Although the oil giant has an enviable headstart, that is only IOC's to lose post-decontrol.

By Ranju Sarkar

Lighting up the night-sky as far as the eye can see, the Rs 59,176-crore Indian Oil Corporation's (IOC) 7.50-million tonnes per annum (TPA) continuous catalytic cracker at Mathura is hard at work. Inside the 1,080-acre complex, consultants from the Rs 311.20--crore Engineers India are busy putting up 2 new units: a Rs 308-crore diesel hydro-desulphurisation unit, and a Rs 1,048-crore hydrocracker unit. By switching over to cheaper crude, the former will help IOC save Rs 3.60 for every barrel of crude it processes. And the hydrocracker will help IOC optimise its product-mix by adding to its output of middle distillates, like diesel and kerosene. But, barely 200 yards away, leaking steam--heat, thus energy--envelopes most of the equipment in the process area.

That is the paradox of being IOC, the only Indian company that is listed in the Fortune 500, 1998. In terms of size, scope, and stature, IOC is sine qua non. Its closest rivals, the Rs 14,383-crore Hindustan Petroleum Corporation Ltd (hpcl) and the Rs 11,833-crore Bharat Petroleum Corporation Ltd (BPCL), lag far behind. And newcomers setting up their refineries, like Reliance Petroleum and the Rs 278.40-crore Essar Oil, have barely got off the starting-block. Now, the gargantuan public sector company is flexing its muscle--built on a diet of fixed prices and returns, and a neatly carved-up market--in anticipation of the deregulation of the country's petroleum sector.

Come April 1, 2002--and IOC will be competing against private and foreign oil majors in a free market. Says M.A. Pathan, the 56-year-old ceo of the company: "Our endeavour is to not only retain our marketshare, but also improve our penetration over a period of time." To meet the challenge, IOC will spend Rs 24,000 crore over the next 5 years to benchmark its operations; upgrade and expand its refineries; set up new pipelines, terminals and depots; spruce up its retail network; set up marketing joint ventures; and foray into the power, petrochemicals, and oil exploration & production sectors.

While IOC has not been found wanting in thinking bigger and better, doubts surface like oil in water. Warns Jagjit S. Yadav, 58, the Managing Director (India) of the $45.19-billion Texaco: "Operating in a regulated environment is like fishing in a barrel: you are certain of the outcome." Particularly as IOC is plagued by ancient process technologies, high refinery- and energy-losses, and gross over-staffing. Will the company best-placed to take advantage of deregulation be able to transfigure the sum of its many parts to take effective pricing and investment decisions? Or has IOC got used to the warm shelter of a regulated environment? BT examines IOC's strategy to, and beyond, 2002.

Refining. With an output of 27 million TPA from 6 of the country's 14 refineries, IOC owns and operates 40 per cent of the country's refining capacity of 67.50 million TPA, which translates into a marketshare of 55 per cent. Now, the Oil Co-ordination Committee and the Ministry of Petroleum & Natural Gas have estimated the demand for petroleum products at 127 million TPA in 2002, which will be fed by a domestic refining-capacity of 114 million TPA. If IOC has to sustain its 55 per cent marketshare, it will have to build an additional 18.60 million TPA of refining capacity, and retain its marketing rights over 16.85 million tpa with standalone refineries.

While the commissioning of the 6-million TPA Panipat refinery will take IOC's installed capacity to 32 million TPA, it is banking on low-cost expansions, the de-bottlenecking of its existing refineries, and grassroots refineries to bridge the gap. So, IOC plans to set up a 9-million tonne refinery at Paradip (Orissa) in a joint venture with the Kuwait Oil Corporation (to be commissioned in 2001), and another 9-million tonne refinery at Nagapatnam (Tamil Nadu) in a joint venture with the Rs 2,720-crore Madras Refineries Ltd (MRL) (to be commissioned in 2004).

However, as many refinery projects may not get off the ground--for instance, Shell recently shelved its 7 million-TPA refinery project with BPCL--demand will continue to polevault capacity. And, as long as there's a tariff differential--the Customs duty on crude oil is 22 per cent while the average duty on petroleum products is between 25 and 26 per cent--margins are assured for Indian refineries. This weighted average protection for domestic refineries will increase from 2.70 per cent in 1997-98 to around 12.10 per cent by 2002. Points out P. Sugavanam, 52, Director (Finance), IOC: "Margins will be affected only if crude prices go up, petroleum product prices fall, and tariff-protection is withdrawn."

While such a combination of the 3 is unlikely, the flow of those margins will depend, to a large extent, on the flexibility of IOC's refineries, which are fully depreciated. Explains S.C. Mathur, 53, the CEO of the Rs 18-crore Triune Projects, an engineering & consultancy firm: "By changing the temperature and pressure in the main fractionation column in the crude distillation unit, it is possible to vary the production of various products by plus-minus 20 per cent."

This ability to alter the product-mix--typically, lighter distillates (like gasoline and naphtha) fetch better prices, but the demand for middle distillates (like kerosene and diesel) is higher in India--could make a significant difference to the post-decontrol bottomline. While IOC's Koyali and Mathura refineries can produce a wide range of products, the commissioning of secondary units--like a delayed-coking unit and a dewaxing unit at Barauni--will significantly improve distillate yields. Currently, 35-40 per cent of the output in some of IOC's older refineries consists of heavier ends, where realisations are lower than middle or light distillates. But IOC's new hydrocrackers will allow its refineries to maximise the production of middle distillates.

Adds H.K. Khan, a former secretary in the Ministry of Petroleum & Natural Gas: "Some of IOC's refineries are too small in size to compete with international scales." With global refining scales anywhere between 15-25 million TPA, some of IOC's refineries are dwarfs in comparison: Digboi (0.65 million TPA), Guwahati (1.00), Barauni (3.30), and Haldia (3.75). As a beginning, IOC's new refineries at Paradip and Nagapatnam will be competitively-sized at 9 million TPA each, and it is expanding the capacity of its 9.50-million TPA Koyali refinery and the 6-million TPA Panipat refinery by 3 million TPA each.

Agrees A.K. Arora, 55, Director (Refineries), IOC: "We need to upgrade the size of our refineries, but with respect to the market." The company also has to squeeze more out of, and cut on energy losses in, its refineries, which are based on process technologies more than a decade-and-half old. Warns Mathur: "While HPCL and BPCL have upgraded their refineries, IOC has done little so far." That's why IOC is now benchmarking its refinery operations against international standards.

Marketing. The search for margins in the petroleum business begins with refining, and peaks with the marketing of petroleum products. In a deregulated market, like the US, the margins from marketing are higher than those from refining: against an average refining margin of $2.70 per barrel in the US, the average marketing margin is $5.70 per barrel. In comparison, the gross refining margins in this country are $2.50 per barrel while marketing margins are between $1 and $1.50 per barrel.

Of course, the reason for this is that marketing is still controlled, and returns--fixed at 12 per cent--are based on investments in net fixed assets. But that will change after April, 2002, when restrictions on expansion of outlets will be removed. That's why IOC is upgrading and expanding its retail reach--6,779 gas stations, 3,423 kerosene/ldo dealers, and 2,902 LPG distributors in 1,335 towns--which is supported by a marketing infrastructure of 4,058 km of product-and-crude pipelines, 184 terminals and depots, 92 aviation fuel stations, and 43 LPG-bottling plants. It would take the competition years, nay, decades, to develop a similar network. But, warns Pathan: "In a free-market scenario, we must have strong infrastructure to service the customer and strengthen facilities at port locations to ease congestion."

The urgency: attracted by the high margins in marketing downstream products--like lubricants--the private sector refineries and foreign oil majors will get into retailing, sooner or later. Explains Sugavanam: "There's lots of money in marketing lubricants and value-added products like benzene, toluene, and paraffin-wax." For the moment, the foreign oil majors can set up their own gas-stations only if they invest at least Rs 2,000 crore in refining.

So, on October 28, 1998, the IOC board cleared two 50:50 joint ventures with Reliance Petroleum and Essar Oil to market their products. Meant to commence operations in 2002, these units will have distinct logos and brands. The company is also zealously trying to retain the marketing rights of stand-alone refineries, like MRL, the Rs 4,366-crore Cochin Refineries, and the Rs 917.80-crore Bongaigon Refinery & Petrochemicals, which, in turn, are eager to market their products themselves.

Finally, at the retail level, IOC is upgrading its outlets: in the metros, 354 Vision 2000 outlets--with convenience shopping--have been set up while 3,500 B-site outlets have been upgraded with Vision 2000 colours. IOC is setting up 40 Jubilee outlets--company-owned-and-operated mega bunks on national highways, spanning 3.50 to 5 acres--with an investment of Rs 90 crore.While IOC's marketing infrastructure is its greatest asset, competition at the gas-station will be dictated by brand pull and advertising. Here, the deregulation of the lubricants market in 1992 is an example of what could go wrong: between 1994 and 1997, the marketshare of IOC's Servo slipped from 48.30 per cent to 39.70 per cent.

To impart flexibility, IOC is restructuring its marketing around 15 state offices--which will report directly to the head-office in Mumbai--while delayering its divisional and regional offices, which will only retain some functions like legal monitoring. Delegating decision-making to the IOC's employees at the ground-level will be crucial in analysing the performance of each station and building up customer profiles. Says Khan: "While IOC will strive to achieve greater efficiency in its refining operations, marketing is likely to be its thrust area"

Diversifications. IOC wants to be a fully-integrated energy corporation. That's why it has formed a joint venture with ONGC Videsh to tap E&P opportunities abroad, and will be bidding for oil blocks being offered under the New Exploration & Licensing Policy with Petronas. Warns Sundeep Bhandari, 35, director, Petrodrill, a Delhi-based E&P consultancy: "Considering that it is all risk money, you can't get into the e&p business by asking how much money you're going to make in this venture." Moreover, production ventures overseas operate on thin margins--the returns are, typically, a few percentage points above the London Interbank Offered Rate (libor)--which is hardly lucrative from IOC's point of view.

Simultaneously, IOC is diversifying into power and petrochemicals. For instance, it will use fuel-oil as feedstock to produce 1,750 mw of power at Panipat, Savli, Kosikalan, Haldia, and Bhatinda at a cost of Rs 7,606 crore. While the Panipat refinery will recover propylene, the Koyali refinery is recovering intermediate products, like food-grade hexane and methyl tertiary butyl ether, an additive used to enhance octane in motor spirit. Managed well, the foray into power will enhance IOC's returns. However, the company seems to be testing the waters in petrochemicals and E&P without a long-term strategy.

Human resources. IOC employs 33,403 people. Although the company has attracted talent over the years, over-staffing remains a problem, especially in IOC's refineries. IOC is trying to cope with the problem by benchmarking its manpower and redeploying people. Says Pathan: "As we upgrade our technology, we shall redeploy people from our existing operations into our new projects." Indeed, IOC has stretched its manpower requirements for its expansions: its employee strength has hovered around 33,300 over the last 5 years. Last year it recruited only 171 employees.

Changing the work-culture of its employees is the real challenge. Agrees Pathan: "We must change the mindset by making employees feel accountable for their actions." While the company has initiated a dialogue with the unions, IOC has a long way to go. Also, the company faces the threat of losing top-notch talent to the private sector. Says Pathan: "The private sector will find it tough to attract a very large number of our employees. But the threat is always there."

Across the world, the experience of oil companies reveals that the roadmap from a regulated to an unregulated environment has been arduous. Says Yadav: "The transition is, generally, painful. If someone says that it is not, he is lying." And so it will be for IOC despite an enviable headstart. With the clock ticking to decontrol day, IOC has enough on its plate--in terms of its marketing engine, refineries, and workforce--to worry about diversifications. In this age of specialisation, IOC has to decide the kind of energy corporation it wants to be if it is to stay synonymous with the business.

A slippery situation

It's an ill-timed disinvestment--that may just work. Recently, the Government Of India postponed the $350 million Global Depository Receipts (GDRs) issue through which it plans to divest its holding in IOC from 91 to 81 per cent. With the prices of crude oil and petroleum products running low--crude is down from $22 per barrel in 1997 to $12-14 now--the Euroissue has been postponed till the first quarter of 1999. Says an analyst with an FII: "We were expecting the issue to close by the third week of December, 1998. I don't know how good the market will be in the first quarter of 1999."

Compounding matters is the fact that the IOC scrip has fallen by 52.07 per cent this year: from a 12-month high of Rs 810 on January 5, 1998, on the Bombay Stock Exchange to Rs 388.25 on October 20, 1998. Warns Sanjiv Joshi, 28, an analyst with DBS Securities: "Considering the situation, it would be difficult to sell the GDR."

At best, the government can hope to price the GDR at a premium of 3 per cent. But, given the IOC's public float of 3.50 per cent, there is a lot of FII interest in the scrip. In case there isn't an oil rush, dollar-denominated GDRs will also be offered to the financial institutions in rupee terms. Pity about the premium, though.

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