Energy giant Reliance Industries was on Friday asked to pay a $1.25 billion penalty for a fall in gas production from its main oil fields, a company executive said.
The government and investors have been concerned for months over Reliance's declining gas output from its main D6 fields in the Krishna-Godavari basin.
"We have got the letter and will respond to it," the company executive said, declining to be named.
The oil ministry's notice to Reliance says it "failed to fulfil its obligations... and wilfully caused breaches, which led to immense loss and prejudice to the government and people of India," media reported.
The reports said Reliance would not be permitted to recover the cost of its investments -- $457 million in 2010-11 and $778 million in 2011-12 -- from the sale of gas.
Under the exploration policy, the government allows firms to first recover their exploration and production costs from oil and gas revenues, and later share profits with the government.
In a statement issued late Friday, Reliance said: "We continue to maintain that a contractor is entitled to recover all of its costs under the terms of the (production sharing) contract."
"There are no provisions that entitle the government to disallow recovery of any contract cost," the statement said.
Reliance, controlled by Mukesh Ambani, late last year started arbitration proceedings against the government to help recover its costs, but the ministry has so far refused to take part in the arbitration.
Since then, the company filed a petition in the Supreme Court, for appointment of an arbitrator on behalf of the government, by the court.
Crude oil production from Reliance's main oil field KG-D6 slid 37.9 percent year-on-year to 4.94 million barrels, said Reliance, when it reported a 20 percent fall in quarterly profit last month.
Natural gas production fell 23.5 percent to 551.31 billion cubic feet (BCF), over levels a year earlier.
"Production from the KG-D6 block has been adversely impacted due to unforeseen reservoir complexities," the company said at the time.
Reliance's shares fell 30 percent in 2011 and the stock continues to underperform the broader benchmark 30-share Sensex index this year.
Last year, British energy giant BP paid $7.2 billion to acquire a 30 percent stake in 21 of Reliance's oil and gas fields.
Reliance hopes that BP's deepwater drilling expertise will give the Indian giant the skills to develop hard-to-exploit reserves and find more oil.
Reliance operates the world's largest oil processing complex in Jamnagar, where two adjacent refineries have a combined capacity to process over 1.2 million barrels of oil a day.