Last week, the government finally announced the deal between HPCL and ONGC. Under the terms of the deal, ONGC will buy the government’s stake in HPCL. This will be the first step towards the integration of the entire value chain of oil under one single line. That is something the Reliance group has achieved to perfection and that is also the trend globally. In the short term the benefits may not be visible but in the longer term the whole will certainly be greater than the sum of the parts. Here are 8 things you need to know about the ONGC – HPCL deal…
8 things you need to know about the ONGC – HPCL deal…
- ONGC, the leading extraction company in India, will acquire the 51.11% stake in HPCL from the government for a consideration of approximately Rs.30,000 crore ($4.5 billion). It has been confirmed that the government will not be charging any premium from ONGC for this stake sale.
- For the government this will be a major boost for its disinvestment program. The government has a full year target of Rs.72,000 crore from disinvestment and this sale will enable the government to meet nearly half of its full year disinvestment targets in just one stroke.
- However, the government has taken great pains to point out that this deal is not just about meeting divestment targets but also about energy security. Currently, India depends on imported crude for nearly 80% of its daily requirements. This really becomes an oil security issue at a time when the global geopolitical situation is already quite volatile. Keeping the stake in HPCL within the PSU group will ensure that the government is able to implement its larger plan towards energy security.
- The big advantage for ONGC will be that it will not have to make an open offer to the shareholders of HPCL and the government has expressly exempted ONGC from the same. Since the ownership resides in PSU hands, this will not call for an open offer. While this will be positive for ONGC and its shareholders, it will negative for the shareholders of HPCL.
- For the oil sector in India, this will be the first step towards integrating and combing the upstream and downstream oil businesses. Over the last few years, we have seen ONGC and Oil India doing extremely well at a time when crude oil prices were headed up. However, since November 2014, when oil peaked at around $115/bbl, the oil extractors have underperformed the overall market.
- The downstream sector in India has benefited from the free pricing of petrol and diesel. Not surprisingly, stocks like HPCL, BPCL and IOCL have appreciated manifold in the last couple of years. Integrating the upstream and downstream businesses will de-risk the business model of the combined entity as it will have a profitable business proposition irrespective of the level of oil prices.
- What is interesting about the deal is that HPCL will continue to operate as a listed company as before. The only change will be that it will now be a subsidiary of ONGC rather than of the government of India. This will be fair to the shareholders of HPCL. A full-fledged merger of ONGC and HPCL would have been instrumental in diluting the equity of ONGC substantially, impairing valuations.
- Above all, this deal must be seen as the first step towards integration of the oil sector and creating oil behemoths. The finance minister in his last budget speech had underscored the need to create oil behemoths to take on the challenge of global giants and also have greater bargaining power in negotiations. In fact, Jaitley had also hinted as combining all the oil companies under one roof eventually.
Why this move towards an integrated oil giant?
Globally, the trend among oil companies is towards creating large end-to-end giants. Look at the big names like Exxon, Chevron, BP, Aramco, Total or China Petroleum. They straddle extraction, gas, refining, marketing, distribution and even downstream products like petrochemicals. This naturally de-risks the business model. Over the next few years, India will have to seriously look at sizable foreign acquisitions to build greater internal self-sufficiency in oil. For that, Indian oil companies will require large balance sheets which are only possible through mega combinations. The HPCL / ONGC deal is just the starting point!