The proposal to merge state-owned oil and gas public sector units (PSUs), which was first mooted 12 years ago, has caught the interest of the government once more, following its mention in Union Budget 2017-18. With the aim of gaining competitiveness in the global energy market, the government clearly stated its intent of creating an “oil major”, an entity which would be capable of matching the performance of international and domestic private sector oil and gas companies.
Indian Infrastructure analyses the possible implications on the industry if the proposal is taken forward…
Simply put, the deal is to merge the major oil and gas PSUs of the country to create a single large national entity. Currently, there are 18 state-owned oil and gas companies, with different scales of operation, business presence and ownership pattern, and with unique operational ecosystems. While pitching the proposal as a part of the current year’s budget, the finance minister said, “It will give them the capacity to bear higher risks, avail of economies of scale, make larger investments and create more value for stakeholders.”
Among the 18 PSUs in the sector, eight key ones are Oil India Limited (OIL), Indian Oil Corporation Limited (IOCL), Bharat Petroleum Corporation Limited (BPCL), Hindustan Petroleum Corporation Limited (HPCL), Oil and Gas Corporation Limited (ONGC), GAIL (India) Limited, Gujarat State Petroleum Corporation (GSPC) and Mangalore Refinery and Petrochemicals (MRPL). The remaining ones are small and fragmented; if these too are merged, it will not make much difference in the final revenue numbers or market capitalisation of the unified entity.
Upon the merger of the eight key players mentioned, the total revenue of the newly created oil major will be close to $140 billion. While it would rank amongst the world’s top 15 oil and gas companies, it would lag behind its counterparts in countries such as Saudi Arabia (Aramco’s revenues amount to $460 billion) and China (Sinopec’s revenues are $440 billion) by a huge margin.
Pros and cons
While the industry stands divided on the proposed merger, the supporters are basing their arguments on several positives that could ensue. Gains in efficiency and competence on a global level, for instance, are perhaps the biggest factors that are expected to drive the success of the merged entity. According to Ficth, a single entity will also eliminate the need to have multiple fuel retail outlets in a single area (which, currently, is an outcome of competition among several players looking to ratchet up their sales in a particular area).
On the cost side too, there would be significant savings, owing to the sourcing of fuel from the nearest dispensing point/refinery. The merged entity, owing to its scale, would also enjoy immense bargaining power, which may enable it to strike better deals with other stakeholders, such as equipment providers. Another major positive that could result is the neutralising of risks associated with fluctuating oil prices. With concerns relating to climate change exerting pressure on the use of hydrocarbons, an oil producing company could reap benefits from being a part of a mega entity that has a presence in varied business areas such as refining, retailing, as well as, to some extent, renewable energy. Overall, business synergies resulting in gains in efficiency and competence is central to the idea of the proposed merger.
The flip side, however, is an aspect that needs to be weighed critically. In the merged entity, with a presence across the oil and gas value chain, the heterogeneity of the players will come with its own set of problems. Companies such as ONGC, OIL, BPCL, HPCL have vastly different business models, as well as work cultures. A key issue in executing the merger will be to contain the number of employees and manage their integration, which, in turn, would defeat one of the outcomes of the proposed merger, namely, the cost efficiency arising out of pruning the workforce to remove those with overlapping roles. Politically too, this is unlikely to find acceptance. Layoffs, if carried out, will result in a new set of issues. Workers’ unions, for instance, will have the power to disrupt production, bringing the national output to a standstill. Such cases have been witnessed in countries like Mexico, where worker unions have enjoyed indiscriminate powers.
Besides, the resulting overcapacity, and that too with a high level of market concentration, would be difficult for the government to utilise. Another major hurdle facing the proposed integration would be getting a go-ahead from shareholders. Most of these 18 companies have public shareholding varying be-
tween 51 and 70 per cent. The operations of these companies are not only varied in scale, but are diverse and vertically integrated, and moreover, have an overseas presence as well, which could further add to complexities.
The “duality of competence” is another area of concern. While it is being argued that the proposed entity will have strong competencies in the international market, the same may not hold true in the domestic scenario. This duality may arise on account of the sheer market share of the new company vis-à-vis private players present in the sector (more competitive than the PSUs at present ), which are likely to be dwarfed in terms of market share. In other words, a monopoly will be created with low levels of competition. Empirical evidence shows that a monopoly always becomes inefficient over a period of time and leads to poor productivity. In fact, even within the public sector, competition among the players gives better market outcomes.
Is the merger a solution?
Within Asia, many countries have national, integrated oil companies. However, this cannot be the only basis for replication in India. China, the most often cited barometer for gauging India’s performance, has a host of state-owned companies which specialise in different aspects of the oil business. It is interesting to note that China as well as Russia once attempted to create a consolidated oil and gas company during the 1990s, but eventually withdrew their plans. Also, looking at mergers that have taken place worldwide, only 29 per cent have delivered returns, according to a global study conducted by AT Kearney.
Another point to be examined is whether oil and gas consumption is nearing its peak. The growing concerns with regard to climate change and commitments from countries such as India at the Conference of Parties in Paris to reduce greenhouse gas emissions are expected to choke some demand for oil in the medium to long term, if not immediately. Electric vehicles, for instance, are gaining traction in several countries across the world. China too is aggressively moving ahead with its decarbonisation plans. Thus, the oil PSUs’ integration strategy must take into account a situation of depressed oil and gas markets (and thus feeble demand for these fuels), wherein the companies will be under constant pressure to seek improvements on returns on their capital investments and to trim costs.
Past merger and acquisition (M&A) evidence too seems to suggest a poor outcome. The merger of two public sector entities – Air India and Indian Airlines – has been one of the biggest fiascos in the country’s M&A space. Till date, the government needs to set aside hefty budget allocations to keep the national carrier in the sky. Coal India Limited is another example. Created as a single entity that controlled virtually all the coal reserves in the country, it has, until recently, been a poor performer and has been responsible for the inadequate supply of coal in the country.
Time and again, panels and committees set up by the government to explore the possibility of such a merger have not favoured the move. In September 2015, a high-level panel on the recast of oil PSUs instead suggested the transfer of the government shareholding in the PSUs to a professionally managed trust. Earlier, in 2005, the Advisory Committee on Synergy in Energy, headed by V. Krishnamurthy, former secretary, Ministry of Steel, concluded that M&As worldwide occurred during times of low oil prices and were instruments to eliminate the excess workforce and duplicate facilities.
The government may find it easier to create a holding company with all the oil and gas PSUs as its subsidiaries. The holding company, in turn, could be listed at a much greater valuation even as the subsidiaries could remain listed too. While the government could leverage the new entity in overseas markets, the domestic operational dynamics can remain intact.
The way forward
Contrary to the belief that the budget proposal of the oil and gas PSUs’ merger would be a non-starter, there are recent reports about ONGC’s “possible purchase” of the government’s entire 51.11 per cent stake in HPCL, which will have to be followed by the acquisition of an additional 26 per cent from other HPCL shareholders. With this it is evident that things have begun to move in the government’s desired direction.
However, the whole proposal must be critically examined. Even if the plan is executed, it must be done in a gradual manner, considering different models of integration while factoring in the current and future energy needs of the country, so that it is a win-win for all the stakeholders alike. While the merger is to be carefully designed so that the transition is smooth and the markets don’t go into shock, the post-merger scenario must also be meticulously designed. A blanket merger lacking the correct rationale is sure to backfire, a situation that India certainly cannot afford.
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