Refining the oil industry

Raghuvir Srinivas

THE DECISION of the Government to sell its stake in the stand-alone refineries to Indian Oil Corporation (IOC) and Bharat Petroleum Corporation (BPCL) is only the first step in the long overdue restructuring of the oil industry.

Last week, the Government said it would sell its stake in Kochi Refineries (KRL) and Chennai Petroleum Corporation (CPCL) to BPCL and IOC respectively. The 2.35 million tonnes per annum Bongaigaon Refinery and Petrochemicals (BRPL) would also go to IOC. BPCL would get total control over its joint-venture Numaligarh Refinery (NRL) with the transfer to it of the IBP's stake.

The logic for the restructuring is certainly sound. The stand-alone refineries do not have a marketing network and, therefore, in a deregulated scenario, would be handicapped vis-a-vis the other players. Again, their capacities are certainly not large enough to facilitate independent operation in a deregulated environment where the refinery would have to source its own crude requirements. Thus, the alliance with the bigger companies certainly makes business sense for CPCL, KRL and BRPL. In a sense, the restructuring being carried out now is inevitable.

Implications for integrated players

BPCL would possibly be the biggest gainer from the restructuring. For long, the company's growth has been handicapped by inadequate refining capacity. At 6.8 million tonnes, BPCL's is the smallest capacity among the three refining and marketing companies. Its expansion plans have been embroiled in controversies over environmental issues, and problems with finding a stable foreign collaborator. The Bina project which was supposed to give BPCL the much-needed extra capacity has almost been given up for the above mentioned reasons.

With a marketing network of around 4,500 retail outlets across the country, the company has had to rely on the Oil Coordination Committee's allocation from other refineries because of its own inadequate refining capacity. For instance, in 1998-99, though the company sold 17.50 million tonnes of products, only 8.57 million tonnes came from its own refinery. In other words, BPCL relies on other refineries for about 51 per cent of its total product sales, which is certainly not a healthy situation.

The acquisition of KRL would now give BPCL access to an additional 7.50 million tonnes of capacity which will bridge the deficit to a large extent. KRL is also planning to expand its capacity to 13 million tonnes and BPCL, with its positive cash flows, can aid the project significantly.

But the transfer of NRL is another matter altogether. The Numaligarh Refinery, born out of the Assam Accord of the mid-1980s, suffers from a bad location. If crude movement is one problem, the lack of a large product market in the north-eastern region is another. Resultantly, BPCL would have to move the products to the other parts of the country which would entail transportation costs and logistics. Thus, the NRL acquisition may not really be a big benefit for BPCL immediately.

For IOC, CPCL is a prize catch. IOC has traditionally had a weak presence in the high-growth southern market as it has no refinery south of the Vindhyas. It has, therefore, had to rely on CPCL (erstwhile Madras Refineries) for product sourcing to maintain its presence in the South. (Only last year BPCL forged an understanding with CPCL to be its marketing agent even as IOC wrapped up a similar deal with KRL.)

The transfer of CPCL to IOC would now give the market-leader a strong presence in the South. It would also fit in neatly with the proposed refinery project of IOC in Nagapattinam as CPCL already operates a mini-refinery in the Cauvery Basin which can be upgraded.

BRPL may add little value to IOC. The former may benefit more from the deal as crude sourcing has been an eternal problem for the company. Its capacity, at 2.35 million tonnes, is nowhere near economies of scale. IOC may have to examine if it should maintain the capacity or increase it, in which case the crude sourcing problem will become greater.

The restructuring would also, in a way, level the field amongst the major players. Though both BPCL and Hindustan Petroleum (HPCL) hold about 20 per cent of the market, the divergence in capacity as of now, is stark -- against BPCL's 6.5 million tonnes, HPCL has 13 million tonnes at Mumbai and Vizag put together. In the new context, BPCL would, at 17 million tonnes, be better positioned vis-a-vis HPCL. Of course, the latter can lay claim to an additional 9 million tonnes of capacity from its joint venture Mangalore Refinery and Petrochemicals (MRPL).

Given its relatively comfortable position in terms of access to product volumes, HPCL is more interested in laying its hands on the marketing network of IBP, which is also up for divestment. If it is successful in acquiring IBP, HPCL would be next only to IOC in the country in terms of marketing reach.

A lot now depends on the methodology of the restructuring and the pricing of the equity transfer. It is unclear if KRL and CPCL would become subsidiaries of BPCL and IOC respectively, or will be merged with them. There could also be some practical difficulties in the case of CPCL as the National Iranian Oil Company holds a 14.29 per cent stake in the company. In case of a merger of CPCL with IOC, this could prove a tricky issue to handle. The choice would obviously be between buying out the stake or offering a stake in IOC itself to the Iranian major. The latter may not be a very palatable move for IOC.

The pricing of the transaction would also be important. It may be tempting for the Government, given its divestment budget of Rs 10,000 crore, to extract the maximum from the sale of its stake. At current market prices of the KRL stock, the 55 per cent government holding in KRL would cost BPCL Rs 341 crore. In the case of CPCL, where the Government holds 52.48 per cent, the transfer at current market price would be Rs 249 crore. The Government has indicated it would receive around Rs 1,800 crore from the whole deal. It is possible that it is banking on an independent valuation so that it can get a better price for its stake.

The bigger prize for the Government may come when it ultimately divests its stake in the three major companies; IOC is likely to be the first some time later this fiscal. Whatever the incidental benefits for the Government and its divestment programme, the fact is the restructuring is a good move for the entire industry. It is probably the only good news for an industry reeling under the impact of the steep rise in global oil prices.