Cairn-Vedanta deal: Oil ministry seeks Cabinets final approval

NEW DELHI: Cairn and Vedanta Resources may have jumped the gun in concluding the $8.5-billion deal before they received the government's formal approval, but the oil ministry has recommended to the Cabinet that the transaction that was conditionally cleared in June should get the final consent, officials said. Vedanta has already paid the money to Cairn for acquiring the controlling stake in Cairn India and appointed its nominees on the board. The home ministry has also cleared the deal, but along with the approval, it has placed on record various environmental, regulatory and human rights issues that Vedanta has faced in recent years. This triggered discussions between the government and the companies involved in the deal, and the CEOs of Cairn, Cairn India and Vedanta wrote to the oil ministry saying they were aware of the issues raised by the home ministry and that the oil ministry would deal with the matter "as appropriate", a government official said. The oil ministry was not moved by the home ministry's concerns, and could not see why the deal should be influenced by factors such as Norway's government pension fund selling share of Vedanta, tribal protests in Niyamgiri and Lanjigarh in Orissa and the concerns of the Church of England about the group's human rights record. The oil ministry has sought the approval of the Cabinet Committee on Economic Affairs to issue security clearance for the deal to Vedanta and said home ministry's concerns about the views of the Church of England and a foreign pension fund had "no bearing whatsoever on the security aspects". Cairn India's director for corporate affairs, Manu Kapoor, declined comment, while the oil ministry and Vedanta did not respond to ET's queries. Oil ministry officials said that the deal was poised to obtain final clearance but added that companies could not take this for granted. "Though, both MHA and petroleum ministry have recommended Cabinet Committee on Economic Affairs for granting an unconditional security approval, uncertainty is not yet over till CCEA's verdict is out," one official who did not wish to be identified said. Officials said that on December 7 Cairn and Vedanta had informed the oil ministry that they had fulfilled all conditions set by the Cabinet and the transactions were being completed. On December 15, the companies informed stock exchanges that the multi-billion acquisition of Cairn India was completed. Days before the companies informed stock exchanges about completion of the acquisition and subsequently appointment of three Vedanta representatives in its board, the oil ministry officials had cautioned the government about MHA's observations. In an internal note dated December 12 (reviewed by ET), the oil ministry had said that the ministry could ask companies "to await further instructions from the government before concluding the transaction."

Problems:

It is just as well that the Cairn-Vedanta deal is finally out of the way. The soap opera has dragged on for too long, 10 months to be precise, and it has done nothing for the reputation of all those concerned with it ONGC, the Government or Cairn Energy. Of the three, the Government has probably come out the worst from the episode, not just because it has shoved an unpalatable deal down the throat of a reluctant Cairn Energy but also because of the way it went about its job as regulator of the industry ever since the deal was announced in August 2010. If there is one fundamental problem that the Cairn-Vedanta drama has exposed, it is that of the government being the umpire and also a player in the oil industry. This was one instance where the conflicting rights and responsibilities of the two roles surfaced and worked to the disadvantage of Cairn and Vedanta. The Government, as the dominant shareholder in ONGC, had to protect the interests of the company and also fight for it. As the regulatory authority for the industry, it also had to grant approval to the deal between two private companies. Rather disappointingly, the decision to grant conditional approval seems to have been influenced by the Government's position as owner of ONGC rather than by its larger role as industry regulator.
UNFAIR CONDITIONS

How else can one justify the two rather unfair conditions imposed on Cairn and Vedanta for approval of the deal? The dispute over royalty could have been settled legally and the Government could have cleared the deal while simultaneously directing ONGC to proceed against Cairn through the courts. Cairn India, after all, will continue to be a legal entity, albeit with a new owner, in Vedanta and will be answerable for all contracts signed in the past. If this is bad, the condition that Cairn has to withdraw the arbitration cases it has filed, over the cess payable on the production from the Rajasthan field, is worse. These are cases filed long ago and Cairn India has been paying the cess of Rs 2,650 for every tonne of oil produced, under protest. The Government has simply used its powers as regulator to push through conditions that will benefit ONGC, where it is the dominant shareholder. This is a misuse of its powers and this is not too different from what happens in Russia, where the government regularly bats for its companies, overturning otherwise perfectly legal contracts. If the conditional approval is unpalatable in itself, the delay in granting it makes it worse. In view of the huge implications, we took time. We wanted to be fair to the investors without sacrificing the interest of the Government of India, said Mr Jaipal Reddy, Petroleum Minister, on Thursday night. What huge implications is he talking about? This is, after all, a commercial deal between two companies, where the underlying assets Rajasthan and other oilfields will remain in India. It is not as if Cairn or Vedanta are going to deprive the country of the oil and gas from the fields. The dispute was commercial in nature and, as with all such disputes, could have been settled through due process of law. That is no reason, though, to drag the approval process for almost a whole year. The decision that was conveyed to the two parties on Thursday could have been delivered many months ago.

NEEDLESS DELAY

Where was the need for the government, including a Group of Ministers and the Cabinet, to expend so much energy and time on what is a straightforward commercial deal? Surely, our senior, learned Ministers have more important matters to attend to than sit in judgement over the small issue of a dispute on royalty payment between two companies? Just imagine the impression we are conveying to the outside world, where an entire government sits in judgement over whether or not to approve a commercial deal for a whole year, and at the end delivers a judgment that is wholly in favour of itself! One suspects that the Government may not have granted its conditional approval even now, but for the fact that ONGC's follow-on public offer is waiting for launch. Continued imbroglio over the deal would have surely cast a shadow over the pricing of the offer and also its subscription. That said, Cairn Energy has also not played its cards well. The moment it sensed the Government's resistance a couple of months into the deal, it could have renegotiated with Vedanta, the way it did this week, and sacrificed a part of the valuation. The deal was certainly less than fair in terms of the non-compete fee which Cairn Energy stood to gain over other public shareholders. In the event, it is poetic justice that it has now been forced to forego this. Yet, with some tactical thinking it could have arrived at such an arrangement much earlier and been richer by $6.02 billion by now. The Government's stance may have been unfair but once assumed in public, there was no chance of Cairn having its way on the dispute. One would have thought the Scottish company would have been wise to this. As for ONGC, the less said the better. Company officials are crowing about the financial gain for ONGC from not having to bear the royalty but the fact is that it is not a benefit secured through fair means. One expected better from a $26-billion maharatna company than this.

Introduction India Inc.s approach towards entry and exits of foreign investments may invite investor protection claims. Particularly, the Cairn-Vedanta fiasco may turn into a battle of many investor-State arbitration claims. The GoM are due to decide on the deal and have been warned by the foreign affairs ministry about the violations of Indias Bilateral Investment Promotion and Protection Agreement (BIPA) obligations. Background Of The Deal The deal involves three foreign entities Cairn Energy, Vedanta Resources and its subsidiary Twin Star Holdings, a holding company incorporated in Mauritius.

Cairn Energy decided to sell its stake to Vedanta Resources and Twin Star Holding. Due to its PACs with the government and the involvement of ONGC in its Gujarat project, it had to take permission from the government before going through such a deal. The government has put five pre-conditions to sanction the deal. One of the conditions is that the arbitration, which is on-going between Cairn India and the ministry of petroleum in the UK (Cess Arbitration) is to be withdrawn by Cairn India, and Cairn India has to agree to pay the entire cess tax, which annually is around Rs 250 crore. Cairn India has been paying the same, but claims that ONGC should bear equal burden. The second condition is to concede to ONGCs stand that the royalty to be paid for the Gujarat project should be equally borne by Cairn India (Royalty Argument). This may further increase the burden by Rs1,400 crore. Possible Claims Against India Article 3 of the India-UK BIPA requires India to give a fair and equitable treatment to all foreign investments by the UK nationals and companies. Article 7 also provides for easy transferability of investment. Indias rigid preconditions and delay in giving approval to the transaction may be a potential violation of these Articles in letter and spirit. Although Vedanta Resources has not yet made investments here, as defined under the India-UK BIPA, it can claim protection under Article 3(1) of Indian-UK BIT claiming failure to provide favourable conditions to make investment. Twin Star holding being legally a separate entity and a corporation under the Mauritian law can make a similar but independent claim under the India-Mauritian BIPA. By asking Cairn India to drop Cess Arbitration and accept the Royalty Argument, India has invited several legal hiccups on its shore. For example, Cairn Energy may bring a claim of denial of justice, which is well-protected by India-UK BIPA.

Also, if the pre-conditions are agreed, it will, in turn, amount to an increase in annual burden of about Rs 16,500 crore on Cairn Indias profit post takeover by Vedanta Resources. It may, in turn, lead to depreciation in offer price by Vedanta to buy the Cairn Energy stake. It can be argued by Cairn Energy that this may amount to a loss of profit, leading to a possible claim of indirect expropriation against India. Another important aspect is that further delay may lead to Vedanta Resources calling off the deal, which may be a situation where Cairn Energy can make claims against India under the India-UK BIPA. One more issue which seems crucial, although conceded by the parties, is the direction of SEBI to remove the call option from the agreement. Call options are a common practice and have successfully been exercised by many foreign investors previously. This can lead to claims of breach of legitimate expectation and differential treatment on behalf of Cairn Energy. Remarks Overall, the situation is graver than one can imagine and India Inc. is sitting on a potential powder keg due to delays in decisions and imposition of unreasonable conditions on the entry and exit of foreign investment.

With time running out, a scramble has begun to find a solution on how London-listed mining group Vedanta Resources can get government approval for its $9.6 billion deal to acquire majority stake in Cairn India. The deal, involving Vedanta acquiring 40 to 51% stake from UK's Cairn Energy Plc and thereafter making an open offer to buy for an additional 20% from minority shareholders of Cairn India, is to be completed by April 15. For Vedanta to complete the open offer well within the deadline approved by its and Cairn Energy shareholders, the government must this week give its approval to the transaction. The deal is facing a challenge from ONGC over royalty payments on Cairn India's mainstay Rajasthan oilfields. Sources in know said Oil Secretary S Sundareshan cancelled his February 9-11 trip to Calgary (Canada) for promoting oil blocks offered for bidding in the IXth round of NELP in order to meet chief executive of Vedanta Resources and Cairn Energy again. D N Narasimha Raju, Joint Secretary (Exploration), who was to accompany Sundareshan for the roadshow in Calgary and then proceed to Houston for another promotional show, too will stay back to discuss the finer points of the deal. Market regulator Sebi has not permitted Vedanta to make the open offer to Cairn India shareholders in absence of government approval to its deal with Cairn Energy. As per Sebi regulation, an open offer requires 55-60 days to complete and Vedanta was expecting the nod by today so as to have a small buffer for any contingency.

But the approval is stuck as ONGC by virtue of its stake in 8 out of the 10 oil and gas properties held by Cairn India, claims pre-emption rights. It wants the issue of excess royalty it has to pay on Cairn India's mainstay Rajasthan block to be addressed before giving its no-objection. Sources said oil ministry has made resolution of the royalty issue one of the 11 pre-conditions for giving its nod. Sundareshan had yesterday met chief executives of Vedanta and Cairn, who opposed three of the 11 conditions, they said. Cairn/Vedanta are opposed to ONGC's demand for recovering the royalty before profits from sale of Rajasthan oil as it will lower Cairn India's profitability and valuation. Sundareshan was to meet the Cairn Energy head Bill Gammell, Cairn India CEO Rahul Dhir and Vedanta officials M S Mehta (Group CEO) and Tarun Jain (CFO) again today but the meeting could not take place, sources said. The Rajasthan block, which gives Cairn India 90% of its valuation, is a losing proposition for ONGC, as it has to pay 20% royalty to the state government on the entire output from the field, even though its share from production is only 30%. Cairn India does not pay any royalty on the crude and has even contested the payment of Rs 2,500 per ton cess on its 70% share.

London-listed mining group Vedanta Resources, which is controlled by ambitious Indian billionaire Anil Agarwal, is all set to acquire a controlling stake in Cairn India, in a bid to diversify into oil business. Cairn India operates in the countrys largest producing oil fields in Barmer, Rajasthan.

Moreover, the mandatory open offer by Vedanta Resources for an additional 20% stake in Cairn India is being routed through its group company, Sesa Goa. For the shareholders of this iron ore miner, it would be akin to a forced deal, with no synergies related to crude oil business.

In fact, the consolidated buy-out at $9.6 billion will be more than Vedantas own market capitalization. This critical point also brings to fore some concerns about minority investors of Vedanta being squeezed into this risk-bearing deal.

Even the shareholders of Cairn India have something to miss about the premium that they should fetch from the open offer by Sesa Goa at Rs.355, which will begin from Oct 11, is hardly 10-12% above the undisturbed share price.

There are many things which are in grey area in this punchy acquisition and needs more clarification on the same from the managements of both the firms being part to the deal.

Let me explain some of them :

1) Open Offer Rule

The Rule says that an open offer for a minimum of 20% in the target company is required to be made by any entity that purchases 15% equity, either from the promoters or from the open market.

Please note the steps :

Step A) Company "A" aquires 15% stake in Company "B" Step B) Company "A" opens a public offer to buy minimum 20% share of Company "B" from public. Whats happening in Vedanta Cairn deal? Exactly Opposite! First Sesa Goa is offering to buy minimum 20% from public. Then based on the response, Vedanta will buy 40-51% from Cairns!!

Why?? The logic given is, at the end of the day, Vedanta wants to hold only 60% in Cairn. But, does that justify bending the rules? First Vedanta has to decide how much it buys from the parent company Cairn Energy. Then, irrespective of how much it buys from Cairn Energy, they have to buy additional 20% from the open offer.

Where does it hit Vedanta with the above stipulated Rule? Vedanta doesnt want to hold more than 60% stake in Cairn India. So, if we suppose that they buy 51% from cairn and then float minimum 20% public buy tender, and they get more than 20%, they will end up holding more than 71% which is out of reach of Vedanta Resources. So, arent they bending rules?

2.) How much is Squeezing Cash from Sesa Goa Ethical ?

I have one more apprehension with regard to open offer rules. Whats happening in the Vedanta Cairn deal is Vedanta is buying 40-51% from Cairns, but Sesa Goa is offering to buy 20% from public. In my opinion, only the company which is buying the target company has to tender open offer to public. Not its sister/subsidiary concern. So, Vedanta is again bending rules? The purpose To use the cash reserves of Sesa Goa. Isnt it unethical? Well, I have not gone much deep into these rules yet, readers can guide me wherever I might be wrong. So, when Vedanta is buying Cairn India, how can Sesa Goa make an open offer for it, being a separate legal entity? Simply, because it is promoted by Vedanta Resources? All of a sudden the cash-rich Sesa Goa will deplete its reserves into a strategic investment in an oil company.

3) Legal Hurdles for Cairns in selling stake to Vedanta

In the fields of Rajasthan where Cairn India is the main operator (to the extent of 70%), ONGC is a partner with Cairn India in the joint venture that runs the latters main oil asset RJ-ON-90/1 in the country.

So, if Cairns want to sell its stake, it might have to offer Right of First refusal to ONGC. Already ONGC is against Vedanta into oil filed. ONGC might consider that they should acquire the stock if Cairn Energy wants to leave.

Cairn can not arbitrarily bring into picture some unrelated outsider which has little experience and necessary consents to deal in the oil field. Also ONGC is not interested for Vedanta as they dont have experience in oil field. ONGC expects those coming into picture AS OPERATOR should bring in their experience.

4) Vedantas Future problems after buying Cairn

If you remember Tata Steel acquisition of Corus 3 years back, what do you see? At that point of time, Corus was bigger than Tata Steel. That means Tata Steel was trying to swallow a bigger fish than its throat could accommodate. What happened next? They could not spit, nor swallow for 3 years. Now after 3 years they have just about managed to push it down their throat.

What is similarity between Tata-Corus and Vedanta-Cairn? Vedanta is intending to buy 60% of Cairn India which is bigger than total market cap of Vedanta. They are simply manipulating excel sheets by bringing in Sesa Goas cash reserves and remaining as debt funds to finance the deal.

ONGC holds a 30 per cent stake in Cairn India's mainstay Rajasthan oilfields, but is liable to pay royalty on all the crude oil produced from the fields, making the nation's largest onland field a losing proposition for the PSU. Its board yesterday recommended to the government that the royalty it pays not only its share, but also on the 70 per cent share of Cairn India, should be deducted from the price realised on the sale of crude oil from Mangala and other oilfields in the Rajasthan block, sources in-the-know of the development said. The ONGC board's resolution will be added to the preconditions that the Oil Ministry has imposed for approving the Cairn-Vedanta deal. Sources said the preconditions, including resolution of ONGC's royalty liability, have been vetted by the law ministry and the same are being sent to the Prime Minister's Office. ONGC's board yesterday noted that the Solicitor General of India has opined that the state-run firm's preemption rights will be triggered upon UK's Cairn Energy selling up to 51 per cent of its stake in Cairn India to Vedanta. The stake sale will lead to a change in ownership in the 10 properties held by Cairn, the nation's second highest law officer opined. ONGC is a partner in seven of these blocks, including all three producing

properties of Cairn. While Cairn had reluctantly agreed to seek the government's consent for a change in ownership in all 10 properties, it has refused to recognise ONGC's preemption rights, a fact that the board noted. In contrast, the ONGC board felt that in line with the SGI opinion, Cairn needs its prior approval for the stake sale, they said. Sources said the ONGC board noted that the Rs 405 a share price Vedanta is paying was about 40 per cent more than its own internal valuation of Cairn India and so it would not like to match the offer or make a counter-bid. The Oil Ministry and its regulatory arm, the DGH, are also in favour of adding the royalty paid by ONGC to the Rajasthan project cost. In the case of fields awarded under the New Exploration Licensing Policy (NELP) -- like the gigantic KGD6 gas fields of Reliance Industries -- royalty can be added to the capital and operating cost of the block, which as per law are deductible from revenues earned on the sale of oil and gas before calculating profits for all stakeholders. The Production Sharing Contract (PSC) for the Rajasthan block is silent on the treatment of royalty and Cairn is opposed to its addition to the project cost as it would lower its profits. The Oil Ministry, which was asked to take a decision on Vedanta buying most of Cairn Energy's 62.38 per cent stake in its Indian unit by the end of the month, had asked ONGC to give its response on the transaction by January 27. The response of ONGC is being submitted to the Oil Ministry, which will incorporate it in a letter it will write to Cairn-Vedanta giving "in-principle" approval for the deal. The letter will list out a set of 11 preconditions that Cairn/Vedanta will have to meet for securing the government nod, they said. Sources said ONGC wants the royalty it pays on the entire expected crude output of 12 million tonnes per annum from Cairn's Barmer oil fields to be added to the project cost and profits for stakeholders be calculated thereafter. As per the Production Sharing Contract (PSC), the operator gets to first recover all project costs from the sale of oil or gas produced from a field before profits for itself and the government are calculated. Treatment of statutory levies like royalty paid by ONGC are explicitly mentioned in the PSC for the Rajasthan block and Cairn is opposed to their inclusion in project cost, as it will not only lower its own profit, but also the profit that the government earns, they said. The preconditions being set for the Cairn-Vedanta deal include the withdrawal of pending lawsuits and accepting the ministry's diktat on future petroleum operations in the Rajasthan block. The preconditions also include Vedanta guaranteeing that Cairn's technical capability will be undisturbed by the share transfer agreement and the London-listed firm providing a fresh financial and performance guarantee. Vedanta would not have factored in reduced profits because of the inclusion of royalty in the project cost

and may be forced to call off the deal if ONGC takes the matter to arbitration. Sources said the royalty liability on ONGC, wherein it has to pay 20 per cent of the price realised on the entire output of crude oil from fields like Rajasthan even though its share of production is only 30 per cent, is a historic legacy and the government had at several times considered reimbursing the part which the PSU pays on behalf of foreign operators like Cairn. The government had in the 1990s put the liability of statutory levies on national oil companies to attract global players to the then-nascent oil and gas sector in India. The royalty liability had made projects like Rajasthan economically unviable for ONGC. Royalty could be reimbursed from the government's profit share from the Rajasthan field, the Oil Ministry had opined earlier. Sources said the ONGC board yesterday decided not to press for reimbursement if royalty is included in the project cost. According to the Production Sharing Contracts and the government of India policy for pre-New Exploration Licensing Policy (NELP) blocks in the 1990s, 100 per cent of statutory levies (including royalty) were to be borne by the NOCs in order to provide a competitive fiscal and contractual regime. During this period, the relationship between the government and NOCs was seen in a different perspective, because the NOCs were 100 per cent owned by the government. As such, the NOCs' rights and obligations in the pre-NELP blocks were to be borne by the government. To attract investment in exploration and production in India during the pre-NELP regime, the government consciously placed the responsibility of royalty entirely on the licensee. In return, NOCs could take a 30 per cent stake upon a discovery in these blocks without incurring any risk capital or past cost. In the Rajasthan block, Cairn invested USD 600 million of its own risk capital on exploration and once the oilfields were discovered, ONGC, as the government nominee, acquired a 30 per cent stake in these fields without paying anything. In 1997, it was agreed by a Group of Ministers (subsequently discussed by Committee of Secretaries in February, 1998, and reviewed various in recent years) that NOCs could be reimbursed for actual liabilities out of profit petroleum accruing to the government, sources said.