Sharing of Profit Petroleum and the Constitutional Bench decision on the nature of royalty

Just as with other minerals, oil & natural gas are owned by the Center when in the ocean, and largely owned by states within their boundaries. This sector has a global standard of using Production Sharing Contracts (PSCs), where after a certain level of cost recovery, a proportion of the profit petroleum is handed over to the government by the extractors. For onshore blocks, the extractor signs a lease with the state, which includes provisions to pay royalty, and the PSC with the center. The 12th Finance Commission examined the question of to whom this Profit Petroleum (the government share) would go to, and decided that it should be split 50:50. The state of Gujarat took the stance that since the oil & gas is the property of the state, it should receive the entire profit petroleum, even though they also receive royalty.

The Constitutional Bench of the Supreme Court recently decided on the question of whether royalty was a tax. By an 8:1 majority, they ruled that royalty was a contractual obligation, payable to the state under the mining lease. After examining various provisions of the State and Union Lists of the Seventh Schedule of the Constitution, they also decided that only states have the power to impose taxes on land, minerals or mineral rights. They also emphasized the public trust doctrine as well as the need for many mineral bearing states to find sources of funds.

The only alternative that the center receives a part of the profit petroleum as a result of signing the PSC seems absurd as they only have rights to regulate and develop and nothing more. Therefore, it would seem that the judgment of the Constitutional Bench has clarified that the stance of the state of Gujarat is the correct position, and this needs to be revisited.

This letter is a follow up to an earlier letter that can be read here.

Minerals and the Public Sector Net Worth: 16th Finance Commission

 Since 2016, I've been engaged with how government accounting for minerals makes their management significantly more difficult. In 2016, Goa Foundation sent the note Mitigating the Resource Curse by Improved Government Accounting to the IMF, UN, WB, INTOSAI, IPSASB and an equivalent set of Indian government officials. Read it, many have said they enjoyed it. Notably, the IPSASB responded, and in their consultation on their Work Plan for 2019-2024, a new standard for Natural Resource was put on the top of their agenda.

After a bunch of responses, Goa Foundation sent Government Accounting and the Resource Curse - Response to FAQs in 2017. While less fluent, it introduces multiple new ideas including the Goa Foundation Benchmark.

In 2018, Goa Foundation wrote to the IMF MD explaining how this government accounting error was resulting in the opening up of protected areas for oil & gas exploration. IMF's Government Finance Statistics Department called for a meeting in August 2018, where I represented Goa Foundation. IMF had nine staff members across 4 departments for a 2 hour meeting, a considerable time commitment. At around the same time, the IMF was working on its October 2018 Fiscal Monitor on Managing Public Wealth, so the ideas were well timed.

Since then, there has been a lot of action. Notably, IPSASB has moved forward on Natural Resources, while the UN and IMF are working together on updating the SNA (System of National Accounts) and  the GFSM (Government Finance Statistics Manual).

The core issue revolves around the long-standing practice of treating royalties and the like as "revenue" as opposed to treating as sale proceeds of a non-debt capital nature arising from an asset-stripping process. This is important if the goal is to have increasing public sector net worth. However, the usual goal of public finances is debt sustainability, without reference to net worth. 

In the attached letter to the 16th Finance Commission, Dr. EAS Sarma and I have argued for a change in the way India manages its public finances.