State of Gujarat vs Union of India, Ministry of Petroleum and Natural Gas and Another

J.B. Pardiwala, J.—By this Writ application under Article 226 of the Constitution of India, the State of Gujarat seeks to challenge the alleged arbitrary and unreasonable action of the Union of India and the Oil & Natural Gas Commission Ltd. (for short, ''the ONGC'') in respect of payment of royalty on the basis of post-discount prices of crude extracted from the onshore blocks situated in the State of Gujarat which, according to the petitioner, is in contravention of the provisions of the Oilfields (Regulation & Development) Act, 1948 (for short, ''the Oilfields Act''). The State of Gujarat also seeks to challenge the action of the Government of India, Ministry of Petroleum & Natural Gas of addressing a letter dated 23rd May 2008 to the Director PPAC (Petroleum Planning & Analysis Cell), New Delhi, thereby withdrawing the instructions issued by the Ministry in its letters dated 30th October 2003 and 28th March 2008 respectively to the effect that the revenue of the State Governments in terms of royalty of crude oil would not be affected by the discount on the ONGC crude oil and that the onshore royalty payable to the State Governments would continue to be paid on pre-discount prices.

The petitioner has also prayed for a consequential relief for the payment of royalty based on pre-discount, fair market driven wellhead price on crude oil produced from the onshore blocks situated in the State of Gujarat.

Case of the Petitioner:

In the State of Gujarat there are 181 Mining Leases in operation, of which 154 are under the nomination of the ONGC. These blocks are allotted to the ONGC by the Central Government. The crude production of Gujarat for the year 2010-11 was 54,71,818 MT net crude. Out of which 53,48,091 MT was produced by the ONGC thereby suggesting that 97.7% of the total crude production of Gujarat is by the ONGC.

In exercise of its powers under Entry 53 of List-1 of Schedule VII to the Constitution of India, the Parliament has enacted the Oilfields Act. This Act provides, inter alia, for regulation of oilfields and development of mineral oil resources. Section 6A of the Act, introduced in the year 1969, pertains to royalties in respect of mineral oils. Sub-section (2) of Section 6 provides that the holder of the mining lease (i.e. the ONGC) shall pay royalty in respect of mineral oil mined, quarried, evacuated or collected by it from the leased area at the rate for the time being specified in the Schedule in respect of that mineral oil.

In terms of Section 6A(4), the Central Government is empowered to amend the Schedule to the Act by way of a notification in the official gazette for enhancing or reducing the rate at which royalty is payable. It further provides that the rate of royalty fixed by the Central Government should not exceed 20% of the sale price of the mineral oil at the oilfields or the oil wellhead, as the case may be.

The Central Government has also framed rules, called the ''Petroleum and Natural Gas Rules, 1959'' (hereinafter referred to as ''the Rules'') under Sections 5 and 6 of the Oilfields Act. Rule 14 of these Rules pertain to the payment of royalty.

Earlier, the royalty payable in respect of crude oil, in terms of the Schedule to the Act, was fixed by the Central Government at Rs. 481 per metric ton. However, in the year 1997 a decision was taken by the Central Government to dismantle the ''Administered Price Mechanism'' (APM). In view of the dismantling of the Administered Price Mechanism, the Central Government decided to alter the rate of royalty. A committee was appointed by the Central Government vide Office Memo No. O-22013/2/98-ONGC. III dated 26th April 2000 inter alia for recommending the criteria for determining royalty on crude oil including the royalty rate. The said Committee was known as the Mauskar Committee. The said committee prepared and submitted its report dated 25th November 2001. In paragraph 6.12.1 of the said report, the committee has observed as under:

6.12.1. According to the National Institute of Public Finance and Policy (NIPFP), Royalty is a return to the owner of land. It is only natural that this return should depend upon the price of oil in case of crude oil. Royalty fixation requires the rationalization of pricing of oil and moving to market determined prices. Crude oil being a largely imported energy resource of the country, the international price of this resource should be taken as the basis for the estimation of royalty as this would reflect the offer price of oil by the consumer in an open market.

In paragraph 7.4.1 (Conclusions & Recommendations) it has been stated that the committee feels that the market driven price obtained/obtainable by the producers should be considered for determining royalty under deregulated price regime. The committee also made recommendations for determination of well head price and the rate of royalty.

In Paragraph 7.4.7(i) the committee has inter alia recommended as below:

After 1.4.2002 under the deregulated regime the wellhead price as derived from the market driven price obtained/obtainable by the producers based on arm''s length transactions in terms of the relevant recommendations be considered for royalty calculations.

Based on such recommendations of the Mauskar Committee aforenoted, the Central Government issued a resolution dated 17th March 2003 which inter alia provides for payment of royalty for the period after 1st April 2002. The resolution provides for payment of royalty at a rate of 20% of the wellhead price. The wellhead price for on land production is to be derived after deducting 7.5% from the crude oil price. Para 2(vii)(a) of the resolution dealing with the royalty for the period after 1st April 2002, states as follows:

The wellhead price of crude oil as derived from the market driven price obtained/obtainable by the producers based on ''arm''s length transactions'' will be considered for royalty calculations.

Para 2(iii) of the afore noted notification states that "royalty will be calculated in accordance with the existing methodology, i.e. on ''cum royalty'' basis", and a ''Note-1'' at the end of the notification sets out the following formula, as far as the existing methodology for calculation of royalty is concerned:

The said resolution dated 17th March 2003 also provides for a revised royalty dispensation for the period between 1st April 1998 and 31st March 2002 with a retrospective effect. The said resolution was published in the Gazette of India: Extraordinary and was acted upon and implemented by the Central Government and ONGC respectively, with immediate effect. Based on the said resolution, the ONGC started making payment of royalty according to the provisions of the said resolution from the month of March 2003 itself. Based on the said resolution the ONGC made a revised royalty dispensation of an amount of Rs. 175,91,05,511/- for the period 1st April 1998 to 31st March 2002 to the State of Gujarat on 26th March 2004 and for the period between 1st April 2002 and 28th February 2003 paid a sum of Rs. 292,00,00,000/- as revised differential amount of royalty to the State of Gujarat on 25th March 2003. Therefore, though the resolution dated 17th March 2003 was termed as a resolution and not a notification, the same was duly published and notified and was duly acted upon by the parties.

On 30th October 2003, the Government of India, addressed a communication to the heads of the National Oil Companies and to the Director, Petroleum Planning and Analysis Cell (PPAC), pertaining to the ''mechanism for sharing the under-recoveries of Oil Marketing Companies on account of the non-revision in the selling prices of PDS Kerosene and Domestic LPG during 2003-2004''. The said communication provided, inter alia, for discounts to be given by the ONGC and Gas Authority of India Limited (GAIL) to the Oil Marketing Companies. However, in para-2(vi) of the letter itself, the Central Government unequivocally clarified that:

The revenue of the State Government in terms of royalty on crude oil will not be affected by the discount on ONGC''s crude oil.

One another communication dated 28th March 2008 was issued by the Central Government, which, inter alia, reiterates that the discounts offered by the ONGC would have no effect in respect of the onshore royalty payable to the State Governments.

On 16th December 2004, a Notification was issued by the Central Government apparently in terms of paragraph 3 of the aforementioned resolution dated 17th March 2003, amending the Schedule to the Act and prescribing the rates of royalty, in terms of the decisions contained in the resolution of 17th March 2003. Para-1(1)(B)(ii) of the Schedule, as amended by this notification, fixes the royalty in respect of crude oil production from areas awarded on nomination basis to National Oil Companies, with effect from 1st April 2002, as 20% of the wellhead price. This Notification also inserted two ''Notes'' (''Note 1'' and ''Note 2''), in the Schedule, which read as follows:

Note 1: Well Head Price of Crude Oil and Casing Head Concentrate for areas covered under 1(1)(B) and 2(1)(B) above will be determined by deducting 7.5% and 10% of the Crude Oil and Casing Head Condensate price considered for on land and offshore production respectively.

Royalty will be calculated on Cum-royalty basis as under:

Note 2: Since consultations with the concerned State Governments took some time, it has become necessary to revise the rate of royalty with retrospective effect. The oil producing states stand to benefit and other states are not likely to be adversely affected.

One another Committee was constituted in the year 2003 by the Central Government for determining the wellhead price of minerals oils (crude oil, wellhead condense and natural gas). The said committee was reconstituted several times. Finally, the committee gave its report in July, 2006. Based on the recommendations of the said committee, another Notification dated 20th August 2007 u/s 6A(4) of the Act, was issued by the Central Government, making certain modifications to the Schedule.

The aforesaid notification, inter alia, replaced ''Note 1'' in the Schedule, with the following:

Note 1: (1) The well head price of crude oil and casing head condensate for nominated blocks of Oil and Natural Gas Corporation Limited or Oil India Limited shall be determined by deducting rupees one thousand two hundred and fifty one only per metric ton and rupees nine hundred forty seven only per metric ton for onshore and offshore respectively from the sale price of crude oil or casing head condensate.

(2) The amounts specified in clause (1) shall be the post well head cost which shall be valid for a period of three years with effect from 1st April, 2007, or such period till the revised rates are notified.

(3) Oil Industry Development Cess and Education Cess thereon shall not form part of post well head cost.

(4) Royalty will be calculated on cum-royalty basis as under:

In the Notification dated 20th August 2007, Note-1 was replaced and instead of a deduction as a percentage, a fixed amount of Rs. 1,251/- per MT for onshore crude oil was prescribed. It deserves to be noted that the royalty is required to be paid on the crude which is exploited. The crude which is exploited would contain various impurities, such as, vapour, gas, water etc. After the crude is exploited, certain preliminary refining/processing is required to be done. After the preliminary refining/processing is done, the crude is also required to be transported for delivery till the delivery point.

Section 6A of the Oilfields Act provides for the payment of royalty upon the sale price of the mineral oil at the Oilfields or the Oil wellhead. The royalty therefore is payable on the crude that is exploited in its original form. The marketing of the crude is done after the preliminary refining/processing. The market price of crude would include preliminary refining/processing and certain transportation cost also. Royalty is not required to be paid on such refining/processing and transportation costs. Therefore, a deduction as a percentage or a fixed amount is made to arrive at the actual value of the crude at the Oilfields or the Oil wellhead. The fixed amount of deduction is a more rational and a fair method of deduction as the actual costs can be deducted. Therefore, by the notification dated 20th August 2007, the only change that was made to the earlier notification of 16th December 2004 was that for determining the well head price of crude, instead of a percentage based deduction of 7.5%, a deduction of fixed amount of Rs. 1,251/- per Metric Ton was prescribed. No other change was made by the said notification of 20th August 2007. Therefore, the situation in all other aspect as it existed upon the issuance of the Notification dated from 16th December 2004 continued.

The Union of India, in the year 2003 adopted a mechanism for sharing the under-recovery of the oil marketing companies on account of non-revision in the selling price of PDS Kerosene and Domestic LPG, whereby the Government inter alia directed the upstream marketing company i.e. the ONGC to give a discount on the sale of crude to the downstream companies viz. Indian Oil Corporation Ltd. (IOCL), Bharat Petroleum Corporation Limited (BPCL) and Hindustan Petroleum Corporation Limited (HPCL). However, clause (viii) makes it explicit that the revenue of the State Government in terms of royalty on crude oil would not be affected by the discount on ONGC''s crude oil. It is to be noted that all the crude exploited by ONGC from the oilfield situated in Gujarat is sold to Indian Oil Corporation limited.

A similar statement has been made by the Union of India in its letter dated 28th March 2008 whereby it has been clarified that the aforesaid arrangement for under recovery shall not have any effect in respect of onshore royalty payable to the State Government(s), which shall continue to pay at the pre-discount prices, in line with the existing instructions of the Ministry. The aforesaid letter is not on record as is not available with the petitioner, however, the relevant passage of the said letter has been reproduced in the letter dated 23rd May 2008 of the Union of India which is at Annexure-A of the application.

According to the petitioner, any discount offered by the ONGC to its buyer i.e. Indian Oil Corporation cannot be at the cost of the lessor-State Government, and should not be taken into account for the purpose of determination of the wellhead price, and the calculation of royalty. The ONGC and the Indian Oil Corporation are both Central Government PSUs controlled by the Union of India. Both are bound by the directives of the Union of India. To compensate for under recoveries by the downstream public sector marketing companies (i.e. IOC, BPCL & HPCL), the Union of India, through its Petroleum Planning and Analysis Cell issues directions for each quarter in respect of the discount to be given in respect of the sale of crude by the upstream oil companies i.e. the ONGC and the Oil India Ltd.

It is the case of the petitioner that the subsidy on the petroleum products given by the Central Government and the discounts directed to be given in respect of sale of crude by the ONGC to the downstream oil companies of the Central Government is an internal matter between the Union of India and the upstream and downstream oil companies which are Central Government PSUs. The State Government has nothing to do with the same. The discounts directed to be given by the Central Government between its PSUs (i.e. ONGC & IOC) cannot affect the amount of royalty that is rightfully recoverable by the State of Gujarat under the provisions of the Oilfields Act.

It is also the case of the petitioner that the ONGC went against the legal provisions and the established practice of paying royalty at the pre-discounted prices and addressed a letter dated 28th February 2008 to the Government of Gujarat taking a stance that the royalty would have to be calculated on the basis of the post-discount price of crude oil, since the royalty amount would otherwise exceed the statutory selling of 20% of the ONGC sale price.

The Central Government vide its communication dated 23rd May 2008 withdrew its earlier instructions issued vide letters dated 30th October 2003 and 28th March 2008 respectively to the effect that the discounts given by the ONGC would not affect the royalty payable to the State Governments.

The State Government i.e. the petitioner herein vide letter dated 31st May 2008 through its Chief Secretary represented to the Central Government requesting it to direct the ONGC to withdraw its direction regarding payment of royalty on crude oil on the basis of the discounted price and to continue to pay the royalty according to the "Ongoing Methodology" for the calculation of royalty.

In response to the letter dated 31st May 2008 of the Chief Secretary of the Government of Gujarat, the Central Government vide its letter dated 12th July 2008 took the stance that the ONGC''s action in the matter had flowed from a decision of the ONGC''s Board. The exact words in the letter dated 12th July 2008 are as under:

It transpires that ONGC''s action in this regard as flowed from a decision of ONGC''s Board. As ONGC''s action of making adjustments from Royalty already paid is not in consonance with the MoP & NG''s guidelines, we are advising ONGC to review its decision.

However, I may point out that as per the law, payment of royalty on onshore crude cannot exceed 20% of the wellhead price, where price is construed as the ''market driven price obtain/obtainable by the producers''. As for your view that discount offered by ONGC to Oil Marketing companies (OMCs) is not relevant for the calculation of royalty payable, I may add that priced discount given by ONGC, as per Burden sharing Mechanism approved by the Government of India, is a direct bearing on the "Price obtained" by ONGC for crude oil produced by it, and therefore, a bearing on the royalty payable to the State Governments.

According to the petitioner, from May 2008 till the date of the filing of the petition, the ONGC has made payment of royalty on crude oil produced from nomination fields in Gujarat on the post-discount prices.

The petitioner has preferred several representations to the Government of India on the subject of payment of royalty on crude oil at the market price. The petitioner has also addressed letters to the ONGC requesting it to make payments of royalty on crude oil at the market price. According to the petitioner, despite the same, the Central Government and the ONGC have continued to pay royalty on the pre-discount prices.

According to the petitioner, the ONGC is liable to make payment of Rs. 3821,18,78,481/- as royalty for the period between April, 2008 and June 2011. According to the petitioner the ONGC is also liable to pay a penalty of Rs. 913,72,95,455/- according to the provisions of the Rule 23(1) of the Petroleum and Natural Gas Rules, 1959.

In the circumstances referred to above, according to the petitioner, they have been left with no other option, but to approach this Court by this writ-application and accordingly have prayed for the appropriate reliefs.

Stance of the Respondent No. 1 - Union of India.

According to the Union of India, with a view to protect the Consumers from the inflationary impact of International Oil prices, it has been modulating the retail selling price of sensitive petroleum products, viz. Diesel, BDS Kerosene and domestic LPG. Prior to 26th June 2010, the price of petrol was also modulated by the Central Government. As a result of the same, the three Public Sector Oil marketing companies, namely, Indian Oil Corporation Ltd., (IOCL), Bharat Petroleum Corporation Ltd., (BPCL) and Hindustan Petroleum Corporation Ltd., (HPCL) incurred under recoveries on the sale of such petroleum products.

According to the Central Government it had to evolve a "Burden Sharing Mechanism" in 2003-2004. As a result of the Burden Sharing Mechanism, the upstream oil marketing companies had to suffer a huge loss. The upstream oil companies, namely, the ONGC and the Oil India Ltd., were directed by the Central Government to give discount on the sale of crude by them to the downstream oil companies such as IOCL, BPCL and HPCL.

According to the Union of India, despite such discount being given by the ONGC to IOC, the ONGC was paying royalty on pre-discounted prices during the years 2003-2004 to 2007-2008 which not only distorted the royalty calculation mechanism but also resulted in a breach of statutory provisions whereby the royalty was not to exceed 20% of the sale price of the mineral oil.

According to the Union of India, in such circumstances it had to address a letter dated 23rd May 2008 along with the opinion of the Ministry of Law & Justice, withdrawing its earlier orders which had stated that the discounts offered by the upstream oil companies to the downstream oil companies would not affect the royalty payment to the State Governments and thereby, bringing royalty competition for crude oil to the State Governments on the same principle applicable to the Central Government.

According to the Union of India such action is in consonance with the principle of taxation and that the royalty is a function of actual price realized and not notional pre-discount price.

It is also the case of the Union of India that the resolution dated 17th March 2003 issued by it was a resolution and not a Notification. In the said resolution it has been stated that the requisite notifications, orders etc. to implement the decision taken by it would be issued separately. Accordingly to implement the new scheme a Notification dated 16th December 2004 was issued superseding the earlier resolution dated 17th March 2003.

According to Union of India, consequent upon the decision taken in the year 1997 of phased dismantling of Administered Price Mechanism (APM) from the petroleum sector, a Committee under the Chairmanship of Shri J.M. Mausker was appointed. Based on the recommendations of the Committee the Central Government circulated a new scheme of royalty vide resolution dated 17th March 2003.

According to the Union of India, it emphasized that recommendations were made by the Mausker Committee keeping in mind the proposed deregulation of the petroleum sector. However, since complete deregulation has not taken place so far, the Burden Sharing Mechanism is being followed by the Central Government leading to discount on realization from the sale of crude oil.

According to the Union of India, the Resolution dated 17th March 2003 provided for royalty payment at 20% of the wellhead price till the year 2006-07. It further provided that the conversion process might commence w.e.f. 2007-08 with tapering rate of royalty of 1.5% each year so as to facilitate conversions with NELP rates of 12.5% within a period of 5 years i.e. by 2011-12. However, according to the Union of India the process of tapering has not yet started.

In the circumstances referred to above, according to the Union of India there is no merit in this petition and the same deserves to be rejected.

Stance of the Respondent No. 2 - ONGC:-

According to the ONGC, under the provisions of Section 6A of the Oilfields (Regulation & Development) Act, 1948 enacted under Entry 53 of List 1 of Schedule VII to the Constitution of India it is the sole prerogative of the Central Government to fix the royalty. It is the stance of the ONGC that u/s 6A(4) Proviso, the petitioner is not entitled to a royalty in excess of 20% of the sale price of the mineral oil. Nevertheless, the ONGC on a specific directive from the Central Government has paid much higher royalty during the period between 2003-04 and 2007-08 almost to the extent of 49.18% in the year 2007-08 as a result of which Rs. 3419 crore excess royalty has been paid.

According to the ONGC considering the provisions of the Act and the Notification, the royalty is payable only on the actual price realized and not on any "notional" pre-discount amount.

According to the ONGC the discount given by them is real and is a result of compliance of directions from the Government. The effect of the discount is that the notional pre-discount amount gets reduced. It is the case of the ONGC that the royalty calculation should not be on any other amount but should be on the actual and the real wellhead price, which is the price after the discount.

It is also the case of the ONGC that it should not be asked to pay the statutory levy on a pre-discount amount which would result in it being subjected to tax on income that had never accrued to it. The ONGC has accordingly tried to justify the payment of 20% royalty on the actual sale price w.e.f. August, 2008.

It is also the case of the ONGC that the phrase "sale price" occurring in Note-1 of the Notification dated 20th August 2007 and which also occurs in Section 6A(4) proviso of the Act could only mean the actual sale price received by the ONGC for sale of the crude oil to the downstream OMC''s. According to the ONGC any attempt to re-write or read down the said phrase to mean a "notional" pre-discount market driven price would be contrary to the expressed language of the statute and to the plain meaning, besides compelling the ONGC to pay royalty in respect of an amount never received by it.

In such circumstances referred to above, according to the ONGC there is no merit in this petition and the same deserves to be rejected.

Submissions on behalf of the petitioner:

Mr. Aspi Kapadia, the learned Counsel appearing for the petitioner submitted that the stance of the Union of India as well as the ONGC is quite unreasonable and misconceived. Mr. Kapadia submitted that the 20% ceiling should be interpreted with reference to the fair value of the crude at the wellhead i.e. the fair market value and not the discount price of crude at which the ONGC sells to IOC upon the directions of the Union of India.

Mr. Kapadia submitted that the table of discounts produced on record would indicate that the discounts directed by the Central Government go as high as upto 95% to 96% which reduces the royalty amount of the State Government to practically Nil. Mr. Kapadia also submitted that the deregulation has already taken place to a large extent. According to him petrol is totally deregularized. Diesel is now almost deregularized and the prices of diesel are hiked upto the market value in a phased manner every month. The giving of subsidy to certain petroleum products could be a policy decision of the Union of India but the same cannot have any relation or bearing on the payment of royalty under the provisions of the Oilfields Act to the State Government.

Mr. Kapadia also submitted that whether to undertake the process of conversions or at what point of time such process should be undertaken would be the decision of the Central Government. If the process of conversions is not carried-out by the Central Government then in such circumstances the Central Government cannot put a cut in the payment of royalty by adopting any arbitrary method.

According to Mr. Kapadia the arbitrariness is writ large in the form of withdrawing certain executive instructions contained in the earlier letters of the Central Government. Mr. Kapadia contended that the reduction in the payment of royalty is permissible only by a legal and valid amendment in the provisions of the Oilfields Act.

Mr. Kapadia submitted that the petition merits consideration and deserves to be allowed.

Mr. Gaurab Banerjee, the learned Solicitor General of India appearing with Mr. Ajay Mehta, the learned advocate for the ONGC, submitted that the petition filed by the State of Gujarat is totally misconceived and untenable in law. Mr. Banerjee submitted that the issue of payment of royalty under the provisions of the Oilfields Act falls under the powers exercised under Entry 53 of List-1 of Schedule-VII to the Constitution of India and, therefore, it is the prerogative of the Central Government to take care of the issue of payment of royalty and the State Government cannot have any say in the matter.

Mr. Banerjee submitted that according to the provisions of Section 6A of the Oilfields Act, the petitioner is not entitled to royalty in excess of 20% of the sale price of the mineral oil at the wellhead whereas on a specific directives of the Central Government, his client has paid much high royalty between the period 2003-2004 and 2008-2009 (as high as 49.18% in the year 2007-08).

Mr. Banerjee submitted that there being no merit in this petition, the same deserves to be rejected.

Submissions on behalf of Respondent No. 1 Union of India:

Mr. P.S. Champaneri, the learned Assistant Solicitor General of India adopted all the submissions canvassed by Mr. Banerjee, the learned Additional Solicitor General of India who appeared for the ONGC. However, Mr. Champaneri laid much emphasis on the fact that the basic objective of the Burden Sharing Mechanism followed by the Government of India is to protect the interest of the end consumer i.e. general public including the people of Gujarat from the impact of rising international oil prices so that the full impact of the International oil prices are not foisted on to the general public.

Mr. Champaneri tried to justify the withdrawal of the provisions of Para 2(iv) of the Order dated 30th October 2003 on the premise that when the ONGC could realize only post-discount price from the Refinery and if the ONGC is asked to make payment of royalty on a pre-discount sell price then it would amount to paying excess royalty on the revenue without realizing the same.

In such circumstances, according to Mr. Champaneri there is no illegality committed by the Union of India and there being no merit in this petition, the same deserves to be rejected.

Having heard the learned Counsel appearing for the parties and having gone through the materials on record, the only question that falls for our consideration is, whether the decision of the ONGC to pay royalty to the Government of Gujarat on a post-discount price on the premise that if royalty is calculated on pre-discount prices, the amount of royalty would exceed 20% which is a ceiling u/s 6A of the Oilfields Act, could be termed as arbitrary, unreasonable or tenable in law.

The Oilfields Act was enacted on 8th September 1948, prior to the commencement of the Constitution of India in 1950. The authority was derived from the Government of India Act, 1935, which held the field at the relevant point of time. The Seventh Schedule to the Government of India Act, List-1, pertains to Federal Legislative List. Entry 36 therein is in the following terms:

Regulation of mines and oil fields and mineral development to the extent to which such regulation and development under Federal control is declared by Federal law to be expedient in the public interest.

It corresponds to Entry 53 in the Union List of the Constitution of India which reads thus:

Regulation and development of oil fields and mineral oils resources; petroleum and petroleum products; other liquids and substances declared by Parliament by law to be dangerously inflammable.

The Preamble to the Oilfields Act indicates that it has been enacted in the public interest to provide for regulation of oilfields and development of mineral oils resources. Section 4 thereof provides that no mining lease shall be valid unless it is in accordance with the rules made under the Act. Section 5 provides that the power to make rules with respect to the mining lease is vested in the Central Government. Section 6 provides that the Central Government may, by notification in the official gazette, make rules for the conservation and development of minerals (this expression was replaced by the expression "mineral oils" in 1957). The definition contained in Section 3(c) makes it clear that the expression "minerals" (which was subsequently replaced by the expression "mineral oils" in 1957) includes natural gas and petroleum.

Before we proceed to answer the question posed by us, it will be profitable to look into the provisions of Section 6A of the Oilfields Act which reads as under:

6A. Royalties in respect of mineral oils.--(1) The holder of a mining lease granted before the commencement of the Oilfields (Regulation and Development) Amendment Act, 1969, shall, notwithstanding anything contained in the instrument of lease or in any law in force at such commencement, pay royalty in respect of any mineral oil mined, quarried, excavated or collected by him from the leased area after such commencement, at the rate for the time being specified in the Schedule in respect of that mineral oil.

(2) The holder of a mining lease granted on or after the commencement of the Oilfield (Regulation and Development) Amendment Act, 1969, shall pay royalty in respect of any mineral oil mined, quarried, excavated or collected by him from the leased area at the rate for the time being specified in the Schedule in respect of that mineral oil.

(3) Notwithstanding anything contained in subsection (1) or sub-sec. (2), no royalty shall be payable in respect of any crude oil, casing-head condensate or natural gas which is unavoidably lost or is returned to the reservoir or is used for drilling or other operations relating to the production of petroleum, or natural gas, or both.

(4) The Central Government may, by notification in the Official Gazette, amend the Schedule so as to enhance or reduce the rate at which royalty shall be payable in respect of any mineral oil with effect from such date as may be specified in the notification:

Provided that the Central Government shall not-

(a) fix the rate of royalty in respect of any mineral oil so as to exceed twenty percent of the sale price of the mineral oil at the oilfields or the oil well-head, as the case may be, or

(b) enhance the rate of royalty in respect of any mineral oil more than once during any

period of three years

(5) Notwithstanding anything contained in subsection (4), the Central Government may, by notification in the Official Gazette, amend the Schedule so as to enhance the rate of royalty payable in respect of mineral oil, produced during the period beginning on the 1st day of April, 1990 and ending on the 31st day of March, 1993, to 24.52 per cent of the sale price of mineral oil at the oilfields or the oil wellhead as the case may be.

Thus, the intent and purpose of the Oilfields Act is to provide real and reasonable compensation to the State for the crude extracted by the holder of the mining lease. The ownership of the crude beneath the land of the State belongs to the State of Gujarat. Sections 69 and 69A of the Bombay Land Revenue Code, 1879 also recognize the same. The said provision provides that the minerals beneath the land of the State is with the State Government and is the property of the State Government. Therefore, subject to the provisions of the Oilfields Act, the State Government has all the powers necessary for proper enjoyment and disposal of such rights in respect of the minerals.

In terms of Section 6A(4), the Central Government is empowered to amend the Schedule to the Act by way of a notification in the official gazette for enhancing or reducing the rate at which the royalty is payable. It further provides that the rate of royalty fixed by the Central Government should not exceed 20% of the sale price of the mineral oil at the oilfields or the oil wellhead, as the case may be.

The Central Government has also framed rules called "The Petroleum and Natural Gas Rules, 1959" under Sections 5 and 6 of the Oilfields Act.

Rule 14 of these Rules pertains to payment of royalty and the relevant portion thereof reads as follows:

Royalty on petroleum and furnishing of returns and particulars:-(1)(a) Notwithstanding anything in any agreement a lessee shall

(i) where the lease has been granted by the Central Government, pay to that Government, and

(ii) where the lease has been granted by the State Government, pay to that Government,

a royalty in respect of any mineral oil mined, quarried, excavated or collected by him from the leased area at the rate specified in schedule of the Act from time to time. The royalty shall be payable on monthly basis, as may be provided for in the lease and shall be paid by the last day of the month succeeding the period in respect of which it is payable.

Provided that the Central Government or, as the case may be, the State Government with the approval of the Central Government, may direct that such royalty be paid in petroleum and natural gas;

Provided further that such royalty shall not be payable in respect of any crude oil, casing head condensate or natural gas [coal bed methane or gas obtained from gas hydrate] which is unavoidably lost or is returned to the reservoir or is used for drilling or other operations relating to the production of petroleum or natural gas or both.

(b) Every lessee shall pay to the State Government, where the lease has been granted by that Government, royalty for the period of lease before the 1st November, 1962, at the rate specified in the lease deed.

Since we are on the issue of royalty, it would be expedient for better adjudication of the controversy to understand the true meaning of the term "royalty".

According to abridged Random House Dictionary, "royalty" means "a compensation or portion of the proceeds paid to the owner of a right, as a patent or oil or mineral right, for the use of it and also an agreed portion of the income from a work paid to its author, composer, etc., usually a percentage of the retail price of each copy sold".

The meaning given to "royalty" in Mozley and Whitleys Law Dictionary at page 327, 8th Edition, is "a pro rata payment to a grower or lessor on the working of the property leased, or otherwise on the profits of the grant or lease, the word is specially used in reference to mines, patents and copyrights".

Dealing with royalty, Halsbury, in Halsbury''s Laws of England, Vol. 26, 3rd Edition, pp. 430 and 435, has explained "royalty" as "it is payment to the lessor proportionate to the amount of the demised mineral worked within a certain period".

The Supreme Court, in The State of West Bengal Vs. Kesoram Industries Ltd. and Others, has explained the term "royalty". "Royalty" has been described as "a share of the product or profit from real property, reserved by the grantor of a mineral lease, in exchange for the lessee''s right to mine or drill on the land". The phrase "mineral royalty" has been defined as "a right to share of income from mineral production".

Thus, the above would show that royalty is a necessary concomitant of mining lease.

The origin of the word "royalty" is to be found out from the definition itself given in unabridged Random House Dictionary. It is the sovereign power which granted permission to a private person or citizen to use its mine or lands, may be in the beginning. Charging such a person a specific amount for the permission to use such lands or mines owned by the sovereign power which was the royal power, the payment made to such a royal power for the use of the lands or mines for mineral appears to have been named as Royalty. The concept of royalty is to compensate a right of an owner of property who permits or allows others to use his rights from his property.

It appears from the materials on record that the royalty payable in respect of crude oil in terms of the Schedule to the Act, was fixed by the Central Government at Rs. 481/- per MT. However, in the year 1997 a decision was taken by the Central Government to dismantle the "Administered Price Mechanism". In view of the dismantling of the Administered Price Mechanism, the Central Government decided to alter the rate of royalty.

A committee was appointed by the Central Government, inter alia, for recommending the criteria for determining the royalty on crude oil and also recommending the royalty rate. Such committee was known as the Mauskar Committee. The said Committee prepared and submitted its report on 25th November 2001.

In para 6.12.1 of the said report, the Committee held as under:

6.12.1 According to the National Institution of Public Finance and Policy (NIPFP), Royalty is a return to the owner of land. It is only natural that this return should depend upon the price of oil in case of crude oil. Royalty fixation requires the rationalization of pricing of oil and moving to market determined prices. Crude oil being a largely imported energy resource of the country, the international price of this resource should be taken as the basis for the estimation of royalty as this would reflect the offer price of oil by the consumer in an open market.

In para 7.4.1 (Conclusion and Recommendations), the Committee has stated that it feels that the market driven price obtained/obtainable by the producers should be considered for determining royalty under deregulated price regime. The Committee also made recommendations for determination of wellhead price and the rate of royalty.

In para 7.4.7(i), the Committee, inter alia, recommended as under:

After 1.4.2002 under the deregulated regime the wellhead price as derived from the market driven price obtained/obtainable by the producers based on arm''s length transactions in terms of the relevant recommendations be considered for royalty calculations.

It appears that based on such recommendations of the Mauskar Committee, the Central Government issued a Notification dated 17th March 2003 which, inter alia, provides for payment of royalty for the period after 1st April 2002. This Notification provides for payment of royalty at a rate 20% of the wellhead price till the year 2006-07 and for ''tapering'' rates of royalty thereafter. The wellhead price for the on land production was to be derived after deducting 7.5% from the crude oil price.

Para 2(vii)(a) of this Notification, dealing with the royalty for the period after 1st April 2002, states as follows:

The wellhead price of crude oil as derived from the market driven price obtained/obtainable by the producers based on "arm''s length transactions" will be considered for royalty calculations.

Para 2(iii) of this Notification referred to above states that "royalty will be calculated in accordance with the existing methodology, i.e. on ''cum royalty'' basis", and a Note-1 at the end of the Notification sets out the following formula as far as the existing methodology for calculation of royalty is concerned:

Section 6A(4) of the Oilfields Act confers powers of delegated legislation upon the Central Government to amend the Schedule of the Act so as to enhance or reduce the rate at which royalty shall be payable. The issuance of Notifications for the purposes of amendment of the Schedule of the Oilfields Act is an act of delegated legislation by the executive and has to be reasonable so as to confirm to the provisions and the intent and purpose of the parent legislation i.e. the Oilfields Act.

In our opinion, Section 6A(4) does not confer any power upon the Central Government to mould the provision for the purpose of providing payment of royalty on the post-discount sale prices.

To our mind, it would be more reasonable to hold that the twenty percent ceiling must be interpreted with reference to the fair value of the crude at the wellhead i.e. the fair market value and not the discounted price of crude at which ONGC sells to the IOC upon the directions of the Union of India.

The phrase "sale price" used in the proviso to Section 6A(4) of the Act would only refer to the arm''s length market price of crude oil, and not to a discounted price. In our opinion, the ''sale price'', for the purposes of Section 6A(4), should not mean the discounted price between two companies of the Central Government, especially when the discount is given on the specific instructions of the Central Government for subsidizing the Public Sector Oil Marketing Companies which purchases oil from ONGC.

The above is made clear by the Notification dated 17th March 2003, which clearly provides that the wellhead price of the crude oil "as derived from the market driven price obtained/obtainable by the producers based on arm''s length transactions" will be considered for the purpose of royalty calculations. To put it in other words, the wellhead price to be used for calculation of royalty is the market driven price, based on arm''s length transactions, which is obtained or obtainable by the producers.

We are in agreement with Mr. Kapadia, the learned counsel appearing for the petitioner, that the use of the words "market driven price", "arm''s length transactions" and "obtainable" clearly rule out the discounted price offered by the ONGC to IOCL (both Government companies) on the instructions of the Central Government so far as the calculation of the royalty is concerned.

According to ''Black''s Law Dictionary'', 8th Edition, the phrase "arm''s length" means, "of or relating to dealings between two parties who are not related or not on close terms and who are presumed to have roughly equal bargaining power...".

In the ''Advanced Law Lexicon'' by Ramanatha Aiyar, the phrase "arm''s length" is defined as "...a transaction negotiated and entered into by unrelated parties, each of whom acts in his or her own best interest using fair market values", and the phrase "arm''s length price" is defined as "the price at which a willing seller and an unrelated willing buyer will freely agree a transaction".

The communications dated 30th October 2003 and 28th March 2008 of the Central Government which are on record are in tune with such position and expressly state that the discounts offered by the ONGC would not affect the royalty payable to the State Government.

As observed earlier, the above position has been accepted by the Central Government and the ONGC, and the ONGC has accordingly paid royalty to the State of Gujarat on the basis of the wellhead price calculated using the pre-discount price of the crude oil, without demur, till the year 2007.

From the materials on record, it also appears that none of the Notifications issued by the Central Government under the Act expressly or impliedly overrides the decision contained in the Notification dated 17th March 2003 or states that any discount offered by the ONGC to its buyers shall be taken into account for the purpose of determination of the wellhead price and the calculation of the royalty.

We find merit in the submission of Mr. Kapadia that if the Central Government wanted to alter the method of calculation of royalty and thereby introduce the post-discount price of ONGC for such purpose, then it would be necessary to issue a notification to this effect in terms of Section 6A(4) of the Oilfields Act and amend the Schedule to the Act. Such is not the position and the Central Government appears to have just addressed a letter in that regard, which runs contrary to the Notification, which still holds the field.

Mr. Kapadia is also right in submitting that even if the Central Government comes out with a notification for amending the Schedule for providing calculation on post-discount prices, the same would be arbitrary and unreasonable, and violative of Article 14 of the Constitution of India.

We have gone through the table of discounts produced on record indicating that the discounts directed by the Central Government reach as high as upto 95% to 96% which reduces the royalty amount of the State Government to nearly Nil. It appears from the table that in the month of September, 2008 the royalty which was calculated by the ONGC was in the negative. The table also indicates that the discounts directed by the Central Government are on an average roughly over 70%. This reduces the royalty amount payable to the State to a meager sum and frustrates the very intent and purpose of the Oilfields Act which is to reimburse the State on a reasonable basis in respect of the crude which is extracted by the mining lease-holder i.e. the ONGC.

We are also of the opinion that any discount offered by the ONGC to its buyer viz. IOCL etc. cannot be at the cost of the lessor State Government and should not be taken into account for the purpose of determination of the wellhead price and for the calculation of the royalty. The ONGC and IOCL respectively are both Central Government Public Sector Undertakings controlled by the Union of India. Both the PSUs are bound by the directives of the Union of India. For the purpose of compensating the under recoveries by the downstream public sector marketing companies (such as IOC, BPCL and HPCL), the Union of India through its Petroleum Planning and Analysis Sale issues directions for each quarter in respect of the discount to be given so far as the sale of crude by the upstream Oil companies viz. ONGC and Oil India Ltd. is concerned.

Mr. Kapadia, the learned Counsel appearing for the petitioner is quite justified in submitting that the subsidy on the petroleum product given by the Central Government and the discounts directed to be given in respect of sale of crude by the ONGC to the downstream companies of the Central Government, is an internal matter between the Union of India and the Upstream and Downstream companies which are the Central Government PSUs. The State Government has nothing to do with the same. Mr. Kapadia is also right in submitting that the discounts directed to be given by the Central Government between its PSUs should not affect the amount of royalty that is rightfully recoverable by the State of Gujarat under the provisions of Oilfields Act.

In our opinion, if the Notification dated 20th August 2007 is construed so as to make the royalty payable on a post-discount sale price, the same would be without competence and violative of Article- 14 of the Constitution of India. If the phrase "sale price of crude oil" is construed to mean the post-discount price, the statutory right of the State to be compensated for the crude extracted would surely stand frustrated and there being no lower limit prescribed for the discount the royalty payable to the State would be reduced to near zero. Therefore, the phrase "sale price of crude oil" used in the Notification dated 20th August 2007 should be construed as referring to a pre-discount sale price and not the post-discount sale price. Over and above the Note-1 appears to be only to substitute the deduction of fixed amount of Rs. 1251/- as a wellhead cost for determining the wellhead price instead of deducting the percentage amount of the price of the crude earlier provided at 7.5%. The said note does not change the methodology of making royalty payable on the post-discount sale price instead of pre-discount sale price.

We have taken note of the fact that even after the Notification dated 20th August 2007 the royalty was being paid by the ONGC on the basis of the well-head price calculated using the pre-discount price of the crude. It is for the first time vide letter dated 20th August 2008 that the ONGC took a stance that the royalty would be calculated on the basis of a post-discount price of crude oil since the royalty amount would otherwise exceed the statutory selling of 20% of the ONGC''s sale price. Even at that relevant point of time it was neither the stance of the Union of India nor of the ONGC that the royalty payment was required to be made on the basis of post-discount price of crude oil on account of the provisions of the Notification dated 20th August 2007 and the consequent amendment to the Schedule of the Oilfields Act.

It is well settled that where the language of a statute, in its ordinary meaning and grammatical construction, leads to a manifest contradiction of the apparent purpose of the enactment, or to some inconvenience or absurdity, hardship or injustice, presumably not intended, construction may be put upon it which modifies the meaning of the words, and even the structure of the sentence. Where the main object and intention of a statute are clear, it must not be reduced to a nullity by the draftsman''s unskillfulness or ignorance of the law, except in a case of necessity, or the absolute intractability of the language used. (see Maxwell on Statutes (10th Edition) page 229)

As held by the Supreme Court in Directorate of Enforcement v. Deepak Mahajan and another, reported in AIR 1994 SC 17.75, normally courts should be slow to pronounce the legislature to have been mistaken in its constantly manifested opinion upon a matter resting wholly within its will and take its plain ordinary grammatical meaning of the words of the enactment as affording the best guide, but to winch up the legislative intent, it is permissible for Courts to take into account of the ostensible purpose and object and the real legislative intent. Otherwise, a bare mechanical interpretation of the words and application of the legislative intent devoid of concept of purpose and object will render the legislature inane.

In Directorate of Enforcement (supra), the Supreme Court was considering the provisions of the Foreign Exchange Regulation Act. While interpreting the words "person arrested" in context with Section 167(1) and (2) of the Code of Criminal Procedure, 1974, the Court held that it is permissible for Courts to have functional approaches and look into the legislative intention and sometimes may be even necessary to go behind the words and enactment and take other factors into consideration to give effect to the legislative intention and to the purpose and spirit of the enactment so that no absurdity or practical inconvenience may result and the legislative exercise and its scope and object may not become futile.

In Commissioner of Income Tax, Dehradun and Another Vs. Enron Oil and Gas India Ltd., the question which arose before the Supreme Court was, whether the loss arising on account of foreign currency translation was allowable as deduction or not and conversely whether the gains on account of foreign currency translation were to be treated as a receipt liable to tax. While answering the said question in the affirmative and dismissing the appeal filed by the Commissioner of Income Tax, Dehradun, the Court made the following observations in paras 13, 14, 36 and 37 as under:

Section 42 is a special provision applicable to oil contracts. It has to be construed in the background of PSC. There is a difference between production sharing contracts and revenue sharing contracts. PSCs were put in place in order to enable the sovereign governments to maximise their gains from oil exploration by private corporations. PSC is a regime.

Prior to the PSC regime, the Governments recovered royalty and imposed tax on revenues from oil exploration. However, in countries like India, where there is a great demand for oil, PSC was devised to give the Governments a stake in oil exploration and development, virtually making it a partner in the process.

To answer this question, we were required to understand the subject of a production sharing contract (PSC). The State hires the investor(s) as a contractor(s) for the conduct of work connected with the extraction of minerals. The subsoil belongs to the State. It has a monopoly over the use of the subsoil and the removal from it of all natural resources. Under PSC the State grants to the contractor (investor) exclusive rights to conduct activity of exploration envisaged by the contract. A PSC is a civil law contract. The contractor (investor) carries out the activities envisaged in the contract (prospecting, search, exploration, extraction, etc.) at this own expense and risk The State does not bear any expenses or risks. If the investor invests in the prospecting and exploration but does not discover any oil, the expended funds are not refundable unless the contract provides otherwise. The State hires the investor as a contractor to perform work for it, but at the expense and risk of the investor. The said work is carried out on a compensated basis, with the State paying the investor not in money, but in terms of a portion of the produced product (oil). This is called as production sharing.

There are two main systems around the world: royalty/tax systems or production sharing systems. PSCs have become the fiscal system of choice for most countries. Taxes are embedded in the Government''s share of profit oil. PSC is a complex system. In it, the foreign company provides the capital investment in exploration, drilling and construction of infrastructure. The first proportion of oil extracted is allocated to the company which uses oil sales to recoup its costs and capital investment. The oil used for this purpose, namely, to recoup capital investment and cost is termed as "cost oil". Once costs have been recovered, the remaining "profit oil" is divided between the State and the company in agreed proportions. The company is taxed on its profit oil. Sometimes, the State participates either itself or through its nominee as a commercial partner in the contract, operating in joint venture with foreign oil companies. In such cases, the State provides its percentage share of capital investment, and directly receives the percentage share of cost oil and profit oil.

From the aforesaid observations of the Supreme Court, it is very clear that the subsoil belongs to the State and has a monopoly over the use of the subsoil and the removal from it of all natural resources.

Having given our thoughtful consideration to the entire matter, we are of the opinion that instead of declaring the Notification dated 20th August 2007, more particularly, the Note-1 thereof as ultra vires Article 14 of the Constitution of India, it will be more reasonable to read down the Notification, more particularly, the phrase "sale price of crude oil" used in Note-1 of the Notification dated 20th August 2007 in the manner to make it more meaningful and purposeful.

We direct that the phrase "sale price of crude oil" used in the Note-1 of the Notification dated 20th August 2007 and the Schedule of the Oilfields (Regulation & Development) Act, 1948 should be read as one referring to a pre-discount sale price and not the post-discount sale price and that the royalty amount should be calculated and paid on the basis of the pre-discount sale price of crude oil.

We direct the ONGC to make the payment towards the amount of shortfall of royalty for the period between April 2008 till this date, within a period of two months from today.

The petition is allowed to the aforesaid extent. However, in the facts and circumstances of the case, there shall be no order as to costs.

FURTHER ORDER

After this order is passed, Mr. Mehta appearing on behalf of the ONGC prays for stay of operation of our order. In view of what has been stated above, we find no reason to stay our order as we have already given two months'' time for making the payment.