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Energy: Synergies through integration - Views on News from Equitymaster
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  • May 16, 2003

    Energy: Synergies through integration

    The Indian oil and gas sector is in a state of transition and the buzzword seems to be vertical integration. Companies are looking to add more value to their businesses by becoming fully integrated. In this article, we try to take a look at the steps these companies are taking in India. We however limit ourselves to the business of the companies related to oil and gas only.

    If we take a look at what was prevalent in the past, we would find companies, which focused specifically on one or more areas like petrochemicals, refining, marketing or exploration. However there was little or no vertical integration. Reliance was into petrochemicals while ONGC was into exploration and production of crude oil only. In case of BPCL, HPCL and IOC, they were into the business of refining and marketing.

    Company Past Current business Future plans
    ONGC Exploration Exploration & Refining Exploration, Refining and Marketing
    RIL Petrochemicals Petrochemicals, Exploration and Refining Petrochemicals, Exploration, Refining and Marketing
    IOC Refining and Marketing Refining and Marketing Exploration, Refining and Marketing
    HPCL Refining and Marketing Refining and Marketing Refining and Marketing
    BPCL Refining and Marketing Refining and Marketing Refining and Marketing

    Currently, competitive pressures and a dismantled APM have led these companies in to looking at vertical integration as a means to their future sustenance. For example, ONGC, which was into oil and gas exploration earlier, bought Mangalore Refineries Private Limited from the A.V. Birla group. This marked their entry into downstream refining though on a smaller scale. In addition they were looking to acquire a strategic stake in HPCL however they were not allowed to do so due to government regulations. ONGC has also got permission for opening about 600 retail networks for marketing of transportation fuel. This will make the company fully integrated in the future. Currently the major portion of its revenues comes from exploration and production business. Once this integration happens it will add stability to its business.

    IOC is the market leader in refining and marketing segment. However the company plans to enter into exploration business in association with major players in the upstream sector. It has been awarded an oil exploration block in consortium with ONGC during the third round of NELP. This will help IOC to backward integrate its business. The company also plans to enter into petrochemicals business to take advantages of the hydrocarbon value chain. Looking at the bidders interested (Exxon-Mobil, Royal Dutch Shell, Chevron-Texaco, BP-Amoco and likes) in the strategic sale of HPCL, we can contemplate that post divestment it is likely to benefit from the integration synergies of its acquirer.

    Another example of vertical integration being carried out by Indian companies is the case of Reliance Industries Limited. In an attempt to extract the benefits of backward integration for its petrochemicals business, Reliance set up the world's largest refinery (27 m tonnes per annum capacity). They also entered into the business of exploration recently and were infact successful in finding the largest ever discovery of natural gas. Reliance has also received permission for setting up a retail network for marketing of transportation fuel, which will see the light of the day by the end of FY04. Thus it will become fully integarated.

    World over it has been observed that the major players in this sector like Exxon-Mobil, Royal Dutch Shell, Chevron-Texaco, BP-Amoco, etc are fully integrated and have presence in both upstream and downstream sector. Having said this, we try to find out the benefits offered by full integration. First and foremost the company benefits as its reliance on sourcing reduces i.e. it becomes highly self-sufficient. Secondly they are in a better state to manipulate their requirements either in downstream or upstream side to get full advantages in terms of cost. Thirdly, it will add stability to their business, which is otherwise dependent on only one revenue stream. Last but not the least, it is beneficial for the industry and the country as a whole given that most of the businesses are dependent on the oil and gas sector for their energy needs. Though Indian oil and gas majors have taken a step in the right direction, it is a long process and will take time. One thing is certain that the ball has been set rolling.



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