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Oil sector needs more competition

LiveMint logoLiveMint 16-04-2017 V. Ranganathan

Union finance minister Arun Jaitley recently mooted the idea of a mega-merger of upstream and downstream oil public sector units (PSUs). The intention, presumably, is to gain the benefits of “economies of scale”, diversification of risk, and market power in the global purchase of oil assets.

In a recent issue of the Economic And Political Weekly, two people had made some of the problems with this clear. Former petroleum secretary Saurab Chandra had clarified that buying oil assets abroad through national oil PSUs (Nopsus) would not serve energy security objectives due to inherent political risks that would prevent oil from being shipped to India in times of crisis. It may give some return on investment, but Nopsus are not required for that; sovereign wealth funds can do the job better.

In the same issue, Bhamy Shenoy has evaluated a couple of alternatives and noted that the finance minister’s mega-merger is the worst of all possible scenarios. Instead, splitting the Indian Oil Co. Ltd into three or four smaller companies would increase competition as well as shareholder value due to the benefits of decentralization.

Though these assessments are just his opinions, some of the arguments deserve attention. One such is this: International private sector oil firms may be vertically integrated—present both in upstream (exploration and production) and downstream (refining, marketing and distribution)—but this cannot be directly transplanted to Nopsus. This is because the latter’s performance in the upstream area is close to zero. The Oil and Natural Gas Corp. has not discovered any oil or gas after its accidental find in Bombay High! As a result, the whole of India was considered barren until Reliance Industries Ltd struck gas in the Krishna-Godavari (KG) basin.

Exploration requires a combination of large investment, huge appetite for risk, the latest technology and a perform or perish ecology. While Nopsus may have the first two, they lack the last two and cannot be successful.

Management expert Yair Aharoni characterized state-owned enterprises as “agent(s) without a principal”. Because many political masters command the PSUs, in effect they become agents without a principal. Due to agency costs, the theory of the public sector posits that efficient operation is definitionally not possible.

Also, because PSUs will never be driven to exit: Due to unlimited access to public funds, they are insulated from survival threats and the drive for achievement is weakened.

Accordingly, in the area of oil and gas, while PSUs may give acceptable performance in routine areas like downstream refining and marketing, they are most likely to underperform in aggressive areas like upstream, exploration and production.

Oil and gas being a strategic resource, many countries keep it in the public sector. China has its PetroChina, Cnooc and Sinopec; Russia has its Rosneft, Lukoil and Gazprom; and Saudi Arabia has its Aramco. Some of them may have a joint venture with a private sector multinational corporation like TNK-BP, which is owned by Rosneft. In these cases, national oil companies are kept under state ownership since the country’s leaders are the principals, and are willing to pay the price, viz. the agency costs.

However, India, as a functioning democracy, has people as the principals, and thus it does not have that compulsion to pay a premium for loyalty over efficiency. Yet, there is a wrong notion among the political class and bureaucracy that it is safer to have the public sector operate in strategic areas—perhaps even to the extent of barring the private sector.

This model was followed in defence production; the result is that defence PSUs have betrayed the nation’s confidence in them, both by underperformance and malicious intent (for instance, a defence PSU bought Tatra trucks at inflated prices). It is high time we shed this mindset.

Right now, inadvertently for the most part, upstream and downstream Nopsus are separate, and both are doing reasonably well. The financial performance of integrated firms—private sector giants globally and Nopsus like PetroChina in China—are being devastated by the bloodbath upstream, although the downstream is reasonably insulated from shocks.

Let us follow the dictum, “Don’t fix it if it isn’t broken.”

In India, both upstream and downstream can do with more competition. In this context, the government has done well to give exploration licences to small firms, private and international, and not to Nopsus. What matters is not size but nimbleness and the ability to acquire the right technology and right people.

In the downstream, they should do something similar—encourage small refiners who will break the existing margin benchmark. Here, private sector refiners who are efficient are making super-normal profits because the price is set by inefficient Nopsus.

The regulator, the Petroleum and Natural Gas Regulatory Board, has made matters worse. It has let itself be outmanoeuvred by big and inexperienced PSUs that have won the tender for city gas distribution, and shifted the bid parameter from cost to consumer to amount of bid bonds. The ministry seems to have realized this embarrassment at last and is trying to set it right.

V. Ranganathan is an energy economist.-

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