Why Indian refineries continue to attract investors with deep pockets

As demand for oil is shooting up to keep pace with GDP growth, picking up a stake in an existing or planned oil refinery is a lazy but effective bet

Today morning, the finance and petroleum ministries will open the bids for oil and gas exploration blocks under the Open Acerage Licensing Policy (OALP). Officials are hopeful the bids, coming after a lot of tweaks in the policy, will show up some interesting offers.

But the big news this morning is a reported offer by Kuwait Petroleum International to buy a 24 per cent stake in Bina refinery, a 50:50 joint venture between state-run Bharat Petroleum Corporation (BPCL) and Oman Oil Co. Last month, Saudi Aramco announced it plans to invest 50 per cent in a Rs 3 trillion refinery project floated by the three state run oil companies— Indian Oil Corporation, BPCL and Hindustan Petroleum Corporation.

Investors with deep pocket like Kuwait Petroleum and Saudi Aramco have demonstrated which options within the Indian energy sector they prefer to sink their money in. It is the downstream business of oil marketing since it is safe. The Saudi and the Kuwait money will simple replace other equally safe bets. The Indian petroleum sector gains little in terms of value added in the process. As the demand for oil is clearly shooting up in India to keep pace with the growth of GDP, picking up a stake in an existing or planned oil refinery is a lazy but effective bet. Refineries across Europe are expected to close big time in the next twelve years. An estimate puts the global capacity that would go out of action at about 1.4 million barrels per day, of which Europe would account for almost 44 per cent. As margins come under pressure, it makes sense to add to refining capacity close to markets like India.

Exploration business on the other hand, is for those who cant win a good deal to buy oil and sell it, within India or abroad. This is keeping the officers glum. Remember the OALP is a good policy that makes approvals easier. Under the earlier regime, the cabinet committee on economic affairs had to meet each time to approve a block for oil and gas exploration preceded by detailed negotiations with the bidders. Not so any longer.

The new policy scraps the approval system with that of continuous bidding through out the year. So any company exploring the blocks that have not been already bid out or are already under production can do so and bring the promising ones to the table. The finance and petroleum ministries have been delegated the power to approve those. The bids would be opened twice a year and the companies know the results within two months. For instance the contracts from the bids to be opened today will be awarded by July. Yet the pain points persist. Which is why Kuwait and Saudi Arabia still prefer refineries to invest in India.

A recent report by consultancy firm Deloitte shows what are the pain points.

One is the nature of contracts to be signed with India. Mega oil companies of the world love to operate under concessions agreement. They have the freedom to explore and run the risk of not finding a good field.There is no guaranteed returns, but once they strike oil they share the royalties at an agreed percentage with the state.

India, insists on production sharing contracts, where the government sits on the board of the oil companies. taking a view on all operational decisions. Even under OLAP it is the same revenue sharing contracts though there are sweeteners like a single licence needed for both exploration and production as well as pricing freedom. Few companies, it would seem, want this. The other pain point is the the lack of a market for gas for measuring risks for exploration. We have promised a gas exchange in November last year. It is still being discussed.

If the government has to sit on board rooms, the foreign investor would much rather have the presence where the risks are controlled. In the refinery business. How much oil to import and which oil pumps to sell to. What could go wrong in these decisions?