Indian Government Plans Sovereign Oil Fund to Support Overseas Acquisition Campaign

Sovereign Oil Fund

India is planning to set up a sovereign oil fund to help state-run companies such as Oil & Natural Gas Corp. (ONGC) and Oil India Ltd. (OIL) to become more competitive in bidding for assets overseas. Indian officials have begun preliminary discussions for the oil fund following proposals by officials from the Ministry of Petroleum and Natural Gas and state-run oil companies that part of India's foreign reserves, estimated at US$278 billion, should be used to acquire upstream assets overseas. The size of the sovereign fund has not yet been determined, however, and discussions are ongoing between the Finance Ministry, which will work out the size of the fund and its model, and the Ministry of Petroleum, which has proposed a US$20-billion figure, according to an unidentified senior official cited in the Financial Times newspaper. ONGC chairman R. S Sharma commented that the fund would help the company to secure energy deals overseas and help to boost production and meet India's energy needs.

The fund idea has been proposed against the backdrop of ONGC's failure to acquire overseas assets in 2009. Although the percentage of overseas production as a proportion of the company’s total production has more than doubled from 7.23% in 2002-03 to 15.42% in 2007-08, the company has been relatively unsuccessful in making acquisitions since the financial crisis, despite the temptations thrown up by the fall in crude oil prices and asset valuations. ONGC Videsh did succeed in finally closing a deal to purchase Russia-focussed explorer Imperial Energy at the end of 2008 for £1.4 billion (US$2.14 billion), although over 2009 the company only succeeded in making one significant acquisition, namely a stake in the Carabobo-1 block in Venezuela, offered as part of the heavy oil tender in the Orinoco Belt (see Venezuela: 12 February 2010: Venezuela Sees Mixed Results in Heavy Oil Tender). ONGC has been keen to emulate Chinese NOCs—which have stepped up overseas activity significantly over the past year, spending US$16 billion on acquisitions and a staggering US$49 billion on oil import and loan deals with state banks—but suffers from a number of disadvantages.

On the financial side, Chinese oil companies regularly inject profitable assets into their listed subsidiaries to boost their share prices while dividends are paid into their parent companies, giving them large amounts of capital to spend overseas while they enjoy low borrowing costs from state-owned banks. ONGC Videsh has also received interest-free loans from its parent company, but the parent company itself is saddled with having to subsidise domestic gas prices from output under the administered pricing mechanism (APM). The bidding ability of other Indian companies such as Indian Oil Corp. (IOC), also looking overseas, is undermined by having to sell fuel at below cost in the domestic market. Since China implemented its cost-plus fuel price mechanism at end-2008 this has put them at a significant disadvantage. ONGC Videsh has also faced delays in getting numerous approvals for overseas acquisitions while Indian oil companies are further constrained from making large bids by their need to offer decent returns to private shareholders. In contrast, Chinese NOCs also tend to invest through their parent companies, which do not have boards of directors to which investments have to be justified. This means they can move fast to secure deals and put in higher and more risky bids. Indian oil companies have an expanding but still limited range of technical expertise, particularly in areas like ultra-deepwater exploration and shale gas development, and do not have the same level of efficiency in implementing projects, which in bidding rounds where technical capability is part of the criteria, can place them at a disadvantage, particularly to IOCs.

Outlook and Implications

If established, a sovereign wealth fund will enable Indian companies to borrow more heavily, allowing them to put in higher bids for assets abroad. This will support ONGC Videsh's strategy of acquiring upstream assets in Africa, Latin America, and the Commonwealth of Independent States (CIS) (see India: 12 March 2010: ONGC Eyes Russia's Oil and Gas Fields). In particular it could help ONGC Videsh to increase the competitiveness of its planned bid with Sonangol for energy assets in Angola's forthcoming licensing round and to obtain assets such as the Trebs and Titov gas fields in Russia and deposits on the Arctic peninsula of Yamal, which the company is eyeing. By increasing the overseas asset base the fund could also have some benefits in terms of boosting equity oil—or oil that Indian firms have the right to take or market—which could increase the profitability of Indian oil companies over the longer term, helping to offset domestic losses.

Nevertheless, even with US$20 billion, Indian oil companies may find it difficult to compete with China, which has set up a sovereign wealth fund of US$300 billion to support investment in energy and mineral assets. Indeed, in a single acquisition last year Sinopec paid US$7.2 billion for Addax Petroleum while China National Offshore Oil Corp. (CNOOC) was apparently willing to pay up to US$50 billion for 23 oil blocks in Nigeria, according to a leaked letter by the Nigerian government. Suggestions that the sovereign wealth fund could lower the 2 million b/d of oil India currently imports are doubtful unless funds are used to finance long-term oil import deals rather than stakes in producing fields by Indian oil companies, which often do relatively little to boost supply security due to the costs of building export infrastructure, the relatively low portions of equity oil from sharing stakes in oilfields, and the often better returns for NOCs from selling output locally.

However, whether the sovereign wealth fund idea will be accepted remains uncertain due to possible opposition from the Reserve Bank of India, which has resisted pressure to spend foreign exchange reserves given memories of the 1990s’ balance-of-payments crisis, despite having excess of reserves to cover the six months of import requirement. There may also be questions over whether emulating China's strategy of lavishly spending on overseas upstream assets is a good use of foreign exchange reserves, particularly in view of India's budget deficit. While the sovereign wealth plan would mark a positive step forward for the oil sector it faces some larger hurdles. The fund itself is further evidence that the 2006 initiative by the Indian government to join up with Chinese oil companies to purchase assets overseas is now largely being ignored and that competition, not co-operation between China and India in the overseas oil and gas sector is the current trend.