Reform On A Slippery Slope

The Royal Dutch/Shell group is currently conducting a feasibility study for a Rs 7,070-crore, seven million tonne refinery with public sector Bharat Petroleum Corporation Limited (BPCL) at Lohagara, near Allahabad. But the $1,28,174.5 million Anglo-Dutch corporations interest in a sector that was opened to private and foreign investment in 1991 is strictly conditional.

We will invest in India only under import parity prices and not under the administered pricing mechanism, says Vikram Singh Mehta, chairman of the Royal Dutch/Shell group, India.

Like every other player in Indias opaque, cross-subsidised and shortage-ridden oil economy, Mehta will be aware that the fate of the Lohagra refinery could hinge less on judgements in North Block, the seat of the finance ministry, and more on the decisions of people like Kewal Kumar, a peanut vendor at New Delhis ITO crossing.

For his Rs 1,800-2,000 a month business and his domestic needs, Kumar uses roughly seven litres of kerosene, Indias most

subsidised fuel. He manages to buy just four litres each month from the public distribution system at Rs 2.85 a litre (roughly seven cents, almost 60 per cent lower than global prices). The rest he procures from the black market at Rs 8 a litre (roughly 20 cents, almost equal to global prices).

Ask Kumar if he would vote for a government that increases the price of kerosene and, predictably, his answer is an emphatic no. Every government that comes to power in India faces the same quandary: of balancing the demands of an expanding economy with the expectation of votebanks that have been nurtured on generous subsidies in the past.

This time, however, it is uncertain whether the next government can be unequivocal in its decision-making. True, falling global prices from $19-20 a barrel (for Brent crude, the global benchmark) last year to $14-16 today a depreciating rupee and a consumption-restricting recession will help India end the year with an oil import bill of $7 billion from $10 billion last year. But the danger signals are blinking.

The urgent need for reform is clear from the political risks the United Front government took last September by raising diesel prices by Rs 1.80 a litre, the highest in recent times, and LPG by Rs 15 per cylinder. This is one of the moves that is expected to help the government end the year with a surplus of

Rs 2,000 crore in the oil pool. The September hikes form part of a timetable that the government declared in November to dismantle the administered pricing mechanism (APM) by 2002 (see The countdown), an agenda future governments may need to take seriously.

The pressure to reform would come from an estimated bill of $150 billion that India is said to need to meet its energy requirements over the next 15 years. So far, the investment in exploration and development, which was selectively opened for bidding in 1991, has been of the order of of $1.6 billion with giants like Enron and Shell stepping in (see page 3).

Not surprisingly, only half Indias sedimentary deposits have been explored, that too in fields that are considered of moderate intensity. In 1995 and 1996, no new investors stepped in because the government has not been able to finalise the policy framework.

In February last year, the government announced a New Exploration Licensing Policy (NELP) that offered both domestic and international bidders international prices for crude. The interest this has generated show that with the right signals, India could strengthen its oil economy.

Refineries have attracted another $2 billion against a total requirement of $10 billion. The current refining capacity in India at 61.55 million metric tonne (MMT) falls short of the 80 MMT needed. In 2006-07, the refining capacity will have to be more than 160 MMT to meet the demand (see page 3).

The problem is that subsidised pricing by increasingly bankrupt governments has locked in public sector oil company funds that could have been invested in exploration and development. In September, the government worked out an ingenious plan under which oil companies were made to subscribe to bonds that carried an interest of 10.5 per cent and would mature in five to seven years. In effect, the Rs 18,200 crore they are owed will only be available between 2002 and 2004.

It is unlikely, however, that the public sector monopolists will ever be able to commandeer the kind of money India needs. For example, the Oil and Natural Gas Corporation (ONGC), the main exploration and development agency till 1992, plans to spend Rs 65 billion in deep sea drilling till 2002. Compare this with Shells R&D expenditure, which was Rs 30 billion in 1992!

Exploration and development is vital to Indias oil economy because it would save the government a huge import bill. By 2002, Indias fuel requirement is expected to be 113 millon tonne, nearly 40 per cent more than this fiscal years consumption of some 85 million tonne -- and that forecast excludes the needs of the private power producers.

Against this, crude production is expected to be only 36.9 million tonnes. Thus, India is expected to import 83 million tonne of crude oil and 14.4 tonne of products by 2002. From then on, demand is expected to increase at about five per cent every year to touch 197 million tonne by 2010. By this time, unless new fields are found and exploited, domestic production will have plateaued at 44 million tonnes.

This implies that India will have to rely on imports to meet almost 80 per cent of its demand in future compared with about 60 per cent today. Even at a conservative estimate of $20-22 a barrel as the average cost of crude in the year 2010, India will need foreign exchange worth $26 billion a year.

The government will have to be bold enough to ensure that whatever has been announced should not be delayed if not compressed. We expect the price of kerosene to be brought to market levels and subsidy through the general budget by the year 2005, says B Bhattacharya, economic advisor, ONGC.

Another deterrent to investments has been marketing. Shells interest in setting up a refinery is primarily to support significant marketing operations in the country. Market access is a precondition for us making an investment, says Mehta.

Till recently, refineries were allowed to market their products only through the four public sector companies, Indian Oil Corporation, Hindustan Petroleum, Bharat Petroleum and Indo Burma Petroleum. This was hardly inspiring since their area of operation and volumes are determined by a Sales Plan Entitlement.

From April 1998, private companies investing more than Rs 2,000 crore to set up a refinery or private upstream oil producing companies with an annual production of over three MMT will be allowed to market motor spirit (MS), high speed diesel (HSD) and aviation turbine fuel (ATF).

But private oil companies consider this insufficient. The sequence of deregulation has been a bit distorted. Without opening up the market, we went into the more difficult issue of exploration and refineries, says R K Sukhdevsinhji, managing director, Essar Oil.

The ostensible reason for restricting market access is that domestic public sector units need to be protected. Private entrants say this is uneccesary. It will take a long time to match the public sector companies by sheer virtue of the distribution networks laid over the years, says Essars Sukhdevsinhji. This gives the domestic companies a clear advantage of five to seven years, an analyst adds.

Indeed, it is clear that some of the government companies are confident of their ability to compete. Give us the navaratna package and we will match these multinationals and also take them on in the international market, says B C Bora, chairman, ONGC.

Boras demand follows a decision in June 1997 to give all national oil companies special status. The proposal included turning them into board-managed entities with professional part-time directors. Eight months down the line, the oil majors are still waiting for change.

This proposal to give public sector companies relatively unfettered freedom highlights yet again the dislocated nature of reform in the sector. As Bhattacharya points out, We cannot be complacent about the type of investment that is coming in. The entire process will need a lot of monitoring and we need to have a proper regulatory framework.

The government has only been thinking of setting up a Hydrocarbon Regulatory Authority on the lines of the Telecom Regulatory Authority. For the upstream sector, a Director General of Hydrocarbon (DGHC) has already been established. But this body is still awaiting approval from a parliament that has been increasingly distracted with issues of survival for the past year.

Energy security and environmental concerns also imply the need to check the growing demand for petroleum products. On this score, the government can be praised for easing import restrictions on liquefied natural gas (LNG), to offset a shortfall of 88 million standard cubic metres a day that is expected by 2002, by putting it on the open general licence and linking domestic and international prices.

Predictably, this has already attracted investment. British Gas has tied up with Gujarat Pipavav Port Trust to set up an LNG terminal with an annual capacity of 2.5 million tonne. Shell has also signed an agreement to set up a Rs 700 crore LNG terminal at Hazira in Gujarat with an annual capacity of five million tonne.

The public sector GAIL, ONGC, IOC and BPCL have set up a consortium, PetroNet LNG to import LNG. The first terminal will be set up by 2002. Similarly, Enron has evinced interest in setting up LNG terminals. Rapid reform clearly has its benefits.

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The new mantra

Three public sector oil majors are restructuring themselves to gear up for the competition.

With total decontrol round the corner and competition from both domestic and multinational oil majors growing, at least three public sector oil giants are looking for solutions to stay afloat. The trio -- Bharat Petroleum Corporation Limited (BPCL), Hindustan Petroleum Corporation Limited (HPCL), and the Oil & Natural Gas Corporation (ONGC) -- are seeking succour from management consultants like McKinsey & Co, Price Waterhouse, Arthur Andersen and Arthur D Little.

While McKinsey is working closely with ONGC on an Organisation Transformation Project, Price Waterhouse is working on its financial restructuring. HPCL has roped in Arthur Andersen while BPCL has sought the advice of Arthur D Little.

The three public sector giants are trying to build competencies for future growth. Take the case of ONGC which has an unwieldy structure. It has reported poor reserve accretion and a declining production. The R group committee, which was set up to study the ills of the hydrocarbon sector and suggest its reform, had set in its seminal report in 1996 that ONGC would have to be restructured to prevent it from slowing down the entire upstream sector.

Now, McKinsey has drawn up an agenda to transform ONGC into a decentralised, asset-based organisation. The idea is to have a lean corporate centre at the top and multi-disciplinary teams (MDT) heading various assets such as producing fields, exploration blocks, or even centralised services like drilling, seismic acquisition and support functions.

Basically, each asset team will be headed by an asset manager. The asset will hire services either from ONGC itself or from other suppliers. And the asset manager will be supported by a MDT while taking operational decisions.

The organisation transformation was important to benchmark our performance against best practices in the industry. In two years time, we shall be at par with the worlds best oil companies, says B C Bora, chairman, ONGC.

While the ONGC-Mckinsey team is working out the details for the systems, procedures and structures within this broad framework, as a pilot case, its Neelam oil field in the Bombay offshore region has already been spun off as an asset or separate business unit.

The asset manager and MDT for it has been selected and the team has started gathering exploration & production data and re-evaluating curent development options. Various task forces are also redesigning the managerial structure and procedures.

The ONGC-Mckinsey team is also chalking out thrust areas for ONGC Videsh, the overseas subsidiary, which has been identified as a major growth area. Plus, it is developing a growth strategy for drilling as a centralised operation with its own accounts.

McKinsey has recommended that ONGC spin off services that are not directly linked to its core competency of exploration and crude production, into separate subsidiaries or profit centres. Other services that could be spun off include well-logging, seismic data collection and well stimulation. These are areas in which ONGC has developed in-house expertise.

While ONGC has already made a beginning, the Rs 10,874-crore BPCL will start restructuring its operations from April 1. This in a bid to gear up for 2002, when the sector will be largely decontrolled following the dismantling of the administered price mechanism (APM). BPCL has drawn up an intense programme that entails compressing management layers, decentralising decision-making in operational and financial matters and creating independent profit centres, and building a brand name for itself.

As a preliminary, BPCL and its management advisor, Arthur D Little have a plan to re-allocate responsibilities, inject accountability and redeploy personnel to other refineries.

Basically, BPCL will be restructured into seven new vertical departments or strategic business units (SBUs). These include lubricants, retail, direct (for industrial users), aviation, refining supply and brand image. All seven will have operational and financial freedom.

As part of its brand-building effort, BPCL had launched a new generation retail outlets (NGRO) programme last year. This aims to provide state-of-the-art, user-friendly retail outlets. The exercise will cost Rs 90 crore in the first year of implementation and Rs 101 crore in the second year. From the third year, it will cost Rs 112 crore a year. BPCLs strategy is to focus strongly on retail marketing since its refining capacity at six million tonne per annum (mtpa) is much smaller than market leader, Indian Oils 35 mtpa capacity.

The move was prompted by a survey conducted by BPCL, which showed that the consumer had a very poor recall of the oil company's outlet he frequented. BPCL hopes now to make the consumer more brand-conscious. Its future plan also includes making the outlets one-stop shops, where consumers can access other goods.

At the Rs 18,089-crore HPCL too, the focus is on becoming more responsive to customer needs. The impetus is clear. HPCLs CMD H L Zutshi has said in a message to employees in December 1997, Operating in a decontrolled scenario would call for greater efficiency and cost-effective operations.

So Arthur Andersen has drawn up a business process reengineering exercise for the company. The aim is to sharpen the competitive edge in all critical areas from operations to marketing to infotech. So four SBUs will be set up: lubes, direct sales, automotive or retail sector and LPG. As a pilot case, the LPG business has already been hived off as an SBU in December. The restructuring will also entail greater empowerment.

In fact, HPCL is not just looking at petrol pumps but even at LPG to strengthen its brand image. This is now going to be more prominently sold under the HP brand and a major image promotion exercise is going to be launched soon.

The new-look PSUs, then, hope to metamorphose into competitive organisations that can take on the challenges thrown up by the privatisation process.