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Industry Commentary

Exports or Imports - The Future of Asian Refining

KEY FACTS
No. of APAC Refineries: 264

APAC oil products consumption:


105 MMbpd

Abstract

Nelson Complexity Index Range


& Average: 1 14; 5.88

2013 APAC Refining Capacity:


China: 39%
Japan: 14%
India: 14%
S. Korea: 9%
Taiwan: 4%
Others: 20%
Total: 32.1 MMbpd
(APAC accounts for 34% of global
refining capacity).
Over the last decade, refining
capacity growth in:

APAC: 3.6% CAGR


Rest of the World: 0.1% CAGR

Will the region be short of refining capacity or will


products be in over supply?

The Asia-Pacific region has traditionally been


a major importer of refined products.
However, thanks to almost 12 million barrels
per day (MMbpd) of refining capacity added
since 1995, the region now has surplus
distillate and gasoline production. Yet,
despite apparently plentiful supplies in the
region, many countries are still planning
additional capacity. The concept of building
domestic refining capacity based on strategic
considerations (security of supply etc.) rather
than solely economic ones is, of course, not
new. However, as many refiners target
exports and markets that will pay top prices,
some countries may need to build refining
capacity rather than want to build it. Price
subsidies decrease the attractiveness of
private investment in refining capacity for
some markets, whilst the subsidies on
products themselves exacerbate rapid
demand growth.

Can the regions refineries effectively be separated


into those that are economically viable and those
that are effectively strategic investments?
Can countries with high price subsidies attract new
investment to the refining sector?
Introduction
During the past decade, there has been a steady
growth in refining capacity1 in the non-OECD
countries where nearly all growth in global oil
product consumption has occurred. Asia-Pacific
(APAC) has had the largest growth in refining
capacity of any region, almost 8 MMbpd since
20022. However, within APAC, there have been
differing trends. Most of APACs new refining
capacity growth has been in China and India.
Industrialized APAC3 experienced no growth in
refining capacity while there were some refining
capacity additions in the remaining APAC
countries.

This article assesses the future for Asian


refining by examining the oil demand outlook,
the location of newly built refineries, and the
companies that are undertaking these
investments. The strategic and economic
drivers for investments in new refining
capacity will be examined to understand the
underlying business model. This will be
applied to the case of the countries that still
import oil products.

The additional refining capacity has allowed China


and India to remain self-sufficient in supplying oil
products to their domestic market4. Most APAC
countries with domestic oil product demand in
excess of 200 thousand barrels per day (Mbpd) are
self-sufficient in refining capacity. The notable
exceptions have been Malaysia, Indonesia,
Pakistan, and Vietnam where refining capacity is
below oil product demand. Since 2003, of these
four countries, only Vietnam has added more
incremental refining capacity than growth in oil
product demand.

This article examines the potential future for


Asian refining and begins to answer the
following questions:

Primary crude oil distillation capacity

Source: BP Statistical Review of World Energy, June 2013

4 Comparing

Comprises Japan, South Korea, Taiwan, Singapore, and Australia


refinery distillation capacity to overall oil products consumption

Industry Commentary

Exports or Imports The Future of Asian


Refining
1.

Outlook for Asian Refining

Over the next five years (2014-2018), APAC refining capacity


additions of 6.0 MMbpd are expected. Again, most of these crude
distillation unit (CDU) capacity additions will be in China (55%),
India (24%) and Rest of Asia (21%), as shown in Figure 1.

The projected growth in refining capacity seems to defy simple


commercial explanation. However, we postulate that the
answer is in the different business models being used to justify
investment.

Greenfield refinery additions account for half of the total refinery


capacity additions planned in APAC for the next five years. Twenty
new refineries are expected to start up during this period including
seven in China and three in India.

2.

Figure 1: Participation in CDU Additions (2014-18) in APAC


3.5
3.0

MMbpd

2.5
2.0
1.5
1.0
0.5
0.0
China

India
NOC

Local Private

Rest of Asia
Foreign

Source: GlobalData

It is interesting to note that nearly 75% of new capacity expansion


in APAC will be built by National Oil Companies (NOCs). Local
Private and Foreign companies will participate in 15% and 10% of
expected capacity additions respectively.
The unusual aspect of the refinery additions in China and India is
that they exceed the combined expected growth in consumption in
their respective countries over the next five years by almost
2.5 MMbpd. In the rest of APAC, outside of the industrialized
countries, refining additions also exceed consumption growth, as
shown in Figure 2.
Figure 2: Changes in Refining & Oil Consumption (2014-18) in
APAC
3.5
Refining Capacity Change

3.0

Consumption Change

2.5

MMbpd

2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
China

Source: GlobalData, IEEJ

India

Industrialised APAC

Rest of APAC

Business Models for Refining Capacity Additions

After World War II, the major oil companies (majors) based in
Western Europe and the US controlled most of the worlds oil
production through private ownership and concession
arrangements. During this period of time, refining investment
was made by the majors in response to rising demand from
their marketing operations. Crude oil supply was plentiful so the
only way to produce more crude oil was to sell more oil products
(Move the Crude). Refining-marketing or Downstream was
required to break even while production or upstream made the
profits in such integrated companies.
This business model changed with the advent of OPEC and the
nationalization of oil reserves in those countries in the early
1970s. Crude oil supply became scarce as a result of
production quotas. The Downstream business was expected to
become profitable and earn a return (Profit Model) since the
large integrated oil companies no longer had excess crude oil to
move. With higher product prices (in part from higher excise
taxes), consumers in the industrialized countries reduced their
demand for oil. The over-capacity in refining in the US, Europe,
and Japan, led to closures of the least competitive refineries.
The large integrated oil companies also divested refineries to
independent operators.
The developing APAC countries have proceeded on a different
path since the early 1970s because of the growth in their
domestic economies. Oil consumption grew with economic
growth and new refineries were needed to supply the oil
products. The majors invested in refineries in Singapore,
thereby establishing an oil products supply hub for Southeast
Asia. The refining sectors in China and India were developed
by National Oil Companies (NOCs), at first by Sinopec and
Indian Oil respectively, and then expanded by other NOCs.
Since the NOCs were the only investors in their countries,
downstream business was operated more like a public utility
with regulated prices that effectively capped margins (Public
Utility Model).
Although the majors had downstream
businesses throughout Southeast Asia, the Public Utility Model
has become dominant in the refining sectors of Indonesia,
Malaysia, Thailand, and recently, Vietnam.

Industry Commentary

Exports or Imports The Future of Asian


Refining
Refining Capacity Additions in APAC

Under the Profit Model, refiners have the responsibility for revenue
collection. As refining margins improve, refiners gain the incentive
to add additional capacity. International Oil Companies (IOCs) and
Local Private Companies will typically wait for the margins to
improve in the marketplace before making investments.
Under a Public Utility model, the NOC must invest to ensure that
the nations oil products demand is met. The return that the NOC
receives on this investment is managed by the state. As long as
the NOCs have the funding (internal and government sources) to
make the necessary investments, the required investment return is
not an issue. The NOCs will continue to invest as long as there is a
market for the output. The problem for governments arises when
there is a shortage of funding for refining investment that causes
the state/NOC to invite investment from foreign or local private
sources; these parties will then seek government support that
provides them with a market rate of return.
Traditionally, refining margins incentivized refining capacity
additions under the Profit Model. These incentives would have
been strongest during the high margin period during 2004-2008.
Given the long lead time to design and build a refinery this would
have led to the greatest capacity expansion after 2008. Since
2008, Asian refining margins (based on spot market transactions in
Singapore) have decreased to an average of US$2.27 per barrel of
crude oil processed over the past five years, and are currently
lower than the average of the previous 15 years, which is
highlighted in historical refining margins shown in Figure 3. The
refining margins shown are for generic conversion refineries
applicable to Singapore, for Medium sour Hydrocracking
configurations.
Figure 3: Historical Refining Margins in Singapore
7

Avg. Refining Margin ('92-'12) = US$2.94


6
Refining Margin, US$/Bbl

Avg.= US$5.26
5

4
Avg.= US$3.24
3
Avg.= US$1.16

Avg.= US$2.27

0
'92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12

Source: BP Statistical Review, 2013

However Asian refining capacity additions steadily increased,


driven by China, during the past 20 years, as shown in Figure 4,
despite the volatility in the refining margins. This indicates that
governments were applying the Public Utility model to meet the
domestic growth in fuels consumption and to achieve supply
security.
Figure 4: Asia Refining CDU Capacity Additions
4
3.5
3
2.5

MMbpd

3.

2
1.5
1
0.5
0
China
'92-'97

India
'98-'03

'04-'08

Other APAC*
'09-'13

'14-'18

Source: BP Statistical Review, 2013, GlobalData

For foreign/private sources of capital, the low margin in recent


years has dampened enthusiasm for refining investment that
would rely on the marketplace without government support. In
countries following the Public Utility business model, the
governments and NOCs have had to promise greater margin
support to new refining capacity hoping that the market will
improve.
Asian Retail Fuel Prices
A particular problem for foreign or local private investors
considering refinery investment is that downstream margins are
based heavily on governmental support when domestic product
prices are regulated below the international market. Malaysia and
Indonesia are no longer self-sufficient in refining capacity as a
result of increasing domestic consumption. These countries have
proposed new refinery projects, which would reduce reliance on
imported oil products. However, both countries have belowmarket retail prices for gasoline and diesel, as shown in Figure 5
(on next page), and must fund pricing below international imports.
Thailand and India (and possibly The Philippines) have chosen to
price diesel below international market prices when the additional
costs involved in fuels distribution and retailing are added. The
governments in these countries must provide more funds to the
refining sector to maintain downstream margins and attract
investment for expansions.

Industry Commentary

Exports or Imports The Future of Asian


Refining
Figure 5: Asian Retail Prices for Gasoline and Diesel in 2012
2.5

US Retail Price
Singapore Spot Retail Price

2.25
Diesel Prices, US$/litre

2
1.75

Japan
Singapore
China
S.Korea

1.5

Pakistan
Taiwan
Philippines
Thailand
India

1.25
1
0.75

Malaysia

0.5

Indonesia

0.25
0
0

0.25

0.5

0.75
1
1.25
1.5
1.75
Gasoline Prices, US$/litre

2.25

2.5

Source: World Bank

India presents a more complex picture. On an aggregate, India


imports refined products for its domestic consumption and exports
refined products produced by local private refiners. The unique
nature of regulation, which allows local private companies to set-up
export-oriented refineries to take advantage of higher international
margins, offers a positive climate for refining capacity additions.
Local private refiners, Reliance and Essar, responded by building
1.2 MMbpd of capacity, which was half of the total refining capacity
additions in India during the 2004-2012 period.
5.

Closing Remarks

The future of refining depends largely on the pricing policies and


capital allocation models implemented by governments. Refining
investments by NOCs, which are supported by government to
accomplish strategic policies, are a major feature of the Asian
marketplace.
Government programs to sell oil products
domestically below international price benchmarks depend on
covering feedstock, manufacturing, and distribution costs, and are
unlikely to be sustainable. Attracting foreign and local private
refinery investments depends on the establishment of a proinvestment climate through either, or both, deregulated pricing and
government tax support.

Republished from an article written by GCA in Chemical Industry


Digest, Vol.XXVII 3, March, 2014 for circulation under permission.
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