Business Today Net Special

Much Oil Will Flow

Govt's IBP divestment move has a flutter both in India and abroad. But the excitement is not so much over IBP as over the fact that deregulation is finally under way.

By Ranju Sarkar

In October 2000, the 10-storey IBP House, corporate headquarters of India's oldest, yet smallest oil marketing company in central Calcutta, has seen more number of strangers than ever before. Ever since the Atal Behari Vajpayee administration announced its decision to divest 33.59 per cent of government stake in IBP Co. Ltd, representatives of private and foreign majors have been doing the rounds of IBP House to do due diligence, in their own informal way.

Indeed, the IBP disinvestment and the relaxation of investment criteria for oil marketing---companies can invest Rs 2,000 crore in downstream infrastructure like terminals and pipelines, which was earlier restricted to refining and oil exploration and production upto 3 million tonnes---has enthused global majors like Shell, Exxon-Mobil, BP, TotalElfFina, Kuwait Petroleum, and Petronas, all of whom have been eyeing the Indian retail market. Says Vikram Singh Mehta, CEO, Shell India: ''It allows us to enter the market in relaxed conditions. We are very supportive of the privatisation process of IBP in favour of a strategic partner.''

He's only being formal. The fact is that the IBP disinvestment, along with the flexibility in investment criteria which comes as an icing on the cake, has generated tremendous interest in regional oil markets like Singapore and Hong Kong. Indeed, the excitement has more to do with the fact that deregulation is happening faster than expected (April, 2002), if the government allows private companies---IBP's strategic partners first, and then private refineries like Reliance Petroleum Ltd (RPL), Essar Oil, and Mangalore Refineries & Petrochemicals Ltd (MRPL)---to set up retail gas stations.

The interest in IBP is obvious. Across the world, the oil business has hardly shown any growth (2-3 per cent). Growth will come from India and China, at an expected rate of 5-6 per cent. At 100 million tonnes per annum, the Indian market is too huge for any global major to ignore. While almost all global majors are keen on entering retailing in India, none of them are willing to start from scratch---the cost of setting up a distribution infrastructure would be killing. And more than the cost, it's the time; it will take a much, much longer time to establish a presence if they start from zero.

With marketing margins of $1.33 per barrel, it would take companies 10-15 years to turn up profits if they start from scratch. Domestic private refineries like RPL or MRPL face a similar predicament. While interest would have been greater if BPCL or HPCL were put on the block---given their stronger presence and infrastructure---the truth is that as of now only IBP is on offer. In other words, IBP is the only vehicle available to enter the Indian downstream oil market if someone wants to ride in on a readymade infrastructure. And what does IBP have to offer?

A Springboard For New Entrants

With 1,527 outlets, IBP may not offer a phenomenal reach, but provides a reasonable platform on which a new entrant could consolidate, post-decontrol. Says a senior executive of a European oil major: ''IBP offers an opportunity to enter a 1-billion barrels per annum market. It may require incremental investments, but a 5 per cent marketshare offers you a platform on which you could build on.'' In fact, its overall marketshare may be 5 per cent, but it has a retail marketshare (petrol and diesel) of 9 per cent, and claims to have the highest through-put per pump in diesel.

Says a Singapore-based analyst with a foreign investment bank: ''Anyone who acquires IBP could increase its retail share as the through-put per gas station can easily be doubled by a smart operator.'' IBP controls more than half of its outlets (799 out of 1,527), mostly through long-term lease with landlords, has 44 company-owned, dealer-operated stations, and 47 Jubilee Retail Outlets (interestingly, this is outside SPE), while the remaining 728 sites are dealer-owned or dealer-operated. Control over outlets would be critical as new entrants would try to rope in dealers of PSU oil majors.

Nearly half of IBP sales come from the North (as majority of its outlets are located there), 20 per cent from the West, while East and South account for the rest (15 per cent each). But post-decontrol, retail expansion, which is now governed by the Sales Plan Entitlement (IBP's share of new outlets: 3.8 per cent), will be free, the acquirer would be free to put new outlets wherever they want. IBP controls more than half of its outlets (799 out of 1,527, or 54%)--- mostly through long-term lease with landlords, own and operates 44 stations, 47 Jubilee Retail Outlets (interestingly, this is outside SPE).

The weak link: it's distribution infrastructure---although potential bidders don't consider it to be a major problem. The company was not allowed to set up new depots and terminals until 1989, and it operated through two depots (one in Budge Budge, near Calcutta and another in Mumbai). But over the last decade, IBP has set up 18 depots, which are either on coastal locations or are connected to the Kandla-Bhatinda product pipeline. It also has 25:25:50 joint venture with IOC and Oiltanking, Germany, for setting up storage tanks. Of course, other oil companies also use these terminals. Says R.S. Guha, 58, Director (Petroleum), IBP: ''The existing infrastructure can meet more than 85 per cent of our requirements.''

The other problem is that IBP has a negligible bulk business (direct sale of industrial fuels like naphtha and furnace oil), though it tried to develop one during the last two years. The lack of a refinery and a ban on inter-state movement of products saw all its customers switching over to private suppliers. But this could well be an opportunity for the acquirer to develop a bulk business. Says S.N. Mathur, the 56-year-old CEO: ''I will be able to develop the bulk business once I get product access (which the acquirer would bring in). It's the threat of product access that would give me products.'' (Companies with refineries have tried to place hurdles for product-deficit companies in developing a bulk business by denying them products). But with refinery margins under stress, not having a refinery could prove to be IBP's advantage.

If being the smallest of the four was not bad enough, it had to live with other disadvantages too. For instance, it was allowed to enter the LPG business only in late 1996; since then it could add only 18 LPG distributors and 75,000 customers. No wonder it has poor financial muscle. For, not only do the other oil companies earn an interest-free cylinder deposit of Rs 1,000 per cylinder, which partly explains their strong cash flows (IOC, for instance, would have mopped up Rs 2,390 crore of principal on a cumulative base of 239 lakh LPG connections, leave the interest earned on this cash.) LPG marketers also gain from the 100 per cent depreciation on the cylinder cost the Oil Coordination Committee allows them to claim.

Of course, there are other issues like higher interest, which pulls down the bottomline. If IBP receives Rs 300 crore of OCC dues or recovers its investment of Rs 180 crore in Numaligarh Refinery Ltd (NRL)---IBP had a 26 per cent stake in NRL, which will be bought by BPCL as part of the restructuring plan---it could retire its debt and improve profits. Similarly, the inability to expand its distribution (investments in the oil business earn a post-tax return of 12 per cent) meant poor asset creation ---the key reason for IBP's poor profit margins (net), which stand at 0.70 per cent, compared to IOC's 2.6 per cent and BPCL's 1.96 per cent. And lastly, IBP's chemicals (industrial explosives) and engineering (cryogenic containers) are a drag on the company, and together posted a loss of Rs 30 crore in fiscal 1999. Potential bidders would have to factor these issues into their bidding price.

The Disinvestment Dynamics

Although these are still early days, there's very little information available on the conditionalities or the qualification criteria. Except that the Government of India (GOI) would offload 33.59 per cent stake and management control in IBP to a strategic partner through international bidding. The partner should be willing to invest Rs 2,000 crore in either refining, or oil exploration/production or downstream infrastructure like terminals, depots or pipelines. Of course, the partner would have to abide by the Administered Price Mechanism (APM) in the interim period till it is dismantled in April, 2002. The government would buy IBP's 60 per cent stake in Balmer Lawrie, which is into industrial packaging and speciality chemicals.

But there's a lot of ambiguity. The Hydrocarbon Vision 2025 talks about relaxation in investment norms for marketing, but it's not a policy document yet. It's not clear if people setting up LNG terminals or related infrastructure would be eligible for marketing or investments would be allowed only in the oil business. What happens if companies bid in a consortium? Who will be responsible for the investment? What Rs 2,000 crore constitute the equity component, deemed equity or project cost?

For instance, one of the proposals was that companies could furnish a bank guarantee of Rs 2,000 crore and invest that amount in a time-bound manner. For most TNCs, money is not a problem as it is ($400 million) a small percentage of their global investment plan. Quips a senior executive of a European oil major: ''What if you cannot find a profitable project to invest in?''

Besides, there are crucial issues like the kind of freedom to be enjoyed by the minority shareholders who say on as strategic partners? Can the new management scrap the IBP brand, and promote its own instead? In the absence of a regulatory structure (although the government has promised to form a hydrocarbon regulatory authority), bidders are not sure if new entrants would be allowed to set prices? What would be the restriction on pricing? How are prices going to be arrived at, in view of the proposed high excise duty on petrol and diesel, at 165 and 45 per cent, respectively.

Similarly, how is the government going to subsidise North-East or far-flung areas? If they decide to do so from the general budget---i.e., the Oil Pool Account moves to the general budget---then going by the current international oil prices, the fiscal deficit will become huge. Says an executive of a US-based energy major: ''It's not clear how the process is going to work or evolve. The government has to work on them. Once that happens, the MNCs will see if it is profitable, look at scenarios for 10 years. IBP would be an excellent mode to enter the market, and we are excited about it. But to go from here, and put in a bid, there are a few hurdles which need to be addressed.''

Why IBP Will See Crazy Valuations

IBP could prove to be just the success that the Vajpayee government has been looking for to push the disinvestment process. It has, by far, generated the best response (better than IPCL). Almost everyone from Shell, BP, Exxon, Caltex, Reliance, MRPL, Oman Oil, and Kuwait Petroleum who have been wanting to enter the Indian retail market, would be bidding for IBP. PSUs would bid in an attempt to corner additional share and deter competition.

Says Vidhyadhar Ginde, Analyst, HSBC Securities: ''The competition would be quite intense.'' Adds an analyst with a Delhi-based foreign bank: ''This is big time. Each MNC is bloated with money from higher oil prices. PSUs are not bloated. PSUs can't match the MNCs. The winner is going to be a bidder whose base is higher. So, if the PSUs bid for Rs 500 per share, I wouldn't be surprised if someone bids Rs 1,000 or above.'' Pricing may thus be strategic, and far in excess of the company's true value.

One factor which will drive that is IBP's low equity base of Rs 22.15 crore. The scrip is hovering around Rs 125 on the BSE (market cap: Rs 276.84 crore), while its book value per share is Rs 153.16. Even assuming that someone is willing to shell out Rs 1,000 per share, the absolute outflow won't be much: Rs 744 crore or $159 million. Since the absolute outflow is small, a multinational or an Indian major like Reliance would not mind paying an extra $50 million to get a strategic entry.

Says Sashi K. Mukundan, Vice-President (India Business Development), Gas & Power, BP, which is considering to bid for IBP: ''Ultimately, it has to make economic sense in the long run. It's easy to push through things by calling it 'strategic', but you've got to stand up and explain it to your shareholders how an acquisition A in country 1 is better than acquisition B in country 3.'' Of course, TNCs like BP would also like to make sure that it makes strategic sense and gives them materiality---how does it provide critical mass in terms of marketshare and presence.

Shell will be another player to watch. It already has a Rs 250 crore-plus lube joint venture with BPCL, and is eyeing the retailing segment. But will these MNCs be willing to invest Rs 2,000 crore? Adds Sandip Biswas, Senior Manager, Andersen Consulting: ''Companies are not going to invest in terminals to get marketing rights, but companies which are already putting up LNG infrastructure and become eligible, would be keen on getting into marketing.'' While Shell is keen on putting up a five million tpa LNG terminal at Hazira with Essar, BP is pushing for Di-Methyl Ether (DME) as an alternate fuel for smaller power projects, and plans to set up an LNG terminal at Kakinada with IOC.

But the strongest contender would be Reliance Petroleum, which needs an outlet to market its products.Right now, Reliance consumes nearly 40 per cent of the products internally, and has an arrangement with IOC for marketing of products under APM for the next seven years. For, Reliance may not like to acquire any more refining capacity. If Reliance acquires IBP, it could use it to gain and hone its expertise, and then storm into the market once the 3,000-km Central India pipeline comes up by 2003.

Of course, there would be dark horses like Kuwait Petroleum or Oman Oil who may surprise the global majors and Reliance, by bidding high. But there's a caveat: interest IBP could come down substantially if HPCL and BPCL were to be put on the block simultaneously. That will be an oil spill (controversy) the GOI would find difficult to control. Although there are no prices for guessing who would gain from such a move.

Issue Contents Write to us Subscriptions Syndication

� Living Media India Ltd