Is The Merger Really Worth?

The Cabinet Committee on Economic Affairs (CCEA) has taken an in-principle decision to divest 51% of the Union Government’s shareholding in Hindustan Petroleum Corporation Limited (HPCL) – a downstream Central public sector undertaking – in favour of Oil and Natural Gas Corporation (ONGC) – a PSU in the upstream segment. A Group of Ministers (GoM) under Finance Minister Arun Jaitley has been set up to work out the modalities of the merger which is expected to be completed within the current year. But is the merger really worth?

- Uttam Gupta

The decision to merge the HPCL with the ONGC is a follow-up of the announcement by Finance Minister Arun Jaitley in his budget speech for 2017-18 to create two or three integrated oil and gas companies by merging the existing PSUs which can compete with energy majors in the private sector – both within India and abroad.

A bigger entity yields economies of scale and enhanced synergies in turn, leading to higher operational efficiency and a lower cost. It can generate a higher internal surplus which gives it the leverage to garner larger sums from investors – both as equity capital and debt. The funding of capital expenditure thus becomes that much easier enabling expansion and growth on the required scale. This is a standard argument applicable to the merger of any business.

In the said context, however, the real guiding principle is to integrate under one roof exploration and production business on the one hand and refining and retailing on the other (this is in consonance with the global practice). The former is the source of raw material, viz, crude and natural gas whereas the latter uses these for making a variety of petroleum products such as diesel, petrol, LPG, ATF and naphtha. The integration gives the unified entity enough flexibility to smoothen out the ups and downs in different segments.

When the international prices of crude and gas are declining, the businesses in the upstream segment suffer as realization from sale goes down. However, for an integrated entity this is compensated by gains in the downstream segment (lower raw material cost leads to a better refinery margin). In a reverse scenario when crude and gas prices increase, the downstream may lose (higher raw material cost squeezes the refinery margin) but there is a corresponding gain in the upstream business.

But in India, things may not work out in exactly the same way.