Govt must divest stake in oil PSUs early

TS Ramakrishnan/Aditya Malhotra | Updated on January 31, 2020

As the growth in oil demand is set to decline, divestment should be done over the next two years to maximise returns

The strategic disinvestment of Bharat Petroleum Corporation Ltd (BPCL) was announced in November 2019. As there is not enough time this fiscal year, it would probably be carried out in FY 2020-21.

Some have raised concerns about the government not meeting the targeted disinvestment for FY 2019-20, stating that if the government is not ready to slip on the fiscal deficit of 3.3 per cent of GDP, it could dent government spending and, thereby, not stimulate consumption growth.

When a party forms the government after electioneering, the financial year is shortened to almost six months as the next Budget is to be presented by February 1. Thus, the government failing to achieve its disinvestment target in FY 2019-20 cannot be faulted. However, FY 2020-21 is a different ball game. The government’s execution of disinvestment is critical for diverse reasons. It must compensate for the shortfall in the disinvestment of FY 2019-20.

The government’s commitment to strategic disinvestment will be there for the investors to see and gain confidence. The receipts from disinvestment from the early years of Modi 2.0 dispensation could help the government consolidate its spending on infrastructure that would stimulate economic growth.

According to the definition of strategic disinvestment by the Department of Investment and Public Asset Management (DIPAM), a strategic disinvestment takes place when the block of shares (50 per cent or higher) to be disinvested are transferred to a private partner, so that the government transfers the management control to the private player.

One of the key objectives for transferring management control to the private player is to ensure that the receipts received through disinvestment are significantly higher than when the disinvestment of shares is thinly spread across multiple players. For instance, if the receipt from BPCL disinvestment as per the current market prices is about ₹60,000 crore, disinvestment to a single private player may fetch the government ₹80,000 crore, including an additional fee for control premium.

Whenever a strategic private partner or institutional investor looks to invest in a business (assuming risk factors are comparable), it seeks a higher Return on Capital Employed (ROCE) than the Next Best Alternative (NBA). For a strategic investment to succeed, the government should disinvest its PSUs well before the signal goes to the markets that these PSUs may lose their competitive advantage and register minimal or even negative growth.

The Air India saga

For a successful exit from the business, it is best to exit when valuations for that business are high. When PSUs face stiff competition either from private operators or from substitutes in providing goods or services, it is next to impossible for the PSUs to survive in the market, especially when their interests are not only governed by profits but also by government objectives towards the electorate.

For example, when the government permitted low cost carriers (LCCs) to carry out operations in India in 2004-05, if the then government had completely dis-invested Air India before opening the skies to LCC’s, the government would have mopped up a respectable amount from the disinvestment, preventing huge cash burns and the additional burden on budget allocation. The money could have been easily used to increase infrastructure spending to spur additional growth.

Once LCCs arrived, Air India, which does not have any substantial control over its costs, faced severe losses, whereas the LCCs are essentially designed to limit costs by increasing their operational efficiency at every stage of the value chain. The white elephant, Air India, by March 31, 2019, had a debt of ₹70,000 crore.

It has become next to impossible to find a strategic private partner who would buy Air India along with its huge debt. In the case of Air India, competition came from LCCs, but in the case of oil PSUs, competition is emerging from a fundamental source of energy, namely electricity, the cheaper substitute for oil. Whenever major disruptions come about through technological or business innovations, PSUs seem to be ill-equipped to handle such shocks and change their course of action in a timely manner.

As per World Oil Outlook 2040 published by OPEC, the crude demand for India would increase from 5.1 million barrels per day in 2020 to 6.4 million bpdy in 2025 at a compound annual growth rate (CAGR) of 4.65 per cent, more than the CAGR of 3.76 per cent in 2016-20. It is also predicted that the CAGR would further decrease to 3.77 per cent, 3.40 per cent and 2.51 per cent in 2026-30, 2031-35 and 2036-40, respectively.

Hence, 2020-25 is the quinquennial that will witness maximum oil demand growth in India. The oil sector may not vanish after 2025, but the growth rate for this sector will decline. The rate of decline in oil consumption depends on two factors.

Firstly, on how quickly the life cycle cost of electric vehicles comes on par with ICE vehicles and reduce further and, secondly, on the rate of growth of petrochemical consumption.

Oil producers diversifying

The growth in consumption of petrochemicals has a direct and strong positive correlation with the growth rate of the economy. Even if petrochemical consumption manages to somehow hold the rate of decline in oil consumption, oil marketing companies do not derive any major revenues from petrochemicals since they do not have any substantial installed capacity for production.

Even if they do install such complexes in the future, their ability to change the product mix in a dynamic and hyper-competitive industry remains a question. But additionally, markets respond to early morning signals than what happens on the ground at a later point of time.

This is the reason why the UAE, which has 6.51 per cent of proven crude oil reserves at the end of 2018, has been aggressively diversifying from its oil-based economy in the last two decades to an economy that is more reliant on aviation and tourism for its growth.

Saudi Arabia, which holds 17.79 per cent of proven crude oil reserves at the end of 2018, no longer wants to depend on crude oil for its economy and is looking for ways to diversify its economy. It has relaxed the rules and norms for tourists. In January 2020, Tesla, the electric vehicle manufacturer’s market value is more than Ford and GM combined, the conventional ICE vehicle manufacturers. All these indicate that there is a high likelihood that valuations for oil firms may decrease in the coming years.

If the government fails to disinvest oil PSUs either in FY 2020-21 or in FY 2021-22, there is a higher probability that the receipts from disinvestment will be lower than what they are today. On the other hand, if the government retains oil PSUs as Maharatnas, it could go the Air India way.

If oil PSUs are disinvested in the early years of this decade, it would be a positive strategic disinvestment. If done later, it may well become a distressed disinvestment.

Ramakrishnan is Member, Pursuitex LLP. The views are personal

Published on January 31, 2020

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