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Who will benefit from the HPCL – ONGC merger?

Companies and Sectors | Published on Jul 17th 2017 | Comment(s) 0
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Even as the details of the proposed merger of HPCL into ONGC are expected by the end of July, the broad contours of the deal are already out. The government of India holds 51.11% stake in HPCL and that stake will be hived off to ONGC. As is known, ONGC is India’s largest extraction company while HPCL, BPCL and IOCL are the key downstream companies in India. While IOCL had for long dominated the refining business and HPCL and BPCL had focused on marketing and distribution, those demarcations are gradually diminishing. Very soon private layers like British Petroleum and Reliance are expected to create a much bigger footprint in the oil marketing business. It is in this changing scenario that the merger of ONGC and HPCL needs to be seen.

Global oil model is one of consolidation…

Some of the world’s largest oil players like Exxon, Chevron, Shell, Total, ENI and Saudi Aramco are end-to-end conglomerates. In India, the activities like extraction, refining, distribution and retailing were traditionally kept distinct. The idea was to help create focus and specialization in each of the sub-segments of the hydrocarbon business. The global model is one of consolidation and not of specialization. For example companies like Exxon and Shell operate in extraction, offshore drilling, and refining, marketing, gas and also in downstream petrochemicals. The only company in India that has attempted that kind of deep forward and backward linkages is Reliance Industries which is present in the entire hydrocarbon value chain from extraction to petrochemicals. That is the model that the government wants the oil sector in India to move towards. In the last budget, finance minister Arun Jaitley had mooted the idea of creating an oil conglomerate which will span the entire gamut of hydrocarbons. It is in this light that this proposed merger of HPCL into ONGC must be seen.

Something much more than disinvestment…

The proposed merger of HPCL into ONGC will help the government realise nearly $4.5 billion for its 51% stake in HPCL. That will surely go a long way in helping the government meet this year’s divestment target of $12 billion. But this merger is much beyond that. This merger needs to be seen in the light of the government’s efforts to move towards greater self-sufficiency in oil consumption. Currently, India depends on global crude imports for meeting nearly 85% of its daily crude oil requirement. This could create a peculiar situation in the event of geopolitical troubles which could impede the traditional trade routes for oil. For this it is essential to ensure that the government retains a semblance of control over these oil companies; either directly or indirectly. By making HPCL a subsidiary of ONGC, the government will be able to raise money for its divestment targets but at the same time the indirect control over oil will continue to predominantly reside with the government.  In the process, the hefty dividend payouts of the oil companies will also reside within government control.

Indian oil companies need a much bigger balance sheet…

The oil extraction capacity of ONGC is substantially lower when compared to global giants like Exxon, Shell, Aramco and China Petro. Growing India’s oil capacity organically will be too time consuming and may not be a feasible solution. The answer will be inorganic growth. For Indian oil companies to even think of acquisition of oil properties in other countries will require a much bigger balance sheet. The merger of ONGC and HPCL may just be the beginning. A larger merger of oil companies will give the holding company a much bigger balance sheet to leverage and raise the necessary resources to undertake major global acquisitions. It is from this larger inorganic perspective that the merger of ONGC and HPCL needs to be seen.

HPCL will be a subsidiary and will not be a merger…

The good news from the perspective of HPCL shareholders is that HPCL will become a subsidiary of ONGC. As a majority shareholder of HPCL, it will be within the means of ONGC to leverage the balance sheet of HPCL. The apprehension is that a full merger will not be value accretive to the shareholders of HPCL, which has enjoyed a 900% appreciation in price in the last 3 years. That is because; HPCL and BPCL have been the two biggest beneficiaries of the free pricing of petrol and diesel. If HPCL just becomes a subsidiary of ONGC, then the twin purposes of a bigger balance sheet of ONGC and protecting the interests of HPCL shareholders will be met. Of course, funding will be an issue as ONGC has cash reserves of just $2 billion on its books. Hence this deal will have to be partially funded by the government. 

A conglomerate will be a better cushion against volatility…

Last, but not the least, the consolidation will also de-risk the business model of ONGC. An inordinately large focus on crude oil extraction will make ONGC vulnerable to weak oil prices. With the OPEC cuts ineffective and countries like the US, Nigeria and Libya flooding the oil market, pressure on oil prices may be here to stay. By creating a single conglomerate spanning the entire value chain of hydrocarbons, model can be substantially de-risked.

The final contours of the actual deal will only be known once the finer points are announced. But, on paper, it is likely to be value accretive for the upstream and the downstream participants.

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