The government is planning to get rid of the cross holding structure of various oil companies. It is logical to have clean and simple holding structures in any PSU. In fact most PSUs, except in the case of oil companies, have a simple shareholding structure that is probably the reason why other PSUs tend to get better valuation than companies in the energy sector. Having a cross holding gets nothing but a dividend which, in most cases, is less than the net margins which these companies earn from all their operations — exploration, refining or gas pipeline.
In essence, there is little reason for an oil exploration company to hold a minuscule minority stake in a gas pipeline company just to earn dividend. Even on treasury operation basis, exploration and oil refining company would be better placed had the investment been in debt fund. So, cutting the clutter in shareholding is the right thing to do.
However, there are some steps to be taken before this process is started. First and foremost, it is necessary to have stability in policy regarding who will share the burden if oil prices were to rise from current levels. In the last six months, the government had shown remarkable stability in policy framework by not asking oil companies to share any burden and by not reducing oil prices. But, in the first week of October, when the government asked oil marketing companies to share the burden of reduction in oil prices by asking them to take a one rupee cut per litre on their books, it broke the discipline holding the valuations in the oil sector. The result was on expected lines. The oil marketing companies lost a couple of billion dollars in market capitalisation and most oil companies have not reached the level they were trading at before October 4. It can be argued that a drop in market capitalisation is a notional loss. But what instability of policy does is that it pushes overall valuation down. Despite, earning a reasonable amount of cash on their books and paying dividends, price earning multiples given by the street are very low for oil PSUs. This effectively means that if the government wants to sell its stake in these companies, it would earn less than it should have.
Secondly, it is worthwhile asking whether this cleaning up of shareholding would be an exercise where shares are sold to public investors or the companies would decide on valuations and buy their shares from each other. It would be better if after having stability on the policy front, the government should allow for a public offering of these shares. If there were clarity and stability on the policy front, there would be no dearth of buyers for paper from the energy sector.
Another factor which policy makers need to be clear about is how the proceeds from the stake sale would be used. Will the funds be used for expansion or will they be routed back to government by way of a special dividend? Because the government wants to have a majority stake in these companies, it can use other financial instruments like convertible debentures. In the end, the government will be able to fetch much more by selling one per cent stake in a large well run oil companies than 2 per cent in a medium-sized oil company. So, the focus must be on making energy companies bigger and also more efficient.