Potential challenges include the problem of resource raising, India’s fiscal consolidation promises and our energy security needs.
Will the Mahagathbandhan of India’s oil majors prove successful? Credit: Reuters
Finance minister Arun Jaitley, while presenting the Budget for 2017-18, made an interesting announcement that will have far-reaching consequences for the petroleum sector. He expressed the Centre’s desire to develop an oil giant 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 the creation of new opportunities to strengthen CPSEs (central public sector enterprises) through consolidation, mergers and acquisitions. Jaitley argued that the creation of a giant oil major would help integration across the industry’s value chain and develop capacity to bear higher risks, avail economies of scale, take higher investment decisions and create more value for stakeholders.
In principle, one cannot argue against the idea of making CPSEs stronger. It is, however, prudent to develop these ideas only after considering the past experiences of such efforts in 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.
On similar lines, the effort to create a large company like Air India by bringing Indian Airlines into its fold 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. The Centre had to provide about Rs 20,000 crore to save the company.
Much of the current enthusiasm in the oil sector, however, emanates from seeing international oil companies. In China, there are three integrated oil majors: CNPC, Sinopec and Petro China. All have a turnover of about $400 billion. Apart from Saudi Aramco, these companies are amongst the largest in the business. In addition to these three majors, China also has an offshore oil company.
Indian Oil is our largest company with a turnover of about $80 billion. ONGC is a profitable company, but with annual revenue stream of less than $15-20 billion. The desire to match some of the global oil majors has driven this idea in the oil sector. What we must realise though is that to match any global oil major, we would need large investment and revenues from operations in other countries and take upon other activities like gas and oil pipelines, technical operations of oil drilling and petrochemical business. This may take time, will almost certainly need resources and will involve a number of risks.
The merger of upstream companies like ONGC with one or two downstream companies like BPCL or HPCL may also have serious problems in an era of high oil prices. When oil prices are high, ONGC will make profit but retail prices may be difficult to increase for downstream companies in view of consumer resistance. The downstream sector will make losses. This will reduce investment capability of the company in new exploration ventures.
Additional taxes
The oil sector is currently taxed heavily and has been a large source of revenue for the government. In an era of moderate oil prices, the new company may generally have a surplus. This will provide an incentive for the government to get additional taxes from this company. It will be easy for the government to get additional revenues from it without much effort. Doing so will weaken the sector and reduce its capability for expansion and investment instead of providing any additional value. The government will need to curb such an approach if it wants investment and expansion. Given the pressures for raising taxes, there are serious worries that the government will not renegade on this approach.
There is also need for clarity on the number of companies which may be merged. We have three companies in downstream sector (IOC, BPCL and HPCL) distributing oil products and one company (GAIL) distributing gas and LPG. There are two upstream producers (ONGC and OIL India). Any merger of all these companies will be considered anti-competitive behaviour. Since the network of private oil product distributors is limited, merger of all CPSU distributing oil products may be difficult to sustain. The mergers will have to be limited keeping this in mind. The competition commission will look at it closely and may not approve any wholesale merger of oil CPSUs.
Another factor that needs to be considered is that OIL India represents the aspirations of the people of North East India. The region is extremely sensitive about its resources and the merger of the company may appear to dilute this independence. The proposal to develop the oil major will have to keep this in mind. This will limit the extent of merger to develop a giant CPSU oil major.
The method of mergers and acquisitions will also need to be looked at from cost perspective too. In one approach, ONGC could purchase the majority share of the government. This could cost the company about $5-6 billion for acquiring a company like HPCL. However, the decision to do so would be costly for ONGC and deplete its capability to invest in expansion. As an alternative measure, ONGC could float new shares and offer it to shareholders of HPCL. This will involve HPCL shareholders, who may not be willing to take these new shares. Some sweeteners, therefore, will almost certainly be needed for mergers to go through.
We also need to consider this idea from an oil security perspective. It is necessary to consider its implications for continued availability of oil and LPG when there are calls for strike by the employee union of the new giant oil major. The risks will have to be weighed against such calls when there are a number of oil companies with their own unions which may take a different view on the strike call. Clearly, when it comes to the potential disruption in supply of essential goods such as petrol, diesel and LPG, the risk with a single union will be higher as against multiple unions.
Given the problem of resource raising, India’s fiscal consolidation path, previous unhappy experiences, the needs of energy security, the aspirations of people in the north east and our legal regime, the benefits of developing a giant oil major have to be assessed. It will be a long grind and the government will have to support such a company by providing full freedom of operation or face disaster.
B.K. Chaturvedi is a former cabinet secretary and former member of the Planning Commission.
