It is premature to celebrate the consolidation of ONGC and HPCL

The Union Cabinet’s in-principle nod to the purchase of Hindustan Petroleum Corporation Limited by the Oil and Natural Gas Corporation has cleared the decks for India to have its own oil giant. The decision follows the Finance Minister’s announcement in this year’s budget that the government would seek to merge public sector oil companies to create larger entities. The acquisition is expected to be consummated over the next year with ONGC buying the government’s 51% stake in HPCL. This would offer ONGC access to HPCL’s refining and retail facilities. The rationale is that a bigger, vertically integrated oil company can help India achieve the scale required to compete at the global level, and help better absorb oil price shocks. In fact, it is expected that the Cabinet may decide to consolidate more public sector oil companies. In addition, the sale of HPCL could contribute almost Rs.30,000 crore to the exchequer and fulfil more than a third of the year’s disinvestment target. All this, of course, makes the ONGC-HPCL deal look like a boon for the government, the oil sector and the overall economy. There are questions about how ONGC will find the cash to complete the deal and how it can bypass an open offer to minority shareholders, but these may be the least of its worries.

Business combinations, even those that strictly involve private players, are potentially destructive to shareholder wealth. Notably, the merger of Air India and Indian Airlines in 2007 failed to realise the expected benefits of scale and synergy from a larger enterprise. ONGC Chairman Dinesh K. Sarraf has spoken of the benefits of synergy from the deal with HPCL. But ONGC’s history of capital allocation, which has come under much criticism from analysts, gives very little reason to support such optimism. The Comptroller and Auditor General had in 2011 criticised it for the expensive acquisition of the U.K.-based Imperial Energy Corporation on unrealistic projections about returns. The CAG exposed various other inefficiencies in ONGC’s operations in subsequent years. Not surprisingly, ONGC’s profits have dropped significantly over the years, and in 2015 it lost its place as the most profitable Indian company. All this is reflected in ONGC’s lacklustre share price performance over the last few years compared to HPCL’s multi-bagger returns. Analysts have also been concerned about whether ONGC will benefit from HPCL’s efficient work culture or end up diluting it. Given that public sector consolidation has been adopted as official policy now, these are questions that merit serious consideration. The lofty goal of creating profitable international oil behemoths cannot be achieved unless they conform to the basic rules of business.