Over The Barrel

Read Time:14 Minute

Mr P Elango MD, Hindustan Oil Exploration Company Ltd (HOEC) shared his insights in a chat with Mr V Shankar, Vice President, MMA; Founder, CAMS and Director, ACSYS Investments Pvt Ltd.

Shankar: In the oil industry, what is the meaning of upstream and downstream?

Elango: India spends $500 million as the daily spend in importing oil from outside.   Broadly, the petroleum sector is divided into three streams: The upstream companies search for oil and gas within the country or outside the country, similar to any mining industry, but with a high level of uncertainty.  Companies like ONGC, Oil India, Vedanta, Cairn and Reliance to some extent, are the leading companies in this business. Based on some geological surveys, they look at areas where condition exists for oil and gas to accumulate. They follow a process of elimination and zero-in on likely areas. The only way to find out whether oil or gas is available is by drilling a well. On an average, a well is drilled to three kilometres below the surface, where the pressure will be very high. It costs roughly about $3 to $5 million to drill a well onshore, about $20 million to drill a well offshore and close to $100 million to drill a well in deep sea water. It’s a highly capital intensive sector. Therefore, you can understand why there are a limited number of players.

The next part is downstream, which is processing the crude oil, that is discovered by the upstream companies or imported by the country from outside India, in a refinery. This is like any other process industry. They feed the crude oil and get different types of petroleum products at different boiling points. All the refining companies have a marketing arm which sells the petroleum product through retail outlets. India has got about 80,000 retail outlets spread all over the country. Then we also have midstream companies that transport the oil either through sea tankers or by pipelines within the country. 

I began my journey in 1985 with ONGC. At that point in time, India was able to meet 85% of country’s requirement and we were only importing 15% of oil. In 2000, the domestic production could meet only 35%. In the last two decades, it has come down further and today, we are able to meet only 15% of the requirement and 85% of the oil is imported.

Imagine we switch off all the lights in an auditorium during evening hours and throw around a box of pins all over. If the task to find those pins and put it back in the box is given only to two people, the probability of finding it is lower. But if the task is to be performed by many people, then the probability of finding the pins is much larger. Finding oil and gas is something similar to this or to tiger sighting. You need to have passion, patience and perseverance. The cost of doing it is very high.

The complexity is less in the downstream side. The leading players here are IOCL, BPCL and HPCL in the public sector and Reliance and Nayara in the private sector. The one good thing India did in the mid and downstream side was that it built capacity in excess of our requirement. India has 250 Million Tons of refining capacity and we need only about 200 MT per year. So we’re able to export 20% of what is being produced. To that extent, the value addition happens within the country.

Shankar: If the producers can form a cartel and set prices, why can’t the consumers form a cartel and dictate prices? What are the dynamics of this market?

Roughly, we have 193 countries recognized by UN as individual nations. Whether you find crude in all the countries or not, you will find a car. If you have a car, you obviously need petrol or diesel. Of these 193 countries who are consumers, only 20 have exportable surplus crude oil. The mismatch starts from there. That’s number one. Number two, crude oil pricing is also determined by basic economics, which is demand and supply. But there is a very important third factor, which is geopolitics that determines the oil prices. 

The unit cost of producing oil has very little to do with the oil prices. Unlike any other commodity, oil production can be controlled very quickly. If the producing cartel decides to reduce the production by X million barrels today, it can be done instantly. In fact, this culture started 150 years back when oil was discovered in the US. They realized that if you produce more oil, the price goes down. So, there was an artificial restriction on production, which resulted in increased prices. 

The largest importers are China, India, US and Japan. Even if they form a cartel, it cannot be really effective, simply because the producers can decide to cut down the production or even deny to sell. The equation rests with a strong bias towards the seller.

Tell us about natural gas production and distribution. Can we substitute oil with gas?

Gas initially used to be a by-product of oil. In terms of its energy content, it is quite similar to oil and can, therefore, substitute quite easily wherever oil is used except for the fact that it’s not easy to store the gas. You need to condense it and convert it to liquid form to serve the gas. Otherwise, it will occupy a large space. In the early 70s, oil companies looked at gas as an unwanted thing.  But subsequently, countries developed the gas infrastructure, which is primarily the gas pipeline and they were able to make a very good use of gas.

Just to give an example, in Russia, 50% of the primary energy consumption is from gas. Global average use of gas is about 24%. In India, it is just 6% because of the lack of infrastructure. PM Modi, when he was the Chief Minister of Gujarat, focused on creating the pipeline infrastructure within the state. So, Gujarat has got about 3500 kilometer pipeline and 35% of Gujarat’s primary energy mix consists of gas. For mobility, CNG (compressed natural gas) is used and piped natural gas can substitute LPG. In Tamil Nadu, right here in Ennore, IOC invested Rs.10,000 crores in setting up a LNG plant, where liquefied gas will be brought through tankers, regasified and put through pipelines. Unfortunately, the utilization of that is less than 10% because of the politics in laying the downstream pipelines.

Shankar: It’s a pretty sad statistic that Rs.10,000 crores of investment is not effectively utilised. In the pre-Covid era, where was India sourcing its oil and gas? What were the nature of our contracts?

Elango: Import of oil need to be through the sea route. Therefore, sourcing from the shortest possible route is advantageous. From that aspect, Middle East is about 1050 nautical miles from Mumbai. It is a short route and it became a major source of purchase for the Indian companies. The second reason to buy from the Middle East is the type of crude. There are two types of crude broadly: Sour crude, which has a slightly higher sulphur content and sweet crude, which has zero sulphur content.  

Sweet crude is always $5 or $6 at a premium to the sour crude. Refineries prefer buying the cheaper sour crude and then processing it to remove the sulphur content. 60 to 70% of our requirement comes from Middle East.  South African crude is about 15 to 20%. The balance is from South America or Russia, which has now gone up. 

Coming to the commercial terms, we have long term contract and spot market deals. The price is determined by the market dynamics on a daily basis and we don’t get a price advantage through a term contract. However, we can ensure security of supplies and the refineries need a certain volume constantly. India buys about 70% through term contract and 30% from spot market. Typically, refineries in the private sector tend to be more aggressive and play in the spot market. The country’s sovereign relationship has some influence in all the arrangements we make. But otherwise, it’s a commercially independent transaction between the buyer and the seller. 

Shankar: When Trump started putting pressure on India to import more, India started importing crude from the US and I think it continues to import crude from the US even now. Was that a strategic decision or was it commercially sound?

Elango:  It is a political decision. We do not lose anything because we are able to benchmark the price. US is a very important player in the oil and gas market. Oil was first discovered in the US and it also became a freely tradable commodity out of the system generated by the US. To an extent, even if Saudi produces oil, the US has a role in fixing the price for that oil.  The US is the largest producer and largest consumer of oil. It is also one of the significant exporters of oil.  One of the important and major developments of the century is the production of shale gas / shale oil in the US. In 2003, they came up with a technology called fracking to pressurise underground rocks with high pressure water and extract shale gas and oil from the rocks. Though this technology existed for many years, it became commercialised only in this century. It dramatically changed US from a large importer to an exporter.

Shankar: We read in the newspapers about ONGC and also private players taking a stake in some oilfields?  How does this arrangement work? Has it worked well for India?  

Elango: Oil requires a larger investment and more players. There are 3000 oil and gas companies in the US but in India, you can count the numbers with your one hand. Our access to capital, during various periods of time, was limited. The exploitation that has been carried out so far is in a very limited manner. If you do very intensive exploration, there is every possibility of finding more oil and gas within the country. The government has been trying to bring in private sector but they are not very comfortable with the prevailing Indian bureaucracy, particularly when things like retrospective tax or windfall tax happen. Investors of large amount require stability and the government has not been able to guarantee that. One major incident will drive away the larger players. Some of them came and tried but could not succeed. 

In Rajasthan, there is a field called Mangala. ONGC drilled some wells and could not find any oil in the field. Cairn Energy was a small independent company listed in the US at that time. Its market cap was 500 million dollars. It believed that if there is oil and gas in Gujarat and Pakistan, then the oil should have migrated and captured somewhere in that region. They drilled 13 wells and could not find the oil. But in the 14th well, they discovered 1 billion barrels of reserves, which is equivalent to $80 billion. Today, that field produces 25% of the total onshore production in the country. That’s the nature of this industry.

Shankar: How can we mitigate the country’s exploration problems? 

The present government has been very focused in attracting foreign investors. As the exploration projects have long gestation periods, not many foreign players are very keen to get into a new country and do that at this stage. The difference between working in the oil and gas sector in China and India is very simple. In China, you can amend the contract. In India, you simply cannot amend the contract, even for a grammatically incorrect sentence. The process is so cumbersome and court alone can come to the rescue.

The government has very rightly increased the share of gas in the primary energy mix of India. There’s a very strong push. Majority of the states have been awarded with the city gas distribution licenses. Pipeline networks are being created with a target to move from 6% to 15%. In Delhi, all the public transport system runs on gas. This was a court mandated decision.  Energy pricing is one of the key complicated issues. Investors always look at the price and they want market to determine prices, which is not fully happening. The government has got its own set of arguments as to why it cannot just free up.

Shankar: Tells us about India’s oil sourcing strategy in the last one year, after the Ukraine war started. Is this strategy sustainable?

Elango: I think the government has done extremely well. In the past, when US put a sanction on Iran, the government of India complied with that and stopped buying crude oil from Iran, which is one of the lead suppliers of oil and gas to India. Then the US imposed sanctions against Venezuela. Again, India complied with it and lost those sources of supply. This time, India decided that we will go and buy the crude from wherever we want.

India has traditionally enjoyed a very good relationship with Russia, particularly in the energy space. Therefore, India is able to get the Russian crude at about 40% discount. India, in a sense, is benefiting by that. What I foresee is for India to get into more of a long term contract with Russia, which would ensure we continue to get at a discounted rate on a long term basis. This strategy has really worked out well.  

Shankar: Can you quantify the benefits?

Elango: From December onwards, we’re buying about 20% of total crude from Russia at 40% discount. This number can increase depending on the outcome of the transportation arrangements. Russia has not been our traditional supplier and it’s far from Mumbai. So the freight cost is higher. Interestingly, the government is looking at Chennai port as one of the possible ports for importing Russian crude. Because the distance from one of the ports in Russia to Chennai is comparatively lesser. Overall, I foresee a situation where this energy alliance between India and Russia will strengthen and it should benefit our country.

Shankar: In the midst of the green movement which is about moving away from hydrocarbon sources, how are we going to manage the transition? 

Elango: In today’s modern world, fuel is equal to food. We import oil, which is for today and tomorrow. One of the important things is that India must use its own resources to meet its requirement. We have abundant coal resources. With our economic growth, our energy needs will continue to grow at an average of 5%. Therefore, I don’t see a situation where India can really get out of coal. The advantage we have is because we need lots of new energy, we can explore new forms of energy. We need every form of energy to meet the requirement and reduce the overall cost and improve the accessibility. India needs to pursue its goal of adding more and more energy sources.

Shankar: Tell us about your entrepreneurial journey from ONGC to HOEC (Hindustan Oil Exploration Company). 

Elango: I began my career with ONGC. After spending about 10 years there, I left ONGC and joined Cairn Energy in 95 or so.  Cairn then was a company which was producing about 3000 barrels of oil. And when I left, Cairn was producing about 220,000 barrels of oil per day. I was really fortunate enough to work for a company which started small and grew big. The growth is very exciting because you see ups and downs, similar to your life.

Then an opportunity came to turn around HOEC—a company which was about to be closed down with losses. The largest shareholder in the company—an Italian company—wanted to exit India. For them, $200 million investment which they had made, was not a big deal. I took up the challenge and my idea was to run the large capital intensive and technology intensive company like in an Uber model, in a lean way, outsourcing the services. When we started the journey in 2015, we were producing about 500 barrels oil equivalent per day. Today, the production in HOEC is about 10,000 barrels of oil equivalent. We are just 100 people. Out of this 10,000 barrels, our share would be about 4000 barrels and the balance is done by our partners. It’s been a bumpy road but I am really satisfied with the journey.

Shankar: A couple of lessons that you want to give to the people?

Elango: I want to share a lesson from an article that I read. When a cow falls into a ditch, what you need to do is to get the cow out of the ditch, find out why it got into the ditch and figure out ways to ensure it doesn’t get into the ditch again. It’s a very simple and commonsensical thing. However, it’s important that you don’t do all the three things at the same time but you need to do them sequentially. Reading this was a revealing moment for me because in our business, there’s a lot of crisis that you need to handle on a daily basis. When the crisis occurs, if you get into why it occurred, you’re delaying the period for the cow to get out of the ditch.