2005 - Oil India Limited

OIL beyond territorial barriers
includes the contingent resources that may be currently
un-economical or the discoveries whose commercial
viability has not yet been determined as well as the value
of the exploration prospects to be drilled by the company.
It is needless to state while determining the asset value of
the company that the risk-weighted values are to be taken
into account.
Against this background, E & P business is highly capital
intensive. Moreover, the time required for exploration,
appraisal of a discovery, development of fields considered
as commercial and build-up of the surface facilities for
production, processing, storage and transportation is
usually very large as new large discoveries are likely to be
located in hostile and far flung areas. By the time
production from the new areas becomes available, the
fields already in production would start to decline.
Globally, the independent
up-stream oil companies tend
to generate internal growth
in their value through
acquisition of assets with
core value and portfolio
management through
swapping of assets.
M E R G E R S A N D
ACQUISITIONS:
PERSPECTIVES
For growth of enterprise
value, the oil companies would normally try to expand
the business within the existing value chain, where
adequate core competency exists. Moreover, in order to
improve the bottom line, the down-stream companies
would like to diversify into chemicals business and upstream
business, where the return on capital are higher
than in refining & marketing business .
As the business dynamics of the petrochemicals business
is comparable to that of the refining and marketing
business, expansion of business of the down-stream
companies by diversifying into the chemicals business
comes naturally. However, the core competencies
required for the E&P business are significantly different
from those of the refining and marketing segment of the
petroleum value chain. Therefore, the down-stream
companies are eager to acquire an up-stream company to
translate their expansion plans by migrating to a value
chain with higher return potential.
Various arguments are often put forward in favour of
vertical integration of oil companies. Out of these, three
important arguments are:
• it would reduce volatility of earnings in the case of upstream
companies.
• it would improve security of supply in the case of
down-stream companies.
• it would improve utilization of logistics assets.
Another reason as to why a refiner would seek vertical
integration is that, integration could lower investment
costs in refining by allowing refiners to optimize their
operations around a known fixed crude oil system.
While the securities of raw material
supply in a process industry is very
critical for its survival as a business entity.
Volatility of crude oil price on an E & P
company is not very critical as
profitability of the company could be
reasonably managed even at the time of
low crude oil price by cutting down the
exploration expenditure, and under
special circumstances, by pruning
development expenditures and shutting
down the marginal fields. The temporary
shortfall in crude availability from these
measures would result in bounce back of
the crude oil price. Utilization of logistics assets is true
only in special cases. In any case, available infrastructures
of different oil companies in the same area could be
shared through contractual arrangements. It is quite
common for the user to pay a tariff to the owner of such
infrastructures if the same is cost-effective.
If we look around the globe, we will find that most of the
oil companies are either integrated oil companies or
independent E & P oil companies. Accordingly, the
Government of India started encouraging the downstream
oil companies to move to up-stream activities in
the 1990s. However, the results so far have not been very
encouraging. This was not unexpected, as the downstream
oil companies have tried to build up their own
competencies in the complex up-stream business, which
is time-consuming .
4