Policy Watch: A Slick Solution

The petroleum ministry is drawing up ambitious plans to help its units survive in a de-regulated market. Will it get the formula right?

In their second-floor offices in New Delhi's Shastri Bhavan, officials of the Ministry of Petroleum and Natural Gas are working overtime. Furiously punching the buttons on their calculators and poring over balance-sheets of two stand-alone public sector oil refineries-Chennai Petroleum Corporation Ltd (CPCL) and Bongaigaon Refinery & Petrochemicals Ltd-they're busy calculating the share prices and enterprise values of these companies.

Who'll get IBP?
Both IOC can BPCL are vying for it. But IBP prefers the open bidding option.

Even as the stand-alone public sector oil marketing company IBP is being readied for disinvestment, an unseemly battle is on for its control. It's understandable too. With 1,400 retail outlets, IBP is a prize catch for both established and new players in the oil sector. The Petroleum Ministry is in favour of Bharat Petroleum Corporation Ltd (BPCL) taking over IBP. But analysts don't agree. Says Pradeep Kumar, 26, Securities Analyst, First Global: ''It doesn't make sense for BPCL to take IBP when there's already a gap between its refining and marketing capacities.''

In any case, BPCL will have to fight it out with the Indian Oil Corporation, which staked its claim to IBP within hours of the disinvestment proposal being announced. Says Subir Raha, 52, Director (Human Resource Development), IOC: ''We have a strong case for IBP.'' IOC officials point out that IBP was carved out of IOC. What's more, IOC was forced to reduce the quantity of its products so that the other oil PSUs could come up. In a deregulated environment, IOC would have to increase production, for which it would need more outlets. Says Raha: ''As this limit on production was forced on us, we should be allowed to take over IBP to meet the marketing needs of our product range.''

That argument doesn't wash with IBP. Says a senior IBP official: ''The company stands to lose from this arrangement. IOC will cannibalise our market share.'' The company wants the privatisation to proceed through open bidding, with both domestic and foreign players being allowed to bid. This will be an interesting battle to watch.

If the Union Cabinet okays a proposal drawn up by the ministry to restructure the state-run oil sector (See Synergising for Strength), these two refineries will either be merged with the public sector refining and marketing company Indian Oil Corporation (IOC) or become its subsidiaries.

Next, ministry officials will begin a similar exercise for two other stand-alone refineries-Kochi Refineries Ltd (KRL) and Numaligarh Refineries Ltd (NRL)-which are to be integrated with the other public sector oil major, Bharat Petroleum Corporation Ltd (BPCL). The ministry is also thinking of merging the stand-alone marketing company IBP, with BPCL-something that makes IOC see red (See Who'll get IBP?).

If all goes well, the new alignments will be in place by year-end. ''It will be our endeavour to restructure the public sector undertakings (PSUs) and concretise the alliances by the end of this year,'' Union Petroleum Minister Ram Naik told BT in an earlier interview.

The restructuring plan is meant to make IOC and BPCL-where the government wants to reduce its stake to under 51 per cent-attractive buys. Says Naik, reiterating a point made by the government's Hydrocarbon Vision 2025 Report: ''The intrinsic value of the marketing firms will increase substantially when the stand-alone refineries are merged with them.''

Privatisation of oil PSUs may be difficult, given Naik's stiff opposition to the idea, but the proposed integration has a logic of its own. In the oil sector, big is not only beautiful, but is also the only way to survive. Globally, oil companies are integrated energy giants that are involved in activities ranging from exploration and production, to the marketing of products. The Indian oil PSUs pale in comparison. Even IOC, a Fortune 500 company, is no match for the might of an Exxon-Mobil or a BP-Amoco. As an IOC official remarks: ''Indian companies are small fish in global waters. They could easily be gobbled up by the sharks."

Right now, the oil PSUs are protected from no-holds-barred competition. Private players are allowed in all operations, except the marketing of products whose prices are controlled through the administered price mechanism (APM). But once APM is dismantled in 2002, the PSUs will have to slug it out with private players in a completely deregulated market. Laments Nitish Sengupta, 68, author of a 1998 report on restructuring the oil sector: ''Our oil PSUs are not equipped to cope with such an environment.'' Agrees Satyawati Berera, 40, Executive Director, PricewaterhouseCoopers: ''The oil PSUs need to be given a level playing field to be able to withstand competition.''

The stand-alone refineries will be particularly vulnerable. In the international market, refining margins are extremely thin, ranging between $1 and $3 a barrel. Marketing margins, on the other hand, are 3-4 per cent higher. Integration protects these refineries from the volatility of the international market by providing them with a dedicated marketing network. Asserts Rajiv Thakur, 31, Manager, ICRA: "Integration is essential in a free market."

If it happens, KRL and NRL will immediately gain access to BPCL's network of 4,500 retail outlets. Ditto for CPCL and Bongaigaon Refinery, whose products will get an assured market through IOC's 6,876 retail outlets. In addition, Bongaigaon Refinery will get a regular supply of imported crude through the proposed Haldia-Barauni-Bongaigaon pipeline. The Bongaigaon refinery has been operating below its 2.35 million tpa capacity for the last five years because of inadequate supply of crude.

It is not a win-win situation for the refineries alone. Downstream marketing companies also stand to gain from integration. They add to their product capacity and are assured guaranteed supplies of products, eliminating the need for maintaining huge inventories.

Take BPCL. With just one refinery of 6.9 million tpa at Mumbai, and a six-million tpa refinery yet to come up at Bina in Madhya Pradesh, there's a huge gap between BPCL's output and its marketing capacity. In 1999-2000, the company sold 18.86 million tonnes of petroleum products against a refinery throughput of 8.87 million tonnes.

Acquiring NRL and KRL's combined 8.5 million tpa capacity will help BPCL partly bridge this gap and offset the loss of CPCL's 6.5-million tpa output, when the latter is merged with IOC (CPCL and BPCL have a marketing tie-up right now).

Post-integration, BPCL's refining capacity will touch 17.37 million tpa, which is a much more comfortable position than at present, though it will still be product deficit. Assuming a 6-7 per cent growth in business, BPCL will need nearly 20 million tpa of petroleum products by 2002.

BPCL may also go slow on the Bina refinery project, a joint venture with the Oman Oil Company. With margins under strain and both India and the Asia-Pacific region facing a glut in production, the refinery business is hardly lucrative. While BPCL officially maintains that the project is on course, it is unlikely to rush it if it has other sources of supply.

The proposed alliances will also add to IOC's clout. The oil major has seven refineries that churn out 36.34 million tpa of products. Against this throughput, its retail outlets sell 46.05 million tonnes of products. Adding 9.35 million tpa from CPCL and the Bongaigaon Refinery will certainly help IOC partially fill the product deficit. Thakur, however, argues that given Bongaigaon refinery's low capacity, its acquisition will not help IOC substantially. IOC officials counter that given the poor demand in the North-East, the company can use the additional capacity elsewhere.

But there are other advantages too. The company gets access to areas where it does not have much of a presence. Subir Raha, 52, Director (Human Resource Development), IOC, points out that acquiring CPCL will give the company a foothold in the south where it has no refineries at present.

Will all this fetch a better price for the oil PSUs? And will it help them take on competition? Analysts are sure that integration would push up the valuations of IOC and BPCL. Thakur points out that post-integration, the companies will have a larger asset-base and net worth. Berera agrees that the value will rise, but more due to better management than anything else.

The new-look PSUs, he feels, will also give domestic private players like Reliance Petroleum and Essar Oil a run for their money. Reliance, however, makes light of this. Says a company spokesperson: ''There's enough room for everyone.''

An analyst with Kotak Securities is less optimistic about the PSUs. He concedes that IOC has a larger refining capacity than Reliance's 27-million-tpa refinery at Jamnagar. But, he points out, the Reliance plant can refine any kind of crude. This flexibility can be very important in a liberalised market. Oil PSUs, with their old refineries, do not have this edge.

They will, therefore, have to seek advantages elsewhere, forming joint ventures with private players, and beefing up their marketing muscle. Both IOC and BPCL are doing this. That, combined with the integration plan, should place these companies in a position to face the challenges of a free market.