New Delhi: London-listed Vedanta Resources suffered a setback as Group of Ministers (GoM) headed by Finance Minister Pranab Mukherjee set strict norms for approving Cairn India deal even though after accepting the stipulations the nation’s largest private sector oil producer will still remain a hugely profitable venture.

Vedanta will have to decide if it should continue to pay Rs 405 per share or USD 6.65 billion for buying 40 per cent stake in Cairn India from its Edinburgh-based parent Cairn Energy plc or a lower amount in view of Group of Minister’s condition that royalty on all important Rajasthan oilfields will be cost recoverable.

Cairn India doesn’t pay royalty on its 70 per cent share of 175,000 barrels per day of oil output, but will now have to agree to deduct the royalties paid by state-owned ONGC from revenues earned from oil sale, lowering its profitability.

Sources said cost recovery of the royalty will lower Cairn India’s profit, in net present value (NPV) terms, by Rs 6,272 crore over the approved life of the field till 2020.

This is less than the net profit that Cairn India earned in 2010-11 fiscal (Rs 6,334.40 crore) and half of the Rs 12,600 crore liability it would have to incur if it were to pay state government royalty at the rate of 20 per cent of USD 70 per barrel oil price on its share.

Sources said when Vedanta in August agreed to buy Cairn India, the Indian basket of crude oil was at around 75 per barrel. In May it has averaged, USD 110 per barrel, a huge upside for Vedanta. Cairn India got USD 94.2 per barrel for oil in January-March quarter.

Vedanta, they said, will weigh if the cost recovery liability is more than the upside it has already got in crude oil price. Also, Cairn India’s peak output is now estimated at 240,000 bpd as against 175,000 bpd.

Oil and Natural Gas Corp (ONGC) had made claim for cost recovery of royalty as per provisions of the contract for Rajasthan field in June 2010, much before the Cairn-Vedanta deal was announced.

Cairn India had in fact in July that year acknowledged ONGC’s letter that asked for approval of oil regulator DGH to be produced for beginning cost recovery process.

While oil ministry as well as Solicitor General of India backed ONGC’s interpretation of contract, Cairn India went back on its word and started opposing cost recovery the moment the deal with Vedanta was announced.

ONGC has to pay Rs 18,000 crore in royalty on the entire output over the life of the field. In the absence of cost recovery, this liability together with its obligation to pay for 30 per cent of capital and operating expenditure in the field, made the Rajasthan project a losing proposition for it.

The six-member Group of Ministers, headed by Finance Minister Pranab Mukherjee, on Friday gave recommendations to the Cabinet Committee on Economic Affairs (CCEA).

According to sources, it recommended that to get the government nod, Cairn or its successor will have to agree to make cost recoverable the royalties paid by ONGC on its most important Rajasthan oilfields.

For ONGC, cost recovery would mean that even though NPV of its take from the field will be reduced by Rs 2,688 crore, the project will still be positive for the state-owned firm.

The government will see its profit take plunge by Rs 5,032 crore in NPV terms, which is less than half of Rs 12,600 crore it would have to shell out otherwise to reimburse ONGC, sources said.

Sources said Cairn has also disputed its liability to pay oil cess at the rate of Rs 2,500 per tonne on its 70 per cent share in the Rajasthan fields, saying ONGC is also responsible to pay cess on its behalf like in the case of royalty.

The government has rejected this position as the PSC imposes royalty liability on ONGC, but is silent on cess, which means partners will have to pay in proportion to their share.

Cairn has initiated arbitration against government on this issue. Sources said the GoM recommended that Cairn should withdraw the cess arbitration and agree to pay its share of cess as the other pre-conditions for approval. Also, the company will have to obtain a no-objection certificate from ONGC for transferring ownership to Vedanta.

For the seven exploration blocks or areas Cairn had won under New Exploration Licensing Policy (NELP), the GoM held that the PSC provision of seeking partner consent must be met. ONGC is a partner in five of these blocks, they said.

In case of CB-OS/2 and Ravva oil and gas fields in the eastern offshore -- the other producing properties of Cairn -- the GoM suggested Also, Vedanta will need a security clearance from the Ministry of Home Affairs, sources said.

It has also refused to accept the requirement of partner consent even though five oil blocks it won under New Exploration Licensing Policy (NELP) explicitly provides for obtaining no objection from partners in case of change of ownership.

Besides royalty, Cairn had also contested its liability to pay Rs 2,500 per tonne cess on its 70 per cent share. But unlike royalty, it is treating cess as a cost-recoverable item and is paying it under protest.

All cost-recoverable items like capital and operating expenditure are first deducted from revenues earned from the sale of oil before profits are shared between stakeholders, including the government.