Ambani vs. Ambani

Posted October 28, 2009

Once again, the Ambani brothers in India are at loggerheads. They are caught in a complicated business dispute that raises questions about the way contracts are honored in India, the role the state plays in such disputes, and the way India prices its assets. None of this augurs well for India’s investment climate.

The current conflict stems from a dispute over the price to be paid for gas, based on an agreement between companies that the united Reliance group controlled, but which have now been divided between the brothers, Mukesh and Anil Ambani. The agreement gained significance at the time of the division of assets between them.

But with Ambanis, nothing is ordinary, and certainly not this dispute. What should be a matter of commercial arbitration between the brothers has turned into a Bollywood-style melodrama, with Anil Ambani going on a pilgrimage to seek the blessings of Hindu Gods, so that the two brothers can sort out their differences. For added emotional appeal, he has said their mother, now 75, could mediate, as she did the time the brothers parted company and divided assets. Mukesh Ambani has noted Anil’s appeal, but they are uncertain about Anil’s intent.

Family disputes are legion, but then the Ambanis don’t represent an average family: The groups controlled by the brothers represent two of the biggest business groups in India. Their activities range from textiles, petrochemicals, refining, power, telecommunications, and finance, and they affect India’s vital infrastructure. Both brothers are on the Forbes magazine’s list of billionaires; the market capitalization of the two groups represents a sizeable chunk of India’s stock market.

The agreement was meant to ensure a stable price—at $2.34 per a million British Thermal Units, over 17 years—at which Mukesh’s Reliance Industries Ltd (RIL) would sell gas from the Krishna Godavari basin off India’s southern coast, to the power project Anil’s Reliance Natural Resources Ltd (RNRL) was going to set up. The price was derived from a bid floated by the state-owned National Thermal Power Corp (NTPC), and became the benchmark price for this transaction, at a time when oil prices were low.

(Gas prices are determined using British Thermal Units, an industry practice where the BTU represents the amount of heat required to increase the temperature of one pound of liquid water by one degree, 60 to 61 Fahrenheit, at a constant pressure of one atmosphere. It is abbreviated as mmbtu, or a million British Thermal Units.)
The price was set in 2000; in 2002, the patriarch, Dhirubhai Ambani, died; by 2006, the brothers had formalized their split, dividing assets. Now the dispute has surfaced, because RIL wants a higher price—$4.20 per unit—for the gas. This price comes from another round of bidding the Indian government had arranged for other projects.

Anil has cried foul. His company, RNRL, has launched a vigorous media campaign, and in a highly unusual move, he devoted the bulk of his speech to shareholders at the company’s annual general meeting, to blast his older brother’s RIL and India’s petroleum ministry, which he accused of siding with RIL. Mukesh’s company, RIL, responded by calling Anil’s campaign “malicious, mischievous, baseless, and ill-informed.”

The government then reminded the companies that neither owned the gas field; the state did—RIL was only a contractor. RIL agreed immediately; for his part, RNRL reassured India’s Prime Minister, Dr Manmohan Singh, that he placed national interests paramount, and that he was not claiming any ownership over a national asset.

RIL has argued that the price RNRL is insisting on paying—at $2.34 per unit—was always subject to government approval. RNRL challenges that interpretation, saying the government has not stake in the matter. RNRL contends that if the old price is honored, RIL stands to lose windfall gains, hence its insistence of the new price; RIL says it cannot go against government’s wishes. RNRL says even if it were to pay the new price, the government won’t gain much—all gains will accrue to RIL.

The way the production sharing contract s structured, as a developer, RIL does get a bigger share of the price, until capital costs are recovered. The government’s share increases over time, but initially, as a developer bearing the risk, RIL gets a bigger share, the shares changing when different multiples of capital costs are recovered. Over the lifetime of the contract, the government stands to get $16.5 billion, RIL would get $10.7 billion—but in the early years, RIL’s share is much higher. Such terms in PSCs are not unusual internationally, where an oil company, being the risk-bearer who invests in a project whose viability is uncertain at the time of the signing of the contract, builds in terms that help it recoup its investment faster.

The petroleum ministry has objected to the old price, arguing that the transaction between RIL and RNRL is not an arms-length transaction. The matter reached the Bombay High Court, which found nothing wrong in the contract between RIL and RNRL, thereby upholding the old, lower price. Now RIL has challenged that verdict, taking the case to the Supreme Court, which will hear arguments in mid-October.

The Indian state’s interest in arms-length transactions is relatively novel. Reliance’s rise is certainly due to Dhirubhai Ambani’s entrepreneurial acumen; it was also because the group knew how to manipulate India’s formerly restrictive regime to ensure that it could grow at the cost of its rivals. At a strategic level, the group’s goal was to squeeze costs from any supply chain.

RIL’s Mukesh, attended Stanford (but returned to India before finishing, to help develop the group’s projects near Mumbai, at Patalganga), and RNRL’s Anil, who got his MBA from Wharton, were graduate students in the United States at a time when Michael Porter’s ideas on competitive strategy were in vogue. Porter had said firms could enhance their competitiveness by being low-cost producers, by integrating processes to squeeze costs and absorbing the slack. Reliance did it by opting for backward integration, acquiring raw material sources, making them part of its value-chain. By securing raw materials, Reliance was competing with state-owned companies, which were neither dynamic nor too concerned about profits. They were too bureaucratic to challenge Reliance, and too unimaginative to compete vigorously, leaving the field free for Reliance to dominate. Some critics have challenged Reliance’s business practices, alleging that its rise was due to its proximity with those in power, and they have questioned its “financial engineering”, and how it used creative invoicing to squeeze costs, Be that as it may, Reliance was not a Ponzi finance scheme; rather, the company built technological and industrial infrastructure on a global scale. Whether its past practices should be condoned, because industry operated in India at that time under unjust conditions, or condemned, because it used all means to dominate the industry, or even celebrated, because the company showed the way how India could globalize, is a matter of perennial debate in India.

That system—of squeezing costs—was built on the assumption that various arms of the Reliance group worked together as part of the whole. But that system had to come apart when the group split. A united Reliance’s profitability depended on synergy. But now RIL and RNRL are not part of the same group: hence the dispute.

In itself, the dispute should not matter—businesses disagree; families separate; brothers fight. So what else is new?

There are three wider issues. First is the sanctity of a contract. The original price of $2.34 was arrived at between two willing entities based on the prevailing price from the NTPC bid. It is nobody’s case that that price was arbitrary. By stepping in this dispute, the state is sending a confusing signal to the market—indeed, to a company it owns—NTPC. Given India’s record, this may be a small intervention, but it is a transgression nonetheless.

Second is the question of how India prices its assets. Whatever the merits of the arguments in the case, it is clear that the state is valuing its assets in an arbitrary manner. If it the price RNRL has got is a bargain by today’s standards, RIL can renegotiate, but what has the state got to do with it? The state has a reason to ask for a higher price – it sends a signal to international markets that India is hot. But it also means the state will have to pay bigger subsidies to consumers – even intermediate ones like state-owned power plants and fertilizer companies, which will be the consumers of the gas. What it gains on the turn, it loses on the roundabout.

Third is the wider implication to India’s reputation as an investment destination. Some oil majors have been avoiding Indian oil exploration bidding rounds because of concerns over stability and certainty of terms offered. (There were no foreign bids in 2006, and only low interest in 2007. Several of the 50-odd blocks had only a single bidder—this, at a time of exceptionally high prices). A clearer pricing policy would attract more bidders, and Indian exchequer would earn more.

The meaning is clear: If you take out metaphors of the Sanskrit epic Mahabharata, in which cousins fought one another, or discard the images of a Bollywood drama, where two brothers fight over a fortune, then this is a relatively straightforward commercial dispute which needs to be resolved quickly, without political interference. The Supreme Court is the best place for that. And until it is resolved, there will be uncertainty—which does not exactly make it easier for those considering investing in India.

Salil Tripathi is a free-lance writer based in London and a former correspondent of the REVIEW.