The Cabinet Committee on Economic Affairs [CCEA] has taken an in-principle decision to divest 51% of Union Government’s shareholding in Hindustan Petroleum Corporation Limited [HPCL] – a downstream central public sector undertaking [PSU] – in favor of Oil and Natural Gas Corporation [ONGC] – a PSU in upstream segment. A group of ministers [GOM] under finance minister, Arun Jaitely has been set up to work out the modalities. The merger is expected to be completed within the current year.
The decision is a follow-up of the announcement by Jaitley in his budget speech for 2017-18 to create 2 or 3 integrated oil and gas companies by merging existing PSUs which can compete with energy majors in the private sector – both within India and abroad.
A bigger entity yields economies of scale and enhanced synergies in turn, leading to higher operational efficiency and lower cost. It can generate higher internal surplus which gives it the leverage to garner larger sums from investors – both as equity capital as well as debt. The funding of capital expenditure thus becomes that much easier enabling expansion and growth on the required scale. This is a standard argument applicable to merger of any business.
In the said context however, the real guiding principle is to integrate under one roof exploration/production business on one hand and refining and retailing on the other [this is in consonance with global practice]. The former is the source of raw material [RM] viz. crude and natural gas whereas the latter uses these for making a variety of petroleum products such as diesel, petrol, LPG, ATF [aviation turbine fuel], naphtha etc. The integration gives to the unified entity enough flexibility to smoothen out the ups and downs in different segments.
When, international prices of crude and gas are declining, the businesses in the upstream segment suffer as realization from sale goes down. However, for an integrated entity this is compensated by gains in the downstream segment [lower RM cost leads to better refinery margin]. In a reverse scenario when crude and gas prices increase, downstream may lose [higher RM cost squeezes refinery margin] but there is corresponding gain in the upstream business.
But, in India, things may not work out in exactly the same way. This is because we are heavily dependent on import viz. 80% of our crude requirements and 35% of natural gas. In this backdrop, the entity emerging out of merger will be weighed heavily towards the downstream segment. This won’t be conducive to realizing the full potential of integration. For instance, when crude and gas price increase, even as refinery margins get squeezed, there is no commensurate benefit to upstream segment [courtesy, low production].
Our focus should therefore, be on building up our own capability for production of crude and gas. Whether ONGC is enabled to do it under subsisting structure or this could be better done post-creation of a merged entity, the key point is they should get requisite resources for funding the much needed exploration and development efforts [current pace is very slow, the last major discovery by ONGC viz. Neelam field was over three-and-a-half decades ago in the 80s].
Will the government’s proposal help? In this regard, the normal capital expenditure requirement of ONGC is over Rs 30,000 crores annually as against its current cash balance of only Rs 13,000 crores. So, already there is a deficit even as the balance has to be met by borrowings. Unfortunately, the manner in which merger is being contemplated does not instill confidence.
ONGC will acquire 51% shareholding of Union Government in HPCL for which it will have to shell out about Rs 30,000 crores. The pay-out could have been more had it not been exempt from ‘take-over’ regulations which require the acquirer to make an open offer to minority shareholders [exemption is granted on the ground that even after acquisition, there won’t be any change of control].
Far from helping, this will further incapacitate ONGC in funding its capital expenditure even at existing normal level [not to talk of spend required for substantial increase in indigenous production]. One of the major objectives of merger is to enable increase in self-reliance which will be defeated in the event of pursuing the said course.
On a close scrutiny, it turns out that the overriding objective of the exercise is to garner resources to meet the target of disinvestment for the current year. Against the target of Rs 72,000 crores, the proceeds from selling shares of HPCL alone would fetch Rs 30,000 crores or 42%. It would appear that the real intent was to plug budget deficit and the same is getting camouflaged as merger.
There would have been no room for suspicion if only the deal had been structured in a manner so as to ensure that ONGC didn’t have to shell out any money. This would require merger of HPCL with ONGC to create a new entity say ‘X’ or OGHP [the two PSUs would cease to exist as independent entities]; instead of the proposed structure wherein former becomes a wholly owned subsidiary of the latter.
On the other hand, if the intention was to go only for disinvestment per se then, the government could have said so and gone straightaway for selling the shares to public. True, in such a scenario, there was no guarantee that it would get the target amount whereas, under the chosen route it was certain to get. So, it decided to go for selling 51% shares to ONGC and yet, propound it as merger – a clear sign of wanting to have the cake and eat it too!
The present action of Modi – government looks anomalous when seen in the backdrop of its actions in recent past of boosting internal resources of ONGC by (i) paying for its mammoth royalty liability on crude supplies to downstream oil PSUs about Rs 12,500 crores for the period April 1, 2008 and January 2014 [arising from Supreme Court decision in February, 2017] and (ii) freeing it from the burden of discount from 2016-17 onward [in the past, the then UPA – dispensation sucked out huge over Rs 200,000 crores via this route].
It needs to go on a correction course.