The PSU oil companies, now on the verge of bankruptcy, are dying a slow death under the crushing weight of subsidies. The same political parties who opposed their privatisation, when in the opposition, are now killing these companies. By Vivek Sharma

Recently, I had posted a blog entry on oil companies consciously creating a shortage of unbranded fuel to push costlier, branded fuel in the metros. Now, the oil companies have gone a step further by limiting supplies altogether. '

We have restricted our sales subject to availability', Indian Oil chairman Sarthak Behuria is reported to have clarified. (See: Government delays decision on fuel price hike as IOC bleeds) It is time to welcome back fuel shortages!

'Availability' is low, not because oil companies cannot find sufficient physical quantities of crude oil in the international market or because of any refining bottlenecks. Instead, availability is low because the oil companies don't have sufficient cash to buy crude oil and process it. It has been like this for these companies for quite a while now and they have already eaten into all their reserve cash. Companies like Indian Oil are now thinking of raising short term working capital borrowings by pledging capital assets. Since working capital is scarce and costlier, they have decided to sell only premium fuel. Can't fault them!

Hold on for a moment; the government has been compensating these oil companies through oil bonds, hasn't it? Besides, upstream oil companies like ONGC and Oil India have been sharing part of the subsidy burden. Then, how come the oil retailers are facing a cash crunch?

Total oil subsidies during the last financial year was estimated at over Rs70,000 crore, or so the government says . Of this, the upstream companies shared a third and the government promised to plug half of the hole by issuing oil bonds. The oil retailers were asked to swallow the rest themselves in good humour, which wiped out much of the money they made from refining.

Now comes the funny or the cruel part if you are an oil retailer. The government distributes the bonds in a peculiarly haphazard manner. And when they get it, oil companies can recognise the amount and set off the losses in their books. But the bonds are not cash. These are long-term bonds which pay low interest and in any case cash flow from interest payments will not be enough for the oil companies. The only alternative is to sell the bonds. Therein lies the rub, there are not many buyers for these bonds. If they must sell, the oil companies will have to sell the bonds at a discount which will hit their bottom-lines even more.

As crude oil price hovers around the $130-per barrel mark, the situation has become even grimmer this financial year. Total subsidies may cross Rs.2.5 lakh crore in 2008-09, or more than three times last year's figure. Here is what the Indian Oil finance director had to say. "If the company is not allowed to increase prices, 'by September, our debt-equity ratio will take a beating and our net worth will be eroded. Sustainable borrowing is an issue". It may be hard to believe, but this is the plight of our PSU oil companies.

Whither capital investments
In the last decade, Reliance Industries commissioned its mega refinery at Jamnagar and is now doubling capacity at the location through subsidiary Reliance Petroleum. The company is raking in profits as its refinery is brand new and process harder crude which fetches higher margins. Besides, Reliance now exports most of the produce – having recently shut down all its retail outlets. Reliance Petroleum, even before its refinery has been commissioned, now commands a market value in excess of Rs80,000 crore. Essar Oil, which launched its refinery project in the mid-'90s, is finally about to fully commission its facility and is talking about another mega greenfield refinery – as big as the Reliance refinery.

In contrast, the last greenfield PSU oil refinery commissioned was Indian Oil's Panipat refinery in 1998. When compared to Reliance's Jamnagar refining capacity of 33 million tonnes per year, Panipat was commissioned with a capacity of 6 million tonnes, which has been recently hiked to 12 million tonnes per annum. ONGC's Mangalore refinery, under subsidiary MRPL, was originally promoted as a private-public partnership between the Aditya Birla group and HPCL. It was commissioned in 1996 and was later acquired by ONGC in 2004 (See: ONGC to finalise power, petro plans; acquires control of MRPL) 

The only new PSU oil refinery commissioned this decade is a micro-facility by ONGC in Andhra Pradesh with a puny capacity of 0.1 million tonnes. Won't even meet the needs of a small town!

It is not that the PSU companies don't have plans to set up new refineries and oil pipelines. In fact, at least three large refineries – in Punjab, Madhya Pradesh and Andhra Pradesh - have been under active consideration for many years now. The PSU companies behind these projects have been negotiating with large global players like Total of France and oil companies from the Middle East. Deals were announced with much fanfare, only to see them fall through later. The only potential partner still in the fray for one of these refineries is Lakshmi Mittal, not through Arcelor Mittal but in his private capacity.

There is only one reason for these projects getting delayed – the PSU oil companies don't have cash. They don't have enough cash to meet daily needs, forget about long-term capital investments. Even ONGC, which should be going full steam with expansions, is holding back – probably because of the subsidy sharing. Nothing has come out of the MRPL capacity expansion and the Rs25,000 crore petrochemical complex in Mangalore announced a couple of years ago.

When Reliance is commissioning its new refinery ahead of schedule, Indian Oil may even be forced to stop implementing ongoing projects – like the Paradip refinery with a capacity of 15 million tonnes. "We have taken a decision that all new projects will not be taken up. We need cash. Unless we have upfront cash, we cannot generate debt", the Indian Oil chairman despaired.

Privatisation by the backdoor
The burden of subsidies has also ensured that the market values of PSU oil companies have languished. The combined value of Indian Oil, HPCL and BPCL now stand at Rs80,000 crore, which is what Reliance Petroleum is valued at even before processing a single barrel of crude! It is sickening to see businesses like HPCL and BPCL valued lower than even Aban Offshore - an offshore oil services company. The low valuations will hamper any capital raising plans, in case the government allows them.

Towards the end of the tenure of the previous government, two significant initiatives that would have dramatically changed the fortunes of the oil companies were scuttled. First was the move to get rid of the administered price mechanism (APM), which was dropped after being very close to fruition as the government suddenly developed chicken feet as elections drew closer. If the oil companies were given even partial flexibility to calibrate their domestic pricing to international oil prices, much of the damage could have been avoided.

The second initiative of the previous government that didn't come through was the privatisation of HPCL and BPCL. If it had happened, it would have accelerated the move to a more market-driven pricing mechanism for fuel. It would also have ensured that at least those two companies had sufficient resources to expand.

Because of the complete drying up of capital investments, these PSU companies are constantly eroding their ability to compete in the future. Even their existing assets will lose productivity and value, for lack of investment. If this continues, the day is not far when these companies become marginal players in the oil and gas industry. Eventually, fuel retailing will be de-regulated, there is no other way. These companies,  weakened by years of underinvestment, will not have the resources to compete in a free market. They will fade away or get acquired by private players.

It is interesting that the coalition parties now in government opposed these two initiatives and played a big role in scuttling them. Their single point argument was that such 'precious family silver' should not be sold off or privatised. And now, by allowing the PSU oil companies to bleed, they are killing them softly.