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Raghuvir Srinivasan

HOW about a newspaper publisher venturing backwards into the business of newsprint production just so that his main raw material source is protected? Or an automobile manufacturer foraying into steel production for the same reason?

Better still, what if a power producer decides to explore for gas just so that one of its sources of fuel is secured? Well, that is precisely what the Rs 25,000-crore National Thermal Power Corporation (NTPC) proposes to do.

NTPC is considering putting in a bid for oil and gas blocks currently on offer under the NELP V round in association with a partner, most probably from the oil industry. The logic is that the company wants to have an assured supply of fuel at competitive prices for its gas-based generation units.

Now, the concept of vertical integration is an established one with several companies, Indian and multinational, successfully employing it. For instance, Reliance Industries, which originally started off as a petrochemicals manufacturer and forayed vertically upstream into oil refining and further on to oil and gas exploration.

There are others such as ONGC who are desperately seeking to vertically integrate from oil exploration and production to refining and, further down, to retail marketing, power generation and even producing petrochemicals.

Does NTPC's plan to bid for gas exploration blocks fall under this model? It does not. The successful models of vertically integrated companies are those that forayed upstream or downstream within their respective industries.

If Reliance has been successful in its foray into oil refining and exploration it is because those are closely related to its core business of petrochemicals.

In the case of NTPC, oil exploration can by no means be termed as closely related to power generation. If NTPC were to foray vertically that would be into power transmission, distribution, power trading and so on. To be sure, the company is already planning to enter all these areas and has even floated subsidiaries for this purpose.

But what is wrong with NTPC venturing upstream of its existing business especially if that will help it protect its raw material supplies? Well, the problem is with the model that it plans to employ. Oil (and gas) exploration is a tricky, high-risk business. It is also capital-intensive and rarely do you find an outsider venturing into it. If you were a power producer with large projects under implementation and on the drawing boards, would you want to sink precious resources into a completely different business with no prospect of assured returns? This is what NTPC plans to do.

It already operates in a capital-intensive business and has budgeted an expenditure of a whopping Rs 88,500 crore for capacity addition over the next decade.

Its brief is to add in excess of 25,000 MW of capacity in this period. Given this, is it prudent to foray into another high-risk, capital-intensive business even if the objective is to secure its fuel supplies?

There are better options available for NTPC to secure its fuel supplies. The company can invest in the equity of the upcoming liquefied natural gas (LNG) projects such as the Kochi terminal of Petronet LNG and the proposed Ennore terminal of Indian Oil. Such investment can be linked to secure gas supplies over the long term.

Or if this proves to be an expensive option, the company can negotiate for long-term contracts with gas producers as it indeed has done with Reliance Industries for the supply of gas for its existing projects.

This is a time-tested model and adequate safeguards can be put in place to ensure continuous gas supplies. Internationally, this is a successful model employed by gas and power producers.

Some would argue that NTPC's strategy is only an extension of its plan to enter coal mining, which it has done with the same objective of securing its fuel source.

However, the vital difference here is that unlike coal blocks, which are assigned and where the presence of coal is definite, oil exploration blocks are bid for and again, there is no certainty that the explorer will strike gas. The risks are, therefore, higher.

NTPC's exposure to coal-based projects is higher than to gas, which probably justifies its foray into coal mining.

Of its present installed capacity of 21,435 MW, 82 per cent is coal-based with the remaining fuelled by gas. The recent problems with coal availability are also an added justification.

The market, where the NTPC stock has seen considerable activity since its listing five months ago, appears to have taken a dim view of the proposed foray into oil exploration.

The stock shed 10 per cent in the last fortnight since the news broke; during which time the Sensex fell just 7 per cent.

The point is that this move enhances the risk-profile of the company and also raises worries over whether scarce resources are being invested in a high-risk, uncertain business at a time when the company is on a major capacity expansion programme.

After all, there is something to be said for sticking to one's knitting.

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