Financial Times

18 October 2006

CRUDE PROCESSING : Reliance Industries’ plans for a second plant by 2008 will help turn India into a regional refining hub

Ten thousand kilometres of pipeline snake across a giant swath of land in Jamnagar, an arid city in north-west India that is home to the world’s third largest oil refinery. The facility, opened in 2000 by Reliance Industries, the country’s largest private sector company, has shifted the balance of the crude processing sector and boosted India’s ambitions to become a regional refining hub.

But Reliance aims to grab an even larger market share when, by the end of 2008, it completes a Dollars 6bn refinery in Jamnagar alongside the existing one. The second plant will increase Reliance’s output of 660,000barrels a day, or 33m tonnes annually, by 580,000 b/d, or 28m tonnes, making the refinery the world’s largest, ahead of those of PDVSA in Venezuela and SK Groupin South Korea.

With its 200km of roads, extensive power and water facilities, housing for 2,500 workers and fruit and timber orchards (part of a required “greenbelt”), the refinery “epitomises what India can do on infrastructure given the right conditions,” says Hital Meswani, executive director of Reliance. Chevron, the world’s fourth-largest oil group, took a 5 per cent equity stake worth Dollars 300m in May’s initial public offering of Reliance Petroleum (RPL), the subsidiary created to house the project.

The US-based group has the option to raise its investment to 29 per cent after the second refinery has been in operation for three months. If it does, Chevron would be the largest foreign direct investor in India with a stake worth more than Dollars 2bn. Chevron has interests in 19 refineries worldwide of which seven are wholly owned and 12 are joint ventures. Sixty per cent of its refining capacity is in North America and Asia.

Of the company’s decision to invest in RPL, Jeet Bindra, president of global refining for Chevron, says: “We are already strong in Asia and we want to further strengthen our strategic presence in the region.” Reliance and Chevron have also signalled the potential for future collaboration on refinery technology and joint oil exploration in India. Chevron’s confidence in the new project is backed by the efficiency and profitability of Reliance’s existing refinery in Jamnagar, which has already recovered its Dollars 3.4bn cost, which was the largest single investment in India. The refinery accounted for almost 60 per cent of Reliance’s total revenue of Dollars 19.9bn in the last fiscal year.

RPL will be housed in a “special economic zone”, part of the Indian government’s plan to boost exports, where it will be exempt from income tax for five years and import duties on factory equipment. Even more promising is the prospect of the second refinery’s more sophisticated capacity to process heavier crude oil and thus yield higher margins. Much of the crude oil being discovered is heavy and sour with a high sulphur content, which is harder and more expensive to process than sweet, light crude oil.

Boosted by its advanced technology, Reliance’s existing refinery claims consistently higher margins than other Asian players. Its hallmark operational efficiencies and cheaper labour costs for skilled engineers help make it even more profitable. India is also strategically located on the route of Middle East crude bound for Asian countries, analysts at KPMG point out. Indeed, 70 per cent of the crude processed at Reliance’s refinery comes from Gulf producers such as Saudi Arabia and Kuwait.

Ironically, the majority of Reliance’s refined products are exported because India’s domestic fuel subsidies make the local market unattractive for private companies. The refinery’s exports reached Dollars 2.26bn in fiscal first quarter; annual revenues account for 4 per cent of turnover for India’s entire corporate sector.

Such results could not have been imagined when Reliance was considering whether to build the refinery. “Every consultant we hired advised against it,” Mr Meswani says. “Returns were not good and the market conditions were not favourable then.”

A refinery construction boom in the mid-1990s added more capacity in Asia but the economic slowdown of the late 1990s caused margins to contract. Moreover, Reliance emb-arked on the project, in 1997, when almost three-quarters of the world’s refineries were more than 25 years old and few could efficiently process heavy crude. Tighter environmental regulations also made it difficult for refineries to meet specifications. Upgrading facilities diverted oil groups from building new ones.

Market conditions have now turned in Reliance’s favour. The energy consultancy Pira estimates demand for refined fuels will grow at an annual rate of 1.5 per cent between 2008 and 2015. Meeting that demand will require an extra 10m barrels a day, which translates into the need for two to four new large refineries a year. Some 500 new refinery projects have been proposed worldwide. In India alone, an additional 16m tonnes of refining capacity will come on stream, adding 13 per cent to the country’s current strength of 120m tonnes. Some 6m tonnes will come from Indian Oil Company, the state-owned oil marketing group, while Essar group in the private sector has a long-delayed 10m tonne refinery nearing completion.

Reliance says its highly complex, state-of-the art refinery gives it an edge over rivals. At Jamnagar it has proven its formula of processing many kinds of fuel for different markets, including liquefied petroleum gas, polypropylene, gasoline, kerosene, diesel, coke and sulphur. Unlike other refineries that focus on specific kinds of fuel, Reliance touts its ability to process according to market demand and cater to different country specifications.

In addition to size and complexity, Reliance has first-mover advantage as new refineries will take at least five years to build. Chevron is also a believer. “Refineries that have the complexity to process heavy crude and have the size and economy of scale to withstand the cyclical nature of business can succeed in the long-term,” Mr Bindra says.

Such is the urgency for more complex refineries that Chevron is investing Dollars 1.5bn to upgrade GS Caltex’s Yeosu Refinery in South Korea, of which it owns 50 per cent. The refinery already has scale with production of 650,000 b/d. But when the upgrades are completed next year, Chevron estimates the cost of processing crude oil will be reduced by Dollars 1 a barrel. “Across the globe we are looking for those kinds of opportunities,” Mr Bindra says.