PSO’s vertical integration plan wins analyst approval

KARACHI: Pakistan State Oil’s decision to explore the possibility of buying out Pakistan Refinery has been welcomed by analysts as the company’s most cost-effective option for vertical integration.

“We have a favourable view of PSO’s plans to raise its stake in PRL as it is an opportunity for the materialisation of PSO’s long-term plan of integration,” said Mohammad Fawad Khan, analyst at KASB Securities, an investment bank, in a research note issued to client on Friday.

Over the past three years, the mounting inter-corporate circular debt in the energy sector - where all companies in the energy cycle have high amounts of money due from their clients and thus cannot pay their own bills - has led many refineries to face losses and produce at below their optimal capacity.

Pakistan Refinery is no exception, having faced losses of Rs1.8 billion over the first nine months of the fiscal year ended June 30, 2010.

From the perspective of oil marketing companies such as PSO, the attraction of buying a refinery consists mainly of controlling supply lines as well as having ownership over pipelines and other infrastructure, according to KASB’s Khan. With PRL, PSO also has the added advantage of buying a controlling stake in perhaps the most professionally-managed refinery in the country.

The location of the refinery, just outside Karachi, also allows for significant expansion. Its proximity to the port ensures that the crude oil imported by PSO can be processed relatively quickly and cheaply before being sent to the northern parts of the country.

PSO already owns 18 per cent of the refinery and is currently in the initial stages of talks to buy out Shell Pakistan’s 30 per cent stake in the company. Shell Pakistan is in the process of realigning its strategic position in the energy sector based on decisions made by their Netherlands-based parent company, Royal Dutch Shell to concentrate on upstream, high-margin businesses.

To this end, they have already sold off Shell Gas, a liquefied petroleum gas distributor to OPI Gas, a subsidiary of the Hashoo Group, for $8 million.

However, analysts have also cautioned against some perils of PSO’s proposed acquisition. PRL’s balance sheet has been severely constrained by the circular debt and the resultant losses, which have reduced its book value. Even after the transaction is complete, the company will likely require a significant injection of cash from its new parent company.

In order to make its investment feasible, PSO will then have to invest billions more in maintaining and upgrading the refinery’s infrastructure. Yet given the option between setting up a refinery from scratch and buying out an existing refinery, the cheapest option according to analysts seems to be to purchase an existing refinery, especially one in which PSO already has a stake.

PSO has been having a relatively good year so far. For the first nine months of the current fiscal year, the company has made Rs7.5 billion in net income. Analysts do not expect that the company will have to raise external financing for the acquisition should the deal go through. At Friday’s closing prices on the Karachi Stock Exchange, PRL’s total market capitalisation was just under Rs2.8 billion.

Published in The Express Tribune, July 3^rd, 2010.