain separate account books with arm’s length relationships between the financial transactions. It is generally considered as the first stage of unbundling.
2. Legal segregation: This helps to identify separate legal entities along with their functions like transportation, marketing, and production of natural gas. They separate legal entity would have different activities. This is considered as the second stage of unbundling.
3. Ownership and Management control segregation: this helps to envisages that the affiliate and the entity have different ownership and the management control of segregation can ensure independent decision-making. This is considered the third stage of unbundling.
Comments of Entities on the Concept of Unbundling
Gas Authority of India Limited (“GAIL”):
GAIL’s in its comments,stated that already they follow three formats of unbundling as mentioned in the public notice and have a three-stage approach for the same:
Stage 1: Implementation of accounting separation has been envisaged by judging the effectiveness of each entity’s ability to prepare various financial statements.
Stage 2: It has been proposed that the Board should pursue legal unbundling of the transportation segments of natural gas transmission entities.
Stage 3: The Board may consider declaring a timeline for Ownership/management control unbundling considering various factors.
Assam Gas Company Limited:
Assam Gas Company Limited replied to the paper by stating that it is a small public sector undertaking company compared to other public sector undertakings. Their total revenue from gas distribution and transportation is approximately Rs. 121 crores, divided between city or local natural gas distribution networks (share is Rs. 76 crores) and bulk transportation (share is Rs. 45 crores). They suggested that the unbundling of activities will only add a burden to them as it will increase the cost of administration and operation and reduce the size and strength of the company as there is a separation between marketing and transportation. Their gas distribution network basically operates in the small town i.e., Upper Assam where the population is very less compared to a metropolitan city. They requested the Board that small public sector undertaking companies like their own company or private companies who work in the area of natural gas and their turnover is less than Rs. 500 crores should be exempted from the unbundling of activities. If the Board does not exempt them, they should give more time to these companies for the segregation of accounts of transportation and marketing of natural gas.
Indian Oil Corporation Limited’s Comment:
Indian Oil Corporation Limited were partiallyagreed with the concept of unbundling as they said that unbundling will provide open access to third parties and promote fair competition. Still, the legal separation alone would not benefit the unbundling of activities as entities would be under the same ownership. Monopolies would not end and as a result entities would try to enter in sub-contract with their subsidiaries. The infrastructure of the pipeline is in the initial stage, and they are not ready for separation of marketing and transportation as it would affect the investment. They also requested the Board to make guidelines for the ownership unbundling regarding usage of transportation on an arm’s length basis. They suggested that web hosting of real-time capacity would facilitate the purpose for fair competition.
H-Energy’s Comment:
H-Energy hadagreed with the policy on unbundling. H-Energy stated that unbundling is useful, manageable, and economical. It protects consumers from abuse of dominant power. This will also create transparency and benefit consumers from competitive prices. It will also scrap the practice of natural monopolies. They are in favor of unbundling and are ready for the legal separation of transmission and marketing businesses.
Gujarat Gas Company:
Gujarat Gas Companystated that India’s natural gas industry is at an early stage as compared to the United Kingdom and North American sector. They initially adopted a systematic approach of unbundling with separation of accounts then they moved towards the ownership separation when the industry understood the concept of unbundling. They have adopted various models and are still reviewing them to make changes. It further added that for legal and ownership separation, the entities require shareholders’ consent to set up a new entity. There would be concerns related to taxation and laws which need to be taken a note of. They requested the board that accounting separation for them should be limited to transportation and other activities because they need to identify their activities, expenses, and assets and make changes in the internal operation for establishing a stable system for unbundled activities.
Adani Gas Limited:
Adani Gas Limitedstated that unbundling has a positive impact on transmission infrastructure as they depend on ‘use and pay’ model for shippers. However, in the case of city natural gas distribution network it might have a negative impact as city natural gas distribution network is based on the marketing of pipeline. It involves law creditworthiness, volume, and more significant number of consumers who require capital-intensive pipeline infrastructure. The profit earned from the marketing is an important source of funding of pipeline, and if they unbundled their activities, it would incur losses to the entity. For creating fair competition in the natural gas industry, the transmission infrastructure shall be independent and open, making transmission contracts flexible and easy operation. The unbundling model introduced by the Government of India and Board is at an early stage for city natural gas distribution meaning that work is still in progress the infrastructure with regards to the network is not yet complete. There is a lot of time for the Indian Natural Gas Sector to mature to unbundle activities and accordingly determining the tariffs on an entry-exit structure. Additionally, introducing open access in the city natural gas distribution network will distort the market.
Judicial Stance
The landmark judgment on unbundling of activities isM/s Gujarat State Petronet Corporation Ltd. v. M/s GAIL. The Petitioner had filed a complaint against the Respondent under section 25 read with sections 11 (a), (e) and (f-vi) and 12 (1) (b) (iv) of the Act, 2006 for not allowing the complainant to access and reserve common carrier capacity in DVPL-GREP and DBNPL on a reasonable endeavor basis and to immediately cease GAIL’s restrictive trade practices of preventing the complainant (consumer) the access of common carrier capacity and by forcing it to reserve capacity only on firm basis with a ship and pay commitment.
Facts of the case:
GAIL published an expression of interest on their website for the booking of common carrier capacity for the natural gas pipeline network. Gujarat State Petronet Corporation Limited booked the common carrier capacity for DBPL-GRBP-DBNPL pipelines on a reasonable endeavour basis, but GAIL convened them the booking would be done on a ship or pay basis and therefore the capacity which they want GAIL will not give them.
Before hearing before the Petroleum and Natural Gas Regulatory Board:
In 2013, Gujarat State Petronet Corporation Limited filed a complaint under the Board where it was held that GAIL’s practice of booking common carrier capacity is discriminatory in nature. It also practices restrictive trade practice that amounts fine under section 28 of Act, 2006. Feeling aggrieved by the Board’s order, GAIL filed anappeal in the Appellate Tribunal for Electricity which upheld the decision of the Board. Aggrieved by the order of Tribunal, GAIL filed an appeal before the Supreme Court where it was held that there are no merits in the case and remanded the matter back to the Board.
After the case was referred, two issues were framed. First, whether the denial of access to common carrier capacity on a reasonable endeavor basis to the two pipelines laid by GAIL (respondent) to the complainant is discriminatory and amounts to restrictive trade practices. The second was to what extent the Petroleum and Natural Gas Regulatory Board (Affiliate Code of Conduct for entities engaged in the marketing of natural gas and laying, building, operating, or expanding natural gas pipeline) Regulations, 2008 apply to the complainant.
After hearing the contentions Board stated some facts which were not in dispute. The first undisputed fact was that DVPL-GREP-DBNPL was a common carrier pipeline, and GAIL had publicized on their website their availability of extra capacity and then entered into an agreement with the shipper. The other undisputed fact was that GAIL had more capacity after fulfilling its own requirement, and it can be allocated on a contract basis which is known as common carrier capacity. The last undisputed fact was that GAIL was engaged in both the activities i. e. marketing and transportation of natural gas, so proviso of section 21(1) and section 11 (a) of Act, 2006 would be applicable. These sections put obligation on the entity to follow affiliate code of conduct.
The disputed fact was that GAIL contended that they don’t come under the purview of the proviso of regulation 3 as applicability of this regulation will be on those who are engaged in the activity of marketing of natural gas by their affiliate or business unit or division or any other category without legal separation of ownership and management control of the same into other entity. The Board referred to regulation 4(2), which prevents the cross-subsidization of the costs between regulated activity (transportation) and non-regulated activity (marketing) and held that the affiliate code of conduct regulations is applicable on GAIL.
The other disputed fact was that GAIL’s invitation on their website for common carrier capacity was on the ‘ship and pay’ basis instead of ‘reasonable endeavor’ basis. GAIL also contended that there is no statute that can compel them to book capacity on a reasonable endeavor basis. The Board held that GAIL is giving special treatment to its consumers who had entered into a contract with GAIL for transportation and purchase of natural gas. GAIL is obligated to charge the transportation fee which the Board fixes but attracts consumers by offering them discounts or concession in a take or pay basis in natural gas sale which is around eight percent. This activity violates the objective of provision ofregulation 4 (2) of Affiliate code of conduct regulation, which ensures protection of the interests of the consumers and other entities. Another disputed fact was that underregulation 8(1) of the Affiliate code of conduct, GAIL is under an obligation to treat other entities, authorized for the marketing of natural gas, on a non-discrimination basis. GAIL and its affiliate are refrained underregulation 8(5), from trading upon, promoting or suggesting any consumer, supplier or third-party that they may receive preferential treatment as a result of the affiliation. Government policy provides no competitive advantage to any gas seller and rather insists on no abuse of dominant position for establishing a gas grid for all entities on a non-discriminatory basis. The allegations made by the complainant was that GAIL was selling and transporting gas to its advantage to prevent competition from emerging in the market for delivery of gas on a reasonable endeavour basis. It was alleged that GAIL took advantage of the market for securing a monopolistic position which is in contravention to the intention of the Act. For the issue of GAIL’s involvement in restrictive trade practices, the Board held that there were no new or additional findings or contention by both parties, so it relied on a case previously decided by the board. It was finally held that GAIL while booking common carrier capacity, was discriminating as well as has resorted to restrictive trade practices and therefore must follow the consequence under Section 28 read with sections 11(a) and section 12(1)(b)(v) of Act, 2006.
Conclusion
Unbundling means dividing a thing into two parts. In this blog, unbundling of activities in the oil and gas downstream sector in India has been talked about. If an authorized entity or player has to lay, build, operate or expand pipeline or network and deal in both transportation and marketing, it will have to opt for only one of these activities in order to have the right to first use on their pipelines. It has also been observed that since the Board roots for healthy competition in this sector to save the interest of the consumers and small entities, therefore unbundling was introduced as it would reduce the chances of an entity to create a monopoly in the industry.
The author suggests that there should be regular checks by the Regulatory Boards on the companies that have separated their activities and shall be issued a certificate for the same as this can result in effectiveness and efficiency in laying of the pipelines. The Board should fix a time period for entities to inform their transportation and marketing businesses and how are they going to unbundle. Further, the Board and Competition Commission of India should come together and shall draft guidelines for unbundling as the Policy for Development of Natural Gas Pipelines and City or Local Natural Gas Distribution Networks, 2006 only talks about following an affiliate code of conduct. These guidelines can be based on regulatory practices in other countries like United Kingdom where five tests have been framed to check unbundling activities, conditions for unbundling, the time period within which unbundling is done, publication by an entity in newspapers and websites that they have to unbundle their activities, etc. Failure to these tests comes with penalties or non-granting of permission to continue with their activities. The author concludes with an opinion that it is better to unbundle activities and carefully opt for the one that increases profit margins in order to avail benefits of first use on the pipeline in the long run.
About the Author
Ms Shriya Paruthi is an Advocate pursuing LL.M. from Gujarat Maritime University.
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Preferred Method of Citation
Shriya Paruthi, “Unbundling in the Indian Oil and Gas Downstream Sector” (IJPIEL, 20 December 2021).
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