Daily Editorial : Merger of Petroleum PSUs – Budget Proposal

Context:

It was announced in the budget that India would merge the existing state-owned oil and gas companies to set up a global behemoth that could compete with some of the largest global petroleum companies.

Why is government looking at the merger of the Oil companies in India?

• Integration is the need of the hour. Globally, M&A (mergers and acquisitions) is the trend in the oil industry. Historically such amalgamation has been successful for international companies like Exxon Mobil, Shell, and Chevron etc.
• Most Asian countries have just one national oil company integrated across the value chain; India has 18 state-controlled oil companies.

How will the merger look like?

• The merger route – whether by creating a holding company like in the case of Coal India Ltd or individual M&A – is yet unknown and will have to take into account the different culture, expertise and compensation of each.
• 13 oil PSUs are being considered for the merger at present. The top eight listed PSUs have a combined market cap of $80 billion, and a merged entity would become the ninth largest globally with about $90 billion market capitalization.
• State-owned Oil and Natural Gas Corporation (ONGC), the top oil producer and one of the largest companies in the country. Other major companies include Indian Oil Corporation, the nation’s largest refiner and fuel retailer, Bharat Petroleum, Hindustan Petroleum, GAIL, Mangalore Refinery and Petrochemicals (MRPL), Chennai Petroleum and Numaligarh Refinery and Oil India.
• The merged entity will have a bigger market value than Russian state oil giant Rosneft and India’s Reliance Industries Ltd.

What will be the Positives of this move?

The proposal will provide scale and muscle, which can be leveraged in the global market

• It results in strengthening of balance sheets as margins improve due to economy of scale.
• It also gives PSUs an edge due to sovereign ownership.
• The proposed merger of state-owned oil companies could reduce inefficiencies across the sector. A merged entity would have opportunities to save on costs and improve operational efficiency, as there would be less need for multiple retail outlets in a single area.
• Transport costs could be reduced by retailers sourcing from the nearest refinery, rather than the ones they own.
• A merged entity would also be able to share expertise for exploration and acquisition of resources
• It will enhance the capacity of oil PSUs to bear higher risks and create value for the stakeholders.
• It will also be a good step in the long run asit will enable the companies to withstand the international volatility in the oil and gas segment.
• The idea of the integrated giant company which would also absorb various institutions related to safety, development and analysis

Potential Problems

• A merger would face significant execution challenges, particularly in terms of managing the integration of employees, addressing overcapacity in the merged entity due to differing HR policies of PSUs.
• There will also be difficulty in winning the backing for the merger from private shareholders as obtaining approval from the 75 per cent of shareholders will be required to approve a merger, particularly if there are concerns over valuation
• Political backlash due to job cuts.
• How the state will handle the likely decline in competition after a merger as private companies are increasing their market share from a low base, but could find it even harder to compete with a single large state-controlled company there by creating the danger of monopolies and cartels being created in the industry.
• PSU oil companies, the committee said, operated in distinct areas across the hydrocarbon value chain — be it refining or exploration — and merging companies varying in areas of competence could be a disaster.

Earlier Proposals

1. In 1995 the ministry, then headed by Captain Satish Sharma, formed a R group (signifying reforms) under Vijay Kelkar, and the chairman of Bharat Petroleum, Sundararajan.

• The view was that a giant entity in the sector wasn’t something desirable given the Indian context. It could mean destabilisation of some of the companies and the industry besides creating problems for consumers. In short, the costs far outweighed the benefits which could arise from a possible merger, many of them felt. There could also be a collateral damage to ONGC too.

2. When Kelkar moved from the petroleum ministry to North Block as finance secretary during the NDA government headed by Vajpayee, the proposal which went through was that of the big oil companies buying into each other.

• Government made a cross-holding plan; ONGC bought 9.1 per cent in IOC with IOC in turn picking up 9.6 per cent in ONGC and 4.83 per cent in GAIL. The move came in for much criticism then, but over five years later, IOC sold part of its holding for over Rs 3,600 crore — a substantial return on its original investment.

3. At the start of the UPA’s term in 2004-05, Mani Shankar Aiyar, the then petroleum minister, approved the setting up of a committee headed by former steel secretary and BHEL chairman, V Krishnamurthy, to take a broad look at the energy sector and to recommend an appropriate structure for India’s state-owned companies engaged in both refining and exploration.
   • It came to the conclusion that rather than creating a mega entity in the sector, it would be better to strengthen the structure of the state-owned oil companies, as it was then in 2005, through policy measures and improvement in managements.
   • Committee then felt that going by the case studies and data, only 29 per cent of all mergers and acquisition transactions led to higher returns for shareholders in those firms.
4. Again in 2014, another committee headed by Kelkar, tasked with working out a road map for reducing India’s import dependency in the hydrocarbon sector by 2020, although it did not directly address the issue of a merger given its mandate, made out a case for empowering and strengthening national oil companies and to strengthen the board processes with greater accountability and autonomy.

Other suggestions from the experts

1. Government may opt to create an overarching holding company with a robust muscle power to borrow as well as invest in oil and gas assets.
2. The other format could be an overall integration resulting in one big corporation which will be a challenging task but will result in far reaching benefits as synergies will be strengthened across value chains leading to sharing of skills, research and development, infrastructure, increase in overall capacity and an edge during bidding for E&P assets.

Conclusion

The move will not have any immediate impact on the sector as the planning and setting up of such a corporation will take 2-3 years and the results will be apparent in a span of 4-5 years.

Given this backdrop, it will now be interesting to see the approach which this government adopts for a potential merger.