Road to Profitability — India’s Public Sector Upstream Oil Companies (Part II)

In the 1st part, we saw how India’s national oil companies are deploying various financial measures to battle the low crude price regime. But mere finance cannot help these companies remain fit. Financial measures must be backed up by appropriate technical and managerial moves.

Hence, in this part we will see the technical measures that can be put in place by ONGC & OIL.

I. Technical Measures

1. Increase spending on remedial well operations: With the fall in subsidy burden, the government has opened up lot of opportunities for public sector players to explore. The added room for expenditure and relative advantage against private players must be utilized immediately to broaden the market share and increase the crude oil production.

The focus globally is maximum production with minimum costs. Service providers and suppliers are scrounging for live orders, creating a buyers’ market. In India, PSUs have been strategically mandated to invest in capex. ONGC is rolling out mega re-development projects off the ageing western offshore fields, as well as the ambitious integrated development plans for eastern offshore deep-water fields. Implementing these high-value projects within the limited window is critical.

Due to the falling oil prices, lot of service companies and drilling companies are offering services and equipment at record low rates. It is high time that both public sector companies make complete use of this disguised opportunity and put the funds saved from subsidy into such operations that can help revive their brownfields. These investments may reduce the profit margin, but will be extremely beneficial for the companies in long-term. When the prices will recover, these companies will come out far stronger than ever and will regain the footing in India’s oil market, similar to what they held in the pre-NELP era.

2. Increase operational efficiency: From the above charts, it is quite clear that the working capital and operating profit margins continue to fall. Despite the reduced cost of inventory and services, it has been difficult for these giant companies to maintain profit margin levels. This is mainly because they operate old and mature fields and it is extremely difficult to raise production rates from these fields. That makes preventing revenues from falling a challenging job.

But companies can attempt to increase operational efficiency. These can be done through variety of ways:

i. Review of old contracts: Lot of existing contracts might have been approved three to four years ago at relatively higher rates, since then the price scenario was in a healthy state. However, now when the prices have taken a downward plunge and because lots of contractor companies are striving for revenues, renewals of contracts at lower rates are carried out.

ii. Austerity measures: Public sector companies must understand that unlike private players, they have limited options for cost cutting. Hence, they must try to implement austerity measures in corporate offices, facilities and urge their employees to follow the route until the price revives.

iii. Purchase v/s. repair analysis: More than half of the facilities and equipment owned by these companies are many years old. Lot of these require repair and revamping. However, due to the reduced efficiency of internally repaired equipment, the companies have suffered in past. In a time, when new inventory is available at reduced cost, companies should look to purchase products and services from outside than to repair or revamp its old equipment. Also, they must simultaneously reduce old inventory to reduce the inventory turnover ratio.

iv. More focus on onshore assets: Naturally, onshore assets involve lesser per barrel expenditure than its offshore counterparts. A large part of assets (70% for ONGC and nearly 100% for OIL) are in onshore. Companies should strongly focus on these assets as they can be made more efficient at a lower expenditure.

3. Increase well stimulation and workover operations: When oil wells fall sick or when they don’t deliver the expected production rates, certain remedial operations like workover and well stimulation are performed to revive these wells. Currently, this is the best time to take these jobs to record-breaking heights. These operations are relatively far cheaper than drilling operations and involve fewer risks. These operations can help companies to gain more out of their brownfields. Moreover, costs of these operations have also fallen in the last five years. Thus, net effectively these operations can bring more money out of the investment than they did few years ago.

4. Severely cut down on drilling: We have seen in the earlier charts that it is extremely vital to reduce expenditure so that the working capital does not get hindered. No matter how much subsidy relief these companies get, it is crucial to understand that their net profit margin will definitely fall with the falling prices. Hence, companies must strictly cut down on drilling operations in exploratory fields because these involve extremely large expenditure and high risk.

But, it must also be noted that the reserve accretion and RRR need to remain at a steady level or follow an increasing trend. To achieve those companies should make use of infill drilling or drilling in known fields to reduce the associated risks.

5. Improved Oil Recovery (IOR): This era of low price has brought drastic transformation in O & G industry. Already, there have been many mergers, acquisitions and divestments of major companies. It is clear that the companies that make most out of this period will come out even stronger and will lead the market share for a long duration. India’s both public sector companies have large and diverse assets that still hold lot of potential. But these fields have been continuously witnessing a natural decline of around 10% per annum in terms of production rates.

In FY16, over 30% of oil produced by these companies has come from IOR techniques that bring out the incremental oil and increase the recovery rates of the existing fields. It is essential to increase the scale of IOR operations to maintain the production rates or even increase them as they will ascertain a steady flow of revenues and will provide substantial ground for these companies to invest in new fields when the prices recover.

Also, most of the IOR operations carried out by these companies are indigenous are done solely by themselves. The operational expenditure of these operations is relatively insulated from oil prices and hence, these operations can be heightened to maximize mature field potential.

6. Reduce CAPEX: Although an easy way of reducing the total expenditure in other industries, it is extremely challenging to reduce the capital expenditure in oil and gas industry because capital projects are decided years before and involve complicated designs and large scale of operations. Yet, the companies must try to redesign their existing or upcoming projects to make them more economical, but sustainable from long-term perspective. Unessential spending must be cut down and terms of services must be renegotiated.

7. Make use of downstream opportunities: A gloomy picture for the upstream market presents a golden opportunity for the downstream sector as crude oil is their raw commodity. ONGC and OIL have been involved in some of the downstream operations as well. They must use this scenario and try to expand scale of operations and immediately operationalize some of the upcoming projects like OPAL to get achieve higher margins of profit from these downstream projects. The speculated merger of HPCL & ONGC is one such way to balance risks.

II. Managerial (HR) Measures

1. Increase training and R&D projects: Most O & G companies in India have not focused on training as well as R&D efforts as they should have done in the past. Their reliance on foreign technology and private services has been immense. With the end of easy oil era and the increasing complexity of oil reserves, it is extremely essential to put substantial amount into these drivers of growth.

Also, it is expected that more than half of top management of these companies is going to retire by 2018. There is going to be a huge deficit in lot of managerial roles and a huge generation shift. Companies must not let the gloomy picture of oil price hinder its training efforts. Rather, they should increase the rate of such projects and put more money and time to ensure that the transition from one generation to another happens smoothly and paves way for more opportunities than threats. This is in fact evident from the fact that R & D expenditure has steadily gone up for ONGC during the past five years.

2. Reduce employee expenditure:

The per employee expenditure of both companies these companies has grown at a CAGR of around 10%. This is higher than the inflation rate and companies should look to reduce these expenditures. It is essential to note that public sector companies don’t have the leverage of retrenchment compared to the private players and hence, the remuneration should not be exorbitant during this period.

Combination of these measures will surely help public sector companies tackle the deep challenges associated with the low crude price regime and there is a high likelihood that they may come out even stronger once the prices recover.

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