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Size does matter... - Views on News from Equitymaster
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  • May 11, 2000

    Size does matter...

    Size does matter. No one can lend more credence to this phrase than the Reliance Group, one of India's leading private sector groups. This 'Growth is Life' Group has a dominating presence in petrochemicals sector and over the next few years it is likely to emerge as a key player in the telecom, power, roads and, of course, the refining sectors.

    Reliance Petroleum: On the bourses

    Reliance Petroleum Limited (RPL), a 50 percent subsidiary, is the largest grass roots refinery in the world and the largest refinery in India. The refinery, set up at a cost of s 14.3 bn, has a capacity of 27 million tonnes per annum and accounts for 29 percent of the domestic refining capacity.

    The refinery has all the makings of a winner. It is port-based and is located close to the Middle East, a major crude surplus region. The degree of complexity of the refinery, which indicates the potential for higher value addition, is the highest among Indian refiners and compares well with its global peers. Its product quality meets the stringiest of environmental norms and specifications in the world. The refinery is so designed that it can use the various forms of crude as feedstock thus giving it an opportunity to hedge costs (infact a group company is involved in crude oil production). All these factors, combined with its gigantic size that give it tremendous scope for exploiting economies, give it an enviable edge over the existing refiners in India. They also indicate that the company will earn superior margins as compared to its peers.

    RPL, which has gone on stream only recently, will start operating at peak capacity by the end of the current fiscal year. The company, however, lacks one thing - a dedicated retail distribution network. To overcome this lacuna it has entered into an agreement with Indian Oil Corporation (IOC), Hindustan Petroleum Corporation (HPCL) and Bharat Petroleum Corporation (BPCL) to market its controlled products (68% of total production) until 2002, when the proposed deregulation of the entire oil sector will be completed. Since, approximately 25 - 30% of the refinery's output of decontrolled products is to be consumed by group companies, it is left with little surplus to market on its own. Thus, the problem is taken care of atleast till 2002.

    The company has already initiated measures to lock its marketing network in the post 2002 era. It has set up a joint venture with IOC to market 48% of its output, while IOC will market the rest independently.

    What adds excitement to the company's prospects is the other game plan that is brewing in the Reliance Group. It is concerning size, once again. The group company, Reliance industries, has stated its intention to bid for strategic stakes HPCL, BPCL and IBP as and when the government takes a decision on divestment. The first two of these companies have their own marketing networks and have a joint capacity of approximately 20 million tonnes per annum. IBP, on the other hand, is purely a petroleum marketing company. If the Reliance Group were to be successful in its scheme of things, it would emerge as a dominant player in the Indian energy sector. The combined entity would command well over 50% market share in domestic refining capacity (existing levels) and a marketing network that would be unparalleled by no other company, not even the IOC (a Fortune 500 company).

    New capacities in the Petroleum sector

    The plan may seem far-fetched to some. However, if the Indian energy sector is to survive the onslaught of their international peers in the post liberalisation era, it will have to focus on size and distribution network. While the first will help it leverage on economies to enable it to fight off competition on the price front, the other will help it in establishing an entry barrier in the form of a large distribution network. The size factor will also take care of the over capacity in the Indian refining sector. As competition would be limited, refiners would be able to manipulate production to protect margins. Currently, the effective difference in duties on the import of crude and other petroleum products is only 2-3%. This puts pressure on the margins of refiners as any increase would lead to imports of petroleum products becoming cheaper than domestically produced output. The Indian government has promised to step up the effective duty protection for the refining sector from 2-3% currently to 12-15%.

    RPL is well placed to face competition from multinational oil companies once they set up shop in India. It is, however, not resting on its current strengths and is instead pursuing an aggressive plan that will catapult it amongst leading oil companies globally.



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