ONGC Videsh Ltd, the overseas investment arm of India's largest oil producer Oil and Natural Gas Corporation, has bought UK-based Imperial Energy, which has oil producing assets in Russia, at a valuation of $3 per barrel of oil reserves. This, ONGC officials say, is half the valuation of global companies with reserves of the size of Imperial.
However, higher tax incidence in Russia, where Imperial has all its oil producing assets, will make the acquisition expensive for OVL. According to Russian tax laws, oil companies' realisations from a barrel of crude oil do not exceed $25 per barrel no matter how high the oil prices may be.
"There is a fixed mineral extraction tax and a profit tax, besides the export duty in Russia. All these taxes keep realisations from the sale of a barrel of crude oil to below $25 per barrel," said a Mumbai-based analyst with a brokerage firm that tracks ONGC and its subsidiaries.
OVL already owns 20 per cent stake in the Sakhalin-I project in Russia, for which it had paid $1.7 billion in 2003.
Russia levies a mineral extraction tax of 22 per cent for all crude oil above $9 per barrel. The export duty changes every two months based on the average cost of the oil in the previous two months. As oil prices rise, export duties rise as well and vice versa.
In September and October this year, oil companies operating in Russia were actually losing money on their sales. The average price of the Russian oil mix then was around $85 per barrel, while the taxes added up to around $84 per barrel. "Coupled with operating costs, there was actually a loss on every barrel sold," said another Delhi-based analyst.
Four analysts said that at $3 per barrel enterprise value, the total of a company's market capitalisation and debt, Imperial's valuation was fair and not cheap due to the high taxes.
ONGC officials said they had examined the deal, the largest-ever by the company, from all angles before making the offer to buy Imperial at 1,250 pence per share, valuing the entire company at pound 1.4 billion.
OVL will complete the acquisition of Imperial, being called a diplomatic acquisition by analysts rather than an economic one, by January 13 after shareholders agreed to tender their shares equivalent to 96.8 per cent of the UK company's total share capital.
Analysts also say that OVL will have to spend $1-1.5 billion just to ramp up Imperial's oil production to the target of 80,000 barrels per day by 2011 from the current around 10,000 barrels per day.
"ONGC's current cash flow is not very strong with oil prices at these levels. If prices remain at around $40 per barrel, the situation could get worse," said another Mumbai-based analyst. ONGC's share price has dipped 46.5 per cent this year compared with a 52 per cent drop in the benchmark Sensex of the Bombay Stock Exchange.
At 80,000 barrels per day, production from Imperial's Russian fields will account for around 16 per cent of ONGC's current oil production from India's fields. OVL currently has 39 oil and gas assets in 17 countries across the world, starting from just one in Vietnam seven years ago.
OVL, being a government-owned company, has been mandated to buy oil and gas assets overseas in order to meet India's energy needs. India is the second fastest growing economy among large countries across the world.
