The ongoing spat between Hindustan Oil Exploration Company (HOEC) and its oil block partner Hardy Oil seems to be much more deep-rooted and extends beyond the Rs 26.8 crore claim by Hardy against HOEC.

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Hardy Oil, controlled by ex-HOEC MD Mannish Maheshwari-led InVenire Energy, is claiming the amount against the costs of a block in which it had partnered with HOEC. The other partners were ONGC and Tata Petrodyne (also controlled by InVenire Energy).

The hullabaloo around the contingent liabilities of HOEC seems more a smokescreen than anything else. What it has done, though, is put the subject of contingent liabilities under the spotlight for investors.

In the normal course of business, companies do get into disputes with parties they deal with. Then there are tax disputes, and in highly regulated sectors, companies often get into tangles on levies and other payments. In the oil & gas sector, royalty payments and profit share from exploration blocks often are a bone of contention. But, don’t underrate contingent liabilities; some of them can over time turn into an existential question, as the experience of the telecom sector with the Adjusted Gross Revenues shows.

First, let’s try and get a better understanding of the current spat and contextualize the insignificance of contingent liabilities in the broader plot.

The Real Spat

ENI UK Holdings, the promoter of HOEC, after upping its stake in the company to 47 percent in 2008, had a change of heart after having to deal with the local regulatory challenges.

Since HOEC was a small piece of its global pie, they decided to exit the business in 2014. Mannish Maheshwari, the then Managing Director along with Chennai-based Atyant Capital was keen to acquire the company. No deal happened though, and ENI decided to wait a bit longer. It roped in the current management team (CEO-CFO duo) to run things, with an offer of ESOPs, till it found a suitor. In 2016, ENI finally sold out to Ashok Goel (Essel Group) and Rohit Dhoot Trust, with the existing managers also picking up small slices of the equity.

Following this, HOEC and Mannish Maheshwari-led InVenire Energy have had a few run-ins. They both bid for Jubilant Energy’s Kharsang block in 2018, which InVenire Energy won by outbidding HOEC. About a year later, after HOEC had struck a deal to acquire Hardy Oil—its CFO is an ex-Hardy Oil hand—InVenire Energy swooped in with a counter offer. A bidding match ensued, but HOEC later backed off. InVenire Energy won this asset too, but had to pay much more than what HOEC had initially offered. By now the gloves were off.

The battle then shifted to the current Hardy Oil block, for which InVenire Energy has claimed non-payment of Rs 26.8 crore as directed by the Arbitration Tribunal in Malaysia. The odd thing on this one, is that the independent operator in the field ONGC has agreed to pay, and this puts HOEC on a weak wicket. However, sources suggest that ONGC’s consent may have been won by waiving certain charges—like interest on expenses incurred, other than the third-party claim.

There is no clarity on this, but this dispute, per se, is less consequential. A bigger bone of contention is the resumption of the field. Sources close to InVenire Energy suggest that HOEC is holding up resumption with one excuse or the other. The counterclaim is that InVenire’s indicated costs are far higher than necessary to be contributed for this.

So, the current spat has less to do with contingent liabilities and more to do with a more deep-rooted rivalry. Is HOEC the treasure they are both fighting over? It’s anyone’s guess. We learn that the company’s operational production which was ~7800 barrel of oil equivalent per day (boepd) last year will rise to ~15,000 boepd from April 1 next year.

The Contingent Liability

On the issue of the contingent, or put simply “conditional”, liability, we need to look at these from a case-to-case basis. And unless you understand an industry well, it is difficult make projections. Therefore, how much of this needs to be recognized is usually a management’s judgement call and auditors would largely base their reviews on this, along with trends in the industry. On this count, HOEC doesn’t seem an outlier on the face of it.

But sources close to InVenire claim that even the Rs 244 crore disclosed by HOEC in its intimation to stock exchanges is understated. And that there are other such liabilities that will require to be paid—adding up to over Rs 160 crore.

Sources close to HOEC contend this is a misrepresentation and that these matters have already been settled by the managing committees of these blocks, each of which has a government representative. We don’t know who is right on this, and it is not ours to judge.

But putting all the numbers together, it doesn’t seem that HOEC has a problem in either paying the claim of Rs 26.8 crore, that it is still contesting, or in meeting its obligations—non-contingent and contingent. This is provided, of course, that you can trust the books. But given that the auditor is Deloitte and cash flows are difficult to fudge anyway, we expect the numbers should be kosher.

Our calculation shows that with just standalone operating cash flows, HOEC can service all these obligations fully in under 18 months. So, that isn’t a concern at all.

Lessons for Investors

This brings us back to the bigger question for investors. Should you be investing in companies with high contingent liabilities? My view: only if you understand the business well. For those who understand highly regulated businesses like oil, telecom, power and infrastructure, there are other less-contingency exposed segments that you can target. If you are looking to play the oil consumption theme, for instance, rather than focusing on oil producers, you could very well look at a segment like lubricants that are also tied to mobility and traffic growth. In fact, you might find the ratios for some as attractive or more, like we did.

FCF – Free Cash Flow; ROE – Return on Equity

Risk is an integral part of investing. But if you don’t understand business or its risks, find one to invest in that you do.