The markets have been rife with expectations of ONGC taking a stake in HPCL eventually culminating in a full-fledged merger of ONGC and HPCL. In his Budget speech, Arun Jaitley had spoken at length about creating an oil behemoth which could take on the global oil giants in terms of size and influence. So how exactly, could the ONGC-HPCL deal be structured?
To begin with it is expected that ONGC will take over the 51.1% government stake in HPCL. At the current market price of HPCL, this works out to nearly Rs.29,000 crore. This will obviously trigger the Takeover Code and that means ONGC will have to make an offer to buy another 26% stake from the public, which will entail an investment of an additional Rs.15,000 crore. Thus for a total consideration of Rs.44,000 crore ($6.6 billion), ONGC will be able to acquire a 77.1% stake in HPCL. On the one hand it will help the government meet its divestment targets for the year with greater ease while the control of HPCL stays indirectly in the hands of a government company. But the perceived benefits are obviously much larger than merely helping the government achieve its disinvestment targets. There is a genuine business case for the same!
ONGC will get a much bigger balance sheet…
ONGC produces roughly 1.2 million barrels per day (bpd) of oil. Despite being the largest oil company in India and accounting for nearly 70% of India’s oil production, ONGC does not even figure in the Top-25 largest oil producers in the world. Consider some of the following numbers. Saudi Aramco produces nearly 12.5 million barrels per day while Gazprom of Russia and NIOC of Iran produce 9.7 million bpd and 6.7 million bpd respectively. Even companies from smaller oil producers like Venezuela, Brazil and Nigeria produce more barrels per day of oil compared to ONGC. Since the capacity to produce oil at lucrative rates in India is limited, ONGC needs to seriously look at global acquisitions to expand its footprint and that will require substantial balance sheet size. Combining HPCL gives the much needed boost to the balance sheet of ONGC.
ONGC has the pockets and the need to take over…
Make no mistake; ONGC is cash rich. The company is sitting on a cash pile of Rs.25,000 crore. Of course, special dividends and buybacks are options that are always available. But for an industry like oil extraction that is hungry for vertical growth, there are better ways to use the cash. The leverage ratio of ONGC is just about 0.30 and that means for the HPCL acquisition ONGC can use a mix of its own funds and borrowed funds. The low leverage ratio gives ONGC sufficient room to expand its debt without negatively impacting its financials.
The oil business is all about vertical integration…
The oil business globally is about vertical integration. Take any of the large oil companies in the world like Exxon, Shell, Aramco, Total or even ENI! All these are vertically integrated oil companies and operate in the complete value chain of the oil cycle. Globally, the same oil company is into extraction, refining and marketing. This presence across the value chain gives the company much greater control over the inputs and the output at various stages and in the process makes the entire value chain more efficient and seamless. We have seen in the case of a vertically integrated company like Reliance where the benefits of this integration are available across the value chain including refining and petrochemicals. Since ONGC largely operates in the upstream area and HPCL operates in the downstream area (refining + marketing), this will form the perfect fit.
Handling crude oil volatility more efficiently…
Globally, crude oil is likely to enter a very critical period which will be marked by high volatility. Consider the following facts… The OPEC and Russia will combine and curtail supply to ensure that oil prices, at least, stay above the $50/bbl mark. The US will have to strike a trade-off between getting more of its oil wells up and running and keeping oil prices at lucrative levels. And in the midst of this confusion, the world is running out of storage space. All this means that the volatility in oil prices is set to continue well into the next year. The big challenge for a large oil company like ONGC is how to handle this oil price volatility. If ONGC and HPCL get together then parts of the business will benefit rather than be overly dependent on only one directional move in oil prices. With oil prices being largely decontrolled in India and near-free pricing permitted, ONGC does not run the risk of having to subsidize high oil prices, at least up to a point.
These are early days and the deal is yet to evolve and will become clearer in the coming days. To begin with, it will surely help the government meet its disinvestment targets. But the entire effort will bear economic fruit if the actual synergies of the action are exploited to the full. That is something that remains to be seen!