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DEC. 4, 2005
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Business Today,  November 20, 2005
BT 500: ONGC
Big Just Became A Lot Bigger

ONGC is leveraging its core competence to enter a host of other fields. The mission: straddle the entire oil value chain and extract every paise worth of value in it.

ONGC's Raha: Running a well-oiled organisation and exploring new avenues

It's been rated as Asia's best oil & gas company by Global Finance, a us-based magazine. It's been ranked as the second biggest exploration and production company in the world by Platts Energy Business Technology Survey 2004. And it ranks 454th by revenues and 95th by profits on the Fortune 500 list. If that sounds like the introduction to a hagiographical corporate story, sample this: the state-owned Oil and Natural Gas Corporation (ONGC), the company in question, is India's most valuable company by market capitalisation (Rs 1,40,000 crore), net worth (Rs 46,500 crore) and net profit (Rs 12,983 crore). Now, for the no-brainer: it topped the list of Business Today's 500 most valuable companies in 2004-05 and, for good measure, has maintained that position this year, too. QED!

And Subir Raha, the 57-year-old Chairman and MD of the company, is spreading his wings further. He's already leveraged his company's steroid-charged profits to lock up resources in Ivory Coast, Sudan, Russia, Vietnam, Australia and eight other countries, and ramped up capacity at home. The next step: enter into businesses that have hitherto been considered out of bounds for the company. On the anvil are projects for underground coal gasification, coal bed methane (CBM) mining and setting up LNG complexes, special economic zones (SEZs), power plants and petrochemical projects.

ONGC's top brass obviously hasn't read the book on core competencies, and even if it has, clearly doesn't think much about its contents. But there's a method in this madness; all the diverse strokes of these apparently unrelated activities do conjure up a coherent bigger picture. "We already have the necessary technology and domain expertise to enter into all these fields. We only have to modify them for our needs," says Raha, adding that all of ONGC's expansion plans leverage its strengths in the hydrocarbon sector. For instance, the company has 10 years experience in Gujarat for the underground gasification of crude. The same technology can be used for underground coal gasification, he explains. "Commercial production of CBM, the first time it's being done in India, will take off in early 2007 and underground coal gasification, in 2009,'' he informs. All the CBM projects are located in and around Bokaro, Jharkhand.

The Chinese Bogeyman
China National Petroleum Corporation (CNPC), China's largest oil and gas producer, is fast becoming a bogeyman for ONGC Videsh Ltd (OVL). Every time OVL has faced off with CNPC over a lucrative oil asset, it has found itself pipped to the post by its Chinese rival.

The latest chapter in this running saga of lost bids was played out at the auction of Canadian oil company, PetroKazakhstan, which is the third largest oil producer in Kazakhastan. OVL, which bid in partnership with steel baron Lakshmi Niwas Mittal, submitted the highest offer of $3.98 billion (Rs 17,910 crore). But CNPC was allowed to revise its bid to $4.18 billion (Rs 18,810 crore), allegedly after the auction had officially closed, and, thus, walked away with the prize. "The goalposts are being changed after the match has begun," Petroleum Minister Mani Shankar Aiyar told reporters in New Delhi. The government even made half-hearted attempts to persuade the Kazakhstan government to reopen the bid, but it was too late. The horse had already bolted.

The same story was played out in October 2004, when OVL signed an agreement with Shell to buy its 50 per cent stake in Angola Block 18. But a generous offer of credit and aid by the Chinese government forced Sanganol, Angola's national oil company, which had a virtual veto over the deal as the sole concessionaire for hydrocarbon exploration and production in that country, to opt for CNPC. And in September this year, the Chinese company again trumped OVL's attempt to buy Canadian company Encana Corp's 75,000 barrels per day oil wells and pipeline in Ecuador.

So, how does OVL explain these consistent losses? "They had as much to do with the aggressive bids placed by the Chinese as with leverage provided by their government," says Subir Raha, CMD, ONGC.

Currently, the OVL board has powers to clear bids of only up to Rs 300 crore, a pittance in the multi-billion dollar global oil market sweepstakes. Anything beyond this has to be cleared by an Empowered Group of Secretaries and the Cabinet Committee on Economic Affairs. That's a sure-fire recipe for disaster in the fast-moving world of global business deals. The need of the hour is simple: give ONGC and OVL full autonomy.

Again, his justification for investing in four SEZs-near the Kakinada refinery (owned by MRPL, an ONGC subsidiary, and ILFs), Mangalore refinery (owned by MRPL), Rajasthan refinery (owned by MRPL, Cairn Energy and the Government of Rajasthan) and Dahej in Gujarat-makes eminent business sense. "By becoming a co-promoter of these SEZs, ONGC will drastically slash project costs because of free import of goods, and will also get to select plots and locations according to its own sweet will," says Raha. Latecomers, he adds, will have to pay a premium for the land and may still be denied their desired location. The development of infrastructure will be left to partners with the requisite experience. The cost, Rs 20-25 crore, is just a miniscule blob on the company's balance sheet.

The long-term goal of reinventing ONGC into a vertically integrated company present along the entire hydrocarbon value chain seems to be taking shape, too. It acquired a 51 per cent stake in the then loss-making Mangalore Refineries & Petrochemicals Limited (MRPL), which was on the verge of being referred to the Board for Industrial and Financial Reconstruction, for Rs 660 crore in March 2003 and turned it around. During the year ended March 31, 2005, it processed 11.85 million tonnes of crude, a capacity utilisation of 122 per cent and earned a net profit of Rs 880 crore. Raha has big plans for the company in which ONGC now owns a 71.6 per cent stake: an expansion of capacity to 15 mmt in the next 2-3 years and then, to 30 mmt by the next four years. This will entail setting up a greenfield refinery in Mangalore. The obvious benefits: ONGC can sell crude to MRPL at arm's length prices and then sell the end products through its own petrol pumps, 50 more of which are expected to be rolled out by next year. This arrangement is expected to add another massive dose of steroids to its profit and loss account.

Five Things Going For The Company
PROFITABILITY: Since most analysts believe that oil prices will remain at the current high levels for the next couple of years, the company's profitability will continue to remain high.

ZERO MARKET RISK: Since there will always be a market for its products-crude and gas-it will continue to enjoy the confidence of investors and shareholders.

STRONG BALANCE SHEET: ONGC is cash rich and debt free. This will allow it to implement ambitious plans and also absorb any short-term setbacks.

NEW INITIATIVES: Its move to enter into downstream sectors such as refining and marketing and other areas like coal gasification and power will contribute to its top and bottom lines.

GAS PRICING: Once gas prices are freed from government controls-and everyone is unanimous that it will definitely hap pen-ONGC will add a few thousand crores to its bottom line.

"Integration along the hydrocarbon value chain is not a matter of choice for a company with global footprint; it is an imperative-we have to squeeze every available paise out of every molecule of crude," says Raha, an electronics and telecommunications engineer from Kolkata's Jadavpur University and an MBA from Leeds University, UK. But there are other, more important reasons for the company's downstream foray. No exploration and production company, he says, can depend solely on a single cycle for survival anymore. "We have to become a part of the crude cycle, the refining cycle and the product cycle to tide over any downturn in any one of them."

Such de-risking is sine qua non for maintaining cash flows, and hence, for future investments in its core exploration and production business. Raha uses the term "cash flows" in its broadest possible sense; it includes raising tens of billions of dollars from abroad, since the Indian capital market still lacks the capacity and depth to generate such humungous amounts. "Forget equity. Why should anyone give us loans if we don't demonstrate our ability to pay back them back. Hence, it's important to have a presence in the downstream sector," he argues.

ONGC's main priorty: securing sustained growth. The gameplan: monetise ONGC's main assets-over 1 billion tonnes of recoverable oil and gas; and "assetise" its huge cash flows. How? "We are milking our in-place reserves to increase production. The cash generated from this is being aggressively invested in hydrocarbon assets in different geographies across the world. We are also placing a major thrust on upgrading technology and machinery, thus, moving up the knowledge ladder. And thirdly, coming back to the original argument, we are entering new businesses where we have synergy," he explains with a flourish.

In line with this third objective, the company is actively engaged in the development of gas hydrates (ice-like crystalline solids found on sea beds which contain rich veins of methane gas). It also plans to set up two captive wind power farms in Gujarat and Karnataka. This, say analysts, will release more oil and gas for sale, save significant costs and help protect the environment.

Five Things That Could Go Wrong
FEW STRIKES: Despite massive investments by the company, ONGC may fail to make new strikes, given the risky nature of its business, both in shallow and deep-water blocks.

OVL's FAILURE: Production and exploration activities can face a setback in ONGC's overseas acquisitions because of political instability in countries such as Sudan and Vietnam, where it has made large investments.

FIRE IN BOMBAY HIGH: Any accident at Bombay High could cost ONGC dear because it accounts for around 60 per cent of the company's total crude production.

FALL IN CRUDE PRICES: Any sudden fall in international prices will not only drastically reduce its profitability but also reduce its investments in exploration and production activities.

GOVERNMENT'S INTERFERENCE: Governmental interference in its day-to-day activities or politicians using it as a cash cow to meet revenue shortfalls could hamper ONGC's fortunes.

However, even as ONGC bets big on these diversifications, which Raha insists are not far removed from its core activities, it is redoubling efforts in its bread and butter exploration and development activities and on acquiring equity in foreign hydrocarbon reserves. The company is spending nearly $1 million (Rs 4.5 crore) every day on exploration and production. The projected capital expenditure: Rs 12,700 crore in 2005-06 and Rs 14,300 crore the next fiscal. ONGC has put up 27 shallow water rigs and three deep water ones as part of this initiative. "We now have the best technology available in the world, technology that is used by Shell, BP-Amoco, Exxon-Mobil and others. Schlumberger and Paradigm Geophysical, again the best in the business, do our data analysis. But data interpretation is done in-house by our own team of experts," he says, adding that he's confident of a deep-water strike in the near future. "We have some leads, which makes us very optimistic about strikes in our deep-water project," he says, but refuses to discuss any further details.

But all this can only be termed educated crystal ball gazing. The truth is that ONGC's domestic record is, at best, mixed. It has 25 oil and gas finds to its credit over the last four years. It's record in 2004-05: zilch. The company's 100 per cent subsidiary, OVL, however, has been a success. From a company with only one property in Vietnam in 2001, OVL-which has invested nearly $4.3 billion (Rs 19,350 crore) worldwide-today has 18 oil properties in 13 countries, making it India's largest multinational. Its latest conquest: a second offshore exploration block in Vietnam's Phu Khanh Basin; the estimated in-house reserves here are a staggering 190 million tonnes. The icing on the cake: it is also the operator for this block. This means OVL will actually run the operations at this block. This is different from most of its other foreign investments where it only gets a share of the crude which is extracted by some other party. Elsewhere, it is already counting the dividends from its crude production activities. Its investment in Sudan gives it 75,000 barrels of oil per day, while production from Sakhalin I in Russia, which will begin to flow from the first quarter of 2006, is expected to net it 50,000 barrels of oil per day. These successes are already evident in its financials. OVL earned a profit of Rs 761 crore on sales of Rs 6,026 crore in 2004-05. It even declared a maiden dividend of 35 per cent, resulting in a payout of Rs 105 crore.

Is the company in a sector where India has a long-term competitive advantage?

ONGC is fast becoming a global oil and gas player with footprints already in 13 countries. While it may still not have the size of a Exxon Mobil or Shell, it has all the makings of a future vertically integrated oil and gas multinational.

Does the company have what it takes to succeed in the long-term?

Yes, the company has already put in place processes, rules and the initiatives to become a long-term player.

Should you invest in the company (sector)?

Yes, company expects that oil prices will firm up in winter, thus improving realisations. Further, it will soon enter the aviation turbine fuel segment, thus, adding to the revenue stream.

But critics continue to carp about ONGC's domestic record, pointing to its poor strike rate within the country. The company has yet to make a major discovery after the Bombay High find in 1974, despite making major investments in this field. They also point to the fact that despite prospecting in the Krishna-Godavari basin for years it drew a blank there (its private sector rival, Reliance Industries, made the initial find of 14 trillion cubic feet of gas in the basin). It was more of the same in Barmer district of Rajasthan, where Canadian company Cairn Energy made the big oil and gas find (5 million tonnes of oil and oil equivalent per year over the next 10 years). "It will take some time for ONGC to really ramp up its production," feels Deepak Mahurkar, Senior Consultant, Oil & Gas, PricewaterhouseCoopers. "One of the reasons for ONGC's poor show could well be the absence of a central data analysis centre, where data from all over is crunched," says an analyst. "It hampers the company's agility when it comes to quick decisions."

And despite OVL's successes, its record is not entirely without blemish. Its attempts at acquiring oil equity abroad have repeatedly been trumped by China National Petroleum Corporation, China's largest oil and gas producer (see The Chinese Bogeyman). There's another major issue: is OVL paying too much for its overseas assets? It paid $2.7 billion (Rs 12,150 crore) for a 20 per cent stake in Sakhalin-1. Exxon Mobil, which has a 30 per cent stake in the project, is believed to have paid a much lower price. "This will be one criterion on which ONGC's performance will be judged in future," says an analyst.

Critics also point to the fact that the ONGC board has too much on its plate these days. "It won't be a bad idea to have an independent, professional board for MRPL. This is not to say that the current board is not doing a good job. But an independent board, focussed exclusively on MRPL, will be in a position to structure the business in an optimal manner," says a consultant.

The biggest threat to ONGC's future, however, comes from the government itself. "If it starts interfering in its day-to-day functioning or even treats it as a milch cow, ONGC's performance is bound to plummet," says the analyst. Raha understands that only too well. He has successfully fought off interference from his ministerial boss, Mani Shankar Aiyar, and other senior oil ministry officials for some months now. And as long as the company's top and bottom lines keep surging, these will remain entertaining, but inconsequential, side shows to the main growth story. Investors will raise a toast to that.




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