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The proposed ONGC / HPCL merger

Posted on 06-Mar-2017 Comments  0

How the ONGC-HPCL merger could redefine oil industry in India..?

The recent reports on the likely merger between ONGC and HPCL have attracted a lot of media and analyst attention. Here are 10 key facts about the ONGC / HPCL deal and why it could be critical in redefining the contours of the oil industry in India…

Larger implications of the ONGC / HPCL deal…

  • It is expected that, to begin with ONGC will be acquiring the government’s 51% stake in HPCL. At the current market price of HPCL, this stake should be worth nearly Rs.29,000 crore. Once the deal is through, then ONGC will obviously trigger the provisions of the Takeover Code and will have to make an open offer to the existing shareholders to purchase another 25%. This will entail an additional investment of Rs.15,000 crore for ONGC and will give a 76% stake in HPCL.

  • For the government of India it will be tantamount to hitting two birds with one stone. Firstly, it will help the government meet its divestment targets. The government has set aggressive disinvestment targets for the year and raising Rs.29,000 crore through a strategic sale will largely help in meeting these targets. Secondly, it will ensure that key strategic assets like HPCL will continue to stay in the hands of government owned companies.

  • ONGC has the requisite cash reserves to undertake this deal. For example,ONGC is currently sits on nearly Rs.25,000 crore in cash reserves.This will help them partially finance the buyout of HPCL. Additionally, ONGC has a very low level of leverage at just 0.3 times.This will give ONGC the leeway to raise additional debt to support the acquisition without endangering its financial position.

  • For HPCL, it will be a de-risking measure. Over the last 2 years since the pricing of petrol and diesel was entirely deregulated, HPCL and BPCL have been the key beneficiaries. This is amply reflected in their stock price. However, if the prices of oil go up further, then the downstream companies may be called up on to absorb some of the burden on the end-customer. Having a captive supplier of crude will be a big defence in these circumstances.

  • From an industry perspective, the global trend is towards vertically integrated hydrocarbon plays. For example large companies like Exxon, Chevron, Shell, Aramco, Total and ENI are present in the complete value chain of oil including oil extraction, refining,marketing and downstream activities like petrochemicals. This tends to de-risk their product portfolio and helps them to manage the risk of oil price volatility better. This will be the first step towards creating such oil behemoths that are present in the entire hydrocarbon value chain.

  • The global oil industry is all about size and that is only possible with a large balance sheet. ONGC currently produces nearly 1.2 million barrels per day (bpd) of crude oil. This ranks ONGC below the 25 mark in terms of daily extraction of crude. Consider some of the larger names. Saudi Aramco extracts nearly 12.5 million barrels of oil while Gazprom extracts nearly 9.7 million bpd while NIOC of Iran extracts nearly 6.7 million bpd of oil. For ONGC to grow it needs to undertake strategic acquisitions abroad and that is only possible with a huge balance sheet.

  • Finally,there is the issue of managing oil price volatility. That is something that is better handled with a mix of internal risk management and external risk management. Internally, when down stream and upstream gets together there is an automatic rebalancing of risks at the two ends of the business. Secondly, with a larger balance sheet, the combined entity will be in a better position to manage hedges on its exposures to reduce its cost in volatile times.

To be fair, the idea is still in its nascent stage and needs a lot more thinking and clarity moving ahead. The merged entity will be not just the largest extractor but also the third largest refiner after IOC Land RIL. The combined entity will have to urgently build the management bandwidth to manage this level of business complexity,which will be a challenging task. Eventually, the transaction may end up in HPCL being fully merged into ONGC. One only hopes that the government shows its intent to take the transaction to its logical conclusion. Merely looking at the transaction from a divestment perspective may end up not realizing the true benefits of an integrated hydrocarbon play.



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