Tony Hayward’s visits to India during his years as the CEO of oil supermajor BP was largely to fulfil his duties as a non-executive director of Tata Steel. But his agenda often included a lesser known item — a low-key meeting with Mukesh Ambani, India’s No. 1 billionaire on Forbes India Rich List and the chairman and managing director of Reliance Industries (RIL).
The two often caught up to discuss the contours of a nascent relationship between their companies. RIL and BP had already bid for and won an oil block in India. And now both began talking of a deeper relationship. But what shape this relationship would take was not clear even to those close to the two men.
The answer came this February. Even though Hayward had been forced by then to quit BP in the aftermath of the Gulf of Mexico oil spill, the new CEO Robert Dudley picked up the threads with RIL. BP announced it will take a 30 percent stake in 23 oil and gas blocks owned by RIL across India, including the producing Krishna-Godavari D6 block.
The two companies also agreed to form an equal joint venture to source and market gas in India. BP said it would make a total investment of $20 billion in these ventures. This would make the deal one of the largest foreign investments in the country.
However, those who have watched the two companies closely say that their coming together was not just the result of friendship; both BP and RIL had been pushed to the corner in their respective businesses and were looking for partners that would help them recover. The alliance was their best chance to achieve that.
To say that 2010 was annus horribilis for BP would be an understatement. The explosion at its platform Deepwater Horizon in April resulted in the biggest oil spill in history. The company is still cleaning up the mess — both physically in the Gulf of Mexico and financially in its balance sheet.
The world’s third largest oil and gas company posted a $4.9 billion loss in 2010, its first annual loss since 1992. It included a total pre-tax charge of $40.9 billion related to the blow-out. The company’s retreat from the US, at least for the medium term, now looks certain.
Though not quite as cataclysmic, the problems of Reliance Industries are quite challenging too. It faced technical issues at D6 (Reliance’s and India’s largest natural gas find) as a result of which its plan to step up gas production was shot to pieces. In fact, the production began to fall. Sustaining production even at levels achieved in March-April 2010 became tough. The company that had brought to production India’s biggest gas field was finding its management and technical bandwidth stretched to the limit.
RIL was also lagging behind in exploration of its portfolio of 20 other blocks that it had bid for and won over the years. There was bad news from drilling in KG D9 that everyone had hoped would be ‘another D6’. The well turned out to be dry.
Exploration at NEC-25, the third prospective block in the Mahanadi Basin had not really developed. For these and the earlier problems between Ambani and his brother Anil, investors were punishing the stock. RIL has lagged the benchmark Sensex for three consecutive years.
The hard work begins for both the companies only now. Given that gas prices are regulated by the government and mostly stay much below international prices, it will be a challenge to make the alliance work, especially in distribution and marketing. Reliance has little experience working with global majors and its earlier partnership with Chevron was short-lived. It will be interesting to see how BP and Reliance leverage their respective strengths.
Find Baby Find
There is one number that reveals how long an oil and gas company can sustain production. It is the Reserve Replacement Ratio (RRR), the extent of a company’s finds over the current rate of production. For Reliance, this number has been falling. "RIL has been unable to significantly add to its reserves since the D6 discovery," says Neil Beveridge, senior analyst at Sanford C. Bernstein in Hong Kong. There have been a number of incremental discoveries, but nothing approaching the scale of D6. The BP deal will bring in the much needed cash to boost its RRR.
RIL has proved its capability in developing the D6 block. But managing an exploration campaign over a huge area involving billions of dollars in investment, simultaneous activity in exploration, appraisal of findings, development and extraction of oil is a very complex affair. With BP’s experience, Reliance will be able to take up such campaigns, says Narendra Taneja, south Asia bureau chief of Upstream, a global oil and gas newspaper published from Norway.
More urgent is the need to fix technical problems that have been hampering production at D6. Here too, BP will make a difference, having drilled in over 30 countries and developed proven reserves of 18.3 billion barrels of oil equivalent.
But investors point out that the deal does not seem to solve RIL’s problem of future growth. Analysts like Vidyadhar Ginde of HSBC expect an acquisition in the petrochemicals segment. The company has cash and cash equivalents of $7 billion on its books and is estimated to generate cash profit of $8 billion in 2011-12. Add to this the infusion of $7.2 billion from BP and it has sizeable wallet to shop with. It has already lined up investment of $7 billion that includes a few projects that are yet to take off. The problem of finding enough large investments is something that the company will have to continue grappling with for some more time —unless of course, the RIL-BP combo is able to find the next big one very quickly.
What’s in It for BP
For BP too, the RRR declined in 2010 after it sold assets around the world to fund liabilities in the Gulf of Mexico. However, it has struck two big deals this year that should increase the RRR — the Reliance deal, preceded by a share swap with Russian gas company Rosneft.
After reducing BP’s scope of operations in the US, CEO Dudley had been looking for growth and diversification opportunity. The vastly under-explored subcontinent was a compelling option.
BP’s Energy Outlook 2030 forecast that India’s energy consumption, which grew by 190 percent over the past 20 years, is likely to rise by 115 percent over the next 20 years. International pressure to cut emissions will also boost gas consumption more than oil over the next few years.
But the real challenge for the alliance comes in the marketing of gas. When RIL first struck large amounts of gas, everyone started speaking of India’s transition to a gas economy. Nearly 10 years later, there is still a huge shortage of gas.
City gas distribution was once considered the Holy Grail of last-mile gas marketing in India. But by now, it has become clear to companies that competition is very stiff and margins very thin in that business.
The deal is a bold move by both companies to bet on India’s future energy profile despite the odds. If they succeed, some of the tarnish may just be wiped out from Tony Hayward’s legacy.
Comments
0 comment