ONGC-HPCL Merger: Risky Deal?

Amidst growing industry concern and market uncertainties, the government has apparently decided to go ahead with the mega merger of India’s oil sector as was proposed in the Budget. If sources at the oil ministry are to be believed, the Prime Minister’s Office has already instructed it to kick start the process of a possible merger between India’s oil exploration leader ONGC and retailer Hindustan Petroleum Corporation (HPCL) in the first phase.

There are rumours that from the merger the government is likely to make a windfall by divesting its 51.11 per cent stake in HPCL, but finance ministry sources have confirmed that this deal is outside the government’s PSU divestment target.

On 1 February, finance minister Arun Jaitley had proposed in his fourth Budget speech government’s intention to consolidate the public sector oil companies.

“The government plans to form a major oil company by merging some of the existing firms in the oil and gas sector to take on international and domestic players...” he had announced in the Budget.

Exactly a month after the announcement, the industry was abuzz with talks of India’s third largest oil retailer HPCL being acquired by the country’s largest oil explorer ONGC in a Rs 44,000-crore deal, which triggered an instant negative market reaction on oil stocks.

Acquisition Vs Merger
Although an official confirmation of a deal between ONGC and HPCL is still awaited, analysts believe the government is evaluating different structures for the deal. While a merger of the two through a transfer of government equity in HPCL to ONGC, making the latter a holding company, has the highest possibility, an all-equity deal can just well be worked out with share swap between the companies.

But clearly, the option of ONGC buying the government’s entire 51.11 per cent stake in HPCL, and following it up with an open offer to acquire an additional 26 per cent from the other shareholders of HPCL, as some reports suggested, seems unlikely in the current scenario.

The government currently owns 68.93 per cent equity in ONGC, and 51.11 percent stake in HPCL. The other shareholders in ONGC include Indian Oil Corporation (7.7 per cent), Gas Authority of India (2.4 per cent), and the rest is held by public. While, the public shareholding in HPCL is 48.89 per cent.

While the petroleum ministry, which holds the government stake in both these companies, want to keep the decision confidential at the moment, other industry stakeholders and analysts have shared mixed takes on the possible challenges of integrating a downstream player with an upstream giant.

Faulty Mix
The rationale behind the proposed merger, involving an explorer and a retailer, seems to be mainly risk aversion. It’s said that with the combined entity, any rise in crude prices would benefit the exploration vertical, while a drop in price would aid refining and distribution activities. However, a section of the industry stakeholders including analysts do not support it as this situation is no more relevant in the current global scenario.

BW Businessworld in its cover story — Oil & Gas: Mega Merger — in the 6 February issue had quoted some industry insiders and sector experts saying integration of the said entities can prove to be highly challenging in the Indian context. And those skeptical of the overall concept of the mixed merger, had said what would rather make sense is a structural reformation by integrating upstream and downstream players separately.

According to a senior industry consultant, India can evaluate the merits of consolidation on the basis of segment such as upstream and downstream separately in oil and gas. “Such consolidation gives the benefit of balance sheet size and focus, resulting in lower costs of capital and ability to execute large domestic and global projects,” said Ajay Arora, partner and national leader (Oil & Gas Practice) at EY India.

Inherent Challenges
While making ONGC a holding company as the government transfers its stake in HPCL looks most suitable, a business and operational integration will certainly be a challenge, considering the different culture of the two companies. Industry experts fear that since the work atmosphere and culture of exploration and marketing companies are widely varied, an integration plan may become rather counterproductive.

A recent Fitch report, though supported the government proposal to merge the state-owned oil companies, both upstream and downstream, as that can reduce inefficiencies and improve competencies, it said such a plan could lead to execution challenges and not be good for consumers and competition.

“There will be considerable difficulties in merging a number of entities with differing structures, operational systems and cultures,” a Fitch analyst cautioned in the report.

The other key challenges, likely to arise in such mergers, are job cuts, personnel-related issues and managing hierarchies.

While the government could also consider merger of other entities or creation of bigger blocks of upstream and downstream companies to take on the local and global completion, experts caution that any such decision would necessarily need to be debated and addressed in the context of India’s diverse energy needs and global energy outlook.