PINC Indian Refinery Scenario

RESEARCH
07 December, 2011
SECTOR REPORT
INDIAN REFINERY
LOOKING INTO A ROBUST FUTURE

Satish Mishra +91-22-6618 6488 satish.mishra@pinc.co.in Urvashi Biyani +91-22-6618 6334 urvashi.biyani@pinc.co.in
RESEARCH
Contents
Executive Summary .................................................................................................................2 GRM to Stabilise going forward ................................................................................... 5 Brief snapshot of GRM Dynamics ................................................................................ 6 What lies ahead .......................................................................................................... 8 Indian GRM should trade at a premium in future ......................................................... 13 India - gaining prominence in Asian refining space .................................................... 15 Global demand scenario ........................................................................................... 18 Global capacity scenario ........................................................................................... 21 Are the upcoming refineries suitably configured? ....................................................... 23 Global crude supply scenario .................................................................................... 24 Crude price outlook ................................................................................................... 27 Snapshot of current scenario ..................................................................................... 30 Companies Mangalore Refinery & Petrochemicals ................................................................. 32 Chennai Petroleum Corporation ........................................................................... 45 Essar Oil .............................................................................................................. 54
RESEARCH
Sector View - Positive
REFINERY SECTOR
COMPLEXITY AND SCALE ADDING PROMINENCE
The oil demand has stagnated in the mature markets specially in the US and Europe owing to global economic meltdown, promotion of fuel substitutes, intensive focus on energy efficiency and sustainable environment. However, in the long term oil demand led by non-OECD countries, specifically China and India should compensate for the slack in oil demand from OECD countries. Indian players are adding refining capacity to match the robust local demand and improving their complexity for better refined products to meet the prescribed environmental friendly specifications. We are positive on the Indian refining sector and initiate coverage on it with a BUY on MRPL and an ACCUMULATE on CPCL. DEMAND DRIVEN BY NON-OECD COUNTRIES: Out of total incremental demand of 5mb/d (CAGR 1.4%) by FY15, non-OECD countries are likely to account for 6.2mb/d more than compensating the decline of 1.2mb/d in OECD countries. China and India should be the major driver with contribution of 2.9mb/d. CAPACITY FOLLOWING DEMAND: With future incremental demand coming from non-OECD, ~95% of upcoming capacity of 6.7mb/d to 99.5mb/d by FY15 is located in the region. China and India lead the group with 3.2mb/d of upcoming capacity (2.3mb/d and 0.9mb/d respectively). IMPROVEMENT IN COMPLEXITY: Matching with the rising demand for middle distillate and better auto fuels, Indian companies are revamping their facilities along with capacity addition. Average Nelson complexity index is likely to increase from the current levels of 6-7 to 9-10 in next 1-2 years. Higher proportion of gasoil against Singapore benchmark makes a case for relative improvement in the future. SINGAPORE GRM TO MODERATE: We expect Singapore GRM to stabilise between USD6.0/bbl to USD7/bbl after trading strong in 9mCY11. However, Gasoil spread is expected to remain strong which should support Indian players GRM. CONCERNS: Current global economic uncertainty remains the major risk as volatility in crude oil price, international GRM and USD-INR exchange rate may falter the performance substantially. Delay in project commissioning can impact the performance. VALUATIONS AND RECOMMENDATION We are positive on the Indian refining sector and we initiate our coverage on pure refining companies, with a 'BUY' rating on MRPL and an 'ACCUMULATE' on CPCL. Essar Oil is also set to benefit with increasing refining capacity and complexity improvement, however, we are currently not rating the company.
07 December 2011
MRPL (Rs mn) Net Sales EBITDA Margin (%) Net Profit YoY (%) EPS (Rs) CPCL (Rs mn) Net Sales EBITDA Margin (%) Net Profit YoY (%) EPS (Rs)
FY12E 513,116 1.7 4,749 (59.6) 2.7 FY12E 438,437 0.8 1,727 (66.2) 11.6
FY13E 561,257 5.0 12,580 164.9 7.1 FY13E 422,789 3.1 4,835 180.0 32.4 FY13E 626,540 8.0 18,903 104.6 13.6
FY14E 586,247 7.0 19,188 52.5 10.9 FY14E 374,617 3.7 5,118 5.8 34.3 FY14E 723,968 7.6 20,832 10.2 14.9
SECTOR OVERVIEW
Essar Oil*(Rs mn) FY12E Net Sales EBITDA Margin (%) Net Profit YoY (%) EPS (Rs) 540,240 5.9 9,237 NA 6.7
OIL&GAS 12000 10500 9000 7500
BSE (Rebased)
6000 Dec-10 Mar-11 Jun-11 Aug-11 Nov -11
Sector Summary
KEY FINANCIALS
Company Mangalore Refinery (MRPL) Chennai Petroleum (CPCL) Essar Oil (EOL)* CMP (Rs) 62 185 69 Mcap (Rs bn) 109 28 94 EV/EBIDTA (x) FY13E 5.9 6.4 4.0 FY14E 3.6 6.0 3.6 P/E (x) FY13E 8.7 5.7 5.1 FY14E 5.7 5.4 4.6 P/B (x) FY13E 1.4 0.7 1.0 FY14E 1.2 0.6 0.9 ROE (%) FY13E 17.2 12.0 21.6 FY14E 22.4 11.8 20.7 TP (Rs) 88 215 NA Rating BUY ACCUMULATE NA
* ESSAR OILs number is bloomberg estimate For rating objective and disclaimer, please refer to last page of the report PINC Research reports are also available on Reuters, Thomson Publishers and Bloomberg PINV <GO> 1
RESEARCH
EXECUTIVE SUMMARY
INDIAN REFINING SECTOR: GAINING IMPORTANCE IN THE ASIAN REFINING SPACE
India, with a capacity of 193mmtpa, currently accounts for ~13% in refining capacity and ~12% of consumption in Asia. In the last decade, export's proportion has increased from ~8% to ~29%. Throughput capacity is set to increase by ~25% to 240mmtpa by FY15, making India an important player in the Asian refinery map. Strong domestic demand: Consumption of petroleum products has shown a CAGR of 4.1% despite gloomy environment. Demand is expected to remain robust at ~6% mainly driven by auto fuels. Strong domestic demand is resulting in ~80% in-house consumption of upcoming capacities. Improvement in complexity: Indian players are spending on improving their complexity to increase their yield, meet the demand of upgraded products and to increase usage of low cost sour/ heavy crudes. Average Nelson complexity index is set to increase from current level of 6-7 to 9-10 in the next 1-2 years. Product slate favoured towards middle distillate: To meet the future requirement, companies are increasing their middle distillate proportion and are upgrading auto fuels quality to Euro III/Euro IV norms. This further puts Indian players in an advantageous position as their average Diesel proportion in product is ~40% against Singapore benchmark's 16%. Robust Gasoil demand scenario across the globe augurs well for domestic players. No major under-recovery risk: With rising crude prices and depreciating rupee, Indian OMCs are under risk of increasing under-recovery. In this report we are talking about pure refiners without marketing setup and hence there is no major under-recovery risk. Increasing refining throughput capacity and higher consumption contribution from struggling US and Europe, coupled with gloomy macro environment across globe can result in unfavourable demand-supply scenario in near future. However, robust Asian demand, improving complexity and favourable product mix are some of the positives for the Indian players. We are positive on the Indian refining sector and we initiate our coverage on pure refining companies, with a 'BUY' rating on MRPL and an 'ACCUMULATE' rating on CPCL.
Robust domestic demand leading to increase in refining capacity...
Higher middle distillate yield promises better margins for Indian players ...
satish.mishra@pinc.co.in
RESEARCH
COMPANIES SUMMARY MRPL: BUY, TP - RS88 (42% UPSIDE)

Agressive capex plan of ~Rs154bn from FY11 to FY14 Capacity increase by ~30% to 15.4mmtpa and Nelson complexity improvement from ~6 to ~10 Distillate yield improvement from ~72% to ~78% (Diesel contribution - 45%) and decrease in Fuel oil proportion from ~16% to <5% EBITDA and PAT to clock a CAGR of 26% and 18%respectively from FY11 to FY14 Concern over delay in project commissioning, volatility in crude price/ international GRM/ INR-USD exchange rate At CMP of Rs62, MRPL is trading at PER of 8.7x & 5.7x and EV/ EBITDA of 5.9x & 3.6x for FY13E and FY14E respectively
1-year forward P/E Band 1-year forward EV/EBITDA
160
300,000
12x
120
19x 16x 13x 10x 7x
225,000
10x 8x
80
150,000
6x 4x
40
75,000
0 Apr-06
Sep-07
Jan-09
Jul-10
Dec-11
Apr-06
Sep-07
Jan-09
Jul-10
Dec-11
CPCL: ACCUMULATE, TP - RS215 (16% UPSIDE)

Capex plan of ~Rs40bn from FY11 to FY14 Capacity increase by 0.6mmtpa to 12.1mmtpa and Euro IV upgradation Current distillate yield of ~69% with Diesel contributing ~36%, residual up-gradation project in pipeline to increase distillate yield to ~77%, awaiting environmental approvals EBITDA to clock a CAGR of 4% and PAT to remain flat from FY11 to FY14 Concern over delay in project commissioning, volatility in crude price/ international GRM/ INR-USD exchange rate Strong dividend history with payout ratio in the range of 35-40% At CMP of Rs185, CPCL is trading at PER of 5.7x & 5.4x and EV/ EBITDA of 6.4x & 6.0x for FY13E and FY14E respectively
1-year forward P/E Band 1-year forward EV/EBITDA
500 400 300 200 100 0 Apr-06

12x 10x 8x 6x 4x
300,000
225,000
150,000
12x 10x 8x 6x 4x
75,000
Sep-07 Jan-09 Jul-10 Dec-11 Apr-06 Sep-07 Jan-09 Jul-10 Dec-11

3
RESEARCH
Global comparison
In order to compare standalone refineries like MRPL, CPCL and Essar Oil, we have included Indian Oil refining and marketing companies (OMC's) like HPCL, BPCL, IOCL and RIL (Intergrated Oil& Gas Company) in the overall Indian average. For the global average, we have build a diversified portfolio which includes refineries across different regions like Asia, US, Japan and Europe. What we can see is that Indian refiners are trading at a premium to global refiners based on EV/ EBITDA multiple for FY13E and FY14E. We believe that these premium valuations are justified on account of expectation of higher average ROE for our universe at ~15% vs global average of ~13%. Recent correction in stock prices further provides an investment opportunity.
VALUATION COMPARISON
Mcap Company Name (USD mn) 14,195 5,031 11,456 4,141 2,526 4,278 15,860 633 3,379 12,381 1,156 13,752 3,031 415 1,539 5,136 Curr EV (USD mn) 13,516 5,535 14,173 5,421 6,735 14,963 44,335 869 4,157 17,216 1,816 18,367 6,257 1,968 2,287 8,821 EBIDTA Margins (%) CY12/ FY13E 6.3 25.8 7.7 6.9 2.4 4.7 4.9 6.4 5.7 4.5 8.0 7.5 4.3 1.7 3.2 4.5 6.5 5.3 2,119 536 1,881 1,927 3,931 12,675 51,853 2,348 1,481 4,183 7,836 8,017 22,416 61,983 5.0 3.1 8.0 2.8 3.0 4.7 13.7 5.8 4.7 CY13/ FY14E 6.6 27.3 7.7 7.1 2.7 4.8 5.3 8.4 4.8 4.1 6.8 7.7 4.6 2.1 3.8 4.8 6.8 5.1 7.0 3.7 7.6 2.9 3.3 4.8 14.5 6.3 4.8 EV/EBIDTA CY12/ FY13E 3.8 5.2 7.0 6.2 7.8 5.8 6.7 2.9 2.8 3.0 2.5 10.8 6.5 4.7 5.0 6.1 5.4 5.5 5.9 6.4 4.4 9.0 7.6 6.2 7.9 6.7 6.3 CY13/ FY14E 3.6 4.7 7.0 5.9 7.2 5.8 6.3 3.0 3.1 3.2 2.7 9.5 5.8 3.5 4.0 5.7 5.1 5.2 3.6 6.0 4.0 8.0 6.5 5.8 7.2 5.9 5.9 17.6 9.1 8.4 6.7 8.7 5.7 5.3 5.8 9.9 7.0 11.0 7.6 7.0 P/E (x) CY12/ FY13E 6.3 5.5 8.2 8.7 9.7 5.6 6.7 5.3 5.8 5.4 4.5 19.0 8.9 CY13/ FY14E 5.8 5.1 8.0 8.3 8.4 5.6 6.4 6.9 6.6 5.5 4.8 17.4 7.0 7.9 12.0 8.7 7.8 6.9 5.7 5.4 4.8 5.2 8.2 6.3 10.0 6.5 5.6 P/B (x) CY12/ FY13E 1.0 0.8 2.0 1.4 0.7 0.5 0.6 0.8 0.8 0.6 1.1 3.0 0.8 0.3 0.9 0.6 1.0 0.8 1.4 0.7 1.0 0.7 1.2 1.0 1.3 1.0 1.0 CY13/ FY14E 0.9 0.7 1.7 1.3 0.6 0.5 0.6 0.7 0.7 0.6 0.8 2.6 0.8 0.2 0.8 0.6 0.9 0.7 1.2 0.6 0.9 0.6 1.1 0.9 1.2 0.9 0.9 ROE (%) CY12/ FY13E 17.0 16.8 26.5 17.2 10.2 11.3 10.3 15.8 12.9 12.8 24.5 14.8 9.4 (7.5) 5.5 6.4 12.7 12.8 15.5 12.0 21.6 11.2 11.6 13.8 13.0 14.1 13.0 CY13/ FY14E 15.7 15.6 23.0 16.5 7.8 10.3 9.8 10.9 9.9 10.7 21.2 14.9 11.0 2.5 7.8 7.1 12.2 10.8 21.4 11.8 20.7 11.6 12.4 13.7 13.6 15.1 13.6
SK Innovation GS Holdings S-Oil Corp. Thai Oil Showa Shell Sekiyu Idemitsu Kosan JX Holdings Delek US Holdings, Inc. Tesoro Corp. Valero Energy Corporation Western Refining Inc. Galp Energia SGPS Neste Petroplus Saras PKN Orlen AVERAGE MEDIAN MRPL CPCL EOL HPCL BPCL IOCL RIL AVERAGE MEDIAN
Source: Bloomberg, PINC Research
RESEARCH
INDIAN REFINERY SECTOR
GRM TO STABILISE GOING FORWARD

Historically crude price and refining margins have moved together signifying crude as the proxy for end consumer demand. This has been true over the last few months as well with GRM hovering at highs of USD9-10/bbl inline with high crude prices. To that extent, one could argue that outside of geopolitics, any demand led correction in crude prices could also have an impact on refining margins.
GRM moved along with crude price historically

Singapore GRM 140 Crude price 15 10 5 90 0 65
Nov-08 Sep-09 Feb-10 Dec-10 May-06 May-11 Mar-07 Aug-07 Dec-05 Jan-08 Jun-08 Nov-11 Apr-09 Jul-05 Oct-06 Jul-10
Singapore GRM to stabilise in the range of $6-7/bbl...

115 Crude price ($/bbl)
-5
40
-10
As we move forward, we expect GRM to moderate to the level of USD6-7/bbl assuming relatively weaker economic environment. We do not view the run-up in Singapore GRM in 9mCY11 as an indication of structural uptrend in refining cycle due to key concerns of surplus refining capacity and slowdown in oil demand. Although Asian refining operating rates have typically been stronger than global averages, rates fell from a peak of ~89% in CY05 to ~82% in CY09. Even though it recovered in CY10/ CY11, we expect utilisation rates to gradually slow-down, however, due to upcoming capacity timeline; it should be at ~85% in CY12/CY13. As we move into CY14, surplus refining capacity will cause rates to fall further, which will in turn impact GRM as we expect it to stabilize at USD6/bbl.
Operating rates to drive GRM

Singapore GRM (US$/bbl) 10.0 84.2% 80.6% 5.0 87.5% 88.5% 86.1% 85.8% 85.1% 81.7% 83.9% 86.0% 85.5% 85.3% 82.0% 82.0% 85.0% Asia capacity utilisation rate, RS 90.0%
Asian capacity utilisation to remain strong at ~85% till CY13...
7.5
80.0%
2.5
75.0%
0.0 2002 2003 2004

Source: IEA, Bloomberg satish.mishra@pinc.co.in
70.0% 2005 2006 2007 2008 2009 2010 2011E 2012E 2013E 2014E 2015E
Singapore GRM ($/bbl)

5
RESEARCH
In future, we expect Singapore GRM to moderate to the level of USD6-7/bbl on the back of excess refining capacity. However, strong demand from Asian countries especially China and India, along with capacity rationalisation should provide support to GRM. We believe that diesel cracks should hold its strength as demand for middle distillate remains robust even after taking into consideration increase in global upgradation capacity. Overall, we expect India to trade at a premium to Singapore GRM on account of Indian product slate largely skewed towards diesel and Indian refiners are incurring huge capex to improve their refinery complexity standards.
BRIEF SNAPSHOT OF GRM DYNAMICS

At its peak in H1FY12 (Avg $8.3/bbl) Gasoline crack (32%, Avg $16/bbl) Gasoil crack (16%, Avg $18.7/bbl) Kero/Jet crack (19%, Avg $19.8/bbl) Incremental demand 5.1mb/d (2011-15) Non-OECD (+) 6.2 mb/d OECD (-)1.1mb/d
Singapore GRM
Incremental capacity 6.7mb/d (2011-15) Asia Pacific 3.2mb/d Middle East 1.1mb/d South America 0.9mb/d
Incremental Middle Distillate demand - 3.6mb/d Transportation (60%, ~6-7% CAGR) Chinese industrial demand (~4-5% CAGR) Shift towards ULSD Strict Marine bunker sulphur specs. Strong domestic demand 0.8mb/d (2011-15) Transportation demand (CAGR 6-8%) Other products (~5%) Refinery Complexity enhancement Current Avg. complexity (6-7x) Future shift towards 9-10x Source: PINC Research ($ - USD)
Indian GRM
Product slate skewed towards diesel (40% weight)
RESEARCH
SINGAPORE GRM PEAKED IN CY11

GRM driven by transportation fuel demand especially gasoline
Strong Singapore GRM in CY11 was mainly led by gasoline cracks (Gasoline constitute 32% in GRM), while most Indian refiners produce 30-40% diesel and 12-20% gasoline. The relative strength in gasoline cracks therefore helps benchmarks more than it helps Indian GRM (with a resultant apparent company margin underperformance). Gasoline drives Singapore GRM to its peak
Complex GRM 20 15 10 5 0 Mar-08 Mar-09 Mar-10 Mar-11 Jul-08 Jul-09 Jul-10 Nov-08 Nov-09 Nov-10 Jul-11 $/bbl Gasoline
Transportation fuel (~67% of product) leads the rally

Gasoline 40 30 20 10 0 Jul-08 Jul-09 Jul-10 Mar-08 Mar-09 Mar-10 Nov-08 Nov-09 Nov-10 Mar-11 Jul-11
7
Jet-Kero
Diesel
$/bbl
Source: Bloomberg
Source: Bloomberg
Spike in cracks in CY11 a function of other one-off events

Libyan crude cut: With gradual recovery of refineries post the earthquake and Formosa fire incident, margins should see some corrections. Also, for Libya, many observers see exports reaching 0.8mbpd by year-end and full production by end-2012, accordingly Saudi Arabia to adjust production downwards. Libya crude cut, Japanese earthquake and Formosa fire supported GRM in CY11... Japanese Earthquake: According to IEA assumptions, Japanese Earthquake resulted in loss of 10 GW of nuclear capacity, requiring an average 170kb/d of additional oil-fired demand. Out of Japan's total refining capacity of 4.6mbpd, around 1.7mbpd had shut down. However, Refining capacity in Japan has gradually recovered and this should put some pressure on margins. Formosa fire: In Taiwan, Formosa's 540kb/d Mailiao plant had been closed since the end of July, when the seventh fire in a year broke out at the facilities. After shutdowns ranging from one to four months at various facilities, FPCC restarted all its facilities during August and September.
RESEARCH
WHAT LIES AHEAD

Non-OECD demand to compensate for slack OECD demand
OECD demand to remain sluggish Recently, IEA cut global oil demand estimates by 380 kb/d for 2011 and by 700 kb/d for 2012 in last four months, with lower than expected Q311 readings in the US, China and Japan and a downward adjustment to global GDP growth assumptions. In the long term, strong demand from non-OECD provides some offsetting support. Global oil demand is expected to rise to reach 94.3mb/d (+5.1mb/d, 1.4%CAGR) by 2015 led by non-OECD demand especially China and India (2.9mb/d).
Oil demand led by Non-OECD (2009-2012)

TotalOECD 50.0 mb/d TotalNon-OECD
Revisions to GDP forecasts (%)

2010 Global Aug Oct 5.1 5.1 3.1 3.1 7.3 7.3 2011E 4.2 3.8 2.3 1.7 6.5 6.4 2012E 4.4 3.9 2.6 1.9 6.5 6.2
45.0
OECD
Aug Oct
40.0
Non-OECD
Aug Oct
35.0
30.0 2009 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12
Source: IEA, PINC Research
Non-OECD requirement led by China to provide support In the last two years, Chinese oil demand has grown strongly led by consumption in diesel, which accounts for 35% of total Chinese demand. We estimate that despite the refinery capacity additions in China, oil demand growth in the country will continue to outstrip incremental product supply growth atleast in near term (2012/13), thereby keeping the domestic demand-supply balance on the edge, particularly for distillates.
Chinese oil demand growth (CY09-CY12)

11.0 mb/d
Chinese incremental oil demand vs capacity

Demand 1.2 mb/d Capacity
10.0
CAGR 8%
0.9
9.0
0.6
8.0
0.3
7.0 2009 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12
0.0 2011E 2012E 2013E 2014E 2015E

8
Source: IEA, PINC Research satish.mishra@pinc.co.in
2010
RESEARCH
Refinery closures and delays to offset excess capacity

Surplus refining capacity to weigh upon demand China and India are expected to add 3.3mb/d over the next few years to the current capacity of ~14.4mb/d which is much more than incremental demand expected over the forecast period of 2.9mb/d. This, we believe, will result in excess capacity in Asian markets and would exert pressure on margins. However, actual refinery capacity additions have always been 20-30% lower than estimates in last three years as slippage in new projects is becoming common owing to logistics, delays in acquiring land, obtaining clearances/permits and some tightness in engineering chain.
Incremental excess capacity over demand

China 0.7 mb/d India
Refining Capacity Additions - World

Estimates in 2009 2.0 mb/d Actual
0.4
1.5
0.1 2008 2009 2010 2011 2012 2013 2014 2015
1.0
0.5
-0.2
0.0 2009 2010 -0.5

Source: IEA, OPEC, PINC Research
Capacity rationalisation and delays to offset excess capacity Though we anticipate a refining capacity addition of 6.7mb/d over 2011-15e, ~3.5mb/d of capacity addition is expected at the end of forecasted period in 2014/15. However, these projects are largely big ticket capacity expansion projects announced in Middle East (Saudi Arabia's Jubail and UAE's Ruwais refinery slated for 2014), which are currently at very initial stages of expansion and run a high risk of delays even beyond 2015. Weak operating environment and rising costs forced several refiners worldwide to close their refineries during CY09-10, both temporarily and permanently.
Refinery closures may salvage GRM

Refinery closures, an ongoing phenomena to support GRM...
OECD North America OECD Europe Total N. American shut-down amount to 330kb/d. Total 270kb/d has been permanently shut. In Feb 2010, French Oil major Total announced it will permanently shut Dunkirk plant. ConocoPhilips refinery (260kb/d) could still be closed due to poor economics. Region dominated by Japan where since 2009, nearly 400kb/d of capacity has either been shut or scheduled to close before 2011, and a further 740kb/d reduction has been announced.
OECD Pacific
2011
RESEARCH
Strong demand to support diesel cracks

In terms of volume, the largest increase in future demand is projected for middle distillate, with an increase of almost 3.6mb/d by 2015, from 2009 levels. This is because diesel is used in a wide range of growth sectors, including the key transport and industry sectors. More than half of incremental demand is from the middle distillates while they account for only ~30% in the current distillate mix.
Total incremental demand (2009-2015) - 6.5mb/d

Other Residual fuel Gasoil/diesel Jet/kerosene Gasoline Naphtha Ethane/LPG -1.0 0.0 0.7 0.5 mb/d 1.0 2.0 3.0 4.0 0.5 1.2 -0.1 3.1 0.5
Cumulative oil product demand growth

Naphtha/ Gasoline 10.0 mb/d Gasoil/ Kero Other Fuel oil
7.0
4.0
1.0 2010 2011 2012 2013 2014 2015
-2.0
Demand patterns point to a further move towards middle distillates

Overall, the medium-term outlook is for a sustained requirement to produce more middle distillates as a large distillate deficit opens up in the Asia-Pacific. However, a continuing surplus for naphtha/gasoline implies gasoline/naphtha price weakness and a balance for residual fuels relative to crude oil. This deficit should keep the middle distillate market tight in Asia, lending strength to GRM. However, the relative strength in diesel cracks would help Indian GRM more than Singapore GRM.
Expected surplus/deficit of incremental product output (CY10-CY15)

Gasoline/ Naphtha 0.8 mb/d Middle distillates Residual fuel Other prodcuts
Strong demand for Middle distillate across the globe...
0.4
-0.4
Asia-Pacific
US & Canada
Europe
Total World
-0.8
Source: OPEC, IEA, PINC Research
10
RESEARCH
Key drivers determining middle distillate demand

1) Robust demand from transportation sector in emerging economies Diesel accounts for almost 35-40% of consumption in China and India. China's diesel consumption currently is ~3.2mb/d, more than 60% of which comes from transportation industry. Oil demand in transportation sector is expected to grow at 6.5% and 7.2% annually for China and South Asia, thus making a case for relative demand strength in emerging economies.
Chinese middle distillate demand trend

Middle distillates 4.0 mb/d 39% 39% 3.0 37% 36% 36% 2.0 33% 1.0 34% 34% % share of middle distillate 40%
Oil demand in road transportation (mboe/d)

2010 OECD Latin America Middle East & Africa South Asia Southeast Asia 20.0 2.0 1.4 1.1 2.1 2.4 2.8 11.8 1.4 2020 19.5 2.3 1.8 2.2 2.7 4.5 3.7 17.1 1.7 Abs. (0.5) 0.3 0.4 1.1 0.6 2.1 0.9 5.3 0.3 CAGR (0.3)% 1.4% 2.5% 7.2% 2.5% 6.5% 2.8% 3.8% 2.0%
34% 34%
China OPEC Developing countries
0.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Transition economies
Source: BP Statistics, OPEC, PINC Research
Source: BP Statistics, OPEC, PINC Research
2) Demand also driven by construction and industrial activity Given the multiple usage of gasoil, rising construction and industrial activities driven by strong GDP growth rate in China will fuel the diesel demand.
China's Diesel Demand by Sector before 2020 (Unit: million tons)

Sectors 1980 Transp. 316 7,652 12.1% 11,833 13,895 5.1% Agri 749 2,084 3.7% 2,815 3,099 3.4% Industry 457 1,915 5.3% 2,338 2,495 2.2% Const. 77 482 6.8% 732 838 4.7% Others 64 1,750 12.5% 2,304 2,587 3.3% Total 1,663 13,883 7.9% 20,021 22,915 4.3%
Demand for Diesel expected to clock a CAGR of 4.3% over the next decade...
2008 AnnualGrowthRate1980-2008 2015 2020 AnnualGrowthRate2008-2020 Source: Industry, PINC Research
11
RESEARCH
3) Shift towards stringent sulphur specifications to drive demand for ULSD Increasing demand for high quality Diesel... Europe's attempt to reduce sulfur content in its road fuels, and its "dieselisation" of its car fleet, has long marked the region out as a premium place for ULSD (Ultra-low sulphur diesel). Today, Europe's current road diesel to gasoline consumption ratio is 2x and is foreseen to reach 2.5x by 2015. In order to meet this requirement, a total increase of 6.2mb/d of desulphurization capacity will be added globally by the end of 2015. Most of the new capacity is likely to be added in Asia and the Middle East, with 2 mb/d and 1.9 mb/d respectively.
Diesel cars in use (% of total vehicle fleet) **

42 %
Upgradation capacity addition by Region

Conv ersion (4.1mb/d) Octane units (1.6mb/d) Asia-Pacific Middle East Desulphurization(6.2mb/d)
34
26
FSU Europe
18
Africa Latin America
10 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
US & Canada mb/d 0.0 0.8 1.6 2.4 3.2 4.0
Source: ACEA (** Select European countries include France, Germany, Italy, Spain & UK), OPEC, PINC Research
The retail price advantage of diesel over gasoline is likely to continue (diesel is currently ~25-30% cheaper) because of sales tax differentials. Globally, the current aim is to produce fuels with sulphur content below 10ppm, consequently, refiners worldwide are investing heavily to comply with such quality specifications.
RSP as on June 2011

Petrol Country RSP 63.7 97.0 98.2 98.5 85.2 98.7 82.5 58.1 43.6 60.7 Ex - Tax Price 37.7 41.6 40.2 45.2 43.6 40.1 47.4 41.0 38.8 35.6 Taxes 26.0 55.4 58.0 53.3 41.6 58.6 35.1 17.1 4.8 25.1 RSP 41.3 71.3 75.0 75.4 68.9 84.6 71.9 57.1 46.6 43.3 46.7 Diesel Ex - Tax Price 33.7 43.0 44.6 47.6 46.5 42.5 50.3 43.6 41.0 35.6 36.4 Taxes 7.6 28.3 30.4 27.8 22.4 42.2 21.6 13.5 5.6 7.7 10.3
On-road diesel sulphur content

Region US & Canada Latin America Europe Middle East FSU Africa Asia-Pacific 2010 15 1,270 15 1,820 490 3,260 480 2015 15 460 10 460 130 2,210 260
India France German Italy Spain UK Japan Canada USA Thailand
Pakistan 41.8 33.5 8.4 Source: IEA, Indianpetro, OPEC, PINC Research
4) Stricter marine bunker sulphur specifications Marine diesel demand to surge owing to change in marine bunker sulphur specifications International Maritime Organisation (IMO) has proposed a reduction in sulphur content in bunkers from 4.5% to 0.5% gradually by 2020. Realistically, to achieve 0.1% sulphur would require a move from using fuel oils to using diesel (Bunkers currently make up about 30% of world fuel oil market and % of global petroleum consumption)
satish.mishra@pinc.co.in 12
RESEARCH
INDIAN GRM SHOULD TRADE AT A PREMIUM IN FUTURE

India's product slate captures the growing diesel demand With demand growth most likely driven by Asian diesel consumption, complex refiners in India can continue to see higher margins and high operating rates, which should help Indian refining stocks (skewed heavily towards diesel production).
Indian product slate

Others 11% Fuel oil 23% Gasoline 13% LPG 5% Naphtha 10%
Asian product slate

LPG 3% Fuel oil 23% Naphtha 7%
Gasoline 32% Diesel/VGO 16%
Jet/kerosene 9% Diesel/VGO 40% Source: PPAC, Bloomberg, PINC Research
Jet/kerosene 19% Source: PPAC, Bloomberg, PINC Research
Arab light-heavy spread to recover Currently, the price differential is USD3.8/bbl much below the peak of USD10/bbl in 2008. High demand for middle distillate and low demand for fuel oil in cargo and bunker market will lead to modest recovery in Light-Heavy spreads. As Indian refiners upgrade themselves to process heavier crudes, a recovery in Light-Heavy spread will benefit Indian GRM.
Light-heavy spread to recover

Singapore GRM 10.0 7.5 $/bbl Arab Light-Heav y spread
Increasing Light-Heavy spread to benefit Indian Refiners...
5.0 2.5 0.0 Q108 Q208 Q308 Q408 Q109 Q209 Q309 Q409 Q110 Q210 Q310 Q410 Q111 Q211 Q311
13
RESEARCH
Refinery complexity standards have improved Indian refineries have undertaken massive investments in lieu of the worldwide trend of the requirement of not only capacity expansions/ revamps, but maximization of distillates, their quality improvement and upgrading the lower value bottom products. As a result, the refineries in India are incurring capex to improve their Nelson complexity from 6-7x to 9-10x.
Nelson Complexity (NCI) for existing and upcoming refineries

16 12 8
Avg. 6-7x
NCI
Avg. 9-10x
HPCL (C - 15mmt)
Cals, Haldia (G - 5mmt)
IOC, Paradip (G - 15mmt)
MRPL (C - 11.8mmt)
HPCl, Bhatinda (G -
IOC (C - 54mmt)
CPCL (C - 12mmt)
BPCL (C - 22mt)
RIL (C - 33mmt)
Average complexity to increase from 6-7x to 9-10x in next 1-2 years...
4 0 RPL (SEZ) (C - 27mmt) MRPL (B - 3mmt) EOL (C -11mmt) BPCL, Bina (G - 6mmt) NOCL, Cuddalore (G EOL (B - 7mmt)
14
C - Current Capacity
B - Brownfield expansion
G - Greenfield Expansion
Source: Industry, PINC Research
6mmt)
9mmt)
RESEARCH
INDIA - GAINING PROMINENCE IN ASIAN REFINING SPACE

India's share in Asian refining industry has been consistently growing post liberalisation in 1991 led by share in demand increasing to 12% from 9% and capacity increasing to 13% from 7% in 1995. We expect the trend to continue as more capacities are being added and strong demand is emerging from transportation sector.
Indian Refinery capacity as % of Asia

India Ref Cap. 5 4 3 2 1 0 1995 1997 1999 2001 2003 2005 2007 2009 mb/d % of Asia, RS 20% 16% 12% 8% 4% 0%
Indian consumption as % of Asia

India Consm 5 4 3 10% 2 1 0 1995 1997 1999 2001 2003 2005 2007 2009 5% mb/d % of Asia, RS 20%
15%
0%
Source: BP Statistics, PINC Research
Export as % of production has risen to 29% in 2011 from 8% in 2001. India is running into surplus (54mmt) of petroleum products like MS, diesel, ATF and Naphtha which are exported to developed and other Asian markets where emission norms are becoming more stringent. This surplus is expected to increase to only 64mmt by 2015. Given the product supply growth at 5.7% annually for the next four years, our calculations suggest that consumption will not be a problem as domestic demand remains strong at 6.2% CAGR which means that ~80% of incremental supply (49mmt) will be consumed internally, thus providing immunity from soft global products market.
Export as % of production
MS ATF FO/LSHS Ex port as % of prod., RS 60 45 30 12% 15 0 2007 2008 2009 2010 2011
Source: PPAC, Crisil Research, PINC Research
Indian product surplus

Naphtha HSD Others 27% 29% 30% 24% 18% 35.0 15.0 (5.0) (25.0)
LPG 75.0 55.0
MS MMT
Naphtha
ATF/ SKO
HSD
FO/LSHS
Others
MMT 24%
27%
25%
6% 0%
2007
2008
2009
2010
2011 2012E 2013E 2014E 2015E
15
RESEARCH
Domestic demand intact, despite soft global market

Strong consumption of middle distillate Petroleum product consumption in India has grown at an average of 4.1% to 2.8mb/d (142mmt) from 2007 to 2011 and is expected to remain strong till 2015 (CAGR - 6.2%) driven by robust demand for middle distillate (CAGR-7.6%).
Domestic distillate-wise demand

Light distillates 200 MMT 134 138 142 150 159 Middle distillates Heav y distillates Others Total consumption 169 180
Domestic demand to clock a CAGR of 6.2%...
160 121 120 80 40 0 2007
129
2008
2009
2010
2011
2012E
2013E
2014E
2015E
Transportation fuel to lead the pack Demand for petroleum products is robust led by transportation sector especially diesel driven by strong sales in car and motorcycles which are historically growing at a CAGR of 12% and 16% respectively. As a result, share of transportation fuels in total consumption is expected to accelerate from 47% in 2007 to 61% in 2015.
Transportation fuel as % of total consumption

125 100 MMT 47% 49% 51% 54% 56% 57% 59% 60% 61%
Proportion of transportation fuel to increase in consumption mix...
75 50 25 0 2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E

16
RESEARCH
Demand for other products expected to remain strong In India, transport fuels are clearly leading the growth due to the rapid expansion of personal vehicles and increasing volume of freight. LPG is also forecast to rise as we switch from traditional fuels and kerosene to LPG. Shift to natural gas has led to decline in naphtha demand, however, in the petrochemicals sector, the usage of naphtha is likely to increase, as it offers a higher product yield than natural gas. Natural gas contains only a small proportion of the higher carbon fractions required for producing petrochemicals.
Demand for other products

Product MS HSD ATF Naphtha LPG SKO CAGR FY07-11 11.2% 8.5% 6.3% -6.3% 7.2% -1.6% CAGR FY11-15 6.6% 8.6% 9.5% 8.6% 3.6% -1.3% Consump. MMT 35 100 13 25 12 9 Remarks Includes replacement of 3mmt by cheaper CNG in 2015 Diesel prices are ~35% cheaper than petrol Driven by growth in air travel market Driven by petchem segment LPG penetration to increase from ~50% to 56% in 2015 Govt. policy to surrender kerosene for new LPG connection
Source: Crisil Research, PINC Research
Refinery capacity expansion to cater to increasing demand

India's installed refinery capacity as of 2011 is around 3.9mbpd (~193mmt) and this is expected to go up by about 0.9mbpd (46mmt) by 2015. Capacity utilization in India has been highest and this will continue to be ~95% to 100% considering the domestic demand for transportation fuel and high quality products that comply with international emission standards is expected to be robust.
Refinery Utilisation in India

Crude Thru 240 MMT 96% 180 95% Capacity 101% 88% 90% 101% % Utilisation, RS 120% 102%
Capacity Additions in India

Upcoming capacity IOC, Paradip HPC, Bhatinda MRPL, Mangalore EOL, Jamnagar MMT 15 9 3 7 5 6 Comm Date Q1 FY13 Q3 FY12 Q1 FY13 Q2 FY12 Q4 FY11 Q4 FY12 NCI 13.0 9.6 9.1 11.8 11.2 8.7
120
60%
Spice Refinery, Haldia NOCL, Cuddalore
60
30%
0 FY06 FY07 FY08 FY09 FY10 FY11P
0%
Source: PPAC, Company, PINC Research
17
RESEARCH
GLOBAL DEMAND SCENARIO

Demand led by Non-OECD
An incremental 5.1mb/d is expected to add up to current oil consumption of ~89.2mb/d (CAGR - 1.4%) by 2015 which is mainly driven by Non-Oecd (China, India, Africa, ME and S. America) on account of favourable demographics, urbanisation and industrialization in emerging markets. Essentially this means that over two-thirds of this growth will come from developing regions such as Asia, with China witnessing the largest expansion.
Incremental Demand breakup

Total Demand 5.1
Demand breakup (region-wise)

Africa Middle East Latin America Other Asia China Europe
0.7 1.0 1.1 1.4 2.1 0.1

FSU Pacific Europe North America
Non-OECD
6.2
-0.3 -0.1 -1.1 OECD -0.4 -0.6 -2.0 0.0 2.0 mb/d 4.0 6.0 8.0 -1.5 -0.5
mb/d
0.5
1.5
2.5
China - a major growth driver Out of the total incremental demand of 5.1mb/d, it is widely expected that 2.1mb/d is contributed from China. The share from China has increased to 33% of the total Asian demand and 10% of the world demand. Demand for transportation fuels led by huge population and rising per capita income in urban areas, will continue to be the main driver for oil consumption growth.
Chinese consumption as % of World

Chinese oil consump. 10.0 8.0 6.0 4.0 2.0 0.0 1995 1997 1999 2001 2003 2005 2007 2009 mb/d Share of World, RS 15% 12% 9% 6% 3% 0%
Middle dist. as % of total Chinese Consump

Middle distillates 5.0 4.0 3.0 2.0 1.0 0.0 1995 1997 1999 2001 2003 2005 2007 2009 mb/d % of total consm, RS 50% 44% 38% 32% 26% 20%
18
RESEARCH
OECD demand matures

Demand for gasoline is likely to reduce in long-term following high retail prices and the shift to more efficient, smaller cars. Further, industrial demand for oil is also under threat from 1) high oil prices and 2) large US natural gas supplies OECD's oil demand averaged ~46mb/d in 2011, up 400kb/d from 2009 levels, but projected to resume its structural decline to the tune of 1.1mb/d by 2015. OECD oil demand has been on a structural decline since 2005 and has already lost almost 1.4mb/d in the last four years alone. However, the drop was very significant in 2009 due to global economic crisis which is now gradually shrinking to 44.7mb/d by 2015.
OECD Oil Demand

North America 60.0 mb/d 49.3 45.0 47.6 45.6 46.2 45.8 45.6 45.5 44.9 44.7 Europe Pacific Total OECD demand
Structural decline in OECD demand due to economic concerns and increasing gas supply...
30.0
15.0
0.0 2007
2008
2009
2010
2011
2012
2013
2014
2015
Demand shift towards middle distillate

Looking at the product categories as a whole, the future demand trend emphasizes a shift towards middle distillates and light products. Transportation fuel (2/3rd of incremental oil demand) provide impetus to demand growth primarily road transportation, followed by aviation.
Product-wise demand
Gasoline
Demand for Diesel to remain robust...

Diesel for transport Gasoil for heating Jet fuel for aviation Kerosene for heating Naphtha
Growth rate is low because of the higher share of North America and Europe in total gasoline demand (56% in 2009). Therefore, demand declines in these regions have a large impact on the global picture, offsetting increases in other regions with 1%-4% growth rates. Growing most rapidly in emerging markets and tightening quality specifications especially in Europe Negatively impacted by the shift towards the increased use of natural gas for heating and electricity. Driven by growth in air travel market mainly in developing countries Will continue to be displaced by alternative fuels in most regions Driven mainly by petrochemicals, volume increases in Asia, albeit from a lower base more than compensating for the stagnant demand in OECD regions.
Source: IEA. OPEC, PINC Research
19
RESEARCH
Globally, Gasoil for transport purposes (CAGR- 2%) and naphtha for petrochemicals (CAGR2%) will drive the demand for middle and light products.
Product-wise demand, 2009

Other 9.3 Residual fuel 9.5 Ethane/LPG 8.5 Naphtha 5.5
Product-wise demand, 2015

Other 9.8 Residual fuel 9.4 Ethane/LPG 9.0 Naphtha 6.2
Gasoline 21.2 Gasoil/diesel 24.3 Source: OPEC, PINC Research Jet/kerosene 6.3 Gasoil/diesel 27.4 Source: OPEC Jet/kerosene 6.8
Gasoline 22.4
20
RESEARCH
GLOBAL CAPACITY SCENARIO

Can the refining capacity addition match with increasing Asian demand?
Global CDU capacity is expected to increase by 6.7mb/d to 99.5mb/d (CAGR - 1.8% and 95% of this in the non-OECD), with further additions in upgrading (4.2mb/d) and desulphurisation (6.2mb/d) by 2015. Largest increase comes from China followed by other Asian countries (India specifically 0.9mb/d and Middle East - 1.1mb/d). Middle Eastern capacities is heavily biased towards end of the forecast period, with the expected commissioning of two mega power projects, namely Jubail in Saudi and Ruwais in UAE, adding some 800kb/d in 2014/15.
Capacity increase mostly in non-OECD with China contributing ~1/3rd...
Total incremental capacity - 6.7mb/d

Total Asia Pacific India China Total Africa Total Middle East Total Europe & Eurasia Total S. & Cent. America Total North America mb/d 0.0
3.2 0.9 2.3 0.2 1.1 0.7 0.9 0.6 0.8 1.6 2.4 3.2 4.0
Refinery shut-downs in developed markets Refineries in developed markets are facing tough times as domestic demand is dwindling, from 49.3mb/d in 2007 to 45.8mb/d in 2011 and is further expected to shrink by 1.2mb/d by 2015, as energy efficiency and demographics shift continue. Uptill now, these refiners have remained competitive by exporting surplus products to energy-hungry, developing neighbors, but have since seen steady declines as global recession and slump in oil demand coincided with a glut of new regional refining capacity. Thus, refiners had to drastically cut runs to sustain profitability and have announced closures and capacity reductions.
Refinery closures an ongoing phenomena to support GRM...
Refinery closures may offset excess capacity

OECD North America OECD Europe Total N. American shut-down amount to 330kb/d. Total 270kb/d has been permanently shut. In Feb 2010, French Oil major Total announced it will permanently shut Dunkirk plant. ConocoPhilips refinery (260kb/d) could still be closed due to poor economics. Region dominated by Japan where since 2009, nearly 400kb/d of capacity has either been shut or scheduled to close before 2011, and a further 740kb/d reduction has been announced.
OECD Pacific
21
RESEARCH
Refinery Utilisation rates to slow down Between 2011 and 2015, global oil demand is expected to increase at a CAGR of 1.4%, whereas global refining capacities are likely to increase at a CAGR of 1.8% during the same period. Hence, refinery capacity additions outpace expected demand growth in 2010-2015 period and global capacity utilisation rates are expected to fall to ~80%.
Refinery Utilisation %
Capacity 110.0 mb/d 81% 95.0 80.0 65.0 50.0 2011E 2012E 2013E 2014E 2015E
2010
Utilisation, RS 82% 85% 84% 90% 83% 81% 81% 80% 70% 60% 50%
83%
85%
86%
85% 85%
84% 80%
Global capacity utilisation to decline from CY14 due to incremental capacity ...
2002
2003
2004
2005
2006
2007
2008
2009
Utilisation rates in mature OECD market will remain weak till further capacity is shut, while non-OECD, and in particular growth centres of ME, China and Latin America, manage to keep rates relatively stable. In Asia, where significant capacities are added, less complex refiners will struggle to source crude resulting in slightly lower utilization rates compared to current excess rates.
Global refinery runs

America
90%
Europe
Middle East
2010
Africa
Total Asia Pacific
85% 80%
75%
70% 2006
2007
2008
2009
22
RESEARCH
ARE THE UPCOMING CONFIGURED?
REFINERIES
SUITABLY
India's refinery configuration has a fairly good share of cracking capacity. In mid-2010, India's ratio of combined cracking to CDU was 43%, much higher than Japan and Asia-Pacific but lower than the share in US (55%). The second characteristic of India's configuration is that India has sharply increased its hydrotreating/ hydrorefining capacity in recent years to address the tightening specifications for diesel and to a lesser extent, gasoline.
Global comparison of Refinery configuration

mb/d CDU FCC/RCC Hydrocracking China 10.98 2.60 1.02 0.26 1.32 0.79 3.17 24% 9% 47% 7% 29% Japan 4.45 0.91 0.15 0.00 0.12 0.75 2.57 20% 3% 26% 17% 58% India 3.75 0.73 0.33 0.17 0.39 0.28 1.26 20% 9% 43% 8% 34% Asia-Pacific 28.77 5.40 2.06 0.81 1.95 3.06 9.32 19% 7% 35% 11% 32% US 17.76 5.66 1.68 0.03 2.42 3.58 13.93 32% 9% 55% 20% 78%
Increasing demand of Auto fuels resulting in refinery upgradation...
VBR/TC Coking Cat reforming HDT, hydrorefining FCC/RCC-to-CDU ratio HDC-to-CDU ratio Cracking-to-CDU ratio Reforming-to-CDU ratio HDT/HDR-to-CDU ratio
Start of 2010 data.'VBR = visbreaking; 'TC = thermal cracking. 'HDT = hydrotreating. Source: FACTS Global Energy and Oil & Gas Journal (US data), PINC Research
A total of 4.3 mb/d of new conversion capacity will be added to the existing global refining base in the period 2010-2015, driven primarily by expanding diesel demand, most of this capacity will come from hydro-cracking units (1.7 mb/d), followed by coking (1.5 mb/d) and FCC units (1 mb/d). The Asia-Pacific region comprises the largest concentration of existing conversion projects, with some 1.3 mb/d set to be located in the region. This reflects the general demand growth for light products, including gasoline, and the need to incrementally process mainly medium sour crude oils.
Upgradation capacity addition by Region

Conv ersion (4.1mb/d) Octane units (1.6mb/d) Asia-Pacific Middle East FSU Europe Africa Latin America US & Canada mb/d 0.0 0.8 1.6 2.4 3.2 4.0 Desulphurization(6.2mb/d)
Conversion capacity addition by Region

Coking 1.6 1.2 0.8 0.4 0.0 US & Canada Latin America Africa Europe FSU Middle East AsiaPacific mb/d FCC HCC
Source: OPEC, PINC Research satish.mishra@pinc.co.in
Source: OPEC, PINC Research 23
RESEARCH
GLOBAL CRUDE SUPPLY SCENARIO

Global oil supply is expected to increase from ~89.3 mb/d to ~94.2 mb/d by 2015, a net increase averaging +1.2 mb/d annually. Incremental supplies are evenly split between OPEC crude (1.7mb/d), OPEC gas liquids (1.4mb/d) and non-OPEC total oil (1.8mb/d). Incremental supplies coming evenly from OPEC, NonOPEC and OPEC-NGL ... 1. Non-OPEC supply will be mainly from high cost areas, for example, Canada (+1.3 MBD), Brazil (+1.0 MBD) and the US (+0.5 MBD). Russian ESPO Blend will be a dominant supply of crude oil in Asia, particularly the Northern Asia region after the ESPO Phase 2 pipeline completes by 2013. 2. While OPEC crude is subject to quotas NGL production is not. Rapid natural gas developments drive OPEC natural gas liquid (NGL) and condensate supply higher by 1.4 mb/d to 7.3 mb/d in 2015, based on major expansion from the UAE, Qatar, Iran and Saudi Arabia.
Non-OPEC supply adds 1.8mb/d (CAGR 0.8%)
56 mb/d
OPEC supply adds 1.7mb/d (CAGR 1.4%)

34 mb/d
54
32
52
30
50
28
48 2007 2008 2009 2010 2011 2012 2013 2014 2015
26 2007 2008 2009 2010 2011 2012 2013 2014 2015
OPEC NGL adds 1.4mb/d (CAGR 5.6%)

8 mb/d
OPEC spare capacity to stabilise at 5-6% of global demand

8 mb/d 8%
6%
4%
2%
0 2007 2008 2009 2010 2011 2012 2013 2014 2015
0 2007 2008 2009 2010 2011 2012 2013 2014 2015
0%
24
RESEARCH
Global Oil supply should become slightly lighter but sourer by CY15
Output will become lighter as weighted average API rises from 33.2 to 33.5 as production rises in Latin America, Middle-East and FSU combined with production decline in North sea oil. In terms of sulphur content, as more barrels of Canadian bitumen production reach the market, available feedstock become sourer, reaching 1.14%. (IEA)
Current gravity and sulphur

40 API Europe Africa Asia Pacific 30 S. America FSU N. America Middle East
35
Global crude basket to become lighter and sourer going forward ...
25
20 0 0.4 0.8 1.2 1.6
Sulphur 2
India's diversification towards African crude

In 2011, only 18% of India's crude requirements were met by domestic production. Over 6070% of the supply is met by Middle-Eastern crude which is mainly heavy and sour in nature. Africa is also of reasonable importance as a source of crude oil for India, supplying 10-15% of requirements. Nigeria is the main African source, responsible for ~80% of African crude imports.
Crude sources CY08 (%)
Crude sources CY11 (%)
ME 79
West Africa 9 Africa (Others) 4 Black sea & Far East 9
ME 74
West Africa 14 Africa (Others) 7 Black sea & Far East 5
*Includes crude sources for PSU refineries only
Source: India Srategy paper on crude supply, PINC Research
25
RESEARCH
Projects Undertaken by PSUs to process HS crude

Indian refiners are investing in order to upgrade refineries so as to handle high sulphur crude in future as the capability to handle such feed stocks will provide the refiners a tool to leverage the cost aspect of the profit equation, considering the fact that crude purchase accounts for a major portion of the operating expenses of a refinery.
IOC Gujarat Refinery Coking Unit (3700 TMTPA), Diesel Hydro-treatment Unit (2200 TMTPA), Hydrogen Generation Unit (68 TMTPA) and Sulphur Recovery Units (2x300 ton per day) Hydrocracking Unit (1700 TMTPA), Hydrogen Generation Unit (75 TMTPA), Sulphur Recovery Units (2x300 ton per day) "Refinery Modernization Project (RMP)" in 2005 to process up to 6 MMTPA of HS crude Phase II (to 9mmtpa), to process about 63% HS crude (Current - 53% HS crude). Upgrading & secondary processing facilities to enhance High Sulphur Crude processing Residue upgrading CDU/VDU revamp is planned to increase HS Crude Processing Phase-Ill expansion along with installation of high severity FCC, Delayed Coker Unit along with Coker Hydrotreater Unit and Gas Oil Hydrodesulphurisation Units.
Haldia Refinery
Indian plaers positioned to benefit with increasing sweet-sour spread...
BPCL Mumbai Refinery Kochi Refinery HPCL Visakh Refinery CPCL MRPL
Source: Industry, PINC Research
26
RESEARCH
CRUDE PRICE OUTLOOK

Emerging markets in much better shape
Net oil demand is expected to grow by 5mb/d during 2011-2015 (1.4% annually). Demand is mainly driven by non-OECD countries, with China alone accounting for 39% of the total and other Asia a further 27%. OECD demand contracts by 1.2mb/d (-0.7% annually) led by slowing growth in North America and Europe region.
Growth in global oil demand

Total OECD demand 100.0 mb/d Total Non-OECD demand
Strong demand in emerging market supporting crude prices...
75.0
50.0
25.0
0.0 2007 2008 2009 2010 2011 2012 2013 2014 2015
Source: Company, PINC Research
OPEC remains a driving force of crude supply

We believe OPEC could support prices should they fall below its desired level (USD90/bb). Saudi's production has risen by nearly 2mb/d since the beginning of 2010 and we believe the kingdom would be willing to cut production by a similar amount to support prices.
Saudi Arabia makes up for Libyan crude cut

Liby a 10.0 7.5 5.0 2.5 0.0 May 11 Sept 11
27
Saudi
mb/d
OPEC maintains muscle power on crude pricing...
Apr 11
Jul 11
Aug 11
2009
2010
2Q11
Jun 11
4Q10
1Q11
RESEARCH
OPEC spare capacity to normalise

OPEC spare capacity to set a ceiling so as to cap oil price spike in the medium term. Although 2011 and 2012 will remain a tight market in terms of oil supply, we see spare capacity returning to more normalized levels of ~5% of demand by 2015 (considering Libyan production resumes).
OPEC spare capacity to stabilise at 5-6% of global demand

8 mb/d 8%
6%
OPEC spare capacity to stabilise at ~5% post Libyan production...
4%
2%
0 2007 2008 2009 2010 2011 2012 2013 2014 2015
0%
OPEC to maintain its control over prices

OPEC accounts for 35-40% of global crude oil production and more than 60% of world's proven reserves. OPEC countries have frequently indicated that the lowest crude oil price with which they are comfortable is USD70-80/bbl so as to maintain their annual budgets.
Break-even prices for OPEC

120 Fiscal break-even price ($/bbl) Ecuador 100 Liby a 80 Algeria Venezuela Angola 60 Qatar 40 0.00
Source: Apicorp, 2011, PINC Research
Nigeria Iraq Iran UAE Kuw ait Saudi
OPEC countries budget suggest crude price bottom at ~USD70-80/bbl...
4.00
Petroleum production (mb/d)
8.00
12.00
28
RESEARCH
Non-OPEC supply
Non-OPEC is the key to increase in supply levels as OPEC is the marginal supplier and tries to adjust the supply to match the requirements in the market. However, increases in Non-OPEC supply (+1.8mb/d by 2015) are likely to lag behind our estimates of 1.2-1.5 mb/ d increase in global demand annually.
Non OPEC supply adds 1.8mb/d (CAGR 0.8%)

56 mb/d
Incremental contribution from Non-OPEC remains equivalent to OPEC ...
54
52
50
48 2007 2008 2009 2010 2011 2012 2013 2014 2015
Seaway reversal leads to a sharp contraction in WTI-Brent spread

The main reason for this was the sale of ConocoPhillips' Seaway pipeline to Enbridge and the subsequent decision to reverse it. Seaway could add a potential 0.3-0.4mb/d offtake from Cushing by 2013, with the initial 0.15mb/d being shipped by Q2 2012. While this may not seem to be very huge in terms of quantity, what it does is unlock the perception that Cushing is entirely land locked with no infrastructure to move crude out to the Gulf Coast.
WTI - Brent spread

30 $/bbl 20
Reducing WTI-Brent spread suggests crude price stabilising at USD100/bbl...
10
0 Dec-08 Oct-09 Sep-08 Aug-10 Sep-11 Apr-08 Jan-11 Apr-11 Jun-11 Jan-10 Feb-08 Feb-09 Mar-10 Jun-10 May-09 Nov-10 Jan-00
29
Jul-08
-10
We believe that oil prices will average USD100/bbl in the medium term. However, we also see an increased possibility of wide swings of upto USD10/bbl either side of this level as oil investors react to political and economic market developments which continue to face much uncertainty.
Jul-09
RESEARCH
SNAPSHOT OF CURRENT SCENARIO

Singapore GRM YTD stands at USD8/bbl driven by transportation fuel cracks. However, for the first time in the month of November after a long significant uptrend, we are beginning to see signs of weakness as gasoline has started to give up its strength at ~USD1.3/bbl down from an average of USD15.3/bbl YTD.
Naphtha crack
5 0 Apr-11 Mar-11 Aug-11 Feb-11 Sep-11 Jan-11 Jun-11 Oct-11 Jul-11 May-11 Nov-11 -5 -10 $/bbl
Gasoline crack
32 24 16 8 0 Feb-11 Aug-11 Sep-11 Mar-11 Jan-11 Jun-11 Oct-11 Oct-11 Apr-11 Jul-11 May-11 Nov-11 4Q12
30
$/bbl
Gasoil/Diesel crack
25 $/bbl
Fuel Oil crack

5 0 Apr-11 Mar-11 Feb-11 Jul-11 Aug-11 Sep-11 Jan-11 Jun-11 -5 -10 May-11 Nov-11 $/bbl
20
15 Mar-11 Feb-11 Aug-11 Sep-11 Jan-11 Jun-11 Oct-11 Apr-11 Jul-11 May-11 Nov-11
-15 -20
Global Oil demand in 2Q/3Q CY11 has been quite low in the last few quarters. Global oil demand growth estimates by IEA are being consistently downgraded in the last few months.
OECD demand
48 46 44 42 40 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 mb/d
China demand
10.8 10.1 9.4 8.7 8 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12
3Q12
mb/d
Other Asia demand

11.5 11 10.5 10 9.5 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 mb/d
Non-OECD demand
46 44 42 40 38 36 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 mb/d
Source: IEA, Bloomberg, PINC Research satish.mishra@pinc.co.in
4Q12
C O M PA N I E S
Mangalore Refinery & Petrochemicals Chennai Petroleum Corporation Essar Oil
RESEARCH
Initiating Coverage Sector: Oil & Gas BSE Sensex: 16,805
MANGALORE REFINERY & PETROCHEMICALS
CMP TP
BUY Rs62 Rs88
GETTING BIGGER AND BETTER

MRPL, a Mini-Ratna PSU is undertaking series of projects which shall make it to the league of complex refineries. Capacity addition of ~30% along with ~67% enhancement in complexity index should boost the future profitability. Full impact of ongoing capex should materialise in FY14 with partial benefit coming in FY13. We initiate our coverage on MRPL with a BUY rating. Ramp-up in Capacity: MRPL is expanding its throughput capacity from 11.8mmtpa to 15.4mmpta with CDU/VDU revamp in phase-I refinery (+0.6mmtpa) and installation of new phase-III refinery (+3mmtpa). Improvement in complexity: Post phase-III refinery, MRPLs Nelson complexity index should increase from ~6 currently to ~9. It will improve further to ~10 post commissioning of ongoing polypropylene project. Distillate yield should increase to ~78% with reduction in bottom products. HSD, a high demand product internationally should contribute ~45% in the product. Multiple incremental capex: MRPL is putting a Polymerization unit to convert the Propylene produced in PFFC into high margin Polypropylene. With increasing capacity and to decrease its dependence on Mangalore port, MRPL is setting up a Single Point Mooring (SPM) facility with an objective to receive crude oil in VLCC tankers. Advantage of economies of scale, access to high acidic cheaper African crude and savings in demurrage should provide an advantage. Concerns: Delay in refinery-III commissioning beyond Mar12, undiversified crude sourcing portfolio (ME ~90%, Iran ~60%), volatility in crude oil price/ international GRM/ USD-INR exchange rate in the current weak global environment may impact the earnings substantially. VALUATIONS AND RECOMMENDATION We expect EBITDA to clock a CAGR of ~26% from FY11 to FY14 despite ~58% de-growth in FY12 (on accounts of rupee depreciation). PAT is likely to show CAGR of ~18% for the same period due to higher depreciation and interest cost. At the CMP of Rs62, the stock is trading at P/E of 8.7 & 5.7 and EV/EBITDA of 5.9x and 3.6x for FY13 and FY14 respectively. We initiate coverage on MRPL with a BUY rating and a target price of Rs88 based on 7.5x FY13E EV/EBITDA. KEY FINANCIALS
FY10 Net Sales YoY Gr. (%) EBITDA EBITDA Margin (%) Net Profit YoY Gr. (%) 319,452 (16.5) 19,253 6.0 11,122 4.7 6.3 23.7 21.5 9.8 0.3 5.3 FY11 389,567 21.9 20,482 5.3 11,765 5.8 6.7 22.5 19.4 9.3 0.3 4.9 FY12E 513,116 31.7 8,653 1.7 4,749 (59.6) 2.7 7.9 7.1 23.0 0.3 18.2 FY13E 561,257 9.4 28,158 5.0 12,580 164.9 7.1 15.5 17.2 8.7 0.3 5.9
(Rs mn)
07 December 2011 Satish Mishra +91-22-6618 6488 satish.mishra@pinc.co.in Urvashi Biyani +91-22-6618 6334 urvashi.biyani@pinc.co.in
INITIATING COVERAGE
STOCK DATA
Market cap Book Value per share Shares O/S (F.V. Rs10) Free Float Avg Trade Value (6 months) 52 week High/Low Bloomberg Code Reuters Code Rs109bn Rs37 1762mn 11.4% Rs62mn 85/55 MRPL IN MRPL.BO
PERFORMANCE (%)
1M Absolute Relative (2.2) 2.2 3M (9.5) (7.6) 12M (14.8) 1.3
FY14E 586,247 4.5 41,239 7.0 19,188 52.5 10.9 21.4 22.4 5.7 0.3 3.6
32
RELATIVE PERFORMANCE
MRPL 100 85 70 55 40 Dec-10 BSE (Rebased)
KEY RATIOS
Dil. EPS (Rs) ROCE (%) RoE (%) PER (x) EV/Net sales (x) EV/EBITDA (x)
Mar-11
Jun-11
Aug-11
Nov -11
RESEARCH
Mangalore Refinery & Petrochemicals
Shareholding pattern
(in %) Promoter FII DII Others Sep-11 88.6 1.3 2.2 7.9
COMPANY BACKGROUND
Mangalore Refinery and Petrochemicals Limited (MRPL) was incorporated in 1988 as a JV between HPCL and AV Birla Group at Mangalore, Karnataka. Phase-I refinery with capacity of 3.69mmtpa got commissioned in Mar 96 and the phase-II came on-stream in Sept 99 to increase the total capacity to 9.69mmtpa. Initial journey of MRPL was thorny as deteriorating financials resulted in mounting losses and Debt/Equity climbed closer to ~10 in 2003. Later on ONGC came as a savior as it bought AV Birla Groups stake in 2003. Subsequently, with debt restructuring and capital infusion, MRPL had a turnaround and currently has the MiniRatna status. MRPL bagged the Petrofed Refinery of the Year Award honoring performance in petroleum refining in India (operational efficiency, along with safety and environmental norms) during the year 2009-10. Currently, ONGC and HPCL hold 71.62% and 17% stake respectively in MRPL. In 2011, through de-bottlenecking, MRPL increased its nameplate capacity to 11.82 mmtpa and has Nelson index of 6.0, which is better than Indias average. PRODUCT PORTFOLIO MRPL has operated consistently at higher capacity utilisation for the last six years averaging at ~125%. The refinery is designed to have maximum of middle distillate of ~55% with total distillate yield of ~72%. It also exports ~40% of its products mainly Naphtha, FO, Mixed Xylene and ATF.
Contribution (%) of different products

FO 15.9 Bitumen Sulfur 2.6 0.4 Fuel & Losses 6.6 LPG 2.4 MS 9.5 Naptha 7.4 Mixed Xylene 0.7 SKO 2.5 ATF 9.3 Source: Company, PINC Research
Product slate designed for higher middle distillate ...

HSD 43.2
CRUDE SOURCING PORTFOLIO The company has the capability to process light to heavy and sour to sweet Crudes with API gravity ranging from 24 to 46. However, the current crude souring portfolio is highly dependent on Iran. Around 3/4th of the current portfolio are high Sulphur crude.
Current crude sourcing contracts for MRPL

Company Quantity (mn MT) 7 mmt +/- 10% 2 mmt +/- 10% 1 mmt +/- 10% 1 mmt +/- 5% 1.6 mmt +/- 10% Remaining
Crude sourcing is done mostly from Middle-East (~90% of requirement)...
National Iranian Oil company Abu Dhabi National Oil Company Saudi Arabian Oil Company Kuwait Petroleum Corporation ONGC Spot Market Source: Company, PINC Research
33
RESEARCH
STRATEGY IN RIGHT DIRECTION Robust demand in Asia is resulting in capacity addition of refineries in India and China region. To remain competitive and to match with future requirements of increasing demand for Middle (HSD) and light distillate (MS) products, existing facilities are upgrading themselves. Spread between sweet/sour and light/heavy is resulting in spurt of complex refineries. MRPL's current capex is in line with future requirement as there will be an increase in distillate yield along with ~30% capacity addition. MRPL is implementing various projects to increase its capacity and improve its distillate yield. Capacity of phase-I refinery will be increased by ~0.6 mmtpa through de-bottlenecking (under hook-up) and 3 mmtpa of new capacity will be added under phase-III refinery. The company is adding new value added and high demand product like Polypropylene into its portfolio. Due to under penetration and robust GDP growth, demand for petrochemical products is expected to remain robust in India. These projects will take total capacity of MRPL to 15mmtpa with Nelson index improving from 6 to ~10. Distillate yield is also expected to increase from ~72% to ~78%. It is also setting up a Single Point Mooring (SPM) facility in the sea of Mangalore Port area with an objective to receive cheaper high TAN crude oil in Very Large Crude Carrier (VLCC) tankers. Along with GRM advantage, SPM will also help MRPL in diversifying its crude sourcing basket which is currently highly dependent on Iran.
Capacity increase by ~30% and Nelson complexity index improvement by ~67%...
Snapshot of on-going projects

Capacity - 11.8 mmtpa Complexity - 6.0 Distillate Yield - 72% Current Facility
Full benefits of all the ongoing project to start from FY14 ...
Phase III Refinery Project
Polypropylene Project
SPM Project
Capacity addition and Improvement in yield
New Value added product
Increased usage of cheaper Crude
Improvement in GRM & higher profitability Capacity - 15.4 mmtpa Complexity - 9.9 Distillate Yield - 78%
34
RESEARCH
DETAILS OF UPCOMING PROJECTS CDU/VDU-I Revamp Revamp of phase-I refinery to increase efficiency and improvement in yield to match Euro-IV requirements got commissioned in Oct'11. Modifications should also result in higher throughput to the extent of ~0.6 mmtpa from phase-I refinery. Total capex incurred in CDU/ VDU-I revamp is Rs2.4bn. Phase III Refinery Project MRPL is currently implementing Phase III Refinery Project at its Mangalore facility. The objective of this project is: Increasing refining capacity to 15.4mmtpa Capacity addition by 3mmtpa to 15.4mmtpa, with improvement in yield... To be able to process more of low price high Sulphur/high acid, heavy crude oils Increasing distillate yield Producing value added products like Propylene and Paraxylene Up-gradation of its total diesel pool to superior (Euro III/ IV) grade Upgrading low value Fuel oils The project will result in decreased production of products like Naphtha and Fuel oil for which demands are steadily declining since Fertiliser and Power sector have reduced the consumption of these fuels and are moving towards efficient and cost effective Natural gas options. The estimated capex for the project is Rs122bn and planned Debt/Equity is 2:1. Around 88% of the total capex will be incurred in INR hence cost over run is not expected due to recent rupee depreciation. MRPL will also get tax benefit u/s. 80-IB of the income tax for the incremental profits coming through phase-III, if they are able to commission the project before Mar'12.
Major equipments of Phase III Project:

Description of New Equipments Petro FCCU, incl Propylene recovery utility (PRU) Capacity PFCCU : 2.2 mmtpa PRU : 0.35 mmtpa Delayed Coker Unit, DCU FCC Naphtha Splitter Unit Diesel Hydrotreater Unit, DHDT CDU/VDU Source: Company, PINC Research 3.0 mmtpa 0.55 mmtpa 3.7 mmtpa 3 mmtpa + LPG TRT + ATF Merox
Complexity improving from ~6 to ~10 resulting in higher value added products...
Along with these units there will also be facilities like Hydrogen generating unit, Captive power plant, hydrotreating unit and other offsite facilities. Post phase-III refinery, complexity should be closer to 9.0 (current is ~6.0) and after Polypropylene project it should be around 9.9. The Project has achieved an overall progress of 88.5% as on 15th Oct, 2011. Progress has been expedited keeping in mind the target of commissioning before Mar'12 and the management is confident of commissioning of major equipments in time. Polypropylene project MRPL is putting Petrochemical FCC unit of 2.2 mmpta capacity under Phase-III expansion. This has been designed to maximize the production of Propylene and should generate 450 ktpa of Polymer grade Propylene. The Polypropylene project under implementation will have a Polymerization unit that will convert the Propylene produced in PFFC into Polypropylene (PP). Margins for MRPL will improve as a result of this value added products.
35
RESEARCH
Prices and spread of Propylene and Polypropylene (USD/ mt)

Poly propy lene 2500 2000 Propy lene Naphtha
Addition in margins with higher value added products...
1500 1000 500 0 Oct-08 Oct-09 Oct-10 Jan-08 Jan-09 Jan-10 Jan-11 Oct-11
36
Apr-08
Apr-09
Apr-10
Apr-11
Jul-08
Jul-09
Jul-10
Robust GDP growth and lower per capita consumption for petrochemicals are expected to result in strong growth of Polypropylene in India. Its wide range of usage like Molding products, Film & sheet, Fiber, pipes etc ensures demand from national as well as international market. As per various industry reports, global market for PP is expected to grow at 3-4% and Indian market is likely to grow at 10-12% in the coming years. Expected capex for PP project is ~Rs18bn and is likely to get commissioned by end of FY13. Single Point Mooring Project MRPL is setting up a Single Point Mooring (SPM) facility in the sea of Mangalore Port area with an objective to receive crude oil in Very Large Crude Carrier (VLCC) tankers. This project will help the company in the following ways: Lower freight cost due to economies of scale Access to high acidic cheaper African crude Lower dependence on the existing Mangalore port which is already congested and will not be able to handle additional traffic post expansion and hence savings in demurrage VLCC has capacity of 280-300 TMT against the current Aframax tankers capacity of 80-90 TMT.
Lower dependency on Mangalore port and access to cheaper crude...
Charter Rates
Middle East/East (VLCC) West Africa/East (VLCC) Indonesia/US West Coast (Aframax ) Mediterranean/North-West Europe (Aframax ) 180 135 90 45 0 Sep 10 Nov 09 May 10 Nov 10 May 11 Sep 11 Jul 10 Mar 10 Mar 11 Jan 10 Jan 11 Jul 11
Nigerian Crude spread to Brent (USD/bbl)

4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 05/Jul/11 05/Aug/11 05/Sep/11 05/Oct/11 Bonny Light Dated - Brent Dated Forcados Dated - Brent Dated Escravos Dated - Brent Dated
Source: OPEC, PINC Research satish.mishra@pinc.co.in
Jul-11
RESEARCH
The company has received all necessary clearances from the Ministry of Environment and other Govt. bodies for the Project. Expected capex for SPM project is ~Rs11.5bn and is likely to get commissioned in FY14. Management is confident of saving in the range of ~USD0.5/bl at gross profit after implementation of SPM project.
Summary of up-coming projects

Project Capex (Rs bn) 2.4 122 18 11.5 Improvement in complexity (Nelson Index) 6.0 to 8.9 8.9 to 9.9 Completion schedule Oct'11 Mar'12 Mar'13 Mar'13 46.9% Current Status (work completed as on 15 Oct 11) Hooked up 88.4%
Complexity to increase from 6 to 10 post implementation of all ongoing projects...
CDU/VDU-I Revamp Phase III Refinery Project Polypropylene project SPM Project Source: Company, PINC Research
IMPROVEMENT IN PRODUCT SLATE With implementation of Phase-III refinery project and Polypropylene project the distillate yield for MRPL is expected to increase substantially from ~72% levels to ~78%. Nelsen index will increase from 6 currently to ~10 after these expansions. Resultantly, substantial increase in profitability for MRPL is expected.
Change in Product Mix after implementation of Projects

Current Mix (%) 48.0 Mix in FY15 (%)
Distillate yield to increase from 72% to 78% and reduction in FO by ~10%...
36.0 24.0 12.0 Naptha LPG SKO MS Mixed Xylene Propylene ATF
HSD
Bitumen
Petcoke
Sulfur
FO
Proportion of Fuel oil should decrease sharply post capex from ~15% currently to <5% with increasing proportions of better margin products. Another important feature of future slate is that HSD should contribute ~45%. We have discussed in our industry section that GRM for next few years should be driven by high quality Diesel and therefore MRPL is well positioned to take advantage of the situation. In coming years MRPL's GRM should trade at significant premium to Singapore GRM which has slate skewed towards MS (HSD is ~16% and MS is ~32% in slate).
Fuel & Losses

37
RESEARCH
ROBUST PAST PERFORMANCE

Consistent higher capacity utilisation Consistent capacity utilisation of more than 100%... MRPL had a name plate capacity of 9.69 mmtpa till FY10 which they have always operated at an average capacity utilization of ~125%. In FY11, the name plate capacity is increased to 11.82 and then also Utilisation level is expected to remain at ~110%. The company is consistently working on improving energy efficiency as can be seen in the declining trend of Refinery Energy Index (MBTU/BBL/NRGF). In FY10, MRPL bagged the Petrofed 'Refinery of the Year' Award honoring their operational performance among Refineries in India and was ranked 1st in "Most consistent safety performer in Refineries" for the year by Oil Industry Safety directorate.
Capacity Utilisation and Crude Throughput

Throghput (mmt) 4.0 3.0 2.0 1.0 0.0 Q1FY08
80.00 63.9 60.00 36.1 40.00 20.00 FY07 FY08 FY09 FY10 FY11
Distillate Yield and Operational Efficency

Fuel&Loss (%) 200% 150% 100% 50% 0% 80.0 Distillate Yield (%) Energy Index , RHS 66.0
Cap Utilization (%)
60.0
63.0
40.0
60.0
20.0
57.0
FY07 FY08 FY09 FY10 FY11
54.0
Gross Revenue Breakup

Ex port 69.9 72.8 Domestic 69.3
Strong export presence augur well for increasing throughput capacity...
Q3FY08
Q1FY09
Q3FY09
30.1
Q1FY10
Q3FY10
27.2
Diversified Product marketing MRPL exports around 40% (revenue wise 30-35%) of its products mostly Naphtha, Mixed Xylene, ATF and FO. In domestic market, sales are mostly done through Oil marketing companies (OMC). Company also does direct sales of small quantity in Karnataka and its adjoining states.
MRPL is the sole supplier to State Trading Corporation, Mauritius and supplies 1.1 mmtpa (agreement is upto Jun'13). It has formed a JV with Shell for marketing of ATF. Post decontrol of Petrol in June'10, MRPL has worked out its Retail Business plan to set up 122 outlets. However, in the current environment of high crude prices they follow a cautious approach. Currently, MRPL is operating two retail outlets (branded as HiQ) in Karnataka. The third outlet at Mangalore is under construction.
38
Q1FY11
30.7
Q3FY11
Q1FY12
66.7 33.3 -
Sales Quantity Breakup

% Ex port 80.0 59.4 52.8 47.2 40.0 40.6 37.8 36.9 62.2 63.1 58.4 41.6 % Domestic
60.0
20.0
FY07
FY08
FY09
FY10
FY11
RESEARCH
Location advantage for MRPL- Cushion from future upcoming capacity in India No distribution network can pose some challenge to MRPL, as all OMCs in India are adding capacity. However, none of the new capacities are coming in the vicinity of MRPL. So we believe that in the current scenario of robust demand for auto fuels, OMCs will keep sourcing from MRPL as it will be freight advantageous for them. It can be seen from the chart below that most of the existing and upcoming facilities are concentrated on eastern coast and Central & Northern India.
BHATINDA (9.0)
No other refineries in the vicinity provide locational advantage despite OMCs increasing capacity...
BARODA JAMNAGAR (13.7) (RIL 33.0+29.0) ESSAR 10.5+3.5 MUMBAI (BPC 12.0) (HPC 5.5+2.4) MANGALORE (11.8+3.6) KOCHI (7.5+2.0)
PANIPAT (12.0+3.0) MATHURA (8.0) BINA (6.0) BARAUNI (6.0)
BONGAIGAON (2.35) GUWAHATI (1.0)
DIGBOI (0.65)
NUMALIGARH (3.0)
HALDIA (6.0+1.5) PARADEEP (15.0) VISAKH (7.5+0.8) TATIPAKA (0.08+0.08) CHENNAI (10.5+0.6) NARIMANAM (1.0)
ROBUST FINANCIALS TO SUPPORT AGGRESSIVE CAPEX PLAN MRPL is incurring an aggressive capex of ~Rs160bn, which will increase the gross block to 3x from ~Rs76bn (in FY11) to ~Rs230bn by FY14. As of Mar'11, the company has Net Debt/ equity at around zero, which provides significant leverage to the company. Around 70% of the upcoming capex will be funded through debt and even at peak debt levels, Net Debt/ Equity for MRPL should be below 1.0.Strong cash flow from operations (CFO) further supports MRPL's capex plan. In the last five years it has generated CFO of ~Rs100bn.
Supporting Debt/Equity ratio

Gross Block (Rs bn) 280 210 140 70 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E FY15E FY16E Net Debt/ Equity 1.8 1.2 0.6 (0.6)
Strong cashflow from operations

Capex (Rs bn) 80 60 40 20 FY12E FY13E FY14E FY15E FY16E
39
CFO (Rs bn)
FY06
FY07
FY08
FY09
FY10
Source: Company, PINC Research satish.mishra@pinc.co.in
FY11
RESEARCH
PERFORMANCE TO IMPROVE POST CAPEX MRPL should commission the Phase-III Refinery by Mar'12 with which the throughput nameplate capacity will increase to 15.4 mmtpa. Favourable slate and robust demand augur that company should be able to achieve 100% utilization level in FY14.
Increasing throughput
Throughput (mn MT) 24.0 18.0 12.0 6.0 FY12E FY13E FY14E FY15E FY16E FY06 FY07 FY08 FY09 FY10 FY11 Capacity Utlzn (%), RHS 160 120 80 40 -
Substantial jump in GRM

GRM (USD/bl) Singapore GRM 12.0 8.0 4.0 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E FY15E (4.0) (8.0)
Prem./ (Dis.) to Singapore
GRM to trade at a premium to Singapore GRM post FY13...
After commissioning of all ongoing projects, Nelson index will increase from current levels of ~6 to ~10. With increase in value added products we expect GRM to improve substantially and achieve level of 9/9.5 by FY14/FY15. However, GRM will also depend on prevailing international environment in future years. GROWTH IN PROFITABILITY The profitability of the company is expected to surge post implementation of on-going projects. We expect EBITDA to grow at a CAGR of ~26% from FY11 to FY14 despite 35-40% degrowth in FY12 (on accounts of rupee depreciation). PAT is likely to clock a CAGR of ~17% for the same period due to higher depreciation & interest cost and ~37% YoY de-growth in FY12.
EBITDA trend - jump after capex

EBITDA (Rs bn) 48.0 36.0 EBITDA Grow th (%) 250.0 200.0 150.0 100.0 50.0 (50.0) FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E FY15E FY16E (100.0)
PAT trend - jump after capex

PAT (Rs bn) 28.0 21.0 PAT Grow th (%) 180.0 120.0 60.0 14.0 7.0 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E FY15E FY16E (60.0) (120.0)
24.0 12.0
FY16E
40
RESEARCH
IMPROVING RETURNS ROCE/ ROE to stabalise at ~20% post commissioning of all projects... Post commissioning of Phase-III refinery (expected by end of FY12) and other two projects that is SPM & Polypropylene project (likely to be on-stream from FY14), margins should improve substantially for MRPL. EBITDA margin should see a significant spurt as Nelson index for MRPL is increasing from ~6 to ~10. We expect ROCE and ROE to stabilise at ~20% post commissioning.
Improvement in Margins
EBITDA Margin (%) 10.0 8.0 6.0 PAT Margin (%)
Returns to increase
ROCE (%) 45.0 35.0 ROE (%)
25.0 4.0 2.0 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E FY15E FY16E 15.0 5.0 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E FY15E FY16E
41
LIKELY BENEFITS - NOT YET FACTORED IN VALUATIONS Tax benefit u/s 80-IB: If MRPL commission the Phase-III refinery before Mar'12 they will get tax benefit under section 80-IB of the income tax. As a result there will be a tax holiday for seven years for the incremental earnings coming from the incurred capex. There will be a capacity addition of 3mmtpa (+25%) and improvement in GRM for the complete facility. All together effective tax rate should come to around ~24% and there may be substantial increase of 12-14% in PAT. Sales Tax deferment benefit: MRPL is in talks with Karnataka State Govt. for benefits related sales tax deferment, concession on CST and concession on entry tax. If these benefits come in, there may be boost to GRM. We have not factored benefits due to above mentioned factors; however, management is confident of commissioning of CDU/VDU of Phase-III refinery by Mar'12. For other benefits we are awaiting for the clarity from the state government.
Income tax and sales tax deferal benefit to boost the profitability...
RESEARCH
VALUATIONS AND RECOMMENDATION Phase-III refinery is likely to get commissioned by Mar'12 and other two projects (Polypropylene and SPM) should come on-stream by end of FY13. Hence full impact of all ongoing projects is expected only by FY14. We expect EBITDA to clock a CAGR of 27% from FY11 to FY14 despite 58% de-growth in FY12 on accounts of rupee depreciation. PAT is likely to show a CAGR of ~18% for the same period due to higher depreciation and interest cost.
1 year forward EV/EBITDA

300,000
12x
1 year forward P/E

160
225,000
10x 8x
120
19x 16x 13x 10x
150,000
80
6x 4x
75,000
40
7x
Apr-06 Sep-07 Jan-09 Jul-10 Dec-11

0 Apr-06
Sep-07
Jan-09
Jul-10
Dec-11
1 year forward P/Book Value

160
Assumptions
FY10 Capacity (mmtpa) 9.69 12.45 128.5 3.56 5.23 47.5 69.8 3.0x 2.5x FY11 11.82 12.64 106.9 5.15 5.83 45.6 86.8 FY12E 12.12 12.91 106.5 7.50 3.00 48.0 110.0 FY13E 13.92 14.62 105.0 6.50 6.50 47.0 100.0 FY14E 15.42 16.04 104.0 6.00 8.50 46.0 90.0
120
Throughput (mmtpa) Capacity Utilsn (%) Singapore GRM(USD/bbl) MRPL GRM (USD/bbl) INR-USD Brent (USD/bbl)
80
2.0x 1.5x
40
1.0x

Source: Company, PINC Research Source: Company, PINC Research
At the CMP of Rs62, the stock is trading at P/E of 8.7x & 5.7x, EV/EBITDA of 5.9x and 3.6x and P/B of 1.4x and 1.2x respectively for FY13 and FY14. We initiate coverage with a BUY rating with an upside of 42% in 1 year... We initiate coverage on MRPL with 'BUY' rating and a target price of Rs88 based on 7.5x FY13E EV/EBITDA multiple. We have given slight premium to multiple (average 1-yr forward EV/EBITDA for last 5 years is 7.4x) as full benefits are coming in FY14. At our target price, EV/EBITDA for FY14 will be 4.8x and P/E will be 12.3x and 8.1x for FY13E and FY14E respectively. Even on DCF, with cost of equity of 13.7% and terminal growth rate of 0%, fair value for FY13 stands at Rs92/ share.
42
RESEARCH
RISK AND CONCERNS Phase III commissioning beyond Mar12 will be a major setback... Delay in project: Project costs have already increased due to delay in execution. Any further delays will severely impact the returns. Missing the income tax benefits u/s 80-IB will be a major drag. Un-diversified crude sourcing portfolio: Currently, MRPL sources most of its crude requirements from Middle-East (~90%) with major dependency on Iran (to the extent of ~60%). Any issue in sourcing from these regions may impact their throughput. Global economic uncertainty may impact earnings substantially... No supporting marketing setup: MRPL sells ~65% of products in domestic market mostly through OMCs. In the current scenario when all OMCs are adding capacity over the next 2-3 years there can be increased competition. However, high demand for auto fuels and the location advantage which MRPL has provide some cushion against the risk. Macro uncertainties may deter the performance: Uncertainties over global economy may cause volatility in crude oil price, international GRM and USD-INR exchange rate, which may impact the earnings substantially. H2FY12 results are likely to be muted on account of depreciating rupee.
43
RESEARCH

Year Ended March (Figures in Rs mn)
INCOME STATEMENT Net sales Growth (%) Total Expenditure Gross Profit Growth (%) EBITDA Growth (%) Other income Depreciation EBIT Interest paid PBT Total tax Net Profit Growth (%) Diluted EPS (Rs) Growth (%)
FY10 319,452 (16.5) 304,199 20,102 (35.3) 19,253 (8.9) 2,712 3,893 18,071 1,155 16,916 5,795 11,122 4.7 6.3 4.7
FY11 389,567 21.9 371,121 25,528 27.0 20,482 6.4 1,848 3,914 18,416 1,043 17,373 5,608 11,765 5.8 6.7 5.8
FY12E 513,116 31.7 506,463 14,606 (42.8) 8,653 (57.8) 3,990 3,974 8,669 1,736 6,933 2,184 4,749 (59.6) 2.7 (59.6)
FY13E 561,257 9.4 535,299 34,125 133.6 28,158 225.4 2,604 8,490 22,273 3,636 18,637 6,057 12,580 164.9 7.1 164.9
FY14E 586,247 4.5 547,207 47,657 39.7 41,239 46.5 2,718 11,082 32,875 4,448 28,427 9,239 19,188 52.5 10.9 52.5
CASH FLOW STATEMENT Pre-tax profit Depreciation Total tax paid Chg in w orking capital Other Adjustments Cash flow from oper. (a) Capital ex penditure Chg in inv estments Other inv esting activ ities Cash flow from inv. (b) Free cash flow (a+b) Equity issued Net debt raised Interest Paid Div idend Paid Cash flow from fin. (c) Net chg in cash (a+b+c)
FY10 16,918 3,902 (4,511) 12,479 (1,346) 27,442 (10,014) 1,795 8,402 0 (2,829) (1,162) (2,461) (6,452) 1,950
FY11 17,375 3,930 (8,237) 7,233 (882) 19,419 15,069 2,624 1,496 (1,394) (1,043) (2,452) (4,889) (3,393)
FY12E 6,933 3,974 (2,427) 8,944 (64) 17,360 1,800 (53,640) 47,399 (1,736) (1,649) 44,014 (9,626)
FY13E 18,637 8,490 (6,523) 998 1,736 23,337 1,900 (2,003) 8,000 (3,636) (2,680) 1,684 (318)
FY14E 28,427 11,082 (9,949) (1,004) 2,448 31,004 (8,882) 2,000 (6,882) 24,122 (11,600) (4,448) (4,123) (20,171) 3,951
(10,820) (35,616) (72,800) (27,240)
(19,040) (17,923) (71,000) (25,340)
BALANCE SHEET Equity capital Reserv es & Surplus Shareholders' funds Total Debt Deferred tax liabiity Capital Employed Net Block CWIP Cash & cash Eq. Net other Current Assets Inv estments Total assets
FY10 17,618 38,347 55,965 16,964 6,602 79,531 32,924 18,603 23,440 (11,672) 16,237 79,531
FY11 17,618 47,671 65,289 15,570 3,472 84,330 30,896 54,674 24,151 (26,340) 948 84,330
FY12E 17,618 50,771 68,389 62,969 3,229 134,587 30,362 124,034 14,525 (35,284) 948 134,587
FY13E 17,618 60,671 78,289 70,969 2,763 152,021 145,907 27,240 14,207 (36,282) 948 152,021
FY14E 17,618 75,736 93,354 59,369 2,052 154,776 162,065 8,882 18,158 (35,278) 948 154,776
KEY RATIOS EBITDA Margin (%) Net margin (%) Div idend Yield (%) Net Debt/ Equity (x ) Asset Turnov er Ratio (x ) Working capital cy cle (day s) ROCE (%) RoE (%) EV/Sales (x ) EV/EBITDA (x ) PER (x ) Price/ Book (x )
FY10 6.0 3.5 1.9 (0.1) 4.0 (31) 23.7 21.5 0.3 5.3 9.8 2.0
FY11 5.3 3.0 1.9 (0.1) 4.6 (43) 22.5 19.4 0.3 4.9 9.3 1.7
FY12E 1.7 0.9 1.3 0.7 3.8 (30) 7.9 7.1 0.3 18.2 23.0 1.6
FY13E 5.0 2.2 2.1 0.7 3.7 (31) 15.5 17.2 0.3 5.9 8.7 1.4
FY14E 7.0 3.3 3.2 0.4 3.8 (31) 21.4 22.4 0.3 3.6 5.7 1.2
1-year forward P/E Band
1-year forward EV/EBITDA
160
300,000
12x
120
19x 16x 13x 10x 7x
225,000
10x 8x
80
150,000
6x 4x
40
75,000
0 Apr-06
Sep-07 Jan-09 Jul-10 Dec-11 Apr-06 Sep-07 Jan-09 Jul-10 Dec-11
44
RESEARCH
CHENNAI PETROLEUM CORPORATION
CMP TP
ACCUMULATE Rs185 Rs215

07 December 2011
AGGRESIVE PLANS, AWAITING APPROVALS

CPCL has capacity of 11.5mmtpa and is one of the most complex refineries in India with Fuel, Lube, Wax and Petrochemical feed stocks production facilities. The company is raising its capacity through revamp and looking forward for residual up-gradation project to increase its distillate yield. Full impact of planned capex should materialise in FY16. We initiate our coverage on CPCL with an 'ACCUMULATE' rating. Euro-IV upgradation: To meet the auto fuels Euro-IV specifications in metros (Chennai and Bangalore) and Euro-III specifications in other cities, CPCL is upgrading its Manali facility with a capex of Rs26bn. NHDT/ISOM units for MS (Jan'11) and the DHDT unit for Diesel (May'11) has already got commissioned. Other utilities and offsite facilities should get commissioned by May'12. CDU/VDU-I Revamp: The company is enhancing its Manali capacity by 0.6mmtpa to 4.3 MMTP by revamping the CDU/VDU. Project is expected to get commissioned in Q2FY13. Aggressive capex plans- awaiting approvals: CPCL is looking for Resid upgradation project to increase the distillate yield of the Manali refinery from the present value of ~69 % to ~77%. Along with the distillate yield improvement, this project should also result in higher usage of low cost High Sulphur crude from the present level of 67% to 83%. This project should result in GRM expansion of USD2/bl. This project should be completed within 33 months from the zero date. Environmental clearance is yet awaited; however, management is confident of getting it soon. Capex envisaged for the project is ~Rs32bn. Strong dividend history: CPCL has strong dividend payout ratio in the range of 35-40% for the last six years (except FY09, when they had loss and dividend was zero). We expect similar strong trend to continue with some exception in FY12. Concerns: Delay in environmental approvals, volatility in crude oil price/ international GRM/ USD-INR exchange rate in the current weak global environment may impact the earnings substantially. VALUATIONS AND RECOMMENDATION We expect EBITDA to clock a CAGR of 4.4% from FY11 to FY14 due to 70% degrowth in FY12 due to rupee depreciation. PAT is likely to remain flat for the same period due to higher depreciation and interest cost. At the CMP of Rs185, the stock is trading at P/E of 5.7x & 5.4x and EV/EBITDA of 6.4x & 6.0x for FY13E and FY14E respectively. We initiate coverage on CPCL with an 'ACCUMULATE' rating and a target price of Rs215 based on 6.7x FY13E EV/ EBITDA.
STOCK DATA
Market cap Book Value per share Shares O/S (F.V. Rs10) Free Float
INITIATING COVERAGE
Rs28bn Rs253 149mn 33% Rs14mn 254/174 MRL IN CHPC.BO
Avg Trade Value (6 months) 52 week High/Low Bloomberg Code Reuters Code
TOP SHAREHOLDERS
Name LIC of India Bajaj Allianz Life Ins. Comp. New India Assurance Comp GIC of India United India Ins. Comp. *As on Sept 30, 2011 % holding 5.9 4.8 2.6 2.2 1.3
PERFORMANCE (%)
1M Absolute Relative (5.0) (0.7) 3M (7.4) (7.9) 12M (21.7) (6.9)
KEY FINANCIALS
FY10 Net Sales YoY Gr. (%) EBITDA EBITDA Margin (%) Net Profit YoY Gr. (%) 249,726 (21.9) 8,532 3.4 6,032 (251.8) 40.5 12.5 18.5 4.6 0.3 8.0 FY11 331,078 32.6 12,019 3.6 5,115 (15.2) 34.3 12.2 14.2 5.4 0.2 5.8 FY12E 438,437 32.4 3,636 0.8 1,727 (66.2) 11.6 0.8 4.5 16.0 0.2 23.2 FY13E 422,789 (3.6) 13,030 3.1 4,835 180.0 32.4 9.8 12.0 5.7 0.2 6.4
(Rs mn)
FY14E 374,617 (11.4) 13,683 3.7 5,118 5.8 34.3 10.1 11.8 5.4 0.2 6.0
CPCL 300 265 230 195 160 Dec-10 Mar-11 Jun-11 Sep-11 Nov -11 BSE (Rebased)
KEY RATIOS
45
RESEARCH
Chennai Petroleum Corporation
COMPANY BACKGROUND
Chennai Petroleum Corporation Ltd (CPCL), erstwhile known as Madras Refineries Ltd (MRL) was incorporated in 1965 as a JV between Government of India (GOI), American Oil Company (AMOCO) and National Iranian Oil Company (NIOC) with a share holding of 74%, 13% and 13% respectively. Currently, Indian Oil Corporation (IOC) and NIOC hold 51.89% and 15.4% respectively in CPCL. In its long journey, CPCL increased its initial capacity of 2.5mmtpa to the present 11.5mmtpa. Currently it has two facilities, one at Manali, Chennai (10.5mmtpa) and another at Nagapattinam at Cauvery basin (1.0mmtpa). Manali plant is among the complex refineries in India with Nelson complexity of 7.3.
Journey so far.
Company was formed Company increased to 5.6mmtpa Cauvery Refinery 0.5mmtpa Initial Public offer Oil jetty commissioned to transport oil from PY-03 Capacity expanded to 11.5 mmtpa
1965
1969
2.5mmtpa capacity commissioned at Manali
1984
1985
AMOCO divested its stake
1993
1994
Lube capacity doubled to 270tmpta
1994
2002
Cauvery refinery capacity doubled to 1.0mmtpa
2003
2004
Manali capacity increased to 9.5mmtpa along with GRM improvement
2011
PRODUCT PORTFOLIO CPCL produces a number of Petroleum and Specialty products like Lube oil, LPG, MS, HSD, SKO, ATF, Naphtha, FO and Bitumin. These find usage in sectors like transport, fertilisers, power, railways, petrochemicals and industries.
Contribution (wt %) of different products

FO 14.5 ASPHALT 5.0 Misc. 1.5 F&L 9.2 LPG 3.6
Product slate designed for higher middle distillate ...
Propylene 0.3 MS 9.0 Naphtha 6.6 LABFS 0.6
LOBS 1.9
HSD 36.9
SK 4.1
ATF 6.7
Crude Sourcing Portfolio: Crude sourcing is done at parent level i.e. through Indian Oil Corporation (IOC). CPCL meets ~85% of its crude requirement through imports. The company being complex refinery uses ~70% of high sulphur crude.
RESEARCH
INVESTMENT RATIONALE
DETAILS OF ONGOING PROJECTS Euro-IV upgradation: To meet the auto fuels Euro-IV specifications in metros and Euro-III specification in other cities, CPCL is incurring a capex of Rs26bn at its Manali facility. The company commissioned Naphtha Hydro-treater / Isomerisation (NHDT/ISOM) units for MS production in Jan'11 and the Diesel Hydro-treater (DHDT) unit for Diesel quality Upgradation in May'11. Other utilities and offsite facilities along with a new Hydrogen generation unit is expected to be completed by Dec'11 and will be commissioned in May'12 shutdown. CDU/VDU-I Revamp: CPCL is increasing its Manali facility capacity by 0.6mmtpa by revamping the Crude Distillation Unit/ Vacuum Distillation Unit (CDU/VDU) in the refinery to raise the capacity from 3.7 to 4.3 MMTP. Total capex planned for the project is Rs3.3bn and was earlier scheduled to be commissioned in May'12. However, as per EIL's latest project monitoring report, the project is running behind schedule and there may be a delay of 3-4 months. DETAILS OF UPCOMING PROJECTS Residue upgradation: CPCL is looking to increase the distillate yield of the Manali refinery from the present value of ~69% to ~77%. Capex envisaged for the project is ~Rs32bn. Along with the distillate improvement, project should also result is higher usage of low cost High Sulphur crude from the 67% to 83%. As per the management, the project should result in GRM expansion of USD2/bbl. Project should get completed within 33 months from the zero date. Environmental clearance is yet awaited; however, the management is confident of getting it soon. 42" crude pipeline: CPCL is planning to implement a new 42" Crude oil pipeline project to mitigate the risk associated with transportation of Crude Oil through the existing 30" Crude Oil Pipeline from Chennai Port to Manali Refinery. Expected capex for the project is ~Rs1.3bn and should be completed within 18 months from the zero date (Environment clearance is awaited). New Brown-field capacity: The company has further plans to put a brown-field expansion at Manali Refinery. Pre-Feasibility Report is under preperation. The configuration for the new refinery will be chosen in such a manner that the new units along with the existing refinery should yield best output. STABLE HISTORICAL PERFORMANCE Consistent higher capacity utilisation: CPCL has two facilities at Manali (10.5mmtpa) and Cauvery (1.0mmtpa). Manali capacity was increased by 1mmtpa in FY10. Manali facility is operating consistently above 100% capacity utilization and is one of the most complex and integrated refineries with three crude distillation units, Diesel Hydro De-sulphurisation unit, Fluid Catalytic Cracking unit, Furfural Extraction unit, Lube Hydrofinishing unit, NMP Extraction unit, Hydro-Cracker unit, Propylene unit and Petrochemical Feedstock unit. Distillate yield for CPCL is around 69% and the company has consistently improved on energy parameter.
Capacity to increase by 0.6mmtpa and Euro IV upgradation in place...
Residue upgradation planned to increase distillate yield to ~77%, awaiting approvals...
Capacity Utilisation and Crude Throughput

Cap utilsn-Manali (%) Throughput (mn MT), RS 120.0 90.0 60.0 30.0 0.0 FY06 FY07 FY08 FY09 FY10 FY11 Cap utilsn-Cauv ery (%) 12.0 9.0 6.0 3.0 0.0
Distillate Yield and Operational Efficency

Distillate Yield (%) Energy Index , RS 80.0 60.0 40.0 20.0 FY06 FY07 FY08 FY09 FY10 FY11 Fuel & Loss (%) 80.0 76.0 72.0 68.0 64.0
Source: Company, PINC Research satish.mishra@pinc.co.in
Source: Company, PINC Research 47
RESEARCH
Strong marketing network through parent company: IOC is the major shareholder of CPCL with ~52% stake. MRPL exports around 40% (revenue wise 30-35%) of its products mostly Naphtha, Mixed Xylene, ATF and FO. In domestic market, sales are mostly done through Oil Marketing Companies (OMCs). The company also does direct sales of small quantity in Karnataka and its adjoining states.
Quantity wise marketing Breakup

Direct marketing is done through pipeline to neighboring industries
Proportion of domestic sales is 90%, of which ~76% is through IOC network...
Coastal movement 10% Export 10% Direct Marketing 4% Through IOC 76% Source: Company, PINC Research
Marketing through IOC is done at RTP prices in 200km radius Coastal movement is to places like Mumbai, Bangalore in west cost and some time even Haldia on east coast Naphtha and Fuel oil form major portion in exported products
NEAR TERM PRESSURE DUE TO PLANNED CAPEX CPPL has a capex plan of ~Rs51bn in five years period from FY12 to FY16, which will increase the gross block to 1.8x from ~Rs62bn (in FY11) to ~Rs115bn by FY16. As of Mar'11, the company has Net Debt/ equity at around 1.1. Poor performance in H1FY12 and with problems lying ahead, cash flow from operations is likely to be disappointing in FY12 and should result in net debt/ equity increasing to ~1.5. Planned capex should increase capacity by 0.6mmtpa (Q2FY13) and GRM improvement due to residue up-gradation should be visible only from FY15/FY16. Hence the net debt/ equity ratio should remain higher at ~1.2 till FY15. We have not yet factored planned brown-field expansion.
Near term stress in cashflow due to low profitability and ongoing capex ...
Debt/Equity ratio at higher side

Gross Block (Rs mn) 140,000 105,000 Net Debt/ Equity 1.60 1.20
Muted CFO adding to problems

Capex (Rs mn) 24,000 CFO (Rs mn) Net Debt (Rs mn) 70,000
12,000
55,000
70,000 35,000 0 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E FY15E FY16E
0.80 0 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E FY15E FY16E 0.40 (12,000) (24,000)
40,000
25,000
10,000
48
RESEARCH
PERFORMANCE TO IMPROVE POST ALL ONGOING CAPEX Capacity to increase by 0.6mmtpa to 12.1mmtpa from May12... CPCL is increasing its Manali refinery capacity by 0.6mmtpa resulting in total capacity of 12.1mmtpa (11.1 mmtpa, Manali + 1.0 mmtpa, Cauvery). Incremental capacity should come on-stream from Q2FY13. With strong domestic demand, we expect throughput to increase steadily and GRM should also improve post FY15 due to residual up-gradation project.
Increasing throughput
Throughput (mmtpa) 12.0 9.0 6.0 3.0 FY06 22,000 15,000 8,000 1,000 FY06 (6,000)
Substantial jump in GRM

Capacity Utilzn (%), RS 120 10.0 90 6.0 60 2.0 30 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E FY15E FY16E (2.0) 0 (4.0) (2.0) GRM (USD/bl) Prem./ (Disc.) to Sing. GRM Sing. GRM (USD/bl) 2.0
Planned capex to start contribution from FY15...
EBITDA trend - jump after capex

EBITDA (Rs mn) YoY (%), RS 300
FY07
FY08 FY08
FY09 FY09
FY10
FY11
After commissioning of all ongoing projects, Nelson index will increase from the current levels of ~7.3 to ~8.5. With increase in distillate and higher usage of sour crude, CPCL GRM should trade at a premium to Singapore GRM from FY15. However, GRM will also depend on prevailing international environment going ahead. PRESSURE ON PROFITABILITY We expect profitability to remain under pressure in FY12 due to increasing interest rate, sharp depreciation in rupee and ongoing constraints at Madras port. EBITDA is expected to de-grew by ~70% YoY in FY12, however, there should be a steady growth in EBITDA from FY13. We expect situation to be slightly different for PAT. After de-growth of ~67% in FY12, there will be recovery in PAT, however, it will remain under pressure due to increasing depreciation and interest burden.
FY12E
FY13E
FY14E
FY15E
FY16E 50 -200 -450
(6.0)
(6.0)
PAT trend - jump after capex

PAT (Rs mn) 22,000 YoY (%), RS 200
15,000
50
8,000
-100
1,000 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E FY15E FY16E
-250
FY07
FY10
FY11
FY12E
FY13E
FY14E
FY15E
FY16E
-700
(6,000)
-400
49
RESEARCH
MUTED RETURNS IN NEAR FUTURE Near term pressure on margins and returns... Major portion of Euro-IV project (capex Rs26bn) has been commissioned in CY12 and remaining will come on-stream in CY13. However, along with increasing depreciation and interest cost there has not been significant improvement in margins due to upgraded auto fuels. This should result in CPCL's bottom-line to be under pressure. We expect ROE to increase to ~15% level only by FY15/FY16 post commissioning of residue up-gradation project.
Improvement in Margins going forward

EBITDA Margin (%) 11.0 PAT Margin (%)
Returns to increase in future

ROCE (%) 45.0 ROE (%)
7.0
30.0
3.0
15.0
(1.0)
FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E FY15E FY16E
FY06
FY07
FY08
FY09
FY10
FY11
FY12E
FY13E
FY14E
FY15E
FY16E
(5.0)
(15.0)
FAVOURABLE VALUATION PARAMETERS Cheaper valuation on P/B and strong dividend history ... CPCL has a strong dividend paying history with payout ratio in the range of 35-40% for the last six years (except FY09, when they had loss and dividend was zero). We expect similar strong trend to continue with some exception in FY12. Strong dividend yield makes CPCL a safe investment avenue.
Strong Dividend Yield (%)

Div idend Yield (%) 10.0 Pay out Ratio (incl tax ), RS 48.0
Attractive on Price/Book Ratio (1 yr forward)

500
1.6x
400
7.5 5.0
36.0
300
1.3x 1.0x 0.7x 0.4x
24.0
200 100 Sep-07
2.5 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E FY15E FY16E
12.0 -
With correction of ~10% in stock prices in last three months has resulted in CPCL trading at a discount to its book value. Currently the stock is trading at ~0.8x its book value on FY12 and ~0.7x its book value on FY13 earnings.
Dec-11
50
Apr-06
Jan-09
Jul-10
RESEARCH
VALUATIONS AND RECOMMENDATION Sharp weakening in INR against USD (~15% YTD) has resulted in heavy losses for refinery players in H1FY12. Oct/ Nov'11 development signals continuing problems. Adding to the woes, none of the on-going or planned capex may add to profitability for CPCL in the near future. Part implementation of Euro IV up-gradation has also not added to GRM. This may lead to problems in managing cash flows.
Assumptions
FY10 Capacity (mmtpa) Throughput (mmtpa) Capacity Utilsn (%) Singapore GRM (USD/bbl) CPCL GRM (USD/bbl) INR-USD Brent (USD/bbl) Source: Company, PINC Research 10.50 10.06 95.8 3.56 4.75 47.5 69.8 FY11 11.50 10.75 93.5 5.15 5.02 45.6 86.8 FY12E 11.50 10.81 94.0 7.50 3.00 48.0 115.0 FY13E 12.10 11.62 96.0 6.50 5.25 47.0 100.0 FY14E 12.10 11.62 96.0 6.00 5.50 46.0 90.0
We expect EBITDA to clock a CAGR of mere 4.4% from FY11 to FY14 due to ~70% degrowth in FY12 (on account of rupee depreciation). PAT is likely to remain flat over the same period due to higher depreciation and interest charges. At the CMP of Rs185, the stock is trading at P/E of 5.7x & 5.4x, EV/EBITDA of 6.4x and 6.0x and P/B of 0.7x and 0.6x respectively for FY13E and FY14E.
1 year forward EV/EBITDA

300,000
1 year forward P/E

500 400 300
12x 10x 12x 10x 8x 6x 4x 8x 6x 4x
225,000
150,000 200 100 0 Apr-06
75,000
Sep-07
Jan-09
Jul-10
Dec-11
We initiate coverage with an ACCUMULATE rating with an upside of 16% in 1 year...
We initiate coverage on CPCL with 'ACCUMULATE' rating and a price target of Rs215 based on 6.7x FY13E EV/EBITDA (median 1-yr forward EV/EBITDA for last 5 years is 7.4x). At our target price, EV/EBITDA for FY14 will be 6.3x and P/E will be 6.6x and 6.3x respectively for FY13E and FY14E. Even on DCF, with cost of equity of 12.5% and terminal growth rate of 0%, fair value for FY13 stands at Rs214/ share.
51
RESEARCH
RISK AND CONCERNS Delay in project approvals will be a major setback... Delay in Environmental clearances: Further delay in environmental clearances for Residual up-gradation and pipeline project may result in increase in Project costs. Competition due to new refinery in Tamil Nadu: Nagarjuna Oil Corporation Ltd. with an initial capacity of 6mmtpa is planned to get commissioned by Mar'12. This facility is located at Cuddalore, Tamil Nadu and is planned to expand to 15mmtpa in future. The competition may intensify for CPCL as ~80% of its products are sold in ~200km radius. Macro parameters may falter the performance: Volatility in crude oil price, international GRM and sharp movement in USD-INR exchange rate may impact the earnings substantially.
Global economic uncertainty may impact earnings substantially...
52
RESEARCH

INCOME STATEMENT Net sales Growth (%) Total Expenditure Gross Profit Growth (%) EBITDA Growth (%) Other income Depreciation EBIT Interest paid PBT Total tax Net Profit Growth (%) Diluted EPS (Rs) Growth (%)
FY10 249,726 (21.9) 241,195 16,768 79.1 8,532 (612.9) 2,351 2,671 8,211 1,374 6,838 805 6,032 (251.8) 40.5 (251.8)
FY11 331,078 32.6 319,059 19,923 18.8 12,019 40.9 1,306 3,145 10,180 2,545 7,635 2,520 5,115 (15.2) 34.3 (15.2)
FY12E 438,437 32.4 434,801 11,857 (40.5) 3,636 (69.7) 813 3,680 769 2,312 (1,542) (3,269) 1,727 (66.2) 11.6 (66.2)
FY13E 422,789 (3.6) 409,759 21,676 82.8 13,030 258.3 976 3,952 10,054 2,837 7,217 2,381 4,835 180.0 32.4 180.0
FY14E 374,617 (11.4) 360,934 22,224 2.5 13,683 5.0 1,171 4,322 10,532 2,894 7,638 2,521 5,118 5.8 34.3 5.8
FY10 6,838 2,671 (1,033) (24,855) 1,405 (14,974) (8,886) (6) 11 (8,882) (23,855) 25,300 (1,395) (2) 23,902 47
FY11 7,635 3,145 (1,307) (2,349) 2,527 9,651 12 43 2,532 1,446 (1,915) (2,084) (2,552) (20)
FY12E (1,542) 3,680 3,269 (7,979) 2,312 (261) (11,656) 14,819 (2,312) (697) 11,810 153
FY13E 7,217 3,952 (2,381) 4,983 2,837 16,608 5,952 (1,281) (2,837) (1,743) (5,862) 90
FY14E 7,638 4,322 (2,521) 4,044 2,894 16,377 (10,467) (10,467) 5,910 (1,131) (2,894) (1,743) (5,768) 142
(7,173) (11,396) (10,656)
(7,119) (11,396) (10,656)
FY10 1,490 33,131 34,621 40,779 5,760 81,159 29,291 12,807 143 38,683 234 81,159
FY11 1,490 36,169 37,659 42,225 6,045 85,929 34,358 11,559 124 39,664 225 85,929
FY12E 1,490 37,198 38,688 57,044 6,045 101,777 42,737 10,896 277 47,643 225 101,777
FY13E 1,490 40,290 41,780 55,763 6,045 103,588 45,822 14,514 367 42,659 225 103,588
FY14E 1,490 43,665 45,155 54,632 6,045 105,831 49,257 17,224 509 38,615 225 105,831
FY10 3.4 2.4 6.5 1.2 3.1 52 12.5 18.5 0.3 8.0 4.6 0.8
FY11 3.6 1.5 6.5 1.1 3.9 38 12.2 14.2 0.2 5.8 5.4 0.7
FY12E 0.8 0.4 2.2 1.5 4.3 36 0.8 4.5 0.2 23.2 16.0 0.7
FY13E 3.1 1.1 5.4 1.3 4.1 32 9.8 12.0 0.2 6.4 5.7 0.7
FY14E 3.7 1.4 5.4 1.2 3.5 32 10.1 11.8 0.2 6.0 5.4 0.6
500 400 300 200 100 0 Apr-06

12x 10x 8x 6x 4x
300,000
225,000
150,000
12x 10x 8x 6x 4x
75,000
Sep-07
Jan-09
Jul-10
Dec-11
Apr-06
Sep-07
Jan-09
Jul-10
Dec-11
53
RESEARCH
ESSAR OIL
NOT RATED CMP Rs69

07 December 2011 Satish Mishra +91-22-6618 6488 satish.mishra@pinc.co.in Urvashi Biyani +91-22-6618 6334 urvashi.biyani@pinc.co.in
INCREASING SCALE AND COMPLEXITY

Essar Oil (EOL), an integrated oil & gas company is undergoing an expansion to increase its refining capacity by 45% to 20mmtpa. Along with expansion, it is almost doubling its nelson complexity which would substantially improve margins and hence profitability. Foray into niche business of Coal bed methane (CBM) provides an upside potential. Capacity expansion EOL is expanding its throughput capacity from 14 to 20mmpta with CDU expansion in phase-I refinery (+4mmtpa) and optimisation through de-bottlenecking (+2mmtpa). Enhancement in product and crude slate
INITIATING COVERAGE
Post optimisation, EOL's Nelson complexity index should increase from ~6.1 currently to ~11.8 which would lead to delivery of better margin products. Also, the crude slate for EOL is expected to improve from 72% of heavy/ ultra-heavy to 87% of ultra-heavy crude oil. Foray into niche Coal Bed Methane business EOL has exposure to upstream sector through 100% ownership in two CBM (Coal Bed Methane) blocks - Raniganj and Rajmahal. Test production and supply to end customer has commenced in Raniganj East (0.22mmscmd) with a peak production of 3.5mmscmd expected over the next few years. Concerns Volatility in crude oil price/ international GRM/ USD-INR exchange rate in the current weak global environment may impact the earnings substantially. Any adverse regulatory change with respect to taxation may affect profitability. Delays in commissioning of the projects holds a downside risk. VALUATIONS AND RECOMMENDATION Essar Oil is also set to benefit with increasing refining capacity and complexity improvement, however, we are currently not rating the company. KEY FINANCIALS
FY07 Net Sales YoY Gr. (%) EBITDA EBITDA Margin (%) Net Profit YoY Gr. (%) 4,740 (579) (12.2) (675) 6.3 (0.4) (2.3) FY08 6,520 0.4 (440) (6.6) (410) (0.4) 6.7 (0.3) (1.2) FY09 380,550 57.4 10,190 3.0 (5,140) 11.5 2.7 3.8 (14.3) 0.5 15.0 FY10 373,190 (0.0) 17,260 5.0 290 (1.1) 7.1 7.8 0.7 0.5 9.4
(Rs mn)
STOCK DATA
Market cap Book Value per share Shares O/S (F.V. Rs10) Free Float Avg Trade Value (6 months) 52 week High/Low Bloomberg Code Reuters Code Rs94bn Rs47 1365mn 13% Rs175mn 148/66 ESOIL IN ESRO.BO
PERFORMANCE (%)
1M Absolute Relative (18.8) (15.1) 3M (24.8) (25.2) 12M (45.7) (35.5)
FY11 479,050 0.3 25,190 5.5 6,540 21.6 11.1 10.8 11.7 14.6 0.4 8.0
54
EOL 170 140 110 80 50 Dec-10 BSE (Rebased)
KEY RATIOS
Mar-11
Jun-11
Sep-11 Nov -11
RESEARCH
Essar Oil
COMPANY BACKGROUND
Essar Oil Limited (EOL) is an integrated oil company currently operating a 14mtpa Vadinar refinery on West Coast of India. Although to a lesser extent, EOL captures the entire value chain via backward integration (Oil & Gas exploration) and forward integration (network of 1,376 retail outlets). The company has exposure to upstream sector through 100% ownership in two CBM (Coal Bed Methane) blocks - Raniganj and Rajmahal. Test production has commenced in Raniganj with a peak production of 3.5mmscmd expected over the next few years. It also has presence in other blocks (Mumbai high fields and Nigerian blocks) which are still in exploratory phases and monetisation is not expected in near term. Essar Energy along with its subsidiary holds 87.09% of the total share capital of EOL. The majority of the shareholding (~74%) is in the form of GDR (Global depository receipts) held by Essar Energy's subsidiaries.
PRODUCT PORTFOLIO
EOL had a capacity utilisation of ~105% (Crude throughput of 14.76mmt) and distillate yield of 73% for FY11. Their main focus is sales in domestic market due to better price realisations, export products include fuel oil and gasoline. Keeping in mind the long term policy shift towards de-regulation, they have a network of retail outlets across the country. However, they continue to have limited exposure to retail segment because of fuel subsidies involved.
Product Mix
Heav y 100% 27% 75% 50% 25% 28% 0% H1 CY10 H2 CY10 CY 2010 H1 CY11 28% 28% 27% 45% 46% 45% 44% 26% 27% 29% Middle Light
Sales Mix
Ex ports 100% 75% 50% 25% 0% H1 CY10 H2 CY10 CY 2010 H1 CY11 58% 60% 32% PSUs Bulk Retail
54% 34% 9% 6% 5% 7%
56% 31%
27%
6% 7%
6%
2%
CRUDE SOURCING PORTFOLIO It can process more than 20 types of crudes including ultra heavy and tough crudes Avg. API (Density) -32.7, Avg. Sulphur -1.62% and Avg. TAN -0.27
Crude Type
Ultra Heav y 100% 30% 75% 50% 25% 24% 0% H1 2010
Source: Company, PINC Research satish.mishra@pinc.co.in 55
Heav y 33%
Light
35%
35%
46%
43%
45%
49%
22% H2 2010
23% CY 2010
16% H1 CY11
RESEARCH
Essar Oil
Capacity expansion plans EOL is currently undergoing an expansion plan to increase its refinery capacity by 6mmtpa to 20mmtpa by 2HFY13 in two phases (Phase-I expansion to 18mmtpa and Optimisation to 20mmtpa). Post-expansion to 20mmtpa, NCI (Nelson complexity) is expected to increase to 11.8 from current 6.1.
Capex Details
Today Phase 1 Q4FY12 2.80 4.65 1.85 6.1 32.4 1.5% Euro III/IV 11.8 24.8 3.0% Euro IV/V Optimisation Q3FY13 4.95 0.38 11.8 24.8 3.0% Euro IV/V 9.75 4.80 12.8 24 3.0% Euro V/US Phase 11
Refining capacity to increase from 14mmtpa to 20mmtpa...
Commissioning Cumulative Capex (USD bn) Incremental Capex (USD bn) Complexity API (density) Avg Sulphur % Product grade Source: Company, PINC Research
As part of first phase of refinery expansion, EOL is planning to expand it's current crude distillation (CDU) capacity from 14mmtpa to 18mmtpa and addition of addition of secondary units like Delayed coker (DCU), Isomerisation unit (ISOM), VGO Hydro-treater (VGOHT), Sulphur recovery (SRU) and Diesel Hydro-treater (DHDS). Most of Units & Facilities under Expansion Project achieved mechanical completion, except of DCU, VGOHT, SRU which are expected to be complete Q3FY12. Finally, Ramp up of throughput expected during Q4FY12. As part of optimization process, CDU capacity is further expanded to 20mmtpa through debottlenecking (Conversion of VBU into CDU) and revamping of FCCU unit. Optimization Project is on schedule (Progress - 63.7%) & expected to complete by Sept, 2012.
Change in Capacity of major equipments

UNIT / FACILITY CDU VDU VISBREAKER (VBU) NAPHTHA HYDROTREATER (NHT) CONTINUOUS CATALYTIC REFORMER UNIT (CCR) FLUID CATALYTIC CRACKING UNIT (FCCU) DIESEL HYDRODESULFURISATION UNIT (DHDS) VGO HYDROTREATER (VGO HT) DIESEL HYDROTREATER (DHDT) DELAYED COKER UNIT (DCU) ISOMERISATION (ISOM) Source: Company, PINC Research CAPACITY (MMTPA) 10.5 7.2 1.9 1.6 0.9 2.9 3.7 CAPACITY Post OPTI 18 10.9 2.0 (CDU) 1.8 1.1 3.9 5.3 6.5 4.0 7.5 0.7
56
RESEARCH
Essar Oil
Improvement in crude slate and distillate yield With implementation of Phase-I refinery project the crude slate for EOL is expected to improve from 72% of heavy/ ultra-heavy to 87% of ultra-heavy crude oil. Nelsen index will increase from 6.1 currently to ~11.8 after these expansions which should result in delivery of high margin products (Light/middle distillate)
Expansion to provide crude as well as product flexibility

14 MMTPA
Ultra heavy 20% Heavy 52%
18 MMTPA
Heavy 25%
20 MMTPA
Light 13%
Crude mix
Light 28%
Ultra heavy 64%
Light 11%
Ultra heavy 87%
Heavy end 25%
Product yield
Fuel Loss 6%
VGO 10%
Heavy end 15% Fuel Loss 5% Light Distillates 21%
VGO 9%
Heavy end Fuel Loss 14% 6%
Light Distillates 22% Middle Distillates 47% Middle Distillates 49%
Light Distillates 24% Middle Distillates 47%
Processing an increasingly high proportion of high sulphur and low API crudes Focus on delivery of higher margin products (middle/light distillates)
Change in product mix Proportion of fuel oil should decrease sharply post-optimisation with higher proportion of value added products. It would also provide EOL flexibility to switch to light and middle distillates. As per management, Euro IV and Euro V grade will contribute 55% and 50% respectively in gasoline and diesel pool.
Improving yield
Fuel & Loss/Residue 100% Others 1.09 2.47 0.70 60% 5.34 40% 20% 0% 3.06 0.53 0.81 14 MMTPA
Source: Company, PINC Research satish.mishra@pinc.co.in 57
Coke
Fuel Oil
VGO 1.41 2.49 1.17 7.72
Diesel
Jet/Kero
Gasoline 2.29 2.63 0.28 9.13
LPG/Naptha
Higher proportion of diesel ensures better margins in tough environment...
80%
1.84 0.60 1.83 0.97 18 MMTPA
0.21
1.75 2.15 0.76 1.28 20 MMTPA
RESEARCH
Essar Oil
Foray into upstream business holds upside potential EOL has exposure to upstream sector through 100% ownership in two CBM (Coal Bed Methane) blocks - Raniganj and Rajmahal. It also has presence in other blocks (Mumbai high fields and Nigerian blocks) which are still in exploratory phases and monetisation is not expected in near term.
EOLs CBM Portfolio

Details of CBM Block Raniganj (CBM) Rajmahal(CBM) Sohagpur-CBM-2008/IV Talcher-CBM-2008/IV IB Valley -CBM-2008/IV Total Source: Company, PINC Research Place West Bengal Jharkhand M.P. & Chhattisgarh Orissa Orissa Ownership 100% 100% 100% 100% 100% Acreage 500 Sq km 1128 sq. km 339 sq. km 557 sq. km 209 sq. km 2,733 sq km 201 5,515 2P/ 2C resources Bcf 201 Best estimate prospective resources Bcf 792 4,723 Unrisked inplace resource Bcf 600 2,600 1,200 4,400 Total Bcf 993 4,723 600 2,600 1,200 10,116 CPR by NSAI (2010) CPR by ARI (2010) As per DGH As per DGH As per DGH Remarks
Details of Raniganj project One of the pioneer in CBM in India... Test production and supply to end customer has commenced in Raniganj East (0.22mmscmd) with a peak production of 3.5mmscmd expected over the next few years. Gas Sales Price of $ 5.25/mmbtu + $1.00/mmbtu for marketing & transportation charges has been approved by MOP&G for test sales. CBM IN INDIA Commercial CBM production has commenced only from 1 block i.e. GEECL's Raniganj (South) since 14th July 2007. The total CBM production figure is expected to be around 7.4 mmscmd by the year 2014-15.
More than 280 CBM Wells drilled Reserve Established 8.39tcf Development Activity in 3 Blocks
Coal Bed Methane

Commercial production Commenced July, 2007 Gas Price 6.79 USD/ mmbtu CBM gas Production @ 7.4 MMSCMD by 2015
Sources: Advance Resources International, PINC Research
Tax benefits supporting EOL GRM Tax benefit u/s 80-IB: If EOL commission the Phase-I refinery before Mar'12 they will get tax benefit under section 80-IB of the income tax. As a result, there will be a tax holiday for seven years on the incremental earnings from the incurred capex. There will be a capacity addition of 4mmtpa (+30%) and improvement in GRM for the complete facility. Sales Tax deferment benefit: EOL also benefits from a sales tax deferral scheme by the Gujarat government, under which, any refinery constructed in the state during the period 1995-2000 is eligible for sales tax deferment over a 12-year period from their commissioning, after which the tax collected becomes liable for payment in six equal tranches. EOL had already availed itself of Rs48bn of this benefit by FY11 as it adds USD2/bbl to it's GRM. However, due to delayed commissioning of the refinery in FY08-09, the State of Gujarat has contested the validity of the sales tax benefit. The Gujarat High Court has, however, ruled in favor of Essar Oil, and the case is now pending a decision by the Supreme Court. Nevertheless, the company remains confident of its entitlement to the tax benefit.
RESEARCH
Essar Oil
INCOME STATEMENT Net sales Growth (%) Total Expenditure EBITDA Growth (%) Other operating income EBITDA incl other op Other income Depreciation EBIT Interest paid PBT Total tax Net Profit Growth (%) Diluted EPS (Rs) Growth (%)
FY07 4,740 5,319 (579) (475) 104 45 (520) 25 (546) 129 (675) 6.3 4.7
FY08 6,520 0.4 6,960 (440) (0.2) 10 (350) 80 30 (380) 60 (440) (30) (410) (0.4) 6.7 5.8
FY09 380,550 57.4 370,360 10,190 (24.2) 1,350 12,020 480 6,550 5,470 10,910 (5,440) (300) (5,140) 11.5 2.7 (59.6)
FY10 373,190 (0.0) 355,930 17,260 0.7 1,280 19,370 830 7,280 12,090 11,810 280 (10) 290 (1.1) 7.1 164.9
FY11 479,050 0.3 453,860 25,190 0.5 1,320 27,790 1,280 7,310 20,480 12,200 8,280 1,740 6,540 21.6 11.1 55.7
FY07 (546) 45 (90) (350) 3 (937) (283) (26)
FY08 (441) 25 (214) (353) (5) (987) (1) (1,160)
FY09 (5,437) 6,549 31 10,223 7,840 19,204 (3,252)
FY10 286 7,283 69 (6,450) 6,503 7,691 (221)
FY11 8,284 7,309 (1,606) (9,257) 7,457 12,186 (43,741) (13,819) (57,561) (45,374) 42,398 (8,465) 10,909 44,842 (532)
(24,652) (14,834) (16,770) (20,505)
(24,960) (15,994) (20,022) (20,726) (25,897) (16,981) 3,525 24,279 (11) (1,074) 26,720 823 12,290 (39) 6,188 18,440 1,458 (818) (13,035) (1,374) 8,431 0 (818) 6,652 16,788 13,307 272
(7,057) (10,133)
FY07 13,455 16,496 29,951 85,714 323 115,988 2,039 106,260 6,430 166 1,094 115,988
FY08 13,420 22,587 36,007 98,153 320 134,480 4,377 132,827 10,028 (13,783) 1,031 134,480
FY09 13,092 22,729 35,820 100,317 15,358 151,496 126,058 19,139 11,746 (6,479) 1,031 151,496
FY10 23,713 23,023 46,737 103,537 7,618 157,891 123,094 43,188 13,508 (23,927) 2,030 157,891
FY11 13,823 51,556 65,379 145,469 9,945 220,793 117,441 84,230 29,587 (11,495) 1,030 220,793
FY07 (12.2) (14.2) 2.6 0.0 (0.4) (2.3) 3.1
FY08 (6.6) (6.3) 2.4 0.0 (0.3) (1.2) 2.6
FY09 3.0 (1.4) 2.5 2.5 77 3.8 (14.3) 0.5 15.0 2.3
FY10 5.0 0.1 1.9 2.4 25 7.8 0.7 0.5 9.4 1.8
FY11 5.5 1.4 1.8 2.2 67 10.8 11.7 0.4 8.0 14.6 1.5
300
650,000
12x 10x
225
500,000
150
16x 14x 12x 10x 8x
350,000
8x 6x
75
200,000
4x
0 Apr-06
Aug-07
Jan-09
Jun-10
Nov -11
50,000 Apr-06
Aug-07
Jan-09
Jun-10
Nov -11
59
RESEARCH
T E A M
EQUITY DESK
Sadanand Raje Head - Institutional Sales Technical Analyst sadanand.raje@pinc.co.in 91-22-6618 6366
RESEARCH
Vineet Hetamasaria, CFA Nikhil Deshpande Tasmai Merchant Vinod Nair Ankit Babel Hitul Gutka Subramaniam Yadav Madhura Joshi Satish Mishra Urvashi Biyani Naveen Trivedi Rohit Kumar Anand Niraj Garhyan Namrata Sharma Sakshee Chhabra Bikash Bhalotia Harleen Babber Dipti Vijaywargi Sushant Dalmia, CFA Poonam Sanghavi Suman Memani Abhishek Kumar C Krishnamurthy
Head of Research, Auto, Cement Auto, Auto Ancillary, Cement Auto, Auto Ancillary, Cement Construction, Power, Capital Goods Capital Goods, Engineering Power Construction Power Fertiliser, Oil & Gas Fertiliser, Oil & Gas FMCG IT Services IT Services Media Media Metals, Mining Metals, Mining Metals, Mining Pharma Pharma Real Estate, Mid caps Real Estate, Mid caps Technical Analyst
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91-22-6618 91-22-6618 91-22-6618 91-22-6618 91-22-6618 91-22-6618 91-22-6618 91-22-6618 91-22-6618 91-22-6618 91-22-6618 91-22-6618 91-22-6618 91-22-6618 91-22-6618 91-22-6618 91-22-6618 91-22-6618 91-22-6618 91-22-6618 91-22-6618 91-22-6618 91-22-6618
6388 6339 6377 6379 6551 6410 6371 6395 6488 6334 6384 6372 6382 6412 6516 6387 6389 6393 6462 6709 6479 6398 6747
SALES
Rajeev Gupta Ankur Varman Himanshu Varia Shailesh Kadam Ganesh Gokhale
Equities Equities Equities Derivatives Derivatives
rajeev.gupta@pinc.co.in ankur.varman@pinc.co.in himanshu.varia@pinc.co.in shaileshk@pinc.co.in ganeshg@pinc.co.in
91-22-6618 91-22-6618 91-22-6618 91-22-6618 91-22-6618
6486 6380 6342 6349 6347
DEALING
Mehul Desai Amar Margaje Ashok Savla Sajjid Lala Raju Bhavsar Hasmukh D. Prajapati
Head - Sales Trading
mehul.desai@pinc.co.in amar.margaje@pinc.co.in ashok.savla@pinc.co.in sajjid.lala@pinc.co.in rajub@pinc.co.in hasmukhp@pinc.co.in
91-22-6618 91-22-6618 91-22-6618 91-22-6618 91-22-6618 91-22-6618
6303 6327 6321 6337 6322 6325
SINGAPORE DESK
Amul Shah amul.shah@sg.pinc.co.in 65-6327 0626
DIRECTORS
Gaurang Gandhi Hemang Gandhi Ketan Gandhi gaurangg@pinc.co.in hemangg@pinc.co.in ketang@pinc.co.in 91-22-6618 6400 91-22-6618 6400 91-22-6618 6400
COMPLIANCE
Rakesh Bhatia Head Compliance rakeshb@pinc.co.in 91-22-6618 6400
Rating Objective
Large Caps Rating M.Cap > USD1bn Mid Caps M.Cap <= USD1bn
Return % BUY Accumulate Reduce Sell More than 15 5 to 15 (-)5 to +5 Below (-)5 More than 20 10 to 20 0 to 10 Less than 0
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PINC Indian Refinery Scenario

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PINC Indian Refinery Scenario

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RESEARCH

LOOKING INTO A ROBUST FUTURE

Sector View - Positive

OIL&GAS 12000 10500 9000 7500

6000 Dec-10 Mar-11 Jun-11 Aug-11 Nov -11

Robust domestic demand leading to increase in refining capacity...

COMPANIES SUMMARY MRPL: BUY, TP - RS88 (42% UPSIDE)

CPCL: ACCUMULATE, TP - RS215 (16% UPSIDE)

500 400 300 200 100 0 Apr-06

Sep-07 Jan-09 Jul-10 Dec-11 Apr-06 Sep-07 Jan-09 Jul-10 Dec-11

Source: Bloomberg, PINC Research

INDIAN REFINERY SECTOR

GRM TO STABILISE GOING FORWARD

GRM moved along with crude price historically

Singapore GRM to stabilise in the range of $6-7/bbl...

Source: Bloomberg, PINC Research

Operating rates to drive GRM

Asian capacity utilisation to remain strong at ~85% till CY13...

0.0 2002 2003 2004

Singapore GRM ($/bbl)

BRIEF SNAPSHOT OF GRM DYNAMICS

Product slate skewed towards diesel (40% weight)

SINGAPORE GRM PEAKED IN CY11

Transportation fuel (~67% of product) leads the rally

Spike in cracks in CY11 a function of other one-off events

WHAT LIES AHEAD

Oil demand led by Non-OECD (2009-2012)

Revisions to GDP forecasts (%)

Source: IEA, PINC Research

Source: IEA, PINC Research

Chinese oil demand growth (CY09-CY12)

Chinese incremental oil demand vs capacity

0.0 2011E 2012E 2013E 2014E 2015E

Source: IEA, PINC Research satish.mishra@pinc.co.in

Source: IEA, PINC Research

Refinery closures and delays to offset excess capacity

Incremental excess capacity over demand

Refining Capacity Additions - World

0.1 2008 2009 2010 2011 2012 2013 2014 2015

0.0 2009 2010 -0.5

Source: IEA, OPEC, PINC Research

Refinery closures may salvage GRM

Source: IEA, PINC Research

Strong demand to support diesel cracks

Total incremental demand (2009-2015) - 6.5mb/d

Cumulative oil product demand growth

1.0 2010 2011 2012 2013 2014 2015

Source: IEA, PINC Research

Source: IEA, PINC Research

Demand patterns point to a further move towards middle distillates

Expected surplus/deficit of incremental product output (CY10-CY15)

Strong demand for Middle distillate across the globe...

Key drivers determining middle distillate demand

Chinese middle distillate demand trend

Oil demand in road transportation (mboe/d)

China OPEC Developing countries

Source: BP Statistics, OPEC, PINC Research

Source: BP Statistics, OPEC, PINC Research

China's Diesel Demand by Sector before 2020 (Unit: million tons)

2008 AnnualGrowthRate1980-2008 2015 2020 AnnualGrowthRate2008-2020 Source: Industry, PINC Research

Diesel cars in use (% of total vehicle fleet) **

Upgradation capacity addition by Region

Africa Latin America