• ONGC’s proposed HPCL acquisition needs more thought

    The Government had announced in this year’s Budget its intention to strengthen its oil PSUs through a mega merger so that they could ostensibly compete with some of the largest global petroleum companies. Such a merger would ostensibly increase their capacity in terms of risk taking, availing economies of scale, creating better value for the stakeholders, improving efficiency etc.
    More recently, it appears that the acquisition of Oil Marketing Company (OMC) HPCL is being considered by the flagship upstream PSU ONGC. This might be the easiest of the possible combinations given the Government’s share in HPCL is just a tad over 50 percent and the firm was earlier considered for divestment (before the Supreme Court put a spanner in the works).

    However, the question to be asked is whether such a development would help the companies in question and help achieve the objectives outlined by the Finance Minister.This is especially relevant as the acquisition will be expensive for ONGC. It is expected, for example, that the Government could get around $4-4.5 billion; and ONGC will also likely have to fork out funds to pay the public for an open offer besides what it pays the Government for its stake (or part of it).

    The Government, while propounding the idea of a merger, drew reference to the global oil majors such as Exxon, Shell, BP etc besides the large Chinese firms which have out-competed ONGC in the past while acquiring assets outside India. But whether ONGC would be left with the financial muscle to compete with these firms after paying billions of dollars to acquire HPCL and consequently witnessing very substantial increase in its debt, remains to be seen.

    It is quite likely that after paying for HPCL, it could struggle to raise funds for any other major acquisition, or have to pay higher interest rates in line with a lower credit rating given the higher debt on its Balance Sheet. The bottom line is whether ONGC would actually be strengthened to take on the might of Chinese firms or an Exxon post the proposed acquisition is certainly questionable.

    ONGC would be far better served by instead acquiring a technically competent mid-sized foreign upstream player. This would help it get more from existing fields, some of in which it is struggling (Imperial comes to mind), or bid for higher stakes and operatorship when it makes acquisitions abroad (currently it has largely taken minority stakes and is not the operator; its technical competence in deepwater fields needs to be better).

    It is also worth noting that ONGC will have to grapple with the acquisition of the ‘Deendayal’ gas field from GSPC. ONGC’s energy and funds could well end up being spent into managing and integrating these two acquisitions instead of focusing and growing its core business, where its production has been stagnating.

    It is true that a downstream firm such as HPCL would be somewhat insulated from higher oil prices through a combination with an upstream firm (although the Government was compensating it earlier and with the recent reforms in pricing of petrol, diesel, LPG and kerosene, it should be already in a better position to tide over commodity cycles than earlier). In that case, one may say that since it would be the beneficiary, it should be leading the acquisition.

    Therefore, should not HPCL be looking to acquire an upstream firm itself rather than be acquired? The time is right because HPCL’s balance sheet is looking far better after the recent few years of relatively subdued oil prices. There is upside potential for HPCL should crude oil prices rise- it could pay relatively less at present for an acquisition and see the value of the acquired firm rise with a possible increase in crude prices.

    Following this line of thought, while HPCL could look to acquire PSU firm Oil India Ltd (OIL), it seems a better strategy for it to acquire a mid-sized foreign crude oil producer to diversify its risks.

    All in all, the Government needs to perhaps think more carefully before pushing ahead with the plans announced in the Budget regarding combining one or more of its PSUs. Size may matter, but the right combinations also do. Else, far from meeting the objectives, the Government may find its flagship PSUs weakened rather than strengthened. Joe Looney Authentic Jersey

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