Should ONGC buy Rosneft?

When oil prices started to hit new peaks in 2004-05, international big oil was one of the first to be blamed. The public perception was that for years oil majors such as ExxonMobil, BP, and Shell had found it more profitable to drill oil in Wall Street rather than in oil fields. Translated, it means that given low oil prices and their high cost structures, the oil majors found it more profitable to buy out smaller exploration firms which were drilling, rather than explore on their own. The $100+/barrel prices put an end to that era, as exploration became worthwhile.

Those happy days may be back again, and may present a once-in-a-generation opportunity for India. Lower oil prices have pushed down the values of oil companies by over 50%, giving India a chance to acquire assets cheap. This is a smart way to hedge our economy against future increases in energy prices.

There are plenty of plum assets to pick from. One such is Rosneft, the state-owned Russian oil major. Rosneft is one of the largest oil companies in the world, with oil and gas production of 5 million barrels per day.[1] That’s more oil than India consumes per day or will consume for several years to come. Rosneft has proven oil and gas reserves of 43.33 billion barrels.[2] Against this, India’s state-owned ONGC has a daily oil production of 1.13 million barrels a day, and total petroleum reserves of 7.1 billion barrels[3].

But there’s a difference—and an edge. The market capitalisation of ONGC is $46.8 billion. The market capitalization of Rosneft is $34.8 billion. This means that for a price less than the market value of ONGC, India (or anyone) can acquire a company producing 5 million barrels a day of oil and gas. It’s possible also because India is already saving over $60 billion annually now that the price of oil has fallen below $50 a barrel from over $100 a barrel last year.

Rosneft’s share value is low because western economic sanctions imposed in 2014 on Russia, following the Ukraine issue, have scared off investors; oil exploration in Russia attracts a higher tax regime; and there is always the risk of interference from the Russian government any time now or in the future.

This would have been an ultimate arbitrage trade, except that the counterparty in this case is the Russian government, and a private investor may not be able to play it. Obviously, this is a theoretical scenario—Rosneft is not on sale and neither has ONGC expressed a desire to buy it.

But it should. Rosneft trades on the London and Moscow bourses—about 10% of the company’s shares. So 5% of Rosneft can be bought for as little as $1.7 billion, giving ONGC and the Indian government a production and a buffer of 250,000 barrels a day—that’s more than the 170,000 barrels a day produced by ONGC Videsh after a decade in business.

Another attractive asset is UK-based Tullow Oil, an independent oil company which has made significant discoveries in Uganda and elsewhere in Africa. Tullow has oil reserves of 1.4 billion barrels,[4] and a market capitalisation of $4.8 billion. Effectively, these reserves are available for $3.6/barrel. Tullow’s stock price has fallen by 50% from August to now, in line with the drop in global petroleum prices.

Other firms have seen an even sharper fall in stock price and valuations. London-listed Enquest PLC, which produces 27,000 barrels a day of oil and has 2P (proven + probable) reserves of 194 million barrels,[5] has seen its market value fall by over 75% in the past six months, to just $317 million.

Several other similar-sized oil and gas companies are listed in stock markets across the world, such as London and New York, whose share prices have fallen sharply in the past six months. The oil majors like ExxonMobil and Shell have not seen such steep declines in valuations because they are integrated companies with other businesses, with oil exploration being just one income stream. For the smaller companies with income only from exploration, an oil price fall means an immediate hit to profits.

India’s public sector oil companies have had limited success so far in buying oil and gas assets overseas. Largely, they have been unambitious, but often they have been outbid by their Chinese counterparts. Most times it has worked against India; sometimes it has not. Like the $5 billion investment made by the Chinese at the top of the cycle for an 8.33% stake in the Kashagan oil field in Kazakhstan—which ONGC had bid for, but lost. Just as well, because the project has seen massive cost over-runs and production has been delayed for years.[6] But unsuccessful deals such as Kashagan are few. Mostly, China has benefitted from its investments.

It is time for Indian oil majors to step up to the acquisition game for energy security. India’s oil companies still have their war chest intact and can now pick up stakes in projects or in smaller oil companies trading in the global markets. New Delhi can direct ONGC to seek such opportunities aggressively, especially since ONGC also has the required exploration expertise. And it can raise the funds: the company has a net worth of over $20 billion and almost no debt, so it can raise more money if it wants to. Making a bid will be a bold first step, indicating that India is now in play.

An alternative is to set up a sovereign wealth fund, which can invest a part of India’s foreign exchange reserves in acquiring such stakes. However, without fund managers with expertise about the oil industry, this may be a less efficient option.

Low energy prices are a boon for India because we are, and will remain, a net energy importer. However, if energy prices start to inch up, as they inevitably do, the acquisitions made now will give India a hedge against higher oil prices in the future.

From the Indian perspective, this is a trade with only an upside.

Amit Bhandari is Fellow, Energy & Environment Studies, Gateway House.

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