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Refining: Can India be global hub? - Views on News from Equitymaster
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  • Mar 7, 2007

    Refining: Can India be global hub?

    The public sector oil refining and marketing major, BPCL has recently decided to establish a trading desk at Singapore to manage its exports of refined products. This once again signifies the intent of Indian refiners to target exports and make India one of the major refining hubs in the world. Now, is the dream of becoming a global refining hub realistic? Can India replicate the success of other major hubs like the US West Coast, Rotterdam, Singapore and Middle East? This is a million dollar question, the answer to which largely depends upon certain requirements before hand.

    Prerequisite for building export-oriented refineries
    Tax and fiscal concessions: In order to build an export-dedicated refinery, operating in international competitive scenario, the government needs to provide support in the form of tax breaks and other fiscal concessions. Tax and fiscal concessions will lead to lower operational cost, which is the basis of international trade. The government has recognised the fact and has offered 15-year tax incentives to refineries that are to be established in export oriented zones. Following this move, Reliance Industries, through its subsidiary Reliance Petroleum, is establishing an export-oriented refinery in the Jamnagar special economic zone (SEZ).

    We also believe that the government needs to ease investments to attract more investment in the sector (FDI investments are currently capped at 24%).

    Petrochemical facility: Detailed feasibility report prepared by Shell Global for studying the potential of India being a regional refining hub stated that an export-oriented refinery should inevitably be linked with a petrochemical facility. The need for the same exists due to enhancement of the value chain presence and diversification of the revenue base. With the current spike in the cost of establishing a refinery, the required gross refining margins (GRMs) to break-even has increased to US$ 10 per barrel for the refineries without petrochemical facilities. Thus, it is an imperative for Indian refineries to establish petrochemical facilities to benefit from the presence across the value chain.

    IOC is establishing a 15 million metric tonne (MMT) refinery cum petrochemical plant at Paradip. Also, the company has established a petrochemical unit at its inland refinery at Panipat to effectively utilise the refined output. Reliance has also recently announced its plan to establish a cracker in the Jamnagar SEZ to effectively utilize the refined by-products.

    Flexibility in handling various crude varieties: Cost differential between sour and sweet crude has increased off late to historically higher levels. The differential, which used to be in the range of US$ 1 to US$ 2 per barrel during 1994 to 2003, has reached to a level above US$ 5 per barrel in 2005. This signals that the world crude slate is getting heavy day by day. Generally, higher the complexity and more flexible the feedstock slate, the better positioned the refinery is to take advantage of more cost effective crude. We have elaborated more on the need on flexibility in handling various crude in our previous articles on refining.

    A classic example of this is Reliance (capable of handling various varieties of crude) as against Indian PSU refineries. Currently, the former is earning more than twice the refining margins made by PSU Indian refineries. Reliance Petroleum has also taken a note of the fact and is establishing its refinery, which can handle various grades of crude.

    Flexible downstream product mix: The flexibility in downstream product mix and capability to switch between various product mix is another dominant factor, which has a major say on the refining margins. Also, the refineries need to have secondary conversion facilities so as to tilt the output towards light and middle distillates, which currently due to greater demand earns better realisation. The composition of light distillates in terms of demand has grown from 35% in 1981 to 42% in 2003, while the demand for middle distillates has risen by 6% and the same for heavy distillates has fallen by 13% during the period.

    Value added products: Oil refining is primarily a margin-based business in which a refiner's goal is to optimise the refining processes and yields in relation to feedstocks used. Thus, refinery should have the capability of producing value added products (earn higher margins), which fulfill the environmental regulations. Complexity of Indian refineries needs to be inclined towards more value added products (likes high octane fuels). To offset the high cost associated with exports (specially for longer distance), the refineries need to have the flexibility in products and complexity to handle various grades of oil so as to earn above average refining margins.

    The Nelson's complexity of Reliance's proposed refinery is 14 - signifying that the refinery is 14 times more sophisticated that basic crude distillate refinery. Refining and marketing major, IOC has tied-up with the US-based UOP, for technical collaboration for quality improvement of its products like petrol and diesel. This tie-up is for upgradation of IOC's refinery in Koyali (Gujarat). It needs to be kept in mind that RPL and RIL are also using the services of UOP for its refineries.

    Debottlenecking of infrastructural issues: The cost mechanic primarily drives international trade of any product, with petroleum products being no exception. Thus, the cost associated with transportation of crude oil and petroleum products (shipping cost) need to be kept in check as it forms a significant part of the overall cost. Reduction in transportation cost inevitably calls for upgradation of the infrastructure. According to estimates by the Ministry of Shipping, the required port capacity to handle petroleum, oil and lubricants (POL) will be as follows:

    POL handling facility at major Indian port in FY05 and capacity required...
    Traffic at Major Ports
    (FY05) (In MMT)
    Capacity at Major Ports
    (FY05) (In MMT)
    Projected traffic by
    FY14 (In MMT)
    Capacity required by
    FY14 (In MMT)
    126.4 157.4 191.2 248.6

    This translates into the addition of more than 90 MMT (58% increase over the current level), which seems to be a tough ask given the current state of infrastructure.

    In a nutshell, it can be said that higher internal efficiency of production coupled with favourable government policies will provide a good export potential for Indian refiners. However, with the poor state of infrastructure (ports and terminals), the dream of become a refining hub seems distant. While the private players will continue to fuel the export growth, the public participants are likely to go slow in their expansion spree. We have already seen rollback of refining capacity plans by ONGC and its plans to tap export market.

    Note: This article is an extension to the series over Indian refining industry. We have written following articles, prior to it for understand of the sector:-

  • Refining:A case for higher spreads!
  • Refining industry:A complete overview-I
  • Refining: Understanding GRMs...
  • Refineries: Some key factors...



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