M&A Critique

In unity lies Strength

The Ministry of Petroleum and Natural Gas has proposed a merger of all 13 public sector oil companies into one behemoth, an idea which was first mooted by former minister Mani Shankar Aiyar as per the recommendations of V Krishnamurthy’s Synergy in Energy panel in 2005. The proposed merger will create a giant with global scale and financial strength to stand among the largest in the hydrocarbon sector globally. Even years before, the country’s largest oil and gas exploration firm – ONGC — wanted a merger to bring upstream, downstream, transmission and engineering business under one umbrella.

Upstream oil companies like Oil and Natural Gas Corporation (ONGC) and Oil India Limited (OIL) and downstream companies like Hindustan Petroleum Corporation Ltd (HPCL), Bharat Petroleum Corporation Ltd (BPCL), Indian Oil Corporation (IOC), Mangalore Refinery and Petrochemicals (MRPL), Chennai Petroleum and Numaligarh Refinery are being considered for the merger. The merger can help in achieving economies of scale, bring inefficiencies and help in acquiring foreign oil equity which would make India energy secured. The merger will bode well for the operations of the oil companies as crude oil and various refinery products have a different price cycle and an integrated oil company can have smoother earnings cycle.

There are synergies to be got from merging oil marketing companies. India can negotiate pricing of crude purchase in the global market as it will be one source for crude imports in very bulk quantity — crude oil is India’s largest import. Retail outlets can be optimized across the country and there is a possibility to make savings in terms of labor rationalization as well. It is a common sight to see retail outlets or terminals of IOC, HPCL and BPCL next to one another in many parts of the country. If the eventual goal is to provide fuel supply, it may just be a better option to create a new company within whose fold the three refiners can jointly function and create allied infrastructure like a pipeline, tankers, etc. If the proposed merger comes through, it will be very beneficial for smaller refiners like MRPL and Chennai Petroleum, which suffer from volatile earnings.

Given how oil refining-marketing companies like IOC have already acquired some oil exploration blocks, they are moving towards becoming integrated players, and so a merger makes even more sense. For records, HPCL and BPCL among themselves control more than 90% of the domestic market for petroleum products. Their merger will mean a single entity controlling the market. Also, with the collapse in global oil prices, it is once-in-a-generation opportunity for India to acquire global assets cheap. This will be a smart way to hedge Asia’s third largest economy against future increases in energy prices. So, a larger company in the global arena can benefit in such deals.

Synergies in the merger

The merger of state-owned oil firms will create synergy and boost efficiency. Both ONGC and OIL – the exploration companies – are hit in terms of profits because of the downturn in global crude prices. For companies with income only from exploration, an oil price fall means an immediate hit to profits. So it is in the interest of exploration and production firms to get merged with oil marketing companies and they can use additional funds for exploration activities.  The oil companies such as ONGC, BPCL, and IOC are navratnas with considerable operational autonomy but are answerable to the ministry of petroleum. If the merger takes place properly there would be benefits of scale, natural hedge as well as synergies.

Vertical integration between upstream – exploration and production – and downstream – refining and marketing – business activities offer a winning formula for capturing market share and growing shareholder value. Mergers send a powerful positive signal to the market about a company’s intention to rationalise and grow. There are lots of benefits in having a huge balance sheet and a higher market capitalization. It will enable the companies, especially ONGC, to easier access and cheaper capital to pursue exploration activities in India and abroad. A larger balance sheet and a vertically integrated company will protect it from cyclicalties of the global oil market. With growing competition from multi-national companies, the size of the company does matter a lot when companies look for foreign exploration assets. In fact, the Chinese petroleum companies have become one of the largest because of their size and have a natural advantage over Indian companies.

In the downstream sector, the proposed merger of three companies – Indian Oil Corporation, Bharat Petroleum and Hindustan Petroleum – will together bridge the gap and make synergy in back-end and logistics. For HPCL, it should be welcome news as its Maharashtra refinery proposed in Ratnagiri has not made much headway and even at its refinery in Rajasthan.

The challenges for the merger

Mergers of state-owned oil companies will involve a host of legal and organisation challenges. Since Hindustan Petroleum Corporation Limited (HPLC) and Bharat Petroleum Corporation Limited (BPCL) were nationalized through a law approved by Parliament, the government will have to bring in legislative changes to alter the structure of these two companies. To look back at the past, BPCL, which was formed in 1977, was earlier known as Burmah Shell, which was taken over by the government of India. It was the first refinery to process the indigenous crude from Bombay High. Similarly, HPCL was formed in 1974 after the merger of Esso Standard and Lube India Ltd by the Indian government.

The Competition Commission of India (CCI) may put a hurdle as the proposed merged entity will become a monopoly in the domestic market. Even in the past PSU oil marketing companies had run-ins with the CCI on cartelization regarding supply of aviation fuel at the airports and diesel tenders for Indian Railways. However, the government can use the provision in the Competition Act, which allows companies to be exempt from the anti-monopoly law of public interest or national security. The merger, however, will have limited impact on employees as there is very little overlap in the operations of the downstream companies.

Past brush with merger

In the past, the government tried merger between IOC and ONGC to create a mega entity in the upstream and downstream space. The two companies had come together in the late 1990s to combine their skills in areas like refining, exploration, power, and petrochemicals, but it did not go according to the plan. Even ONGC had plans of picking up stake in BPCL’s Bina refinery as part of its vision to enter the downstream space and eventually, got a bigger foothold in the marketing arena through its acquisition of Mangalore Refinery and Petrochemicals. But eventually, the company had to keep its focus on exploration as India imports a large share of its crude requirements and increasing domestic availability is a top priority.

Financials of PSU oil companies


ONGC: The country’s largest upstream oil company reported a decline in net profit in 2015-16 to Rs 16,004 crore as compared to Rs 17,733 crore in 2014-15 because of the lower oil prices globally. However, the company’s crude oil production has risen for the second consecutive year in 2015-16 but natural gas output declined. ONGC produced 22.37 million ton of crude oil in the financial year ended March 31, 2016, a notch higher than 22.26 MT in the previous fiscal. In 2014-15 it had reversed a 7-year declining trend in crude oil production as it brought small and marginal fields in western offshore to production. ONGC used to produce more than three-fourth of country’s oil needs but that share has slipped down to 60 per cent now.

Oil India Ltd: It is the second largest hydrocarbon exploration company in the country with its operational headquarters in Duliajan, Assam. The company’s history spans the discovery of crude oil in the far east of India at Digboi, Assam in 1889 to its present status as a fully integrated upstream petroleum company. In 2015-16, it reported the net profit of Rs 2,330 crore, down 7% from Rs 2,510 crore reported in 2014-15.


Indian Oil Corporation: The country’s largest fuel retailer reported its highest ever net profit in a single year at Rs 10,399 crore in FY16, nearly double the level (Rs 5,273 crore) reported in FY15. This is despite its total income from operations dropping by 19.86% to Rs 3,50,603 crore in FY16 against Rs 4,37,524 crore in FY15. The company’s physical performance had improved, the company had cut down its costs and inventory losses have been less. Moreover, the profit was aided by a sharp drop in revenue loss or under-recoveries on sale of LPG and kerosene because of the crash in international oil prices. Under-recoveries dropped from Rs 39,758 crore in 2014-15 to Rs 7,757 crore in 2015-16. The refineries processed a record 56.2 million tons of crude oil 2015-16, up from 53.6 million tons in the previous year while fuel sales soared 6 per cent to record 72.7 million tons. IOC maintained its leadership position with 45.5 per cent market share in domestic fuel retail.

Hindustan Petroleum Corporation Ltd: Ranked at 327 in Fortune Global 500 list and 133 in the list of Platts Top 250 Global Energy Companies in the year 2015, HPCL recorded an impressive financial performance in 2015-16. It’s profit after tax was at Rs 3,863 crore, up from Rs 2,733 crore in 2014-15. During the period April – March 2016, the refineries have achieved highest ever crude throughput of 17.23 million tons, which is 116% of the total installed capacity, as against 16.18 million tons during the corresponding previous period April – March 2015. The company has a market share of 21.3% in the PSU category.

Bharat Petroleum Corporation Ltd:  It is India’s second largest oil marketing company commanding 21% of the domestic oil retail business with a turnover of 34.5 million metric tons. In 2015-16, the company reported a net profit of Rs 7,432 crore, up 46% from Rs 5,085 reported in 2014-15.

Global merger experience of oil companies

Globally, most of the oil companies which had merged were vertically integrated companies. In the late 1990s, falling oil prices prompted a wave of mergers in the sector globally as oil companies sought to bulk up in order to compete in tough times. In 1998, BP started the merger move when it forked over $48.2 billion to buy Amoco. A year later, Exxon bought Mobil for $82 billion and at that time the two companies were world number one and number two, respectively in revenues. Similarly, Shell bought BG Group in $70 billion deal and other oil companies followed up with their own acquisitions, including Chevron buying Texaco for $100 billion in 2000.

Post merger, Exxon-Mobil has consolidated its position as the top company in a deal that was memorable for uniting competitors. After the merger, the companies went for a massive restructuring. They achieved significant cost savings through the elimination or outsourcing of non-core functions, the rationalization of staff and cutbacks on overheads. They also re-jigged their portfolios and achieved a better balance by divesting or closing down business that was poor performers and at the same time pursuing new growth opportunities in large emerging markets like China. The recent merger of British Petroleum with American oil giant Amoco for $48.2 billion will enable the two companies to consolidate their spending on exploration. The deal will also enable them to become more competitive in regions like the Russia, China, and Latin America, where competition has increased as companies seek new sources of revenue.

As compared to global peers, Indian oil companies are very small. For instance, Exxon-Mobil is one of the world’s largest energy companies with a market valuation of $269 billion. Royal Dutch Shell is valued at $265 billion, and BP at $226 billion. On the other hand, ONGC’s turnover was $54 billion last year. A Larger balance sheet helps the global giants to take high risks and expand to new geographies to explore oil and gas. If the proposed merger goes through, a combined oil PSU entity from India could be amongst the top 15 energy companies in the world by market capitalization and would also rank among the regional behemoths.

To conclude, mergers do offer an opportunity for substantial value creation and the proposed merger of the state-owned oil companies should reach a logical conclusion in an endeavor to team up and remain competitive.

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M & A Critique