A few days back government announced its decision to merge HPCL with ONGC. Finance minister, while presenting the budget for 2017-18, had expressed a policy intention of developing an oil major in the public sector which will be able to match the performance of international and domestic private sector oil and gas companies. His rationale for this decision was creation of new opportunities for CPSEs through consolidation, mergers and acquisitions. He had argued that this will help integration across the value chain of an industry, develop capacity to bear higher risks, avail benefits of economies of scale, take higher investment decisions and create more value for the stakeholders. The current decision is in pursuance of the above policy.
The decision to develop a global size oil major needs to be seen in a certain perspective. Some of the largest companies in the international market are Chinese. The country has three integrated oil majors: CNPC, Sinopec and Petro China. All have turnover of about $400 billion. Some other oil majors like Shell, Saudi Aramco and Total also have a huge turnover of about $300 billion to $400 billion. ONGC is a very profitable company but with an annual revenue stream of less than $15-20 billion. With integration of HPCL, the total turnover of the company will increase to about $50 Billion. To match the global giants, it will have to undertake further integration and invest in pipelines development, gas distribution network acquiring oil and gas assets abroad and exploration. This may take a couple of years and large financial resources.
The implementation of this decision will face many challenges. Government policy in this regard would have to be cognizant of these. Let me indicate some major issues in this regard.
First, it will be prudent to evolve the structure of the new company after considering the past experience of such efforts by the government. The proposal to have a holding company of STC, MMTC and PEC in the eighties did not succeed. It did not add any value and the experiment had to be finally given up. Efforts made recently to create a large company like Air India by merging Indian Air Lines and Air India has not been a happy one. There are a large number of issues relating to personnel and the new company is financially weak and there has been no creation of additional value to stakeholders. Government of India had to provide more than Rs 20,000 Cr to save the company. According to reports after the merger HPCL will continue to be an independent company and be a subsidiary of ONGC. This appears to be a good model to begin with. To get full advantage of value chain, some changes will, however, need to be made at a later stage.
Second, the modality of merger must keep the objective of this exercise in mind. The crucial question is: how will ONGC fund the acquisition? According to news reports, ONGC will acquire HPCL by purchasing majority shares held by the government. This could cost the company about $4 to $5 billion for acquiring the company like HPCL. According to available data, the total cash and investments resources reserves of ONGC are about Rs 30,000-40,000 crore. If these are used to buy HPCL shares, ONGC will become financially very weak and have no money left to develop the new company, invest in exploration, finding oil and gas and undertaking expansion. It would be disastrous for ONGC and deplete its capability.
This method of acquisition may meet only one objective: transferring all ONGC reserves to government. This may strengthen budgetary resource of the government or meet their disinvestment target but will be bad for ONGC and the new company. In absence of financial resources and capability to invest, the new company will not invest in new activities and will have no chance of ever becoming a global oil giant.
Another alternative being mentioned according to some reports is for ONGC to sell shares of IOC held by it and raise resources. It could also borrow money from the market. Both these methods would not make the new company a very financially strong entity. Unless that happens investments and expansion will not come.
Instead of transferring resources, a better method would be for the government to get ONGC shares in lieu of HPCL shares held by it. This will require private investors of HPCL to be given the same offer. It may also need a nod from SEBI. Of course, government will not get any money from this transaction directly. This is a more difficult process but will further the objective of developing ONGC as a global oil giant and enable it to retain its reserves to be used for expansion of the company.
Third, crude oil prices vary sharply with OPEC and other oil producers trying to organise production of oil to maximise revenues. Government’s taxation policies would have to recognise the difficulties caused by such volatility. Oil sector is currently taxed heavily and has been the largest source of revenue to the government. In an era of moderate oil prices, the new company may generally have a surplus. This may be an incentive for the government to get additional taxes from this company. It will weaken the sector and reduce its capability for expansion and investment instead of providing any additional value. Government will need to curb such an approach.
Similarly, in an era of high oil prices ONGC will make profit but retail prices of petrol and diesel may be difficult to increase for downstream companies in view of strong consumer resistance or if elections are round the corner. The downstream sector will then make losses. These will be met by surplus of upstream. This will reduce investment and expansion capability of the company.
We must realise that global majors have acquired that status after large investments. ONGC needs to be made financially strong if it is to match these global oil players. By asking it to fund HPCL acquisition by transferring its reserves or pay for it in cash, we would lay a weak foundation for our potential Giant.
— Author is a former cabinet secretary and member, Planning Commission