Oil companies merger to create giant PSU could lead to mega-employee union threat

Published: February 16, 2017 6:04:43 AM

While working cultures could clash, the threat from a powerful mega-PSU employee union can’t be discounted

The historic reason for the vertical integration was the inability of oil companies to market their oil during times of surplus crude oil. John D Rockefeller cornered the oil business by taking control over the refinery and marketing operations. (Reuters)The historic reason for the vertical integration was the inability of oil companies to market their oil during times of surplus crude oil. John D Rockefeller cornered the oil business by taking control over the refinery and marketing operations. (Reuters)

Since oil prices are extremely volatile, it is claimed that integrated operations give better earnings stability. This again is disproved when we look at the recent period when oil prices dropped from above $100/barrel to below $30/barrel.

Earnings stability: While operating income of the super majors has declined from $109.1 billion to a loss of $4.9 between 2010 and 2015, downstream operating income has not been able to compensate for such a massive loss despite a significant increase. It is true that better downstream results have softened the shock of the oil-price drop. But it is not enough to give what is generally understood as earnings stability.

The historic reason for the vertical integration was the inability of oil companies to market their oil during times of surplus crude oil. John D Rockefeller cornered the oil business by taking control over the refinery and marketing operations. During those times, an oil company which did not have their downstream operations could not dispose of their oil production. Since most of the profit was made upstream, oil companies were not looking for maximising their returns on downstream operations. However, after the first oil shock—when Opec got into the driver’s seat to control the oil price—there was a need to earn returns both upstream and downstream. As a result, the need for integrated operation has disappeared today.

Blending cultures: Most of the criticism in the media of the proposed policy of creating a giant oil company has concentrated on the difficulty of blending companies with different cultures. While this is certainly true, it is manageable if handled properly. Take the example of a giant company like General Electric of the US. It became a giant by merging several companies. After buying Conoco, a company with very different culture accustomed to take high risks, Dupont managed it in an innovative way by keeping it separate. However, later Dupont sold Conoco when it realised that the benefits of vertical integration may not be commensurate with the complexity of managing two vastly different companies.

In the Indian context, an example cited frequently to highlight this problem is the Indian Airlines-Air India merger. However, this is not because of any inherent problem of different organisational cultures. Globally, there are several examples of airline companies successfully merging to derive the benefit of horizontal integration. In India, where politics enter the equation, a merger of two PSU airlines became a problem. The same will happen when oil companies with different cultures are merged because of the unavoidable political interference.

Competition: There is hardly any competition in the oil market today as a result of the government owning majority shares in the three marketing companies—IOC, HPCL and BPCL. All of them sell their products more or less at the same price. Reliance, Essar and Shell were competing with these state-owned companies till UPA decided to “protect” consumers of petrol and diesel from higher crude oil prices. The government forced the oil companies to sell petrol and diesel below cost. During 2005-2014, losses suffered by them was Rs 4.3 lakh crore.

We can apply the lesson India has learnt from the banking sector while analysing this issue. In India, though we have both private and public sector banks, the latter have a large market-share. As a result, the consumers of banks have been suffering ever since nationalisation of banks. It is not an exaggeration to state that today, the banking sector is driven either by political agenda or for its employees, and never to promote consumer interest. As a result, despite India having access to world class expertise in IT, digitisation has been minimal in this sector.

Energy security: The most clinching argument to oppose the formation of the giant company is its impact on energy security. Unfortunately, this issue has not featured whenever the topic of merging of oil companies has been discussed. Here, we have a very good example to learn from. In Mexico, Pemex has been the only one in control of all links of the oil value-chain for the last 80 years. It has been only two years since private companies were allowed in retail marketing, after years of monopoly power exercised by Pemex. In addition, the Pemex employee union had great power in shaping government policy, and some times, even the presidential election.

When one single oil company controls the marketing and distribution operations, it has the power to hold the entire country to ransom, threaten to close down all petrol stations or stop the distribution of LPG to residences. Mexico lived under such a threat for 80 years, despite the law which did not give the right to strike to the oil industry. In 1989, Mexican government arrested the leader of the union in a military raid because their workers were conspiring against the government, according to a report in the Los Angeles Times.

India has finally started to fill strategic petroleum reserves to ensure energy security. So, why would we now deliberately create an environment where an artificial shortage of petroleum products is a possible threat? The probability of such an event looks small today, but it cannot be ruled out. Should such an event take place, results would be catastrophic with civic unrest throughout India. Should we take a chance, just for the doubtful benefits of merging oil companies, to create a giant one? On the other hand, there is some justification in splitting the giant downstream company, Indian Oil, into three or four smaller marketing companies to have more competition and also promote energy security.

Bhamy V Shenoy

This is the concluding part
of a two-part series

The author is former senior manager, Conoco, and former board member of the national oil company of Georgia

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