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Resource nationalism a hindrance to acquisitions, D K Sarraf, Managing Director, ONGC Videsh Limited

05 Nov 2012

ONGC Videsh Limited (OVL) is India’s second largest E&P company in India- both in terms of oil production and oil and gas reserve holdings. A wholly-owned subsidiary of Oil and Natural Gas Corporation Limited (ONGC), the flagship national oil company of India, OVL is projected to more than double its production of oil and oil equivalent of gas in the next five years. In doing so, the company will set about its acquisitions through a healthy mix of exploratory and producing assets across the globe. In a freewheeling interaction with Neeraj Dhankher, OVL’s Managing Director, D.K. Sarraf talks about the company’s roadmap and acquisition strategy. Excerpts:

Please throw light on OVL’s production profile as on today

Though OVL was incorporated in 1965, we first started production of hydrocarbons in 2002-03, when it started gas production from Block-6.1 in Vietnam in January, 2003. Later, during the same year in March, we acquired 20% stake in producing Greater Nile Oil Project in Sudan. From a modest start of 0.253 MMTOE of oil and oil equivalent of gas (OEG) in 2002-03, our production rose to 9.45 MMTOE in 2010-11.

In 2011-12, our production declined and stood at 8.753 MMTOE of oil and OEG due to geo-political difficulties faced in Syria and Sudan for part of the year.

Our production in 2012-13 is likely to be still lower mainly because of continuing difficulties in Sudan and Syria, and also somewhat due to aging fields. The satisfaction is that some of our other assets which are under-development will start producing in 2013-14. These include blocks-A1 and A3 in Myanmar where we would produce gas. Similarly, the Carabobo oil field in Venezuela will also start producing during the next fiscal. This would see our production looking up.

In addition, we recently made an announcement for our proposed acquisition of 2.72% stake in one of the world’s largest producing fields – Azeri-Chirag-Gunashli (ACG) in Azerbaijan from Hess Corporation, a US energy company along with 2.36% of Baku-Tbilisi-Ceyhan (BTC) crude oil pipeline for US$1 billion. So our production is expected to improve in the coming years. We are also looking at more acquisitions.

How does the company arrange funds for managing its E&P operations? How is capex worked out?

Our capex comprises of maintenance/ committed capex which is for surveys, exploratory & development drilling, addition of facilities etc. in our existing exploratory, development and producing assets. This we estimate on a yearly basis keeping in view our work program. However, the major capex is for acquisition of new oil and gas properties. Acquisition is an uncertain business; it is hard to predict how many acquisitions we would be able to conclude during the coming year. So we keep the acquisition capex as flexible. It depends on how much success we get in our acquisition efforts.

Most of the capex in existing assets is financed by ongoing revenue generation i.e. these are self-funded. However, the new acquisitions are financed partly from cash flows generated by existing producing assets and borrowings from ONGC and the market. We are the 100% subsidiary of ONGC, the national oil company of India, a company with highest profit in India, which is also a debt-free company with significant cash reserves.

What is the acquisition roadmap and strategy for OVL for the future? What are the areas that you are looking to explore?

Recently ONGC finalized the group’s long-term strategic plan – called the Perspective Plan-2030 which is the basis of our acquisition strategy.  As per the Plan, OVL has been given lot of responsibility for ONGC group’s growth. As per the Plan, OVL’s current production of 8.753 MMTOE of oil and OEG is planned to be increased to 20 MMTOE by 2017-18 and up to 60 MMTOE by 2029-30.

The production would be added by new exploration assets as well as producing assets. While exploration blocks gives more value addition because acquisition cost is lower, but it takes longer to reach the production stage and is risky. In case of producing assets, one has to pay more, but production can be added in near-term and is more certain. We intend to continue to have an optimal mix of exploration and production. For our short term target (2017-18), we will stress more on producing assets. At the same time, to achieve our long term target (2029-30), we are emphasising on acquiring exploration assets.

We have identified certain focus areas for acquisitions.  These include the oil sands of Canada, shale gas in USA which can be brought to India as LNG and heavy oil in Latin American counties. We believe that these are the places where world’s most of tradable reserves are available. In addition, there are multiple LNG opportunities in East Africa, Australia and the Arctic. Being an E&P company, our focus is just not only on LNG terminals, but on upstream natural gas fields also - so we produce gas, convert it to LNG and then transport LNG to India.

Most of the major recent hydrocarbon discoveries have been in deep-water, like Brazil, Mozambique, Angola, Nigeria, the KG basin of India, to name a few. So we also plan to look at opportunities in deep-water in coming years. To start with, we would like to be a non-operator in deep-waters.

Then, we are also looking at opportunities in old brown fields, where decline has already set in.  Our parent company, ONGC has extensive expertise in managing and adding value to such fields, demonstrated by maintaining the production of Mumbai offshore fields even after more than three decades of production. We plan to leverage ONGC’s expertise in this area in our quest for acquiring depleting fields, especially those in offshore.

We would like to have presence in exploration in the Arctic region as well.

What are the challenges faced by OVL today in conducting its E&P business?

Firstly, M&A game is becoming increasingly competitive, since in most of the cases it is ‘seller’s’ market. Then, due to volatile oil prices, valuation is difficult. Further, during operations, the safety and environment norms have also become, and that for good reasons, more stringent.  And then, there is a wave of resource nationalism. The E&P business by nature is risky; the risks are increasing with time.

What are the financial problems faced by OVL in Russia?

In Russia, we have two producing properties. Sakhalin-I has PSC regime, where we purchased 20% participating interest in 2002, with Exxon Mobil as the operator. Operations in this field have been very successful with respect to production, project management and hence financial returns. There is stability due to the PSC regime. Then, in 2008, we acquired Imperial Energy. However, the fiscal regime in this case is Royalty and Taxation (R/T) regime. The difficulty here is that while there are significant oil reserves, they are held in very tight reservoirs. We are not able to produce these in absence of a technology which would be viable given the existing fiscal regime. It means that even when oil price is US$100 per barrel, our netback realization is less than US$20 a barrel, after payment of taxes in Russia and oil transportation tariff to the Russian state entity. So the option for us is to either get a technology which produces at US$20 a barrel, or fiscal regime needs a change. So we are working on both fronts i.e. identification of the required technology and efforts are also being made to persuade the Russian government for optimizing the fiscal regime. We have had partial success in both.

There was a big hue and cry over OVL’s exploration activities in Block-127 in the South China Sea, with the Chinese government conveying its unhappiness over the Indian presence in the region. What was the real issue?

In Vietnam we had acquired two blocks-Blocks 127 & 128. In Block-127, we drilled a well but did not find success. So it was surrendered. In case of Block-128, we could not commence drilling operations as the sea bed was very hard due to which we were not able to anchor the floating rig. So we needed a different technology for anchoring, which we got. However, it would increase drilling costs. Re-evaluation of economics showed that the block may not be economically viable with increased costs. This was informed to the Vietnamese authorities, which suggested that they would make available additional geological data from the near-by areas and asked us to hold on to the block for another two years and conduct a fresh view after that period. As far as we are concerned, the block was given to us by the Vietnam government, which confirmed their right over the area. I do not know where the reference of China comes from?

There is a perception that India lags behind China when it comes to bidding for large scale E&P projects across the globe. Do you think we are short on financial resources, technology, political environment or strategy as compared to the Chinese?

There is no comparison and also not fair to contrast. Their policy and strategies are altogether completely different. The type of returns they look at is also different. OVL approaches any project as a commercial company, while they have a country perspective. Their system also supports them to take a country’s macro-view – they have financial support and offer an inter-sectorial package. Here, if OVL gets sovereign funding support and systems are put in place for inter-sectorial package, including services and infrastructure also, then things could be different. I do not think that we lack either of financial resources, technology, political environment as compared to the Chinese; our strategies could be different. And, we not only compete with Chinese, we cooperate with them as well; for example, we acquired producing assets in Syria and Colombia along with Chinese companies; we partner with them even in Sudan.

What suggestions would you give on improving the decision making process for E&P acquisitions?

We have an excellent and robust system of decision making on acquisitions. We form an in-house team for each opportunity we examine. It comprises regional, technical, financial experts. We engage consultants to give us independent advice on various domain areas of expertise – technical, legal, financial and tax & accounting. Once the proposal is fully gone through internally, it is examined by a Project Appraisal Committee (PAC) of the Board, comprising of the independent directors, Government nominee on our Board and functional directors. The recommendations of the PAC go to our Board for approval, if it is within its empowerment, else it recommends the proposal to ONGC’s Board in case it is within ONGC’s empowerment. In case of large value proposals, the approval of the Government is sought, first at the level of a Committee of Secretary and then at the level of a Cabinet Committee. Though final approval goes through various stages, it works quite fast.  With regard to empowerment of our board, we have requested the Government for enhancing the level.

How would you rate OVL’s performance over the years?

In 2001, we had only one asset and no production. Today, we have 30 assets in 15 countries, 10 of which are producing and five are discovered. It is not easy to develop an E&P company from the scratch. The figures speak for themselves.

(InfralineEnergy thanks D K Sarraf, MD, OVL for sharing his valuable insights with our readers. The column 'In-Conversation', is a platform to engage experts from various sectors to share their views on the different transformations happening in the Indian energy sector.)