As ONGC Videsh Ltd (OVL) enters the final lap to acquire UK-based Imperial Energy, there is all around applause. At $2.6 billion, it is the largest Indian outbound deal this year so far and the third largest on record. Some have other reasons to celebrate. OVL will best its ace rival China’s Sinopec. In the recent past, China has won most of the bidding wars over India.
Illustration: Jayachandran / Mint
The deal also marks OVL’s first big-ticket investment in the current era of high oil prices. The last time it spent big, it acquired the Greater Nile oil field in strife-torn Sudan in 2003 for around $700 million. Global oil prices then were around $25 per barrel. Today, with oil prices in three-digit figures, the scope for errors in commercial judgement is less.
The Sudan acquisition offers an important parallel with Imperial. It was only after the Canadian firm, Talisman Inc., exited in response to US sanctions on the political regime that OVL could move in. The promoters of Imperial want to exit Russia, their main asset base. But the parallel ends here.
First, Talisman exited in distress — OVL got a discount deal, and oil prices subsequently shot up. Second, while the ruling Sudanese junta could be propitiated with much needed investments, India has little leverage with Russia.
India’s experience there so far points to that lack of leverage.
The Sakhalin-I project in far eastern Russia, in which India invested around $1.7 billion in 2001, saw costs escalate by 60% in 2004. The main reasons: First, under the terms agreed, most of the equipment was to be sourced locally and procurement costs had risen significantly. Second, there were cost overruns resulting from delays in Russian approvals. State-owned Rosneft’s presence was no help. And there was further cost escalation in subsequent years.
The project remains troubled — operator Exxon has been denied extension of the licence area, reducing the projected output by around 10%. The potential value of gas is unrealized, because the Sakhalin-I consortium has not so far got clearance to set up a liquified natural gas terminal to export gas. Against international prices of $17 (spot) and $10-12 (long-term contracts) per mBtu, domestic sale, the only current opportunity, yields about $1.8 per mBtu. In the medium term, sale of gas to neighbouring countries through pipelines will at best realize a few more dollars.
If despite this, Sakhalin-I has proved a success story, that can’t be entirely credited to OVL’s business acumen — or its technical expertise in assessing the prospects of a field — but rather to the phenomenal rise in oil prices subsequent to its entry. I
Improved assessment of reserves helped, too — in 2003, Exxon, announced that the reserves had vaulted 20-30%. However, geological risk cuts both ways — the Russian government estimates the growth at 6-9%! In assessing reserves several kilometres below sea level, valuations are in the realm of probability, not surety.
At a broader geopolitical strategy level, although much is being made of India’s engagement with Russia on the energy front, Sakhalin-I was the only time India got a slice of the action. It was Russia’s Prime Minister Vladimir Putin who took a decision rejecting BP Plc. in favour of OVL and, as part of the deal, OVL gave a soft loan to Rosneft. Despite several assurances, no deal has come through since then.
And the times have changed — flush with petrodollars, Russia is no longer won over by just cash investments. Rosneft paid back the loan in cash in 2006, and OVL which had been expecting it would be paid in oil, didn’t realize those hopes.
So, how realistic is OVL’s expectation that the Indian government would have the required influence to ensure transaction costs are contained, and to mitigate the risks that could well render OVL’s investments ineffective? By offering Russia more attractive trade and investment opportunities, can India get more influence?
A big question is whether the overall scheme of things is changing now, especially after Georgia — after all, it commands a strategic space in the West’s perception of its energy security. One difference is that Asia is turning out to be a preferred market, as Western companies are turning wary of an increasingly resource nationalist Russian regime. Their concerns would be justified. In 2006, Russia used environmental norms to force operator Royal Dutch Shell Plc. to relinquish control of the Sakhalin-II project to state-owned Gazprom at a below-market price. In another among several instances, BP was forced to sell out a gas field project to Gazprom last year.
Regardless, and despite the OECD (Organisation for Economic Co-operation and Development) prognosis that the “biggest obstacle to further investment remains the risk of greater state interference”, the lure of getting even a small slice of business in Russia has meant foreign direct investment rising from $32.4 billion in 2006 to $52 billion last year. The flow into hydrocarbons, tripled to reach nearly half of that total.
Finally, in the larger pursuit of energy security, OVL’s case for securing oil and gas fields in risk-laden regions is still strong. But while supply security can be had from such acquisitions, economic viability is as crucial, and far tougher, a proposition. Note that Reliance Industries Ltd, with its far superior strike rate over OVL’s parent company ONGC Ltd back home, does not even look at discovered blocks — its focus is on virgin, exploration projects, where returns are far higher as entry is cheap.
OVL lacks the expertise — while it has invested more in virgin than discovered fields, it has either dug dry wells or struck small. Is this due to a lack of human resources, access to technology or just poor incentives? Can these be addressed with private partnerships such as the alliance it has with the Mittal group for oil business in Central Asia?
While one will have to wait for the answers, it is evident that a strategy of “have money, will buy” can only go thus far and be limited to geographies fraught with political risk. Further, in this game Chinese oil companies will almost always have more resources than OVL. So, while Imperial may or may not prove to be a good buy, it is unlikely to be a harbinger of the future.
Poonam Madan is deputy editor, Views pages, at Mint. Comment at email@example.com