Essar Oil - Rosneft deal to change the refining landscape in the country

Essar Oil has sealed definitive agreements to sell its flagship asset, refinery business along with retail network and related infrastructure of Ports to Russian oil conglomerate Rosneft, international trading firm Trafigura and Russian Investment fund UCP  for an enterprise value of approximately $13 billion.

This is a landmark deal for India, which over the years tried to attract investments in the refining sector without much success. As long as the petrol and diesel prices were controlled, the market wasn’t lucrative for any foreign player.

The Rosneft deal first came up when both petrol and diesel prices were deregulated giving a level playing field between the private and public sector refiners to market their products within the country.

While Reliance, the only other private player in refining company built, expanded its refineries with export focus, Essar by far sold much of its refined petroleum products within the country through public sector refining and marketing companies.

At the same time it started aggressively pushing for retail expansion once the two main auto fuel went out of price control. For, it realized that foreign players were keen on the market India provided more than the refinery.

For Rosneft too Indian investment provide a market to sell its crude, and the products from Vadinar refinery would get sold without any difficulty despite the excess refining capacity the country has at present. Because petrol sales has been hitting double digits for most of last 24 months, and diesel sales growth came back to stabilize. Refiners are looking a stable growth rate of 5-6% in Indian domestic consumption which would eventually make the country fall short on refining capacity in the next few years.

Essar’s Vadinar refinery situated on the west coast in Gujarat, with a 20 million mt/year capacity is a modern refinery with a Nelson Complexity Index of 11.8 with ability to process 85% heavy and sour crudes. It has the capacity to produce even Euro VI compliant fuel, and India has already fixed a deadline for transition from Euro IV to VI.

An old data sheet points out operating cost at the refinery was $2.8/barrel (2013) and as per the last published data the gross refining margins the company earned in December 2015 quarter was $13.25/barrel, exhibiting great parameters. Except for the huge debt burden the company had piled up, one with long delays in project implementation, two on cancellation of a tax benefit, Essar’s Vadinar Refinery is a top class refinery.

Rosneft in its initial deal information had said it would supply 10 million mt out of 20 milion mt the refinery would process every year for 10 years. This may not directly be Rosneft’s Russian production, but may come from any of its other assets or a swap deal/trading deal to bring in opportunity crudes.

This gives assured crude supply source for the company. Second Trafigura stepping in with a stake could mean better trading skills in terms of either sourcing crude or placing products. This is a real game changer for the Indian refining industry. Reliance is the only refinery in the country with very nimble and best crude sourcing strategies, and product placements and would be interesting to see how this large player reacts to Rosneft, Trafigura entry into the Indian refining scene.

Second it challenges the slow and not so operationally efficient public sector players. It would challenge them to cut operational costs, get quick on buying crude, get smart on term contract tie-ups and compete on the retail space where the product premiums may vanish if competition hots up.

Indian consumer may finally see the impact of free pricing, if retail prices come down even marginally with competition.

The Rosneft, Trafigura investment may also change the mood as far as attracting foreign investment in the oil sector, be it upstream or downstream.

What is still not clear, or not going to be clear about the deal is how much of the value of the deal would accrue to the company, reduce its debt and how much of it is going to pay for the equity stake of 98% from the Essar Oil promoters, the Ruias.

Essar’s Prashant Ruia told reporters that the equity value would be close to the market valuation at which the delisting of its shares from stock exchanges was completed. That means and equity valuation of $5.75 billion. There doesn’t seem to be any real logic as to why the deal price is being pegged to market value of delisting. Hope it gets clearer when the deal is complete and final announcements made likely by the end of the first quarter of 2017.

But, even at the price it is a win-win deal for the Ruias in terms of the return on investment they have got despite the trials and tribulations they had to go through to see the refinery up and running.

From the initial public offer of shares in 1995 to commercially starting up the refinery in 2008, it has been a long way in the making. Yet Ruias were very smart in quickly ramping up capacity from 10.5 million  mt/year to 20 million mt/year by 2013 and getting out of the corporate debt restructuring scheme.

Once the refinery stabilized, cash flows got strong, and market place became equal for private and public sector players Ruias decided to delist and also sell stake. It is a relief for bankers if the new players bring in money and reduce debt, and a great deal for Ruias who walk away with lot of cash. It is a million dollar question actually how much of that cash would they use to reduce debt in other group companies.

One more thing to note is this may by no means be called the largest FDI. For the money after all may not come to India. For Ruias at the time of delisting had mentioned Oil Bidco (Mauritius) as the promoter of Essar Oil.

For real FDI one has to wait till the time Rosneft brings in money to pare debt, invest in increasing the refining capacity from 20 million mt/year to 25 million mt/year before they take up their stated plans to take the capacity up to 40 million mt/year.

The Rosneft deal overall, their investments in India, and also Indian public sector buying stake in its oil producing assets in Russia might be the result of big bilateral push the government has given. India’s public sector companies are getting into some of their biggest deals with investments in Rosneft’s Vankor field and Taas-Yuryakh. Rosneft also needs partners as it tries to skirt US sanctions and also the tightness in upstream investments by global oil companies.