The Comptroller and Auditor General of India (CAG) criticised Reliance Industries and the government over development of the country's key natural gas field in the Krishna Godavari (KG) basin and called for revamping profit sharing arrangements from oil and gas blocks.
The offshore KG basin was expected to contribute up to one-quarter the gas supply for Asia's third-largest economy, but lower-than-expected output has left the energy-hungry nation more dependent on expensive, imported LNG to fuel power and fertiliser plants.
The CAG report, submitted to parliament on Thursday, said production sharing contracts between the government and operators were designed to encourage increasing capital expenditure by private contractors, which reduces the government's share of oil and gas revenue.
The CAG and the supreme court have been increasingly active over the past year at scrutinising major government contracts.
The report said Reliance Industries, the operator of the KG-DWN-98/3 block, was allowed to violate terms of its production sharing contract.
It said Reliance Industries was allowed to enter the second and third exploration phases of its blocks without giving up 25 per cent of the contract area at the end of each phase, as required, by instead treating the entire area as a discovery area.
Still, investors greeted the report with relief, with Reliance shares ending 2.3 per cent higher, outperforming the broader market, after falling more than 2 per cent earlier in the day.
"From a Reliance point of view the report is not as serious as feared," said Jagannadham Thunuguntla, strategist and head of research at SMC Global Securities.
The auditor does not have prosecuting power, but its findings can form the basis of any possible government action against Reliance, as well as future policy on exploration.
The report may also give opposition parties more ammunition against the government, which is struggling to fend off corruption allegations, including in the award of telecoms licences that may have cost billions of dollars in lost revenue.
New Delhi recently agreed to press ahead with tough anti-graft legislation after facing the biggest protests in decades.
Reliance Industries, India's largest listed firm, said it was unable to comment on the auditor's report as it had not seen its contents. The company said it will continue to cooperate with the government on the audit.
Reliance Industries, controlled by Mukesh Ambani, India's richest person, has been under fire in recent months from the upstream regulator, investors and analysts over slowing gas output from its KG blocks, and its shares have suffered.
Earlier this year, Reliance sold a 30 per cent stake in 22 oil and gas blocks, some in the KG basin, to BP in a $7.2 billion deal, in part to benefit from BP's expertise in deep water exploration.
In May, India's upstream regulator said Reliance was producing 48 mscmd (million standard cubic metres per day of gas) from its main D6 block in the KG basin off India's east coast, lower than the 60 mscmd it produced a year earlier, and far off the planned peak capacity of 80 mscmd.
Thursday's report said that while Reliance raised the development cost for the D1-D3 gas blocks to $8.8 billion from an initial $2.39 billion on the assumption that production would increase to 120 mscmd from an estimated 40 mscmd, the recent fall in output raises doubts about justification for the hike.
The higher the capex cost, the longer it takes for the government to see revenue from the blocks.
The CAG report called for reviewing the profit sharing mechanism on energy blocks between the government and operators.