India: A manufacturing hub for the hydrocarbon sectorpetrotech.in/uploadfiles/Speakerprofiles/PS - 3 Make in India.pdf · India already has a high level of indigenization in design,

Authored by:Navtez BalAmit KheraSuvojoy Sengupta

India: A manufacturing hub for the hydrocarbon sector

December 2016

Prepared for Petrotech-2016 12th International Oil & Gas Conference and Exhibition

Copyright © 2016, by McKinsey & Company, Inc.

India: A manufacturing hub for the hydrocarbon sector

Authored by:Navtez Bal Amit KheraSuvojoy Sengupta

December 2016

Prepared for Petrotech-2016 12th International Oil & Gas Conference and Exhibition

Acknowledgements

We would like to thank the Steering Committee of Petrotech 2016 for giving us the opportunity to share our perspectives. This report synthesizes our learnings from proprietary research and the cumulative experience of McKinsey experts worldwide. The research and examples cited are meant to be illustrative and not exhaustive.

We acknowledge the counsel of Rajat Gupta and Shirish Sankhe, senior partners from the Mumbai office. We are also grateful to Vivek Dua, an associate partner and Rajat Modwel, a senior advisor, both from the Delhi office for their guidance.

This report would not have been possible without the dedicated efforts of the McKinsey team—Abhishek Agarwal, Nitesh Jain, Puja Jain, Aakash Jhaveri, Nipun Rastogi and Artika Thakur.

We thank Noorain Nadim, Punita Singh, Parameshwari Sircar and Malini Sood from the Client Communications team for their editorial support, and Fatema Nulwala, Ava Tata and Natasha Wig for their inputs on external communication. We are also grateful to Manali Raul, Pradeep Singh Rawat, Royston Wilson and Vineet Thakur for their support on design and visual aids.

Amit Khera Partner

Suvojoy Sengupta Partner

Navtez Bal Partner

vIndia – A manufacturing hub for the hydrocarbon sector

Executive summary 01

Overview: The oil and gas landscape in India 02

Robust growth despite global slowdown 03

Opportunities for indigenization 08

Government initiatives for indigenization 14

Strategies to fuel “Make in India” 16

Contents

1 India – A manufacturing hub for the hydrocarbon sector

India is taking several steps to transform into a global design and manufacturing hub. The Make in India initiative, launched by the Government of India to encourage national and multinational companies to manufacture in India, could help achieve this aspiration through its compelling objectives—job creation, skill enhancement and attracting capital and technological investments, while minimizing environmental impact and setting high quality standards.1 The stage is set for economic growth with India surpassing USA and China in Foreign Direct Investments (FDI)—in 2015, India received USD 63 billion in FDI, making it the highest ranked country for capital investments.2

In parallel, there has been good progress on the policy front to increase activity in the oil and gas sector—a must for driving demand for equipment and services. Further, refining capacities of the industry increased at a fast pace since delicensing in 1998. The government modified the gas pricing formula to link to global markets under the “New Domestic Gas Pricing Policy” in November 20143. It released the “Hydrocarbon Vision 2030 for North-East India” in February 2016, outlining steps to leverage the hydrocarbon sector for the development of the northeast region in India. The government also approved the “Hydrocarbon Exploration and Licensing Policy (HELP)”3 and the “Discovered Small Fields Policy” in March and May 2016 respectively to enhance domestic natural gas production.3 Multiple fiscal initiatives were also laid out for the benefit of the hydrocarbon sector—for example, the 40 percent subsidy on gas operations to private companies operating in the northeast region of India has been extended under the government’s Hydrocarbon Vision 2030 for the North-East.3 All these initiatives, coupled with growing demand for energy in India, are likely to increase the level of activity in India’s oil and gas sector.

India already has a high level of indigenization in design, fabrication and construction in its downstream sector. The upstream sector, especially offshore, still has opportunities to drive up local content in both manufacturing and services. This knowledge paper is aimed at taking stock of the current status of the Make in India initiative in India’s oil and gas sector. It also hopes to initiate a discussion on increasing indigenization in the sector to propel economic growth.

1 'Make in India' website

2 The FDI Report 2016: Global greenfield investment trends, FDI Intelligence, April 2016

3 Ministry of Petroleum and Natural Gas website

Executive summary

2India – A manufacturing hub for the hydrocarbon sector

Energy is the “oxygen” of the economy and the life-blood of growth. The energy sector constitutes a relatively modest share of the Gross Domestic Product (GDP) in most countries, except for those in which oil and gas income loom large. However, the sector’s impact on the economy is greater than the sum of its parts. Energy is an input to nearly every good and service in the economy. For this reason, stable and reasonable energy prices could be beneficial for reigniting, sustaining and expanding economic growth.1 India is set to become the fastest growing economy in the world. Yet, with its energy use increasing rapidly and one-fourth of its population still without electricity, the swift growth of the energy sector in India, particularly the oil and gas landscape, has become the need of the hour.2

While India is now self-reliant in refining capacity, over 80 percent of its crude oil and over 30 percent of its natural gas is currently imported.3 To improve this scenario, in as early as 1980, exploration blocks were offered to companies. However, the real change in Exploration and Production (E&P) happened in the 1990s through a series of actions, most notably the New Exploration Licensing Policy (NELP) in 1997–98. Refining was also delicensed in 1998. Since then, the energy sector in India underwent many changes.

Refining capacity more than tripled from 69.99 mn metric tonnes (MMT) in April 1999 to 232 MMT in April 2016.3 Oil production from Rajasthan and gas from the Krishna-Godavari (KG) blocks increased domestic production and hence, self-reliance. With these changes, the domestic manufacturing and services market also developed. As a result, the downstream sector has a very high degree of indigenization, with most design, fabrication and construction happening in India. Indigenization levels in the upstream sector also increased; however, there is significant opportunity for further growth. This paper, therefore, focuses largely on the upstream sector, while touching upon relevant points on the downstream sector as well.

It is clear that great opportunities await the energy sector in India; however, it must be ready for growth. The demand for petroleum products is expected to grow between 4–6 percent in the long term, while petrochemicals can expect a growth of 10 percent over the next 15 years.4 To meet this demand, the sector may require large investments in capacity creation and expansion. The E&P sector is also poised to grow as 28,000 MMT5 of oil and gas reserves are yet to be completely harnessed. This growth could be supported by a developed and

1 Energy for economic growth, World Economic Forum and IHS CERA, 2012

2 Report on India's energy outlook, NITI Aayog, International Energy Agency and Teri, April 2016

3 Petroleum Planning and Analysis Cell

4 Building a self-suffcient petrochemical intermediate industry in India by 2025, McKinsey & Company, March 2015

5 'Make in India' website

Overview: The oil and gas landscape in India


vibrant manufacturing and services setup in India. Such a robust manufacturing and services setup could also ensure maximum secondary and tertiary benefits to the Indian economy.

Further, indigenization could be seen as an important tool to scale up the performance of India’s energy sector. The benefits of indigenization are many—it may significantly bring down costs, improve quality and offer livelihood to several people in the country.6 Several countries such as Norway and Brazil have already indigenized over 60 percent of their upstream sectors. On the other hand, India has been successful in indigenizing to a 25–30 percent level, showing significant potential for growth to reach the 60 percent of indigenization achieved by many other countries. The Make in India initiative could be a significant step towards achieving this goal. If focussed steps towards improving the overall ease of doing business and indigenization are taken, the energy sector in India could fuel India’s economic growth.

6 Emerging opportunities and challenges, World Energy Council and Pricewaterhouse Coopers, 2012


India’s energy consumption almost doubled since 2000 and the potential for further rapid growth is enormous1. The oil and gas sector saw significant growth over the past few years as GDP grew at over 7 percent per annum. A huge contributor behind this growth are urban and rural households that purchased automobiles and two-wheelers in the last decade, an anomaly restricted to the affluent a few years ago2. More growth seems to be written on the cards for India’s energy sector, with the country’s energy consumption expected to grow between 2010 and 2030. Oil and gas demand is also expected to significantly grow (Exhibit 1).

This is in stark contrast to the energy outlook for a large part of the rest of the world. Energy consumption is likely to plateau in most countries as energy efficiency becomes a focus. Further, oil and gas consumption is likely to decrease due to increasing environmental concerns.

1 India Energy Outlook, World Energy Outlook Special Report, 2015, IEA

2 Petroleum Planning and Analysis Cell, IHS Automotive

Robust growth despite global slowdown

Exhibit 1

Primary energy demand, India

MBOE

Liquids

Gas

Non-commercial

Hydro, renewables and nuclear

Coal

2,665

1,143

1,143

1,186

8072,021

800

207

+4% p.a.

5,356

2010

10,770

4,935

2030

379

23%

4%

41%

7%

24%

11%

7%

50%

7%

25%

SOURCE: McKinsey 2030 Global Energy Perspectives

2010 share 2030 share


Drivers of growth In India

The increase in consumption in India could be driven by four fundamental drivers:

� Growth of the overall economy: India’s GDP is expected to grow at an average rate of over 6.5 percent per annum over the next 15 years. This may lead to an overall increase in the consumption and demand for energy.

� Increasing per capita energy consumption: India’s current per capita energy consumption is about 1/3rd the global average, 1/4th of China’s, and 1/15th of that of some developed economies3. This number could increase in the future.

� Growth in the transportation and industrial sectors: With inter and intra city travel becoming increasingly easy, the transportation sector is expected to see substantial growth. As a result, the growth for liquid and gaseous fuels is likely to continue.

� High energy intensity: As India embarks on a manufacturing-led growth path after multiple years of growth from the service sector, the energy intensity of the GDP could increase.

To unleash the power from these drivers of growth, a large amount of investment could be expected in India’s oil and gas sector. While foreign investments may be subject to global investment sentiments, local investments are expected to be strong, even in the next few years. Much of this investment is expected to be done by National Oil Companies (NOC) who have strong balance sheets and are much less impacted by the global outlook for the sector. The promise in India’s NOCs—BPCL, HPCL, ONGC and IOCL—stems from the fact that these companies feature in the “Platts Top 250 Best Energy Companies in the World” and “Global Top 50” lists for 2016, with operating cash flows of over USD 1 billion (Exhibit 2).

3 India Energy Outlook-World Energy Outlook Special Report, IEA


A healthy pipeline of investments

The outlook on investments in the upstream oil and gas sector in India is expected to be positive. This positive outlook has been bolstered by the domestic demand situation and the pressing need to enhance India’s energy security. Since 2014, investments in the global upstream oil and gas segment has been decreasing at 11 percent per annum. However, investments in India’s upstream oil and gas segment increased at a healthy 5 percent per annum (Exhibit 3).

In the future, a few large projects in the pipeline, such as the development of gas fields, may need large investments. Clarity on the investment regime and the ongoing small fields round could lead to increased exploration investments.

Exhibit 2

Financial highlights of top Indian oil and gas companies

SOURCE: Platts Top 250, Company annual reports FY2015

2016 PlattsTop 250

Total assetsUSD bn

Operating CashflowUSD bn

Oil India Limited 201st 5.8 0.5 0.03

GAIL 132th 10.7 0.6 0.4

Bharat Petroleum 35th 14.1 1.6 0.4

HP 48th 13.2 1.3 1.2

ONGC 20th 53.3 5.6 0.2

14th 36.5 2.9 0.6Indian Oil

Net debt/equity


Owing to a significant refinery presence, India is already a significant global player in the downstream segment (Exhibit 4). A number of brownfield refinery and fuel quality upgradation projects are currently underway. A few more projects are in the pipeline to cater to increasing domestic demand. India may struggle in the chemicals sector if it doesn’t find adequate investments—by 2025, up to USD 225 billion in investments can be expected to fill the shortage in chemical supply versus the demand in India (Exhibit 5).

Exhibit 3

Upstream CapEx Investment

USD billion

6%

8%

5%

-11%

SOURCE: Rystad Energy

2010–2014 2014–2017

1,000

900

600

500

11

10

8

7

12

800

9700

2010 14131211 2017E16E15

IndiaGlobal

CAGR, Percent


Exhibit 4

Refining capacity and refining project pipeline

SOURCE: McKinsey Refining Capacity Additions Database

5.1

7.8

2025

2.7

2020

5.3

5.1

0.34.6

2015

+3% p.a.

+8% p.a.

India’s refinery capacity forecastsMillion barrels per day

Firm and probable capacity

Speculative capacity

Exhibit 5

85% self-sufficiency in chemical industry may need capacity additions worth USD225 billion to bridge production gap

SOURCE: IHS (Global Insights)

India chemical industry sales and production projection – 2025USD billion

370

ProductionRequired (85%)

Currentproduction

55

Production gap

90

225

315

Import (15%)Net Sales


Increasing indigenization in countries could offer the dual benefit of boosting growth and providing employment to the local population. In the case of India where fast growth is a national aspiration and job creation is a necessity for its rapidly growing population, indigenization has recently become a national focus through the Make in India campaign.

The benefits are many

The indigenization of India’s oil and gas sector could bring in multiple benefits to the economy (Exhibit 6).

The most significant benefits of indigenization to India could be:

For the country as a whole, the most significant benefits are

� INR 15,000–20,000 crore in FDI inflows could be expected to set up manufacturing, assembling, research and other facilities in India

� 25,000–30,000 jobs could be available to leverage the highly skilled, English-speaking workforce in India

� Roll-on development of related industries could be expected—for example, the shipping and steel industries could see massive development as they are key enablers for the oil and gas industry

Opportunities for indigenization

Exhibit 6

Value creation potential of indigenization

15,000–20,000 crore FDI

25,000–30,000 jobs

Development of shipping and steel industry

India

5–30% procurement cost reduction

20–25% shipping time reduction

Development of key capabilities (e.g., R&D)

Oil and Gas sector


Specifically, for India’s oil and gas sector, the most significant benefits of indigenization could be:

� 5–30 percent reduction in procurement cost, from buying local content in INR, and incurring lower transport and handling costs on the same

� 20–25 percent reduction in shipping times, leading to speedier execution of projects and reduced maintenance delays, especially for critical equipment like platforms and rigs

� Development of key capabilities through exposure to processes and equipment that are currently outsourced from foreign companies

The current state of indigenization

As of 2013, India’s oil and gas sector was only 25–30 percent indigenized in the upstream sector1 (Exhibit 7). However, there is a great degree of variation among different segments within the sector—some segments have significant indigenization, while other sectors in the oil and gas industry are almost completely outsourced.

1 Only the upstream oil and gas sector was analyzed given the regular capital spending of India.

Exhibit 7

Historical level of indigenization in the Indian O&G sector

20-25%

Indigenization level 2013

25-30%

Local sourcing by foreign vendors

Adjusted indigenization 2013

Outsourcing by Indian vendors

SOURCE: IHS, Rystad, McKinsey analysis


Moderately indigenized segments include logistics services, chemicals and fluids, onshore rigs and onshore Engineering, Procurement and Construction (EPC) contracting. Segments with local sourcing by foreign vendors include labour for low-medium technological services and vendor-based services like fabrication. EPC equipment and rig equipment contracting see extensive outsourcing of labour in India.

Precedents of rapid indigenization

Indigenization could fuel the growth of the energy sector like never before. It could unleash the potential of local players, urging them to increase the quality of their services to compete with global standards. Such healthy competition could benefit customers too. To understand the implications of indigenization, it is important to take stock of precedents in India and across the world.

Learnings from Norway and Brazil

Norway and Brazil indigenized their oil and gas sectors between 1975–1985 and 2000–2010 respectively (Exhibits 8 and 9). The three critical levers for their indigenization were:

� Procurement policies to ensure local content: These policies typically mandate a certain amount of local content in the project and may, therefore, provide a direct boost to indigenization through volume and exposure to local businesses

� Financial incentives to attract investments: These investments could boost the development of critical functions such as R&D, technology, etc., that are required to sustain and develop indigenous operations

� Capability-building measures to ensure transfer of technology and skills: These measures could promote innovation and hence, are critical to ensure transfer of technology, best practices and know-how for satisfactory indigenous operations


Exhibit 8

Rapid Indigenization case study – Norway

Also led to significant growth of allied industries such as shipping & construction, beyond the core OFSE market

40

20

50

30

10

40

10

20

60

0

70

50

30

0

US$ billionPercent

050095908580751970

Foreign deliveries Local deliveries, US$ billion (RHS) Local content share, percent (LHS)

▪ Minimum local content requirement of 50%

Procurement policy

Capability building measures

▪ Mandate of 50% R&D to be conducted in Norwegian institutes

▪ National program PETROMARKS to promote technology innovation

▪ Partnership of Statoil with BP and Schlumberger to develop proprietary technology

Direct government financial levers

▪ Tax breaks for R&D expenditure

▪ Statoil allowed to markup costs by 2% for R&D

Description Levers Norway success story

Exhibit 9

Rapid Indigenization case study – Brazil

▪ Local content reached 60% in 2005▪ Led to a boom in local construction of ships▪ Led to increase in National shipyard

workforce from 2,000 to 50,000

40

30

20

10

40

30

20

10

00

60

50

15

45

25

35

5

US$ billionPercent

050095908580751970

Description Levers Brazil success story

▪ Minimum R&D expenditure of 1% of revenue

▪ National Programs for Modernization of Supply Vessels Fleet (PROMEF) with tax benefits & loans

Direct government financial levers

▪ Specific local content requirement

▪ EPC contracts broken for application of local content

Procurement policy

▪ World class research center CENPES to develop technology in collaboration with Schlumberger

▪ National program PROMINPto train professionals

Capability building measures

Foreign deliveries Local deliveries, US$ billion (RHS) Local content share, percent (LHS)


Learnings from India

Rapid indigenization is not unprecedented in India. The Indian auto-components sector has grown at 16 percent per annum since the 1990s (Exhibit 10). Today, it sells 30 percent of its products in foreign markets. The key drivers of growth in the Indian auto-components sector were:

� Entrepreneurial leadership: Over 70 percent of the auto-components sector in India consists of promoter-led companies—these companies have taken risks and modernized rapidly to meet and subsequently set global standards

� Robust exports: Exports, driven by sales to vehicle manufacturers in Europe, USA and Japan, are growing at the rate of 20 percent per annum

� Availability of skilled labour: The Indian auto-components sector enjoys a 10–25 percent advantage in labour cost compared to USA and Europe

� Quality consciousness: 500+ auto-component companies in India are ISO TS 16949 compliant; also, India has the largest number of auto-component companies to have won the Deming prize outside Japan2

2 Quality leaders—Learning from the Deming prize winners in India, International Journal for Quality Research, Jagadeesh Rajashekharaiah, http://www.ijqr.net/journal/v8-n3/11.pdf


Exhibit 10

Size of the Indian auto components industry

USD billion

4

1

31

39

+16%

2015201020001990

Share of foreign OEMs in passenger vehicle components1

sales, %

360

13

600

82

740

87

240

0

SOURCE: SIAM, ACMA

1 Car, SUVs, MPVs

Auto suppliers in India, #


The government has taken a number of initiatives to increase manufacturing in the hydrocarbon sector. Five key government initiatives (Exhibit 11) that could boost the sector include:

� Promotion of PCPIRs: The government promoted Petroleum, Chemicals and Petrochemical Investment Regions (PCPIRs), which are specifically delineated investment regions, to plan for the establishment of production facilities for the hydrocarbon sector

� Set up Petroleum Economic Zones (PEZs) for Oil Field Services and Equipment players (OFSEs): The government set up PEZs—zones similar to ‘Special Economic Zones’—where OFSE service providers were given concessions to set up facilities

� Provide multiple measures to improve the ease of doing business: The government offered single-window clearance for government services, simplified forms for industry licenses and set up online processes for environment and forest clearances

� Set up various national skill development missions: The government set up missions to identify the skills required for future jobs and to train people on relevant skills

� Offer financial and policy incentives: The government allowed higher amounts of FDI in the hydrocarbon sector by reducing duties

Government initiatives for indigenization


Exhibit 11

Existing initiatives undertaken by the government

SOURCE: ‘Make in India’ website, press search

Improving the ‘ease of doing business’

▪ Reducing and simplifying procedures and processes to improve the efficiency of governance

Promotion of PCPIRs

▪ ‘Petroleum, Chemicals and Petrochemicals Investment Regions’ for setting up manufacturing facilities

▪ Currently approved in 5 states

Concessions for OFSEs with PEZs

▪ Ongoing efforts to build global sourcing hub for OFSEs

▪ PEZs are similar to SEZs, where service providers will be given concessions to set up shop

National skill development mission

▪ Hydrocarbon Sector Skill Council set up to skill 2 million people by 2025

▪ 134 trades identified to create job roles – training modules and certification courses being developed

Financial and policy incentives

▪ 100% foreign direct investment (FDI) in E&Pprojects/companies and 49% in refining

▪ Various incentives (e.g., EPCG and area based schemes)


The Make in India campaign has done well for the energy sector in India ever since its launch two years ago. However, there is significant potential to boost its power.

Possible levers for indigenization

Three broad levers (Exhibit 12) could be used to boost the indigenization of India’s oil and gas sector through the Make in India campaign:

� Creating specific and non-specific industry clusters and fostering partnerships with foreign companies to develop such clusters: Industry clusters and hubs assume significant importance and provide multiple benefits—faster and easier approvals, lower taxes, potentially easier and more reliable utilities, integration with component/feedstock suppliers, etc. These clusters could be export-oriented and hence, coastal, given the lower availability of critical mass in a few areas and the ease of importing raw materials.

� Increasing the use of local content and manpower: Mandating a minimum percentage of local raw materials or labour for certain projects/services, categorizing local vendors as “preferred” vendors and incentivizing their involvement in projects could help indigenize the energy sector through content and manpower.

� Providing fiscal incentives: Offering tax breaks for R&D in India, subsidies for local vendors, incentives as a percentage of revenue/profit, mandating minimum investment amounts, etc., could help increase indigenization.

Strategies to fuel “Make in India”


Prioritization of opportunities

Given the rich opportunities available for indigenization, it is important that policymakers invest time, effort and money on the options that could provide the greatest returns. Hence, the best way to prioritize opportunities for indigenization is by looking at the “value on the table”, as well as its “existing capability”. This could help leverage current capabilities to extract the maximum value from initiatives. A framework could be drafted to illustrate this concept for opportunities, especially in the upstream oil and gas sector (Exhibit 13).

Exhibit 12

Possible levers to boost indigenization

Description Levers

▪ Hubs for specific industries (e.g., shipping, steel)

▪ Research institutes set-up in partnership with international companies

▪ National education programs for PhDs, MScs in focus areas; specialized tracks in NOCs

Industry clusters

▪ Tax breaks for R&D expenditure

▪ Subsidies to NOCs and local vendors

▪ Joint-investment projects (with government)

▪ Minimum R&D expenditure as % of revenue/ profit

Fiscal incentives

▪ Minimum local content

▪ Minimum manpower requirement

▪ Preferred categorization of vendors (e.g., price preference, categories open only to local vendors)

Local contentrequirement


Beyond these opportunities in the upstream sector, a few areas that could be prioritized in the near term are:

� Fabrication of static equipment for process plants (e.g., refineries, petrochemicals plants)

� Shipyards (vessels, LNG ships, offshore rigs)

Thus, the Make in India campaign has done well to boost the oil and gas sector in India. However, by further tapping into indigenization, greater growth in the sector could be expected. Such an inclusive growth story could take the growth of the oil and gas sector to new heights, while fuelling the growth of the economy.

Exhibit 13

Potential framework for prioritization of opportunities – Upstream example

Capability in India1

Strategic intent

Develop capability over long-term in India

Plug capability gap by collaboration

Promote procurement from local vendors

Val

ue o

f im

por

t (2

012-

13)

Low Med High

M

L

H

WSS manufacturing and services

Down-hole and Well completion

Onshore seismic acquisition

Offshore seismic acquisition

Rotary equipmentDrilling and logging services; fluids, chemicals, tubulars and casings

Hiring of floaters

Wire line logging, LWDand MWD contracts Jackup rigs construction

EPC offshore contracts manufacturing

Jackup rigs hiring and onshore rigs constructions

Logistics vessels

EPC offshore contract services and onshore manufacturing

1 Defined by number of current vendors; ability of vendors to meet the quality standards (e.g., technical specification); existence of ancillary industry

Crore

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India: A manufacturing hub for the hydrocarbon sectorpetrotech.in/uploadfiles/Speakerprofiles/PS - 3 Make in India.pdf · India already has a high level of indigenization in design,