Will ONGC seize the moment?

IT WAS OUT of a movie—a bone-rattling ride in a nine-seater Dauphin helicopter, a fraught landing on a shaky platform in the middle of a choppy Arabian Sea, and a desperate prayer that the chopper would not blow up in the flares from burning gas, some 80 km from land. That was a decade back, when I first visited the offshore Vasai Basin, a little distance from Mumbai High, both owned and run by the Oil and Natural Gas Corporation (ONGC).

A lot has changed in the decade since. The policies governing the oil and gas sector have been changing steadily, and with that, the economics of the state-run ONGC. In the early 2000s, ONGC was headed by the feisty Subir Raha, a man who was not afraid to speak his mind and ruffle the feathers of the people in power. He had taken over a beleaguered public sector undertaking (PSU): It was facing stiff competition from the private sector for the first time and had to fight cutting edge technology with dated equipment. “We have to squeeze every available paisa out of every molecule of crude,” he told me. And then went on to get the government to loosen its purse strings to allow ONGC to spend on modernisation and redevelopment of ageing fields, as well as on risky acquisitions.

Raha was a great risk-taker and most of his gambles paid off handsomely, but his habit of speaking his mind did not endear him to his political and bureaucratic bosses. So, an accident caused on Mumbai High (then Bombay High) by a ship colliding with a gas pipe, which resulted in several deaths, was blamed on lapses on the part of ONGC’s management, and Raha was shown the door. After that, ONGC has been headed by a series of undoubtedly competent people who won’t rock the boat. (Raha died prematurely of lung cancer in 2010.)

At any other time, the leadership qualities and risk-taking abilities of an ONGC chairman and managing director would not have been cause for much comment. But ONGC is at a critical point in its history: when an age of protectionism and subsidy is ending and a new era of unfettered competition is just beginning. Is the government’s star performer in the oil and gas space ready to take advantage of the new liberalised environment that had shackled its growth for so many years?

A lot of that depends on the man at the helm—56-year-old Dinesh Kumar Sarraf. A hardcore finance man, Sarraf has a postgraduate degree in commerce, and is an associate member of the Institute of Cost and Works Accountants of India and the Institute of Company Secretaries of India. To this, he’s added three decades of experience in the oil industry. He was part of the team that helped ONGC make the transition from the Oil and Natural Gas Commission to a commercial company in 1993, and drafted the memorandum and articles of association of the company. That meant ONGC was no longer a statutory commission that had to carry out the government’s diktats. As a public limited company, it could take decisions independent of the government, and would be governed by the Companies Act, 1956. Sarraf also helped the then petroleum minister, Satish Sharma, answer questions when the ONGC transition came up for debate in Parliament.

The big question: Will his financial smarts be enough to steer ONGC through the undoubtedly testing times ahead? The company will have to manage competition from nimbler private players, while sustaining outputs from ageing oilfields like Mumbai High and those in Gujarat and Assam, discovering new oil and gas fields both at home and abroad, and profitably working with unconventional sources of energy.

That’s a tall order for a man who has been on the job only a few months. Sarraf’s tenure will be up in 2018, a year before the next general election, but unlike the government, there’s little chance of a re-election for him. (Traditionally, ONGC’s chairpersons retire once their four-year tenure is up, usually because they turn 60—the official retirement age.) He’ll have to make his mark in the few years he has. He’ll have the backing of the government (which owns 69% of ONGC), since fixing the oil and gas sector will be a huge selling point come election time. ONGC, ranked 7 on the Fortune India 500 for two years running, produces 68% of the country’s crude and 62% of its natural gas. The company reported revenue of
Rs 178,000 crore last year, and net profits of Rs 22,000 crore.

There comes a tide in the life cycle of a public sector company, which, if taken at the flood, leads on to fortune of course, but also the chance to skip a few steps, to break the trend of linear growth, and do something far bigger. It has happened before, notably at GAIL (formerly Gas Authority of India), when B.C. Tripathi took over as chairman and managing director on August 1, 2009, when he was 49. The youngest CMD of a public sector company, Tripathi came in when GAIL was already the country’s largest gas transmission and distribution company. It would have grown regardless of the person at the top, but Tripathi decided to accelerate this growth by pushing GAIL into new areas, notably LNG and exploration. One of the few PSU chiefs to have been given a second term, Tripathi has put in an order for nine ships for importing LNG; he plans to set up a floating regassification terminal off the coast of Andhra Pradesh as well. All this has seen GAIL’s revenue grow to Rs 57,245 crore (FY14) from Rs 24,996 crore (FY10)—a compounded annual growth rate of 18%.

“A CONSTELLATION OF diverse forces is going to propel ONGC to the next stage of growth,” says Rajiv Kumar, senior fellow at the New Delhi-based think tank, Centre for Policy Research. Chief among these forces, he says, is the new government, which “believes that the only way it can generate enough funds to fuel infrastructure growth is by radically cutting food and fuel subsidies”. Diesel subsidies have already been cut and subsidies on cooking gas (LPG) and kerosene are likely to come down.

But cutting subsidy alone may not do the trick, says Amitava Sengupta, former director (finance and commercial), Petronet LNG. The real question is whether the government will ask ONGC “to provide additional dividends to take care of the fiscal deficit, or take up stakes in projects that may not be totally beneficial for the company or the shareholders”, he says. For ONGC to refuse will call for a chief who is confident enough of his powers to go head to head with the powers that be.

Over a few conversations, Sarraf doesn’t come across as a very forceful person but an earnest one, seemingly happy to trot out the same old lines: “We have been given a mandate by the government to ensure the energy security of the nation and we will do everything to accomplish it.” It takes much probing to get him to elaborate: that ONGC is spending Rs 100 crore a day just on domestic exploration and production in an attempt to bridge the demand-supply gap. Because he’s been at the helm for such a short time, it’s difficult to judge what Sarraf will do. What is clear, however, is that he’s not going to undo the work set in motion by his predecessors. Going by what he says and by what others in the industry say, Sarraf has his eye on the big picture. And that is energy security.

Sarraf has shown that he’s capable of getting his way in an understated manner, which keeps the bureaucracy off his case. When ONGC was in the process of being corporatised, its foreign lenders were alarmed, believing that if it was no longer a statutory commission, it would renege on repayment. Sarraf was deputed to convince the lenders that ONGC’s outstanding loan of $3 billion (Rs 18,150 crore) would be paid on time. He did, and the loans were paid back.

After this, Sarraf’s star was on the rise. He was sent on a three-year deputation to the Oil Coordination Committee (disbanded in 2002 when oil prices were deregulated), to prepare a cost-plus model for pricing crude. This, he says, “was a very successful part of my career, as I was able to achieve my mandate and provide a balanced approach, without being biased towards ONGC”. He also played a role in the partial decontrol of petroleum products.

His track record seems to suggest that Sarraf is more one of the policy wonks, without the operational experience that earlier ONGC bosses had. His predecessor, Sudhir Vasudeva, had spent 19 years managing Mumbai High, and was one of the first generation of engineers tasked with creating infrastructure to produce oil and gas from offshore oilfields. Vasudeva was also responsible for the second redevelopment of Mumbai High, an attempt to revive the ageing oilfield. Sarraf’s practical experience in the exploration and production aspects comes from a four-year stint in Assam when he was with Oil India in the days before he joined ONGC. Other than that, he’s always been a finance guy, all the way up to 2007, when he was made managing director of ONGC Videsh (OVL), the company that acquires and manages ONGC’s overseas assets.

His stint at OVL may well have been the turning point. An ONGC insider, who asks not to be identified, says that Sarraf’s “negotiating power and capability to take quick decisions came in handy when concluding deals” at OVL. This, he says, started when Sarraf was finance director of OVL from 2005 to 2007, when the company made significant acquisitions in countries such as Syria, Brazil, Colombia, Venezuela, Cuba, Egypt, and Myanmar. As managing director of OVL from 2011 to February this year, Sarraf introduced the “zero-based” risk review mechanism to assess risk in major acquisitions. Of course, since finance is deeply ingrained in him, Sarraf actively participated in the financial due diligence and price negotiations for OVL’s major acquisitions, including those in BC-10 in Brazil, NEMED in Egypt, AFPC in Syria, as well as blocks in Mozambique and Colombia. (Today, OVL is seen as the future growth engine of ONGC, but more on that later.)

It is this marriage of a shrewd financial brain with an understanding of the complexities of the oil exploration business that will guide ONGC. Add to this that most important of abilities: getting along with the government. And Sarraf has that covered. In the few months he’s been at the helm, he’s been careful not to rock the boat. Look at the issue of raising natural gas prices, which the previous government had promised to do, but the new NDA government has deferred by some months. Private players such as Reliance, BP (earlier British Petroleum), and Cairn Energy have been loud in their condemnation of the delay, and Reliance has even sent an arbitration notice to the government for the latter’s failure to raise prices in April as promised.

A back-of-the-envelope calculation shows that if prices go up to $8.4 a unit (what has been promised, nearly double what it is now), ONGC will add Rs 16,000 crore to its revenue and Rs 5,000 crore to profit after tax. But ONGC has been silent about the delay in raising gas prices; when asked, Sarraf defends the government, saying: “It is too much to expect the new government to take a decision on such a critical issue in such a short time. It requires a good amount of discussion and deliberation with all the stakeholders.” It’s win-win for Sarraf—ONGC is seen as a team player by the government, but it will reap the benefits of an early hike in prices if the government gives in to the private sector’s pressure.

THE NDA GOVERNMENT has made it clear that though it wants to delay the impact of a gas price hike, it is not going to stop reforms in the oil and gas sector, and has hinted that new steps will be taken to rein in the runaway oil subsidy bill. Analysts are cautiously optimistic; a July 2014 report from HDFC Securities says that if these reforms are actually implemented, “India’s largest E&P player [ONGC] will become the biggest beneficiary of the revamp”.

Already, despite higher crude prices—a fall-out of the Iraq crisis—the gap between the international and domestic price of diesel came down to Rs 2.50 per litre by July-end (as against Rs 9.40 roughly a year ago). That’s a huge relief for both upstream (exploration and production) and downstream (refining and marketing) companies, as well as the government, which had to fork out Rs 62,837 crore last year to meet the diesel under-recovery bill—the difference between the international price of crude and the actual selling price of diesel, subsidised LPG, and kerosene. “Such a step alone will halve the country’s oil subsidy bill from Rs 1.4 lakh crore to nearly Rs 90,000 crore in FY15,” says a June 2014 Barclay’s equity research report on oil and gas.

Last year (2013-14), while crude was priced at an average of $106 per barrel, ONGC took home only $40.97 per barrel, because it had to give a discount of $65.75 per barrel to Indian Oil, Bharat Petroleum, and Hindustan Petroleum respectively, which amounted to giving away Rs 56,380 crore. “Since we are never sure of our cash position [because of an ad hoc subsidy-sharing formula], it is extremely difficult to draw up an action plan for exploring new areas within the country or even making acquisitions abroad,” says A.K. Banerjee, director, finance, ONGC.

It gets even tougher as the cost of extraction grows steadily, given that the easily accessible oil and gas pockets are getting rapidly depleted. “In the 1970s and early-1980s, one barrel of energy produced 30 barrels of crude. Today, that same barrel produces only five barrels of oil. And when it starts producing only one barrel of oil, then it will be time for the E&P companies to shut shop and look elsewhere,” says N.K. Verma, managing director at OVL.

This year’s petroleum subsidy bill has been slashed to Rs 64,426 crore. A staggered increase in LPG prices and a better targeting of kerosene will help bring this down further. As Vikas Halan, vice president and senior credit officer at international credit rating agency Moody’s, points out: “We expect the government to increase the retail selling price of kerosene and LPG in a staggered manner to help control the subsidy burden rather than go for a one-time hike.” (Under-recoveries in cooking gas came to Rs 46,458 crore last year.)

POLICY CHANGES ALONE won’t give ONGC the firepower it needs to take on the likes of Reliance and Cairn Energy. Sarraf is deeply conscious that ONGC needs to increase production either by reviving old fields or by discovering new ones. “For us, it is like running on a treadmill because we need to produce more and more just to maintain our current levels of production, because most of our output comes from ageing fields,” he says ruefully.

What ONGC needs is another mega-find like Mumbai High; despite promising results from the Krishna-Godavari belt, a block of the same magnitude doesn’t seem likely. Though studies show a vast amount of oil in the K-G basin, the cost of extraction is likely to be far more, hence higher realisation from the existing finds—at least $65 a barrel—is a must.

Inside ONGC, OVL is considered the next growth engine. The international vehicle is expected to contribute nearly 46% of the group’s total output by 2029-30 from the existing 15%. The first steps to bolstering OVL’s portfolio have already been taken, and Sarraf’s experience has been useful. In just one year, OVL has grown its assets dramatically. It bought a 2.7% stake in the ACG field in Azerbaijan, an additional 12% in Brazil’s BC-10 block, and a 2.4% stake in the 1,786 km BTC pipeline that will carry crude from the Azerbaijan field to the Mediterranean Sea. There have been setbacks too, chief among the recent ones being OVL’s failure to acquire 8.4% in a Kazakhstan oil field; it lost the bid to Chinese oil major CNPC.

One of OVL’s most promising acquisitions has been a 20% stake in a Mozambique gas field; it bought out U.S. energy major Anadarko Petroleum Corporation’s 10% stake in the field for $2.6 billion, after having already taken a 10% stake in the same from Videocon and Oil India jointly. The plan is to set up a liquefaction plant in Mozambique and a regassification plant in India to bring LNG to the country. “Mozambique is far closer to India than Australia or even the Americas, and hence the company will be able to save on freight costs. Plus our biggest advantage is that we have our own gas,” says Sarraf. The company is also looking to buy a stake in an American company that is involved in extracting shale gas, though officials refuse to give details.

While the focus will increasingly shift abroad, the domestic front is not going to be neglected. ONGC’s crude refining capacity (refineries come under its subsidiary MRPL) is expected to increase to 21 million tonnes in a couple of years from the current 15 million tonnes. Also, the complexity of the refinery is being increased, which will allow it to process even low-grade crude, something that the private players (Essar and Reliance) are able to do.

Sarraf is also keen on continuing the seemingly random projects started by his predecessors. Notable among these is the 3 million tonne per year fertiliser plant set up by ONGC in Assam. Quizzed about this, Sarraf explains that it would have been impractical and too expensive to set up a gas pipeline from ONGC’s Khubal field in the hills of Tripura to the plains. So, he says, “we decided to set up a power plant [726.6 MW] because power can be transmitted far more easily through transmission lines”. And the leftover gas is used as feedstock for the fertiliser plant, adding to ONGC’s revenue.

But the domestic project that excites Sarraf the most these days is the northern development block in the Krishna-Godavari basin—also known as the DWN 98/2 deepwater block, off the Andhra coast, next to Reliance’s controversial KG-D6 basin. He says this is the project he’s “most passionate about” since he took charge. The other project that has him both excited and hopeful is the Daman offshore gas field, north of Mumbai High, which holds reserves of around 4 trillion cubic feet of gas. Though the field was discovered in 2002, the field development plan was finalised only in August this year with gas output expected to begin from 2016. “The two fields will add another 35 million cubic metres, or another 60% of the current production of 60 million cubic meters, of gas per day to a gas-starved nation,” claims Sarraf. An increase in gas price will also help in the extraction from small and marginal fields; if not, the company will possibly end up spending more on extraction than it gets by selling the fuel.

Complete deregulation of petroleum prices opens up another revenue stream for the company—running petrol pumps. Its subsidiary MRPL already has a licence to run 1,100 petroleum pumps, which don’t function today because their financial viability is in doubt. If the government sticks to its pro-reform track, this could end up being a profitable venture and yet another revenue source for ONGC.

Over the past few months, there’s been a sense of optimism about ONGC’s prospects, an optimism reflected in the share price which shot up by 55% in June, and continues at those levels (Rs 440 on Sept. 1, 2014). Many brokerages and advisories have a “buy” rating on the stock. It’s up to the government and Sarraf to keep this positive sentiment going.