Policy imperatives for natural resources
Aug 19 2013
Both are India’s maharatna public sector undertakings, among the most profitable, and in the crucial energy sector. The two companies recently reported their first quarter results of the current financial year.
ONGC had sales of Rs 192 billion, with cost of raw materials (CORM) consumed as Rs 1.1 billion (less than 0.6 per cent of sales); Coal India had sales of Rs 165 billion and cost of raw materials consumed as Rs 14 billion (roughly 8.5 per cent of sales). The equivalent results for ONGC’s downstream subsidiary MRPL were Rs 152 billion sales and Rs 143 billion was cost of raw materials (94 per cent).
The limited purpose of mentioning these figures is not to analyse the quarterly performance of these companies (which too requires a detailed comment since both have reported lower relative performance compared to previous year’s quarter), but to highlight a totally different point: the massive financial gains possible in the primary sector of the economy since the cost of input raw materials is almost negligible. The established canons of relationship between sales revenue and cost of raw materials to produce finished goods that exists in any manufacturing sector (as shown in the case of MRPL) do not exist here.
The difference between ONGC and Coal India revenue models lies in the risk profile and labour intensity of the respective industries. Oil and gas exploration is a high-risk and high-investment business. Striking oil and gas fields itself is a hi-tech task, and then extracting the same and pumping it to refineries too is quite complex and risky. Therefore, high-margins in this business are only to be expected.
In the case of Coal India, the uncertainty about existence of coal is negligible and therefore the only major task is extraction and transportation. The risk comes from mining and extracting at great depths and that too using a labour-intensive approach. Thus, the major cost in this business is human labour and related welfare measures (which can be as much as 40 per cent of sales). Once extraction is accomplished and no other processing is done, the returns are high. This is a low-risk and high-returns business based on economies of scale and priority allocation of coal blocks.
In normal commercial sense, there can be two other scenarios: high-risk, low-returns and low-risk, low-returns. In the case of former, businesses will be wary to enter unless there are some guarantees of minimum assured returns and possibilities of future long-term gains. In this case, many existing businesses get stuck due to overcapacity, long gestation periods, or policy paralysis. Typical examples are large power projects and commercial airline business, where the entry barriers are high and dependence on continued policy support is imperative.
The case of low-risk and low-returns is typical of commodities business, where it is difficult to differentiate one’s products, and entry and exit barriers are low. Competition is usually very tough since individual firms can easily come and go.
Conceptually, the low-risk and high-margins category should not exist in a market-led, efficiency-led competitive economy. But as mentioned, it exists only because of entry barriers put up by the government and rights exercised by it to grant licences. Individuals and small firms can get rich overnight if they can scale the artificial barriers through manipulation of government officials or by being simply dabang. We have seen this in land deals, including conversion in land use, coal-blocks allocation to individuals, grant of water rights, among others. Personal interest gets precedence over government interest.
Throughout India, one can see mining and blasting at massive scales and their ill effects. On way to Jalgaon via Aurangabad, one can see many half-remaining hills as if eaten away by termites. On way to Chitrakoot from Kanpur, sometimes it is almost impossible to drive due to poor visibility for long stretches.
People like Durga Shakti Nagpal and Ashok Khemka would remain sole fighters (or victims) until the government formulates a set of holistic policy guidelines for granting rights to private individuals for exploitation of any national and state property. The process must be thoroughly transparent with clearly articulated procedures. A constitutional body comparable with CAG needs to be created which will approve the whole process before the grant of rights (unlike the CAG, which comes in only after the horse has bolted).
India is also on the cusp of high-technology, high-risk businesses where winners and losers are decided rather quickly and ruthlessly. Entrepreneurs who survive and thrive on competition, creating customer value and excellence should feel encouraged to be in this country.
(The writer is a professor of strategy and corporate governance, IIM-Lucknow)