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INDIA S REFINING HUB, REALTY OR A MYTH India s GDP is growing at a rapid pace, the GDP is growing above 8% during

the last few years, and this growth rate is second highest in the world. To sustain this growth rate for longer duration a country should be self sufficient in energy requirements. Fuels like petrol, diesel, LPG, naphtha are used in every walk of life and more over they have weightage of 22% in the inflation calculations. If we are seeing the refining capacity in that corner the present refining capacity is more than sufficient to meet the petroleum products demand. But the global dynamics have made the refining business too lucrative. The refining margins are at the peak. But this business has to be taken very cautiously this is because it is capital intensive, a 1MMPTA capacity addition will cost you around 1K 2K crorers depending on the location. Added to this, refinery utilization can seriously undermine the refinery margins. Any refining capacity addition with the view of exporting the petroleum products has to study the long term demand and supply positions. In the present discussion we will explore, the possibility of India becoming a refining hub. Snapshot of Indian energy sector: By closely looking at the primary energy usage we can notice that coal is the major energy source, followed by oil and gas, but in coming years the share of gas is set to

increase to 20% of the primary energy usage from current level of 8%. Though the pie chart represents the energy mix of 2005, there is no major shift of energy mix of 2007 compared to the level of 2005. Source: BP Statistical Review 2006 India s energy mix is going to be as follows in the coming future, India has abundant coal i.e. to the tune of 210 bn tons, this amount to 7% of the total world deposits this is the reason why coal is going to be main stay of the energy basket for the coming years on other hand we have oil reserves of .5% and gas reserves of .4% of the total world reserves. The following table represents the share of energy source in the following years India s energy consumption (projection) Data units "million tons equivalent in oil" or "MTEO") Source: Draft Report of the Expert Committee on Integrated Energy Policy, Planning Commission, Government of India Indian Refining overview: India has a refining capacity of around 149 MMPTA of which majority of the refining capacity comes from public sector companies. Source: Ministry of petroleum presentation to consultative committee (June 07) The current demand of petroleum products is around 1201MMTPA; the consumption pattern is shown as below. The excess capacity is been exported, India exported petroleum products worth 32.42 MMTPA, which amounts to 17.6 bn$3 So far the story is good, but the XIth five year plan (2007

2011) states that the refining capacity is going to be increased to 2414MMTPA at the end of the year of 2011, it also future states that we will have near about 935MMTPA for exports. But the moot point is, whether market exist for this much products. Currently the Gross Refinery Margins i.e. nothing but the difference between crude intake price and products price are at the peak, this made the refinery business lucrative, but what if, if suddenly refining capacity increases. Sources: 1 Ministry of petroleum 2 Ministry of commerce 3 Ministry of commerce 4 Planning commission 5 Planning commission Global Refining Business: The refining business is often termed as unfashionable, capitalintensive, low-returns business with overcapacity, but the situation has changed, now every investor want a piece of this business, this is because margins are flourishing and there are now real concerns of a global shortage of refining capacity. Some analysts and oil producers went a head and predicted that shortage of refining capacity as the reason for high oil prices. A closer look at the refinery margins from the year 1992 2006 shows that the margins recovered sharply from 2002 crisis and presently are at the peak. This was driven by

strong demand for all products in Asia (China and India in particular) and robust gasoline demand growth in the US. US margins soared even higher as a result of events such as Hurricanes Katrina and Rita, which also propped up European margins at the strong 2004 level, however Asian margins declined. Refiners who can process heavy, sour crude have benefited even more significantly over the last two years as high crude prices have driven sour margins even higher. Refining margins have been strong as underinvestment into the sector has been exposed by a sharp rise in demand and changing demand trends with long lead times for a new capacity. Gross Refining Margins in $/bl 0 2 4 6 8 10 12 14 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Years ( 1992 - 2006) GRM $/bl USGC West Texas Sour Coking NWE Brent Cracking Singapore Dubai Hydrocracking Source: BP Statistical Review 2007

The next question that creeps up to the mind of potential investors is, for how long this peak is going to sustain. Current estimated suggest that the refining margins are going to be tight for another three to four years, after that margins are going to dip as 170 new refineries or expansion projects (including GtL projects) are coming at a cost of US$480bn, adding around 30mbbl/d (or 35%) to global capacity. Source: UBS These projects have long lead time because of shortage of skilled labour and project executors, so estimates predict that only 13.8mbbl/d of capacity will be added by the end of 2012 this addition has the potential to bring the capacity utilization from 86% to 82%. Source: UBS Below graph represents demand growth and refining expansion growth, here we can see, up to 2008 demand growth rate is higher than refinery expansion growth creating a shortage of refined products which in turn has propelled the refinery margins to the peak. This has made the refinery business lucrative, so world over refinery capacity expansions are taking place heavily. Most of the new refining capacity is coming during 2010 2011, during this period their may be possibility that their will be excess supply. Source: UBS The point is, where the new refining capacity is coming and when is it coming. The discussion on where the new refining capacity is coming is

important because the refining business is controlled by the location parameter, suppose if the new refining capacity is coming heavily in the Middle East, which has a cheaper access to the crude oil, it will have rippling effect on the other refineries. Various reports say that new refining capacity is coming heavily in Middle East, China and India. The net primary distillation capacity addition during the period 2006 2015 will be around 14.6 million b/d, this is against the demand growth of 11.1 million b/d. The major refinery capacity addition is taking place in Asia and Middle East. Added to this their will be 1.12 million b/d of capacity coming in the form of biofuels. In all together their will be net surplus addition of 5.6 million b/d during the year 2006 2015 CDU capacity additions to 2015 Source: EMC World Refining Outlook Oct 2006 Source: EMC World Refining Outlook Oct 2006 Regional Refining Outlook: North America: North America is the largest consumer of petroleum products and the largest importer of petroleum products. Stringent product specifications and more concern for environment are making refinery business tougher and tougher. As for as investment in refinery business is considered, most of the investment is coming in the area of conversion units, such as cokers and hydrocrackers, this is to meet the very low

sulphur specifications for gasoline and diesel. The refinery capacity addition in the North America will be around 1.7 million b/d during 2006 2015. These investments in conversion capacity will increase the conversion ratio from 48% in 2006 to 81% by 2011. Refining Capacity and Operations North America Source: EMC World Refining Outlook Oct 2006 Forecast North America Products Trade Source: EMC World Refining Outlook Oct 2006 Latin America Regional primary distillation capacity is projected to increase by 1.6 mb/d between 2006 and 2015. This would be significantly in excess of the forecast rise in regional oil product demand and reflects plans to build several export refineries aimed at supplying local regional import requirements and the large North American deficit of products. Investment in conversion and upgrading units is expected to total around 1.5 mb/d (FCC equivalent). It will be focused on supplying the rising proportion of transportation fuels and dealing with declining fuel oil in both the regional and export demand barrel and on meeting the more severe product quality specifications. Accordingly, there will be several new cokers, together with new or expanded hydrocracking and a considerable amount of additional desulphurization capacity. The regional conversion to distillation capacity ratio is forecast to rise from 38% in 2006 to approaching 47% by 2011.

Refining Capacity and Operations Latin America Source: EMC World Refining Outlook Oct 2006 Forecast Latin America Products Trade Source: EMC World Refining Outlook Oct 2006 Europe: In view of the small increase in regional oil demand in the next 8 years, there is little incentive for European refiners to invest in new primary distillation capacity. More investment takes place in conversion units like hydrocracking and desulphurization. Product table indicates that their will be surplus of gasoline this is because of more diesel cars on the road. This surplus gasoline can head for the deficient USA market. Refining Capacity and Operations - Europe Source: EMC World Refining Outlook Oct 2006 Forecast Europe Products Trade Source: EMC World Refining Outlook Oct 2006 Former Soviet Union Their will be limited refinery expansion in this region and more investment in the conversion units. This is for export purpose to the European market which is facing shortage in all the products baring gasoline. Their will be increase in the average complexity ratio of FSU refineries from about 16% in 2006 to around 33% in 2015. Refining Capacity and Operations - FSU Source: EMC World Refining Outlook Oct 2006 FSU Products Trade Source: EMC World Refining Outlook Oct 2006 Africa

The refinery capacity addition will be in the tune of 1.17million b/d. Some of the refinery expansion is also planned for the export purpose for which conversion units are also taking place. Refining Capacity and Operations - Africa Source: EMC World Refining Outlook Oct 2006 Africa Products Trade Source: EMC World Refining Outlook Oct 2006 Middle East The refinery capacity addition will be around 3.6 million b/d during the period 2006 to 2015. The addition is planned for catering the growing demand and for export market also. New conversion units are also planned to produce products of exportable products. Refining Capacity and Operations Middle East Source: EMC World Refining Outlook Oct 2006 Middle East Products Trade Source: EMC World Refining Outlook Oct 2006 Asia Refinery addition is around 7.5 million b/d during the period of 2006 2015. Most of the refinery capacity addition is planned for meeting the local demand. Most of the refinery addition is coming up in China 3.3 Mb/d Indian Subcontinent 3.2 Mb/d Indonesia 0.9 Mb/d Taiwan 0.9 Mb/d S. Korea 0.5 Mb/d Vietnam 0.3 Mb/d Other 0.2 Mb/d

Refining Capacity and Operations Asia Source: EMC World Refining Outlook Oct 2006 Asia Products Trade Source: EMC World Refining Outlook Oct 2006 Refinery products movement: The situation is not that grave even though there are product deficits in many areas. This is because regional product deficits are met through regional product surpluses, for example there are gasoline shortages in USA market that can be met through excess gasoline available from European Market. Similarly LPG & Naphtha shortages in Asia can be met through excess availability of these products from Middle East. Opportunities in Refining Business from Indian point of view: As we seen from above analysis that global refinery margins are going to dip in the coming three to four years, it is not wise to expand the refining capacity with out studying the global dynamics. The recent concern for the environment is throwing good opportunities to the refining business. The concern for environment is making the product specification stricter which requires huge investment for producing these products. Refineries need to invest heavy amount in the conversion units, to produce these products. These will greatly affect the economics of a refinery. The effect is more in places like USA, Europe and Japan. They usually have high operating cost and installation cost with respect to India, China.

On other hand getting environment clearances for the construction of new refineries are becoming harder in USA, Europe and Japan. In all together doing refinery business in these areas is becoming harder day by day. This is primary reason why players like shell and Exxon are selling their refinery business in Japan and Europe and more over they don t have any major expansion plans in USA. But places like India, China and Middle East has huge potential in this business, this is because places like India and China have low operation cost and has huge talent pool and places like Middle east has access to the cheap raw material. This is the region why many big players like Chevron, Shell and Exxon are showing keen interest to invest in this business in these regions, recently Chevron picked 5% stake in Reliance Industries Limited s RPL ( Reliance Petroleum Limited) But market will only be their for the refineries which are able to produce Euro V products. So all the export oriented refineries should have conversion units.