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Interview

with Arvind Mahajan, Executive Director, Advisory Services, KPMG

01.08.2011 / Energyboardroom

One of India’s most strategic industrial sectors today is the oil and gas industry, considering energy security is one of the country’s major bottlenecks. How important has the Indian oil and gas (O&G) sector been for KPMG, in both a national and global context?

O&G is one of KPMG’s very high priority sectors both globally and in India. It is part of our energy vertical, which includes also power, utilities, and renewable energy. O&G is a large share of that vertical.

In India, energy security is critically linked to the growth of the country. A large portion of the country’s energy needs are met by the coal and O&G sectors. The O&G part of the energy requirements is significantly dependant on imports – the country imports over two thirds of its crude oil consumption -, therefore India is subject to oil prices and availability risks.

The country is keen to see how the industry is able to mitigate those risks. Most of the oil companies, specifically the national oil companies (NOC), are looking at acquisitions overseas to meet the growing domestic demand. They are particularly active in Africa and in the CIS (Commonwealth of Independent States) markets, which are historical markets for the Public Sector Undertakings (PSU).

The tendency of sourcing energy from abroad has been mostly driven by the NOC. However, more recently, and not necessarily from a security perspective but more from a capability and business perspective, the Indian private sector companies have also started extending their global footprint. For instance, Reliance seems to be a promising player on unconventional sources of energy, including shale gas.

India expects to offer shale gas and oil licensing sometime in 2012. Therefore the companies which will have the technical capabilities established beforehand will have a better chance of attaining a good share of those licenses in India. Global companies will obviously have an interest as well.

Because India is import dependant, there is a pressure to look at resources outside the country, in which we have not necessarily been very successful as compared to China. Chinese companies have been more aggressive in foreign markets, mostly thanks to an efficient banking system able to financially back their operations, which allowed a ‘new colonisation of Africa’ and active investments in Latin America.

Indian private sector companies like Reliance are able to compete with the Chinese in shale gas, a proof that the private sector has been more nimble footed. In fact, some of the private companies have done important acquisitions of refineries such as Essar in the UK. Essar is also actively looking at oil in Africa as well. There is more private sector activity in reference to the entire oil value chain outside India.

As for the O&G domestic market, the NOC have been the most important players. Fifteen years back, the market was only driven by state owned enterprises. It was only after the first New Exploration Licensing Policies (NELP) rounds that the private sector got involved in the upstream.

Over the years, based on Reliance’s aggressive investments, India has become a very profitable export for refining. Not only does India beat any other country from a scale perspective despite being a late entrant, but the technology which the country is applying in the refining sector enables India to have greater flexibility to use crude. This translated into a great performance of Indian refining companies, which enjoy very positive margins.

Nonetheless, unfortunately, the government policies have not necessarily supported the development of the retail and distribution market because of price control. Today, the market is partially decontrolled, although a major chunk of the retail market, the diesel, remains under price control.

Because prices in India do not move up with the global situation, there is a subsidy impact. The NOCs are in one sense acting as a buffer between the consumer and the state rather than the government directly providing subsidy to consumers. There are talks among government officials to implement medium to long term direct subsidies to the individual, to avoid an unfair mechanism in place today, where for instance the driver of a Mercedes Benz, equipped with the best Diesel engine, receives a subsidy from the government – indirectly, not for owning the car, but for operating it.

Meanwhile, the gas segment of the upstream sector has been very promising since the KG-D6 gas discovery and other finds in the same region. However, Reliance has faced challenges with ups and downs in the production, which demonstrates a significant technology gap, as deep sea implies highly difficult conditions.

To fill the current gap, companies can acquire part of the skills through service providers, or by recruiting people, but the institutional knowledge associated with how to take decisions in reference with drilling is not something they can subcontract to just anybody. Such expertise is developed by acquiring compatibilities through partnerships, as it is reflected in the Reliance/BP deal, where the international partner, in addition to the money coming in, is bringing a lot of technology and experience in deep water.

This deal has the potential to be a game changer. It will have a ripple off effect on others: ONGC and GSPC for instance who have deep water blocks may look at forming partnerships with companies that can bring in both technology and investment.

There has been a lack of focus on the market from international players, but if this very venture proves to be successful, we will see a lot more interest from international companies.

Will the solution to India’s energy problem come from inside or outside the borders?

The solution cannot come exclusively from outside the borders; it needs to be found through a partnership. India’s regulatory environment and the high complexity of the market prevent foreign players to navigate on their own in the country.

The Indian regulatory environment is evolving. You need to identify the directions that it takes rather than looking at the market only the way it is at this point. Local players can better do it than overseas players.

However, if you have a significant presence in the market, you are approached like a local company. Hindustan Unilever, which has been in India for over 75 years, has a different approach to India because of the confidence they acquired through the various successes they have had. Their approach of taking risks for instance is based on past experiences. Their view of the market is very realistic. In that context, there are also available partners for foreign players.

There will continue to be opportunities upstream. There are players looking at the East Coast. Many players – private and public – are looking at floating LNG terminals. LNG is an area where there has been a slow down in investment, but it will pick up again. The Reliance/BP deal has also a downstream gas component.

One way or another, demand is going to grow – either through imports, or through domestic E&P following the NELP rounds. An improvement in the domestic production on both the oil and the gas fronts is to be expected, while imports will continue to be important in the future, considering the share of domestic production will not drastically increase in a short to medium term.

How challenging is it to be the knowledge partner of the industry compared to other countries??>

It is critical for foreign companies to get a good partner. What KPMG can bring to its customers is its knowledge of the Indian regulatory environment, the types of partners or the types of structures needed to better cope with the tax issues and other medium to long term challenges a newcomer may face.

As a partner of knowledge we help set up the business, by either supporting the client with elements related to its strategy, merger and acquisitions (M&A) operations, or due diligence, as well as guiding the client on where to focus.

KPMG can provide support on the systems and processes associated with various areas, whether it is finance, control, or talent management, which are increasingly challenging areas in the industry. We have particularly worked in this area with foreign players as well as with local players.

Many national oil companies, as they face competition, are looking to transform themselves in order to become more responsive in the market place. They are under pressure to reduce costs .They know that both foreign and private Indian players will come in the retail area in the future, so they are preparing to this new scenario.

KPMG is able to help companies strengthen their position in existing businesses as well as build competencies in some of the new areas where they venture into, such as non traditional areas like shale gas. As an example, although Vedanta was not in O&G, the company will be active in this sector through the Cairn acquisition.

Companies entering the sector often do not have existing knowledge of the sector, so they look for companies like KPMG to give them a key understanding of the business environment for them to be able to create value within it. KPMG’s set of offerings applies for both companies entering the market and companies already operating in India.

On one hand, KPMG can support foreign companies in understanding the market from a regulatory, business, and tax perspective. On the other hand, KPMG helps established players improve their performance and growth, by strengthening their positions in terms of people and finances, and supporting them in their M&A activities. Indian oil companies are more and more looking at acquiring companies outside India.

KPMG brings not only a deep knowledge of the O&G sector, but also a functional knowledge that is similar to other sectors. KPMG is able to bring a cross functional consulting experience in technology, business transformation, strategy, operations improvement, transactions, internal control, and risk management.

We also leverage on our global experience. The expertise which we have in the other countries can be brought to India. As an example, as competition increases, especially in retail, oil companies look at customer relationship management (CRM). It is new to O&G India, and KPMG brings its extensive knowledge from outside India as well as from other sectors, e.g. financial services and telecom.

How good has KPMG been in establishing strong business relationships with the PSUs?

Established companies in India are the largest chunk of our revenue at this point, although it also depends on the type of work we do.

We have been selective in our approach with the PSUs: we have decided to focus on specific companies and penetrate them deeply rather than working with all of them in a limited way.

What will be the biggest challenges for the O&G industry over the next few years, and what role will play KPMG in the O&G sector?

The O&G industry is going to increase by a significant factor over the next five years. If India is going to grow by 8% to 10%, there is no choice but to grow its energy sector.

Since more investments will come from foreign companies as well as from existing players, and NOCs will transform themselves to compete in the market place, the O&G industry will invest in advisory and consulting services. Having that in mind, O&G is an area where KPMG is substantially investing, scaling up both in terms of numbers and value such that we continue to be a leading player in this market.

Upstream activities will continue to boom both in India and overseas. The Indian refining and retail markets will grow significantly. The transformation of the NOCs will require a lot of investment, which will create opportunities for service providers. Non conventional segments, such as shale gas or Coal Bad Methane (CBM), will increase in share over the next five to ten years.

KPMG has been building capabilities in all these areas.

Lastly, the O&G sector will need to be financed. Many of the O&G companies have looked at listing overseas – Essar or Jubilant have done it. This will also considerably create opportunities for KPMG India.

What is your final message to the readers of the O&G Financial Journal?

India offers opportunities you cannot ignore. Do not necessarily try to do the entire job yourself, but rather look for advisors as well as for partners. KPMG is well positioned to help.

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