The urge to merge

While the government continues to blow hot and cold on the idea of merging the public sector oil companies into two vertically integrated giants, one headed by Indian Oil Corporation and the other by ONGC, the latest proposal—to have a SAIL-type holding company—is neither here nor there.

On paper, the idea of getting companies such as ONGC, HPCL, and BPCL to coordinate their plans sounds good, given that each company has aggressive retail ambitions. But it won’t really work in practice.

For one, there is no certainty about the future. It makes sense for ONGC to go slow on its own retail plans only if it is clear that neither HPCL nor BPCL will be sold off later.

While there is some certainty about this in the UPA regime, who can say what will happen with the next government change? Second, since a very large part of the immediate gains of merger will come through cost and tax savings, a holding company structure is irrelevant.

Both ONGC and Oil India Ltd (OIL) pay a 4 per cent sales tax on their 30 million tonne production, involving an outgo of several hundred crores.

From the corporate point of view, this is a cost that can be avoided only if the government thinks merger. Neither ONGC nor Indian Oil will benefit from a holding company structure.

The main gains of merger will be operational. Today, for example, the three oil marketing companies have separate storage depots in each major region, but this can be reduced substantially once HPCL and BPCL are merged with ONGC.

The combined entity, needless to say, is more likely to command a higher price-earnings multiple than what the individual firms have today (as in the case globally), and this will mean greater leverage in borrowing and raising funds.

Most important, since oil and product prices move in a fairly lagged fashion, a vertically integrated company’s advantages are obvious.

ONGC had, sometime back, calculated that the profitability of the combined firms would be 20–25 per cent higher than the sum of the profits of the individual firms after taking into account the tax savings, the lower transaction costs, and other advantages.

On the other hand, the arguments against merger are not without merit, either. Globally, very few mergers yield the kind of benefits promised due to differing organisational cultures.

Moreover, is it worth creating a bigger public sector monopoly in the oil sector? Giant PSU behemoths are more open to abuse than several small ones.

And given that the dismantling of the administered price mechanism (APM) has been messed up without so much as a by-your-leave, there’s every reason to believe that politicians and the government will not leave the merged PSUs alone.

The entry of big private sector and foreign companies in the retail segment will, of course, curb the ability of public sector monopolies to ride roughshod over consumer interests. Selling large chunks of stocks of the new merged firms to private investors will also be a partial solution, but the experience so far with 51 per cent government control is that ministers do not really lay off.

In sum, while merging public sector oil companies may be a good idea in itself, the more important thing is to expand the competitive space by encouraging the private sector to expand fast.