W13574

BHARAT PETROLEUM’S UPSTREAM STRATEGY AND EXPLORATION

SUCCESS

Professor Noel Machado, G. Krishnakumar, Sanjeev Pillai and P.V.S.L Narasimham wrote this case solely to provide material for
class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors
may have disguised certain names and other identifying information to protect confidentiality.

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Copyright © 2014, Richard Ivey School of Business Foundation Version: 2014-02-03

Late one evening in April 2010, as he sat in his office in Mumbai, Ashok Sinha contemplated the future
of Bharat Petroleum Corporation Limited (BPCL), a Fortune 500 company of which he was chairman and
managing director. Under his leadership, over the last five years, BPCL had more than doubled the gross
profit in its traditional refining and marketing business. These had been difficult times; the world had
been gripped by a series of financial crises, and crude prices had peaked. Yet, BPCL had taken greater
risks and forayed upstream into oil and gas exploration. Its investments in Mozambique had resulted in a
huge gas discovery that was ranked the biggest in the world in the first quarter of 2010.

Sinha was aware that the spectacular results of BPCL’s corporate strategy were being variously credited
to the leadership team, to him, or to plain old luck. He wondered: If the complete story was to be told,
then to what might the company’s success be attributed? Importantly, he had to guide the development of
BPCL’s corporate strategy for the next five years. Should it be similar to that of the last five
overwhelmingly successful years, or should it be different?

HISTORY OF THE PETROLEUM INDUSTRY IN INDIA

Oil was first discovered in India in the late 1880s near Digboi in the northeastern state of Assam.
Commissioned in 1901, the still-functional Digboi Refinery was India’s first refinery and one of the
world’s oldest. In those days, oil wells were dug by hand, and legend has it that the town and refinery got
their name from the command “Dig Boy! Dig!” from supervisors to diggers. Interestingly, it was much
later, in 1938, that oil was struck in the Middle East, which went on to become the world’s biggest
producer of crude. However, the size of oil discoveries in India was small and the country never produced
enough crude to meet its requirements. In 1947, when India gained independence, the business of
importing crude and refining and marketing petroleum products was dominated by three international,
integrated oil companies, namely Burmah-Shell, Esso and Caltex.

The leaders of independent India had chosen the socialistic model of economic development. This meant
that the state was to play a primary role in industry, particularly in sectors that were in the “national and
public interest.” In keeping with its stated economic model, the Indian government gradually took over
private-sector companies (both Indian and foreign), a process of acquisition that was referred to as

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“nationalization.” In the 1950s and ‘60s, several companies and entire sectors of the economy were
nationalized, including Tata Airlines, several banks and all (about 245) life-insurance companies.
However, the government could not as easily take over the local operations of oil companies for want of
access to crude. On April 30, 1956, the Indian government announced a new industrial policy stating its
monopoly over future petroleum projects. That year, the government also set up the Oil and Natural Gas
Commission (ONGC) with a mandate for hydrocarbon exploration. In 1959, two more companies were
founded. The first was the Oil India Company, formed as a joint venture (JV) with two foreign
companies, to undertake exploration activities in northeastern India. The other was the Indian Oil
Company (IOCL),1 which would engage in the refining and marketing of petroleum products.

As it secured independent supply sources for crude, the Indian government learned that the cost of crude
was significantly lower than what was stated by the foreign refining and marketing companies. The
government asked Burmah-Shell, Esso and Caltex to lower the prices of refined products or to process its
imported crude for a fee. The Western companies were in a quandary:2

 The government was their biggest customer, without whom it made little sense to do business in
India;
 Though very profitable, their Indian businesses formed a minuscule part of their global operations;
 The bulk of the profits of their parent companies accrued from the transfer price of international
crude, and not from refining; and
 Given the spate of nationalization, their Indian businesses were likely to be taken over soon.

Although the foreign companies effected some price reductions, they declined to refine the government’s
crude. In response to a situation that seemed hopeless, they started liquidating their assets in India. Most
of these were sold (sometimes at throwaway prices) to IOCL, which under the circumstances was the only
company interested in buying any refining and marketing infrastructure. IOCL’s business grew rapidly,
while the market share of foreign companies declined from 92.5 per cent in 1960 to 37.9 per cent in 1972.
By 1976, their share of installed refining capacity in India had dropped to 42.28 per cent, and the
utilization of these reduced capacities had fallen to 55.99 per cent (see Exhibit 1). Between 1974 and
1976, all foreign refining and marketing companies were nationalized. Esso and Caltex were merged to
form Hindustan Petroleum Corporation Limited (HPCL), while Burmah-Shell was taken over to form
Bharat Refineries Limited.

On August 1, 1977 (coincidentally, the very day that Sinha joined the company), Bharat Refineries was
renamed Bharat Petroleum Corporation Limited (BPCL). Sinha described the situation thus:

By the time the company was nationalized in 1976, our market share had come down to 15% and
IOCL’s had grown to 60% . . . I was one of the first recruits . . . after a 15-year period when there
had been no recruitment. By that point, because of the pressure both on products and on size, we
had simply sold off everything as it stood to IOCL. We had been present in 90 airports, which
were reduced to two; from 40 LPG plants, we were down to two . . . There was a huge exodus of
people and our decline continued until 1980 when we again started to focus on growth . . . and
rebuilding the company back to what it was.3

1
In 1964, the Indian Oil Company was renamed Indian Oil Corporation Limited (IOCL).
2
Saumitra Chaudhury, “Nationalisation of Oil Companies in India,” Economic and Political Weekly, 12:10, 1977.
3
Excerpted from J. Ramachandran and V. Venkatesh, “Shaping the Destiny of a Public Sector Enterprise: In Conversation
with Ashok Sinha,” IIMB Management Review, 2006, p. 340.

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HISTORY OF EXPLORATION IN INDIA

For about 75 years after Digboi, there were no major hydrocarbon discoveries in India. Then, in the early
1970s, ONGC found a giant oil field off the shores of Mumbai (then called Bombay). The oil field was
named Bombay High and its first well was drilled in 1974. Yet, India’s demand for petroleum products
steadily increased and it continued to import crude. While the world’s major oil and gas companies
operated as integrated businesses, there was a functional divide among India’s public-sector oil
companies; some focused exclusively on exploration and production (e.g., ONGC), while others were
purely into refining and marketing (e.g., BPCL, HPCL and IOCL). Given the size of the country, the
scope for exploration was immense; yet India lacked the technology and financial resources to undertake
extensive exploration. Thus, between 1980 and 1995, the Indian government held nine bid rounds,
inviting bids from Indian and international exploration and production (E&P) companies. These rounds
evoked a poor response (see Exhibit 2) for a range of reasons:4

 Declining demand and price of crude

 The perception that high-potential blocks were reserved for state-owned companies
 Poor incentives to bidders
 Delays in governmental decision making

In its quest for self-sufficiency in hydrocarbons, the Indian government announced the New Exploration
Licensing Policy (NELP) in 1997. NELP sought to create favourable conditions for foreign companies.
The government later also allowed refining and marketing (R&M) companies to enter into exploration.

STATE OF PUBLIC-SECTOR R&M COMPANIES IN INDIA

Important trends that had historically affected India’s public-sector R&M companies were: (i) crude
prices, (ii) government subsidies and (iii) assured returns.

Until 1970, the rate at which crude prices increased was lower than the rate of inflation.5 Between 1970
and 2003, despite fluctuations and occasional shocks, the average price at which India bought crude
remained under US$30 per barrel (see Exhibit 3). The British had introduced subsidies of petroleum
products in India in 1939. They had offered subsidized kerosene through the public distribution system
until 1945. The Indian government first introduced subsidies in the late 1960s, for the distribution of
liquefied petroleum gas (LPG) to residential customers (see Exhibit 4). In 1976, the Administered Pricing
Mechanism (APM) was announced, whereby the government set prices for most petroleum products.
Fixed pricing and subsidies did not affect the financial returns of oil companies. Subsidies were offered to
retail consumers for products such as petrol, diesel and LPG, while most industrial customers were
charged market prices. Such differential pricing helped offset a part of the subsidies. R&M companies
were allowed to retain from their sale proceeds the cost of crude, refining and operating costs, and an
assured 12 per cent post-tax return on investment.

Control and protectionism addressed the socio-economic objectives of the government, but also insulated
its oil companies from market risks. Crude had historically been “affordable.” Due to these reasons, even
after NELP was announced in 1997, R&M companies had neither the need nor the incentive to explore
opportunities beyond their traditional businesses.

4
“Review of E&P Licensing Policy,” Petrofed, 2005, www.petrofed.org/19_Sep_05.asp, accessed April 30, 2013.
5
“Oil Price History and Analysis,” WRTG Economics, www.wtrg.com/prices.htm, accessed May 5, 2013.

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However, as regards R&M, there was intense rivalry between Indian oil companies. BPCL’s strategy was
to build its share of the retail market. This was a challenge due to a government regulation that limited the
number of outlets that each company had under its brand (BPCL was permitted only 18.3 per cent of the
total retail outlets in the country). In the early 1980s, BPCL chose to invest in the quality of customer
service. This was an audacious decision considering IOCL held about 60 per cent of the market; it was
also a farsighted move in an age when customers were taken for granted.6 By 1986, despite limited
outlets, BPCL had clawed back three per cent to achieve an 18 per cent share of the market. The same
year, it increased its retail network budget fivefold to US$2.2 million,7 selected its dealers with care, and
steadily continued to grow market share and capture efficiencies in its overall business.

A few years later, in 1991, the Indian government began the process of liberalization. It permitted private
enterprise into hitherto restricted sectors and gradually deregulated the economy as a whole.
Liberalization allowed private Indian companies to enter the petroleum sector. Reliance Industries
capitalized on this opportunity and set up the fifth-largest refinery in the world. This refinery was
commissioned in July 1999 at Jamnagar, Gujarat, with an installed capacity of 27 MMTPA,8 at a time
when the combined capacity of public-sector R&M companies was 62 MMTPA. Meanwhile, public-
sector R&M companies had also been setting up new refineries and expanding capacity at existing ones.
This resulted in a glut of petroleum products, reduced prices to industrial customers and, consequently,
lower profitability for state-owned companies. It was obvious that the opening up of the economy had
increased competition and made business difficult for public-sector R&M companies. Nevertheless, Sinha
noted, “The process of liberalization also liberated the profit margin.”

In response to liberalization, BPCL began a process of reinvention. In 1993, BPCL secured the
government’s approval to enter into a lubricants joint venture with Shell. In 1996, under the leadership of
U. Sundararajan, its chairman and managing director at the time, BPCL undertook a visioning exercise,
involving people at all levels, and evolved its shared vision and values. The company restructured itself to
be more responsive to customers and to better adapt to increasing competition. Its function-based
structure was dismantled and replaced with a process-based one. Until 2000, BPCL had only one refinery
(in Mumbai) but it added capacity, improved efficiencies, and grew its retail market share throughout the
country. That year, BPCL became the first public-sector oil company in India to go live with SAP’s
enterprise-wide resource-planning solution.9

An inflection point for R&M companies was 2002, when their business conditions turned turtle. The
government decided to do away with the APM10 and withdrew the policy of assured financial returns. For
the first time, companies were exposed to market dynamics and had to compete for survival. Ironically,
soon after the government stopped subsidies, crude prices started racing upwards. A year later, the
government had no option but to administer retail prices again; however, this time it did not bring back
the “assured returns” regime. Under-recoveries of public-sector R&M companies (incurred on account of
subsidized prices) were partially compensated for by the government. Compensations were through cash
transfers and grants of government bonds, but these were inadequate and losses were mounting (see
Exhibit 5). The companies faced a peculiar problem: sales and revenues were growing, but profitability
was dipping (see Exhibit 6). It was a strange time for R&M in India, when growing market share could
also increase losses. Yet, BPCL continued to focus on customer service and market share, and took this

6
J. Ramachandran and V. Venkatesh, “Shaping the Destiny of a Public Sector Enterprise: In Conversation with Ashok
Sinha,” p. 339.
7
In this and following instances related to BPCL, rupee values have been converted at a standardized rate of US$1 = INR
45.
8
MMTPA stands for million metric tonnes per annum.
9
Company website, www.bharatpetroleum.co.in/General/CR_Journey.aspx?id=4, accessed May 4, 2013.
10
Although the Indian government withdrew the APM, it continued to subsidize kerosene and LPG for residential customers.

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counterintuitive logic much further; it committed to a corporate strategy of vertical integration. Sinha
explained:

Our work was about the national interest — it was not simply about profits. We knew our
business strategy for retail was right for the long term. Our corporate strategy to vertically
integrate was also about India’s energy security — and we were executing on that. In entering
exploration we were taking risks, but we looked at it as balancing portfolios. If we got both
strategies right, then the profits would come.

INTEGRATING WITH THE UPSTREAM: TAKING MORE RISK TO REDUCE RISK

As early as 1997, coinciding with NELP and in anticipation of the opportunities upstream, Sinha had
facilitated a change in the company’s articles of association to include E&P activity. The same year, the
government conferred the “Navratna”11 status on BPCL. Boards of Navratna companies were given more
autonomy than those of other public-sector enterprises. Autonomy included the discretion to form
subsidiaries and JVs and invest up to US$44 million per project, where total investments in such projects
would not exceed 15 per cent of the company’s net worth.

In 1998, BPCL set up a Special Projects Team at its corporate headquarters to evaluate business
opportunities outside R&M. In the initial years, the team explored alternative-energy sources such as
wind, solar, power and biofuel. However, by 2002, it had become clear that BPCL’s core business would
need to address the dual challenge of rising crude prices and the burden of government subsidies. In
recognition of the fact that the greatest margins in the petroleum value chain lay upstream (see Exhibit 7),
BPCL began to seriously consider a vertical-integration strategy. The key operational objectives of its
upstream strategy were:

• To provide supply security to the refinery

• To hedge against spiraling oil prices
• To find [BPCL’s own] sources of gas (as a cheaper substitute for other products)
• To add significantly to the bottom line

In August 2003, Professor Amarlal H. Kalro12 joined BPCL’s board as an independent director. Kalro
explained the context of the company’s corporate strategy:

Business growth in the mid-2000s was possible due to increase in demand, which was led by
conditions such as economic growth in the country, growing population, and also regional
demand, such as [demand] from Sri Lanka and Bangladesh. However, by then it was increasingly
clear that we had reached the limits of profitability.

We knew that worldwide, the best returns in the petroleum sector were reaped by upstream
players. The policies of government, based on concern for the poor and also to provide largesse
for political reasons, had led several government organizations to experience severe distress. We
didn’t want BPCL to reach the same fate and so we looked for options. At the same time, we

11
Navratna in Sanskrit means “nine jewels.” In 1997, when the list was first announced, it contained the top nine public-
sector companies based on financial performance.
12
In 2003, Professor Kalro was the director of the Indian Institute of Management, Kozhikode. Prior to that, he was dean at
the Indian Institute of Management, Ahmedabad.

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didn’t want to go outside the energy sector. We had some of the best talent in the oil and energy
sector. In addition, we were a spectacular company.

In 2003, a separate team was created within Special Projects to develop the strategy and plans for
upstream integration (see Exhibit 8 for a brief description of the E&P value chain and relevant terms used
in the remainder of the case). This team reported to Sinha, who was then BPCL’s director of finance.
Although it knew that the greatest profits in petroleum lay upstream, BPCL had no knowledge or
experience of E&P; the team was aware that the risks involved would be extremely high. In Sinha’s
words:

Exploration is about the riskiest business that I can think of. Every metre you drill, it’s a 1-0
game. You drill another metre, plug and abandon. In a public-sector environment where we are
trustees of public money, we are accountable at all times. So, it’s like putting your head on the
chopping block. You’ve got to be convinced, and it doesn’t end there ... consensus has to be built
around it. Every decision is taken by the board and you need to convince fairly diverse
independent directors, government directors, your own directors; after all, you are betting large
sums, and you could be writing them off the next day. But there are lots of opportunities that are
available. Now, you can either let it pass and you won’t be the worse for it and neither will the
organization, or you go that extra mile and say, “Yes, this is the opportunity, let’s see what I can
do with it.”13

BPCL initially set boundaries for itself. Sinha explained, “We decided to cautiously invest upstream,
limiting the risk capital to US$333.33 million, to leverage the knowledge of external experts, and to bid
with one or more experienced partners — and only for blocks in India.” Soon, BPCL engaged the services
of Dr. S. Srinivasan (who had retired from ONGC as director of exploration), to advise the company on
geo-seismic data analysis and prospect evaluation.

BPCL’s first footprint upstream was the award (in February 2004) of three blocks in India, one block each
in the Krishna-Godavari, Mahanadi and Cauvery basins. It had aligned with a consortium led by ONGC,
which also became the operator for each of these blocks. BPCL’s participating interest was 10 per cent
each in two blocks and 40 per cent in the third block. BPCL was a first-time bidder, while ONGC had
immense expertise in E&P. In 2004, ONGC’s revenues were eight times those of BPCL. This was an
unequal partnership from the perspective of the resources and capabilities of each partner. ONGC had
undertaken all work involved in the bid, including prospecting and gaining access. In effect, BPCL had
played the role of an investor and gained little experience about E&P.

In August 2005, the Indian government enhanced the delegated powers of Navratna companies.
Investment limits in subsidiaries and JVs were raised 500 per cent to US$222 million per project, and the
overall investment ceiling was doubled to 30 per cent of the company’s net worth. The same month,
Sinha was appointed chairman and managing director of BPCL. About six months later, Sudhir Joshi and
Raj Kishore Singh, who had also joined BPCL in the late 1970s, were inducted to the board as director of
finance and director of refineries, respectively. Others on the board included those from BPCL as well as
nominees of the government. Most of the directors were in their early 50s; they knew they would have a
long, shared tenure before they retired and this helped them develop a stable and inspiring vision and a
cohesive corporate strategy. Joshi said, “We wanted to make an unprecedented difference and leave a
legacy for the company.”

13
Company archives. Interviewed in August 2010 by Robert Thomas, executive director of the Accenture Institute for High
Performance.

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THE ALLIANCE STRATEGY

It was probably too early, but soon after its first bidding experience, BPCL decided not to restrict its
investments to India. Its board approved the constitution of a smaller committee of board members to
make quick decisions on matters pertaining to E&P investments. Given the huge financial risks in E&P
and its lack of geo-science expertise, a key decision BPCL had to make was with whom to partner.
BPCL’s first general manager of exploration and production, D. Rajkumar, recounted:

The questions we asked ourselves were: Should we seek alliances with top E&P companies?
Should we consider an “equal” partner in terms of business size and reputation? World leaders in
E&P wanted to know what was unique about what we brought to the table.

When BPCL approached some of the world’s leading E&P companies, those companies were either not
interested or treated BPCL as a financial investor. They did not envision a role for BPCL in technical
evaluations or decision making. Sinha realized that an alliance with a dominant company might bring
credibility and reduce risk; however, if BPCL was unable to effectively coordinate that relationship, it
would remain a financial investor and would not develop its own capabilities and options. Its vision for
E&P was not restricted to simply building its financial assets. Therefore, BPCL decided that it would be
prudent to partner with small and mid-sized companies, provided it had scope to build its E&P expertise.
Rajkumar spoke about the company’s partnership strategy:

We had to learn to play the role of a junior partner, and not go with the mindset that we are a
Fortune 500 company. We had to demand fewer answers, offer solutions wherever we could and
be willing to learn. In essence, our strategy for partnership was to be an active non-operator.

In 2005, BPCL bid for blocks in Oman as part of a six-member consortium including Oilex, Videocon14
and three other Indian public-sector oil companies. Oilex was a very small Australian E&P company; at
the end of financial year 2005, it had only two permanent employees.15 The consortium won Block 56 in
the South Oman Salt Basin, and Oilex became the operator. This was BPCL’s first international win and
its participating interest was 12.5 per cent, but the block was later found to hold no commercially viable
reserves. In 2006, due to their former Oman relationship, Oilex invited BPCL to join bidding rounds in
Australia and East Timor. BPCL agreed. The consortia won blocks in both geographies, with BPCL
holding a participating interest of 20 per cent and 25 per cent, respectively.

In the three years since it ventured upstream, BPCL’s investments had failed to strike oil or gas. In early
2006, BPCL farmed into a 14.5 per cent stake in Cachar, Assam. Here, after some encouraging early
results, the block was surrendered due to geological challenges. BPCL’s Oman interests had been
unsatisfactory. Its Indian NELP blocks had remained unexplored due to a slow approvals process and the
operator’s lack of deepwater rigs. On the subject of missed opportunities, Srinivasan said, “The same
piece of geo-science information is interpreted differently by different experts. As a result, companies
give up their interest or refuse to farm into blocks that become producing fields in short spans of time.”
BPCL had bid in areas that turned out to be unproductive, had won some bids where it was too early to
estimate potential, and had missed opportunities that later proved promising. Sceptics began questioning
the wisdom of entering an area outside the company’s core competence. The board, however, did not
succumb to despair over these initial failures; on the contrary, it persisted with the chosen corporate

14
In 2005, Videocon’s consolidated revenues were US$1.22 billion, while those of BPCL were US$14.43 billion. Source:
Company annual reports.
15
www.oilex.com.au/index.cfm?objectid=51965D17-C09F-1F3C-C8C0F985361BD334, accessed May 6, 2013.

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strategy, recognizing that the nature of exploration involved such risk and that it took time to build one’s
own competence upstream.

Gradually, BPCL made its presence felt in the international E&P arena. Working within large consortia
gave it much-valued insights, not only about the technical aspects of E&P, but also about managing and
leveraging relationships with multiple partners and JVs. Importantly, through the Oman experience,
BPCL and Videocon developed an understanding to scout for E&P assets together. Though it was much
smaller than BPCL, Videocon was already present in the upstream business and had a revenue-generating
asset at Ravva oil field in the Krishna-Godavari basin of India. It had a technical team with capabilities
for estimating E&P prospects. Videocon was willing to share its technical expertise and also bear equal
financial risk. However, there were key differences between the two companies, their strategic objectives
and corporate cultures. While BPCL was a Fortune 500, public-sector petroleum company, Videocon was
a much smaller, privately owned company with interests in a range of industries. BPCL’s vertical-
integration strategy was geared towards India’s long-term energy security. Videocon had a shorter time
horizon and was primarily interested in increasing the value of its investments.

CREATING A SPIN-OUT ORGANIZATION

As BPCL found new partnerships and grew its E&P portfolio, it became clear that its corporate strategy
could not continue to be executed by a small team within Special Projects. BPCL was faced with another
dilemma: Should it create a new strategic business unit within the existing structure, or spin out the E&P
business into a separate organization?

As BPCL considered options on how best to build on its corporate strategy, some fundamental differences
between its traditional R&M business and the upstream business became evident. Unlike E&P, traditional
R&M operations were relatively stable and projects were of a much shorter duration. BPCL was used to
implementing high-value projects and processes at its refineries. These projects had quantifiable and
almost assured benefits, such as improved distillate yields, reduction in fuel loss, lower energy
consumption, etc. On the marketing front as well, BPCL was adept at projects such as expanding its sales
network and distribution facilities and setting up cross-country pipelines. Here again, returns such as
improved product margins and reduced operating costs were easier to predict. E&P, on the other hand,
had its own peculiar dynamics of extreme uncertainty that the larger employee base in BPCL was not
familiar with. For many at BPCL, it was unheard of to invest in projects involving multiple and unequal
parties with differing objectives, such that any party could exit at any time and allow other players to
enter, when ultimately the entire project could either be a hit or a miss. Sinha remarked:

Although we started our exploration team with some of the finest engineers from BPCL, we were
aware that the organizational culture to ensure success in upstream operations had to be different
from that for successful refining and marketing. Our exploration business had to reach out to
embrace ambiguity, risk and uncertainty.

The board responded by passing a resolution in May 2006 to establish a wholly owned subsidiary focused
on E&P. In October 2006, Bharat Petro Resources Limited (BPRL) was incorporated with share capital of
US$330 million and B. K. Menon was appointed its managing director. BPCL’s board decided that all
operating decisions would be taken by BPRL, while investments would be approved by BPCL. Through
the establishment of a separate legal entity, BPCL addressed two key objectives: to make quick
investment decisions and limit liabilities arising from upstream failures and risks. Joshi remarked, “After

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all, one of the main objectives with which we entered the high-risk upstream was to de-risk the existing
business.”

The success of BPRL rested heavily on its ability to attract and retain technical expertise. Competitors
from the private sector were able to offer higher salaries; however, compensation in public-sector
enterprises was limited by government regulation. To overcome this challenge, BPRL adopted a lean
organizational structure. It engaged Indian geoscientists on contract, and based on geographical location,
it utilized the services of international consultants such as Gaffney and Cline & Associates. At the same
time, BPRL facilitated knowledge acquisition by embedding in-house analysts in the technical and
operating committees of the consortia that it had joined.

STRIKING IT BIG

It so happened that later in 2006, an international investment bank approached BPCL with a farm-in
opportunity. Encana Corporation (Canada) wanted to farm out its participating interest in 10 blocks in the
deep waters off Brazil. Petrobras16 was the operator in nine of the 10 blocks, while Anadarko17 was the
operator in the remaining block. Although Encana was selling, both Petrobras and Anadarko were holding
on to their respective participating interests. Petrobras had previously partnered with BPCL in a NELP
round in India in 2005. Given their past relationship, Petrobras contacted BPCL about the Encana
opportunity. From BPCL’s point of view, it was an attractive proposition: not only was Petrobras a party
it could work with, but Brazil and India also shared excellent diplomatic relations and both companies
were highly valued by their respective governments. Petrobras had relevant deepwater drilling and
development technology and the lowest lifting costs in deepwater projects. Given these considerations,
BPCL initially intended to bid for Encana’s participating interest in all 10 blocks, and Videocon decided
to ally with BPCL. Meanwhile, BPCL’s geo-science experts indicated that the single block located in the
Campos Basin (where Anadarko was the operator) had limited potential. Accordingly, the BPCL-
Videocon combine ultimately submitted their bid for nine blocks. Encana called for negotiations, and a
team headed by Raj Kishore Singh went to Calgary, Canada. Negotiations were competitive, as other
parties were also interested in Encana’s stake. Encana insisted that it wanted to exit all 10 blocks and that
interested parties should bid for “all or none.” This created an impasse that BPCL did not want to resolve
by paying for a block which technical experts had advised against. Suddenly, an idea struck Singh. He
saw a way to bid for all Encana’s blocks, but he would need the approval of the board committee to go
forward. He called Joshi and Sinha to discuss his idea. Kalro recalled:

Joshi made a late-night call to me, asking if I would support the idea of bidding for all of
Encana’s interest, such that we bid the agreed amount for nine blocks and a notional one dollar
for the 10th block. I instantly agreed, so did Menon, and Sinha gave the final approval.

When BPCL and Videocon revised their offer, Encana placed a condition that in the event of a
commercial discovery in the 10th block, a contingent payment of US$10 million be made to it. The
combine accepted and signed a formal agreement with Encana. On September 24, 2008, after a lengthy
statutory process, BPCL and Videocon’s stake was approved. This was a time when the sub-prime crisis
was at its peak; Lehman Brothers had declared bankruptcy and several banks and financial institutions
were themselves in deep waters. Yet, within four days, BPCL secured an international loan of US$100
16
Petrobras was Brazil’s integrated national oil company. In 2005, its revenues, at US$36.98 billion, were 2.5 times those of
BPCL. Petrobras ranked 125th on the Fortune Global 500 list, while BPCL ranked 429th. Source: Fortune Global 500 List of
2005.
17
Anadarko Petroleum was a private American E&P company founded in 1959. In 2006, Anadarko had about 3,500
employees and US$7.1 billion in revenues.

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million and acquired its participating interest. Rajkumar recalled, “Precisely 10 days after we invested in
Brazil, there was a huge discovery in one of the blocks. This was our biggest find ever — the block where
Anadarko was the operator — a find for which we had bid only one dollar.”

MORE SUCCESS AND NEXT STEPS

On the strength of their Brazilian relationship, Anadarko invited BPRL to join a consortium it was leading
in 2008 for deepwater exploration off the coast of Mozambique. Joshi, Menon and Rakjumar led the
negotiation team. The consortium won the bid and, within months, made a sizeable gas find. This
discovery was rated by IHS survey studies as the first among the top 10 oil and gas discoveries in the
world18 in the first quarter of 2010. Two large, consecutive finds (in Brazil and Mozambique) were rare in
E&P history and they boosted BPCL’s confidence. BPRL had begun building a cadre of in-house
technical specialists. In February 2010, its first batch of geologists and geophysicists joined the company.
And so it was that BPCL/BPRL continued to bid and secure participating interests in various acreages
around the world. They had pursued opportunities in countries with low political risk, used a mixed
strategy of bidding and farming in, and resolutely stayed out of producing fields. From initially seeking
partners who would give credibility to its nascent E&P strategy, BPCL had quickly moved to allying with
partners who would help build its capabilities. By being an “active non-operator,” BPCL found that its JV
relationships had entrained its entry into newer geographies and possibilities.

During 2005-2010, BPCL’s traditional R&M business in India was also growing. It now had three
refineries and was constructing a fourth; by the end of financial year 2010, its retail market share had
climbed to 19.6 per cent. BPCL ranked fourth among Indian companies in the 2010 Fortune Global 500
list. In its upstream business, the company had invested US$266.66 million from 2002 to 2010. It had
participating interests in 26 blocks at various stages of exploration and appraisal spread across 15
geological basins in seven countries (see Exhibit 9). It had 20 partners from 12 countries and, working
along with 10 operators, had made seven discoveries. The stock market recognized that BPCL’s corporate
strategy was working. On March 11, 2010, a financial analyst reported, “Approximately 21% of [BPCL’s]
value is being driven by new businesses.”19 BPCL’s average stock price on March 31, 2010, was 68 per
cent greater than that of its peers (see Exhibit 10).

When asked to whom or what BPCL’s success should be attributed, Kalro surmised:

The board backed the strategy and the leadership team acted seamlessly. I don’t seem to recall, at
all, whether there was anyone who thought we should do something different. We also knew that
early success would give us the confidence to move fast. We had two groups looking at risk; one
looked at geological risk and the other at alliance and political risk. In all of this, you should not
underestimate Sinha’s contribution — he was the chief driver of our strategy.

In considering BPCL’s corporate strategy for the next five years, Sinha pondered over several questions.
Should the company:

 Sustain the pace in E&P or wait for more results?

 Remain a non-operator, work with fewer operators, or become an operator?
 Explore shale gas?
 Enter the midstream, i.e., build liquefaction plants and pipelines for the transportation of gas?
18
BPRL’s Annual Report for the Financial Year ending March 31, 2010, p. 13.
19
“BPCL,” Ambit Capital Pvt Ltd., http://smartinvestor.business-standard.com/BSCMS/PDF/bpcl_110310_01.pdf, accessed
May 6, 2013.

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As he looked further, into the next decade, Sinha visualized BPCL becoming a global, integrated oil and
gas company with diverse sources of energy around the world. He also saw a future where clean and safe
water would likely become scarce and thought that perhaps BPCL could do something about that. He
perceived three key challenges on the road to that future:

 Building a pipeline of leaders who saw a purpose beyond their jobs and personal interests, and who
would pursue risk to make a difference to their organization and to society;
 Managing partnerships, without which BPCL’s strategies of integration, diversification and
internationalization would not work; and
 Dealing with very diverse laws, languages, people and governments, given that resources such as oil,
gas and water were sovereign commodities.

It is said that oil and water never mix, and Sinha smiled as he recollected Kalro’s words about luck:
“Sometimes luck does play a role, but anybody who believes in pure luck is living in a fool’s paradise.
There is no substitute for hard work. Some people grab the opportunity, while others let it go.”

Professor Noel Machado teaches at the School of Inspired Leadership (SOIL). G. Krishnakumar is the Chief Manager -
Training & Development at BPCL. Dr. PVSL Narasimham is the Chief Manager - Quality Assurance at BPCL. Sanjeev
Pillai is the Sr. Manager - Talent Management at BPCL.

The authors are grateful to Jyoti Gouda, Kalyan Mukherjee and Sameet Pai for their invaluable support in the research
undertaken for this case.

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EXHIBIT 1: MARKET SHARE OF PRIVATE AND PUBLIC-SECTOR OIL COMPANIES (%)

Burmah-Shell,
Year IOCL Esso, Caltex Others
and Others
1960 0.2 92.5 7.3
1965 21.0 73.4 5.6
1968 42.5 53.8 3.7
1970 50.9 44.8 3.7
1972 57.3 37.9 4.8

Total Installed Refining Capacity Utilization

Capacity in India (%) (%)
Burmah-Shell, Burmah-Shell,
Year Esso, Caltex Year Esso, Caltex
and Others and Others
1960 100 1963 98.24
1968 60.04 1968 61.37
1973 42.28 1973 55.99

Source: S. Chaudhury, “Nationalisation of Oil Companies in India,” Economic and Political Weekly, 12:10, 1977, pp. 439-
440.

EXHIBIT 2: BLOCKS OFFERED UNDER PRE-NELP EXPLORATION ROUNDS

No. of Blocks Offered Bids Contracts Signed

Year Round
Offshore Onshore Total Received Offshore Onshore Total
1980 One 17 15 32 4 1 0 1
1982 Two 42 8 50 Nil 0 0 0
1986 Three 27 0 27 13 0 0 0
1991 Four 39 33 72 24 2 3 5
1993 Five 29 16 45 15 4 2 6
1993 Six 17 29 46 20 2 3 5
1994 Seven 17 28 45 12 2 3 5
1994 Eight 15 19 34 38 1 3 4
Nine − JV
1995 10 18 28 22 1 1 2
Round

Source: “Review of E&P Licensing Policy,” Petrofed, 2005, p. 87.

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EXHIBIT 3: PRICES OF THE INDIAN BASKET* OF CRUDE**

Financial Year
Price US$ / bbl***
(ending March 31)
1998 12.50
1999 17.66
2000 27.51
2001 26.92
2002 22.54
2003 26.65
2004 27.97
2005 39.21
2006 55.72
2007 62.46
2008 79.25
2009 83.57
2010 69.76

Notes: * Indian basket of crude refers to crude oil procured for the country from international oil fields.
** Average per annum.
*** bbl stands for oil barrel, which is a unit of volume equivalent to approximately 159 litres.
Source: Figures for 2001-2010 extracted from “Basic Statistics on Indian Petroleum & Natural Gas,” Petroleum Planning &
Analysis Cell, Ministry of Petroleum & Natural Gas, Government of India, www.petroleum.nic.in/petstat.pdf, p. 21, accessed
May 5, 2013; Figures for 1998-2000 computed by the authors from Historical Statistical Data from 1965-2011,
www.bp.com/statisticalreview, accessed May 5, 2013.

EXHIBIT 4: HISTORY OF PETROLEUM PRODUCT SUBSIDIES IN INDIA

Subsidized kerosene included in the public distribution system for

1939-1945
residential consumers
Subsidies for liquefied petroleum gas (LPG) introduced for
Late 1960s
residential consumers
The Administered Pricing Mechanism (APM) is dismantled and
2002 petroleum prices liberalized, but prices are still administered for
kerosene and LPG for residential use
2003 Government resumes price controls
Chaturvedi Committee recommends liberalization of petro-product
2008
prices
Parikh Committee recommends market-oriented pricing of petro-
products
2010
July: Petrol prices liberalized through modest price increases,
resulting in large protests and strikes

Source: Excerpted from B. Shenoy, in “Increasing the Momentum of Fossil Fuel Subsidy Reform: Developments and
Opportunities,” GSI-UNEP Conference Report, 2010, p. 38.

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EXHIBIT 5: UNDER-RECOVERIES BY PUBLIC-SECTOR R&M COMPANIES*

Financial Year
Product (ending March 31)
2006 2007 2008 2009
PDS Kerosene 3.25 4.20 4.74 6.14
Residential LPG 2.31 2.51 3.86 3.83
Gasoline (Petrol) 0.62 0.48 1.82 1.13
Diesel 2.86 4.41 8.73 11.37
TOTAL 9.03 11.51 19.16 22.45

HOW SUBSIDIES WERE FINANCED

Financial Year
Source (ending March 31)
2005 2006 2007 2008
Transfer from Upstream 1.34 3.16 4.82 6.39
Government Budget 0.67 0.66 0.72 0.70
Oil Bonds 0 2.60 5.67 8.77
TOTAL 2.01 6.42 11.21 15.85
Losses Absorbed by
- 2.61 0.40 2.31
Companies

Note: * US$ billions.

Source: Shenoy, “Increasing the Momentum of Fossil Fuel Subsidy Reform: Developments and Opportunities,” p. 39.

EXHIBIT 6: TOTAL INCOME (STANDALONE)* VERSUS PROFIT AFTER TAX

INCOME

Financial Year
Company (ending March 31)
1997 1998 1999 2000 2001 2002
BPCL 4,035.20 4,650.03 5,744.75 7,978.45 10,484.31 9,457.12
HPCL 4,059.92 4,636.86 5,843.62 7,669.44 10,907.48 10,158.22
IOCL 14,001.67 13,594.32 15,688.38 21,429.46 27,477.67 25,845.53

PROFIT AFTER TAX

Financial Year
Company (ending March 31)
1997 1998 1999 2000 2001 2002
BPCL 90.58 115.87 156.90 155.92 185.04 188.85
HPCL 136.05 155.81 195.40 234.98 241.78 175.11
IOCL 313.12 379.22 491.81 542.85 604.36 640.87

Note: * US$ millions; rupee values have been converted to U.S. dollars at a standardized rate of US$1 = INR 45.
Source: CMIE Prowess Database, accessed May 1, 2013.

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EXHIBIT 7: VALUE CHAIN ECONOMICS AND CONTRIBUTION TO NET MARGINS

OF AN INTEGRATED OIL COMPANY (U.S.)

Value Chain Contribution

Exploration 36%
Production 41%
Transportation 5%
Refining 13%
Distribution 4%
Marketing 1%

Source: “Oil and Gas Value Chains,” PetroStrategies, Inc.,

www.petrostrategies.org/Learning_Center/oil_and_gas_value_chains.htm, accessed April 30, 2013.

EXHIBIT 8: BRIEF DESCRIPTION OF EXPLORATION & PRODUCTION

IN THE PETROLEUM VALUE CHAIN

Broadly speaking, the petroleum value chain is made up of three parts: exploration and production
(upstream), transportation (midstream), and refining and marketing (downstream). Exploration and
production occurs through a four-stage process: (i) prospecting, (ii) gaining access, (iii) drilling and
evaluation, and (iv) development and production.

Prospecting starts with a government segmenting its land (or waters) into blocks, and announcing its
intent to lease them for exploration. E&P companies consider available geological and seismological data
(and terms set by the government) to decide whether the blocks on offer may be a good prospect. E&P
companies either have their own teams of geologists or obtain research and analyses from specialized
consultants. If the prospects of finding oil appear favourable, then a range of interested companies form
competitive consortia to bid for blocks. Successful bidders enter into a contract (a licence or lease
agreement) with the government to gain access to allotted blocks. Then, the “operator” identified in the
contract undertakes drilling and evaluation in three phases. First, exploration wells are drilled; if these are
promising, then commercial potential is announced. Second, appraisal wells are drilled; if these are also
successful, then commercial discovery is declared. The process between exploration wells and
declaration of commercial finds typically takes two years. Third, detailed evaluation and appraisal is
undertaken; this phase is usually completed within six years. If the block is considered commercially
unviable at any time during the drilling and evaluation process, E&P companies complete their minimum
work commitment and surrender the lease to the government. The entire process from prospecting to
initial production typically takes between six to eight years.

The formation of consortia helps raise funds, hedge risks and leverage capabilities required for E&P. A
consortium involves several parties — often three or more — where each party may itself be a JV formed
by two or more companies. The stake of a party in the consortia is referred to as its “participating
interest.” The operator in a consortium is that company which undertakes the actual drilling and
production. Investing companies diversify risk by building a portfolio of assets at varying stages of E&P. In
some blocks, a company may choose to enter at the very early stage, i.e., at the bidding stage. Later, it
may choose to sell its stake to another interested party (or parties). Such risk-diversification practices
result in continual ownership changes in E&P JVs. The process of selling one’s participating interest is
termed “farming out,” while that of buying is termed “farming in.” A greater certainty of striking oil is
attained as the stages in E&P progress towards commercial discovery, and farming in at a late stage
could be less risky but very expensive.

Such terminology, borrowed from agriculture, is consistent with the term “oil fields,” which refers to areas
where drilling is being undertaken or oil is being produced. Based on the location and depth at which
hydrocarbons are explored and extracted, oil fields are classified as on-land (on-shore), offshore (in

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EXHIBIT 8 (CONTINUED)

shallow waters), and deepwater (beyond the continental shelf). E&P in deepwater fields poses greater
analytical and technical challenges to operators. Just as the outcome from agriculture is difficult to predict
(due to dependence on weather, etc.), it is similarly difficult to predict returns from E&P, especially in the
early stages due to reliance on geo-seismic data. Data of a given block that is interpreted as “not viable”
by one company is sometimes interpreted as “promising” by another. This explains how sometimes a
company that acquires interest in wells relinquished by another, strikes oil within a few days of drilling.
The business of E&P not only involves financial risk, but also political risk, environmental risk and JV
relationship/partnership risk. As political climates in countries change, or as wells find more oil than
expected, governments sometimes seek to renegotiate contracts. Loss of life and impacts to livelihoods
and the environment have resulted from accidents during E&P, and the subsequent financial liabilities can
force the closure of companies. Since E&P is mostly carried out through transnational alliances involving
several parties of differing interests and compulsions, managing these JVs and relationships is also a
challenge.

Success ratios in E&P are such that 100 contracts/leases result in one producing well or, seen another
way, among 10 wells drilled, only one strikes hydrocarbons. Yet, in the entire petroleum value chain, E&P
is the most profitable. It contributes about 75 per cent to the net margins of an integrated oil company.

Contract with Exploration Failure Lease expires

Government Wells

Success

Declaration of Commercial Well

Typically 2 years
or 6 months
Appraisal Failure
from second
appraisal well Wells

Success

Declaration of Commercial Discovery Development

Area Defined

Maximum No
6 years to Further Development Development
Production Appraisal Area Lapses

Success

Development Decision to Develop

Capex & Opex

Source: “Offshore Access to Oil and Natural Gas Resources,” American Petroleum Institute, Washington, D.C., 2009;
Flow chart adapted from F. Jahn, M. Cook and M. Graham, Hydrocarbon Exploration and Production, 2nd Edition, Elsevier,
Amsterdam, 2008, p. 14.

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EXHIBIT 9: STATUS OF BPCL’S CONSOLIDATED E&P PORTFOLIO AS ON MARCH 31, 2010

Participating
Year
Block Country Interest of the Comments
Acquired
Group (%)*
KG/DWN/2002/1 India 10 • Seismic surveys have been completed in all
2004 MN/DWN/2002/1 India 10 three blocks. Wells being identified.
CY/ONN/2002/2 India 40
2005 Block No 56 Oman 12.5 • The block is being relinquished.
WA/388/P Australia 14 • Technical study indicated low prospects.
2006 • The find so far is sub-commercial. Drillable
JPDA 06-103 Australia/Timor 20 prospect for balance commitments is being
identified.
KG/DWN/2004/2 India 10 • Interpretation of 2D and 3D seismic data
KG/DWN/2004/5 India 10 completed.
CY/ONN/2004/1 India 20
CY/ONN/2004/2 India 20
RJ/ONN/2004/1 India 11.11
2007
AC/P32 Australia 20 • No hydrocarbon shows in the drilled well. Post-
well studies are in progress.
48/1b&2c - North • Poor flow reported in appraisal well. Technical
U.K. 25 studies to improve the flow rates and feasibility
Sea
studies are in progress.
SEAL-M-349 Brazil • Most of these blocks are in an advanced stage
SEAL-M-426 Brazil of exploration.
40
SEAL-M-497 Brazil • One well (Wahoo-1) in BM-C-30 in the Campos
SEAL-M-569 Brazil Basin flowed at a test rate of approximately
ES-24-588 Brazil 7,500 barrels per day of crude oil and
2008 approximately four million cubic feet per day of
ES-24-661 Brazil 30
associated natural gas.
ES-24-663 Brazil
BM-C-30 Brazil 25
POT-16-663 Brazil
20
POT-16-760 Brazil
Mozambique • Discovery of 169 net metres of natural gas.
Mozambique 10 Rated first among the top 10 oil and gas
Rovuma Basin
discoveries of the world by IHS survey studies.
2009
Nunukan PSC, • Exploration activity is under progress. One well
Indonesia 12.5 (Badik-1) is under drilling.
Tarakan Basin

Note: * Group refers to BPRL’s subsidiaries and JVs.

Source: Compiled from BPRL’s Annual Report for the financial year ending March 31, 2010.

EXHIBIT 10: AVERAGE STOCK PRICE ON THE LAST TRADING DAY IN MARCH (IN RUPEES)

Year
Company
2007 2008 2009 2010
BPCL 304.88 416.06 375.77 517.27
HPCL 247.00 258.57 268.20 317.48
IOCL 399.83 448.21 394.06 297.52

Source: National Stock Exchange of India.

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