The proposal to merge Reliance Industries Ltd [Get Quote] and Reliance Petroleum Ltd [Get Quote] has caught stock market analysts off-guard, with brokers and fund managers grappling with the likely reasons and consequences. However, if one digs deeper into the models of top oil and gas exploration companies, a larger plan emerges.

According to a section of analysts, the amalgamation of RPL with RIL is the first step by Mukesh Ambani towards a major asset re-structuring exercise, drawing a clear distinction between the group's refining and non-refining assets.

To understand this, it is necessary to look at the different segments where Reliance has a major influence.

Currently, the petrochemicals business, including refining, contributes 60 per cent to Reliance's revenue. The company also has ambitious growth plans in oil and gas exploration worldwide, apart from the other businesses such as engineering, procurement, construction and retail, which are still relatively small.

According to analysts, while income from refining and petrochemicals depends mainly on gross refining margins, linked to the highly fluctuating prices of crude oil, the exploration and production business will become the backbone and a major revenue spinner for the group in coming years.

"The refining margins can only be boosted by a high rate of exploration and production and, therefore, the price to earnings ratio of oil and gas exploration companies are much higher compared with that of refining companies. Thus, it becomes necessary for Reliance to draw a clear line between its exploration and refining business and, accordingly, restructure its assets," says Deepak Sawhney, head of research at Mumbai-based Networth Stock Broking [Get Quote].

While RIL alone already accounts for 40 per cent of India's indigenous hydrocarbon production, its aggressive pursuit of E&P can be gauged from the fact that it has had nine offshore discoveries over recent years. The inventory of discovered blocks stands at 37, reflecting a success ratio of 63 percent, way above the international average.

RIL has already invested more than $10 billion for E&P and the company is expected to generate strong cash flows from its gas business as its volumes gradually increase to the targeted 80 million standard cubic metres a day. It is also known well now that RIL is trying to make inroads in oil and gas exploration overseas, with a foothold in both Iraq and Vietnam.

Says Deven Choksey, managing director of KR Choksey Shares and Securities: "RIL has a number of blocks lined up for exploration in the coming couple of years and this will require huge capital. While some can be raised through borrowings, a major portion of it will come from profits in the refining business, which shows why the merger of RPL was necessary."

Thus, it was necessary to bring the assets together, as both RIL and RPL operated a refinery. Moreover, when RIL was implementing the RPL project, the largest single-location refinery in the world, there were substantial risks involved. Now that the project is onstream, the risks have been mitigated and project costs can be met through a public offer. Also, it would not have been possible to bring together the two mega refineries in a single company without merging RPL.

Analysts say once the merger is through and the oil and gas exploration business matures, the domestic capital market will see the biggest unlocking of value. The world over, too, an oil and gas exploration giant's refining business is comparatively smaller in size. It is quite possible that there would be two companies, one with the refining and petrochemicals business, and the other with oil and gas exploration and other smaller business like SEZs, EPC and retail, which will also be hived off at a later stage to mitigate the risks when the valuations are right, say both Sawhney and Choksey.

Post-merger, it could be Reliance Retail's turn to get listed on the bourses and eventually get merged with its parent, Reliance Industries. This could happen in the next three years, said market experts.