DEMAND, DEREGULATION MAY ATTRACT MORE REFINERS TO ASIA

Of the nations with growing requirements for refined products, China and India offer greater opportunity for foreign investors to enter downstream projects, says IEE. Also offering excellent business prospects are Thailand, Malaysia, and Indonesia.

BACKGROUND

Historically, the refining business has been governed like a utility in most Asian countries. Under this control, says Energy Security Analysis Inc. (ESAI), Washington, D.C., in its Asia Pacific Refining Study: "Capital is governed, and to a degree, assured by the state."

In countries like China, Taiwan, India, and Indonesia, the refining business has been a state monopoly or oligopoly. "Prices of finished petroleum products are still under state control or supervision in almost every Asian country," says ESAI. This control makes operation less harsh than in countries where market forces alone determine profitability. In fact, the term "gilded cage" has been used to describe refining under government control.

"That 'cage' is gilded to various degrees in each country of Asia," says ESAI, "but it is likely that the profitability of refining in the least gilded of the Asian cages is still better than it is in the uncaged refining business of America and the free parts of Europe."

On the down side, regulation has reined in expansion in Japan, with the prohibition of most product exports. ESAI says Japan's Ministry of International trade & Industry (MITI) may deregulate refining altogether in the next 10 years, however, making the Japanese regional majors.

Other countries, such as India and China, who have historically barred foreign participation, now are courting foreign companies for investing in refining projects.

OIL DEMAND

Demand for oil in Organization for Economic Cooperation & Development (OECD) countries will increase about 0.5%/year between 1993 and 2005, according to an IEE report written by Tsutomu Toichi and Hiroshi Kashio. The report says oil demand in Asia will increase 4.5-5%/year during the period.

Similarly, DRI/McGraw-Hill's most recent Energy Forecast Report projects Asian oil consumption to increase by 25% between 1994 and 2000. Over the next 20 years, says DRI, Asia will account for 53% of the increase in global energy demand.

In fact, Asia will consume 35% of global energy by 2010, compared to 24% today. And energy demand in developing Asian countries will triple by 2015, says the report.

DRI also says the economies of Korea, Taiwan, Singapore, and Hong Kong are maturing, and that these countries are moving into less energy-intensive phases of development. China has been a net importer of oil since the end of 1993, but DRI projects the country will import 4 million b/d in 2015. Indonesia and Malaysia are expected to become net importers at the beginning of the next century.

Japan's market is becoming less attractive in comparison to other Asian countries. The causes are limited growth in oil demand (about 1%/year) and anticipated reduced profitability because of deregulation, says IEE. But, although growth there is slow, Japan will remain the region's second largest energy consumer and its major oil importer.

The demand for LNG will nearly double in the Asia/Pacific region between now and 2010, according to Indonesia's Pertamina (OGJ, Mar. 27, p. 33).

Demand in a low forecast will climb from 52.2 million tons this year to 97.6 million tons in 2010; and to 139 million in a high forecast. Japan will continue to dominate world demand, requiring 61.5 million tons in the high case in 2005.

IEE says Japan has a unique opportunity to play an important role in adjusting the region's supply/demand gap by increasing product exports. To meet this challenge, however, Japan will have to increase refinery utilization, improve upgrading and export facilities, and increase the overall operating efficiency of its oil industry.

In its study titled, "Energy and Refining in East Asia, A Critical Evaluation During a Decade of Change," Chem Systems Inc., Tarrytown, N.Y., says dependence on residual fuel in the region's expanding power sector will decline in favor of coal and gas-based facilities, although the absolute volume of petroleum used for power generation is expected to increase slightly.

Chem Systems' analyses show that about 70% of increased demand will be concentrated in five countries: China, Japan, South Korea, India, and Indonesia. China's 30% share of new demand, however, will dominate growth.

Table 1 (33129 bytes) shows demand projections for oil and refined products, by country, through 2005.

PRODUCTS

The number of registered automobiles, trucks, and buses is rising sharply throughout the region, as is the need for air transportation and freight. This increase is pushing up demand for gasoline, gas oil, and jet fuel.

East Asia's demand for refined products will increase 4.5%/year, resulting in 10 million b/d of incremental demand by 2005, says Chem Systems. Demand will shift toward cleaner products, with gasoline outpacing demand for other products.

Regional gasoline demand is expected to increase from 2.56 million b/d in 1993 to 3.66 million b/d in 2000 and 4.49 million b/d in 2005, says IEE. This constitutes an average annual growth of 4.8%.

IEE projects naphtha demand to increase steadily due to expansion of ethylene capacity. Annual growth rates for naphtha and jet fuel are, respectively, 3.2%/year and 3.5%/year. In contrast, demand for fuel oil is expected to grow at only 0.8%/year.

IEE's projections also show gas oil demand growing sharply, from 4.10 million b/d in 1993 to 5.83 million b/d in 2000 and 7.15 million b/d in 2005, constituting 4.7%/year growth.

These changes will result in a continuing shift toward lighter products in the region. IEE projects demand for naphtha through gas oil, as a percentage of total products, to increase from 67% in 1993 to 72% in 2000 and 74% in 2005.

In addition, plans are under way throughout the region to reduce or eliminate lead in gasoline and to reduce sulfur in gas oil and fuel oil. Implementation of these plans varies among the Asia/Pacific countries.

REFINING CAPACITY

Asia/Pacific crude capacity was 14.4 million b/d at the beginning of this year (OGJ, Dec. 19,1994, p. 45).

The region has been the fastest growing refining center for several years running. Asia/Pacific countries have increased crude distillation capacity from 12.6 million b/d in January 1991 to 14.4 million b/d in January 1995. This is an increase of more than 14% in just 4 years.

In fact, the Asia/Pacific region has displaced Western Europe as the world's second largest refining center behind the U.S. And with only a 900,000 b/d difference between U.S. and Asia/Pacific capacities, the region is poised to surpass the U.S. refining industry, in terms of capacity, in the next decade or so.

The growing demand outlined in the previous section is making it necessary for Asian countries to increase refining capacity further, either by expansions or new construction. While refiners in developed regions, such as the U.S. and Europe, are concentrating on reducing costs, proving product quality, and digging deeper into the bottom of the barrel, Asian refiners are simply increasing total production volumes'

Table 2 (44274 bytes) shows IEE's outlook for distillation capacity in the region, by country, through 2005.

The predominant regional position of the majors, led by Royal Dutch/Shell and Caltex, is certain to strengthen, says IEE. But despite mushrooming demand, grassroots construction carries such high risks that major oil companies are establishing joint ventures with regional enterprises.

Although national governments in the region are heavily involved in the refining industry, the trend is toward reduced government ownership and regulation, says Chem Systems. The limited private investments seen so far in countries like China, India, and Indonesia are simply a reflection of the lack of legal and regulatory framework required to provide private investors with adequate access to those markets. The more rapidly these frameworks are developed, says the study, the faster the pace of capacity additions in these markets.

CAPACITY ADDITIONS

Chem Systems says refining investments in the region will include more advanced configurations than are currently operating there. In addition, the new schemes will have additional capability for converting residual fuel, and will address mandated product quality improvements, including reduced lead in transportation fuels and decreased sulfur levels in diesel and residual fuel. The level of upgrading capacity added, however, may be excessive in the medium-term.

Chem Systems anticipates general improvement in global refining margins during the coming decade. In fact, the firm says margins should be adequate to support refinery construction in major, growing East Asian markets.

India has some eight possible grassroots refinery projects planned for the medium term. Major plans also are under way in China, Malaysia, Thailand, and Viet Nam. Projects in Thailand and Malaysia tend to involve local companies and majors, while projects in China and Indonesia are joint ventures between local and foreign firms. IEE says possibilities are shrinking that these joint ventures will progress smoothly and take place in the near future. Capacities in Japan and the remaining countries are expected to increase steadily, mostly as a result of expansions of existing plants.

Based on these developments, IEE expects regional distillation capacity to increase from 15.3 million b/d in 1993 (according to IEE's capacity figures) to 18.88 million b/d in 2000 and 20.11 million b/d in 2005. Plans also are under way to increase capacity for cracking and other upgrading processes. IEE projects total cracking capacity (fluid catalytic cracking, hydrocracking, and thermal cracking) to increase from 3.15 million b/d in 1993 to 4.05 million b/d in 2000 and 4.25 million b/d in 2005.

Fig. 1 (19190 bytes) shows ESAI's projections of changes to catalytic cracking capacity in the region. A 500,000 b/d increase is expected between 1993 and 1998. In addition, regional hydrotreating capacity is projected to increase by more than 360,000 b/d.

ESAI defines refinery complexity as "cracking capacity as a percentage of distillation capacity." Complexity in Asia, as a whole, is expected to remain at 18% through 1998. Australia and China are the current leaders at, respectively, 32% and 29%.

Australia's complexity reflects greater demand for light products, compared to other Asian countries. China's cracking capacity reflects low fuel oil demand and a heavy crude slate. Japan and India have complexities in the 15-20% range, while the other Asian countries fall below 15%.

Fig. 2 (26440 bytes) shows ESAI's complexity estimations, by country.

In the following section, ESAI's regional analysis will provide a description of the specific activities in the most active Asian countries.

JAPAN

ESAI projects that by 1998, Japan's distillation capacity will return to the 5.5 million b/d level it last saw in 1983. This said, the actions of MITI with regard to industry deregulation will have a big effect on japan's refining industry.

In 1990, supply disruptions from Kuwait caused MITI to remove many restrictions on refinery throughput levels. Japan was transformed, within a year, from a large product importer to a product exporter.

"The question now," says ESAI, "is whether MITI will take the next step - deregulation of product exports." Current restrictions require that exports:

• Have no effect on Japan's oil supply and demand

• Have no adverse economic effects on destination countries

• Be priced at levels that do not raise fears of product dumping.

"Apparently, MITI is concerned that 'unleashing' Japanese oil companies might ultimately lead to Japanese penetration of, say, the U.S. West Coast to the detriment of larger U.S./Japan trade relations."

In 1996, the Provisional Measures Law for Importation of Petroleum Products expires. Given MITI's concerns about unleashing Japanese oil firms, says ESAI, it is unclear whether the expiration of the law will necessarily mean significant changes in the country's oil industry.

But Japan's first socialist prime minister, Tomiichi Murayama, came to office in June 1994. And Murayama has expressed his commitment to decreasing japan's trade surplus, improving strained relations with the U.S., and reducing consumer prices, among other things. The impact of Japan's changing political climate will first be seen in the area of product import and export controls, says ESAI's report.

A government committee was reported to have recommended in 1993 that export controls be phased out. ESAI sees this possibility as the most likely outcome: "We do not believe that the Japanese oil refining industry will be totally or even largely deregulated. One thing seems clear, however, based on the changes that have already occurred since the Gulf War: Japan will remain largely self-sufficient in terms of refining capacity, and it will be-on the margin-a net exporter... of product."

Japanese refiners will continue the debottlenecking campaign that began in 1991. At least 100,000 b/d/year, possibly 200,000 b/d/year, will be added, says ESAI. Table 3 (35185 bytes) shows the firm's estimate of capacity expansions expected through 1998.

If Japan's oil demand grows at ESAI's projected rate (to 6.1 million b/d), and if political policy continues to favor self-sufficiency in the refining industry, a grassroots refinery probably will be needed. "If built," says ESAI, "it would be the most expensive refinery on earth (in dollar terms), and would almost certainly motivate a Japanese refining company or group of companies to dust off the joint venture plans with Saudi Aramco that were abandoned in late 1993."

SOUTH KOREA

South Korea's refining industry has grown dramatically in the past 10 years. If Korean refiners' current plans, most of which have received government approval, are realized, refining capacity will increase by an additional 800,000 b/d in the next 10 years.

ESAI considers four Korean grassroots projects "plausible":

• Ssanyong's 200,000 b/d refinery at Onsan (1995)

• Hanam's 220,000 b/d refinery at Yohchon (1996)

• Yukong's 180,000 b/d refinery at an unknown location (1997)

• Hyundai's 128,000 b/d refinery at an unknown location (1998).

Given Korea's robust demand expansion, Korean refiners will need to stick with this capacity-addition schedule in order for the country to remain self-sufficient, in terms of refining. If, on the contrary, Korea's demand is less than ESAI's projected 800,000 b/d increase between 1994 and 2004, this expansion schedule will result in product exports.

According to ESAI, "The clear need for additional refining capacity, and the comparatively favorable business environment for refiners in Korea, make it the most appealing place for a joint venture."

TAIWAN

Taiwan's capacity expansion depends on the rate of privatization of the state oil company, Chinese Petroleum Co. (CPC).

The government has partially deregulated the oil market in Taiwan (in the LPG, city gas, LNG, and gasoline service station businesses). Taiwan's continued deregulation is likely to result in a refining market largely protected by barriers to entry, and by continued price supervision or regulation.

ESAI says Taiwanese industry officials believes there is a need to expand refining capacity to 880,000 I)/d from 610,000 b/d by 2000. Two efforts to build grassroots refineries are under way:

• Formosa Plastics plans a 150,000 b/d refinery (1998).

• Tuntex plans a 150,000 b/d refinery, attached to a petrochemical plant (post-1998).

ESAI believes these projects will materialize before CPC's expansion plans, as privatization will be slow and subtle.

SINGAPORE

Singapore's status as the region's main product export center is under attack. Originally, many thought this attack would come from Indonesia's export-oriented (EXOR) refineries, although financing problems have reduced the importance of this factor.

No new refineries are scheduled for construction in Singapore. "In fact," says ESAI, "BP's small Pasir Panjang refinery will be shut down to make room for expanding the harbor." In addition, existing refineries in Singapore will not expand distillation capacity significantly.

INDIA

Until recently, India's government owned the country's entire refining sector, with each refinery being guaranteed a 12% profit. Today, product prices still are controlled by the government.

The Indian government is planning to open up its refining industry to foreign investment. Because of the so-called "gilded cage," ESAI expects negotiations between the Indian government and private refining companies to focus on regulations that support, or even assure, a reasonable rate of return.

"Such negotiations are taking place in India now," says ESAI, "and among the issues being discussed are the cost differences between a foreign and a local refining company." ESAI believes private money for refining investments in India will likely come from Indian companies allied with oil-exporting countries.

Grassroots refineries considered likely to be built in the near term are:

• A 60,000 b/d refinery in Mangalore

• Karnal's 120,000 b/d refinery in Panipat

• Koyali's 60,000 b/d refinery at an unknown location

• Accord's 60,000 b/d refinery in Assam.

ESAI considers four projects likely to built after 1999:

• A 180,000 b/d Reliance Industries refinery

• A 120,000 b/d joint venture refinery (Bharat Petroleum Co. and Oman Oil Co.) to be built in central India

• A 120,000 b/d Indian Oil Co. joint venture refinery slated for Assam

• A 120,000 b/d joint venture refinery (Hindustan Petroleum Co. and Oman Oil Co.) to be built in western India.

INDONESIA

At one point, it appeared that is many as four EXOR refineries, with a combined capacity of 500,000 b/d, might be built in Indonesia. It now looks as if only one of these projects - the now-on-stream 125,000 b/d EXOR 1 refinery in Balongan, West Java - will materialize in the 1990s.

Part of the reason for this change of plans is the Indonesian government's realization that state oil company Pertamina could not afford to finance its share of the projects. In the meantime, domestic demand has grown so fast that most of the products from EXOR 1 will be sold within the country.

Potential partners in the other EXOR projects are discouraged by the Indonesian government's reluctance or inability to guarantee profits. Others are waiting to see whether deregulation plans go through, in which case selling products for domestic use would not be as disadvantageous as in the past.

MALAYSIA

In the late 1980s, Malaysia's government offered tax incentives to attract foreign investment in an attempt to increase refining capacity. Reaction was better than expected, raising concerns that the refining shortage may turn into a glut. As a result, the incentives were withdrawn, says ESAI, leaving only two firm plans on the books.

One is Esso Malaysia's debottlenecking at Port Dickson, which will increase capacity 17,000 b/d; the other is Petronas' construction of a 120,000 b/d sour crude train at its Malacca refinery.

Under this plan, Malaysia could "import beer and export champagne," by feeding sour, Middle Eastern crudes to the Malacca refinery and exporting sweet Malaysian crudes to simpler refineries outside the country. Since 1990, however, the price of sour crude has risen, relative to the price of sweet crude.

CHINA

In the early 1990s, China Petrochemical Corp. (Sinopec) decentralized the refining industry by allowing other Chinese oil companies, such as Sinochem, China National Petroleum Co., and China Petrochemical, to build refineries to meet surging demand. Given this looser structure, says ESAI, several variables will determine the rate of expansion of refining capacity:

• The amount of capital allocated to China's refining companies, who have to compete for funding with other industries within the country

• The amount of direct, foreign investment made in the Chinese refining industry.

This second factor is subject to sudden change if the government should prove unable to cope with rapid growth, or if Deng's succession proves difficult.

Table 4 (27072 bytes) lists China's likely capacity expansions through 2000. The ultimate fate of these projects, however, is difficult to determine, says ESAI.

Currently, 60-70% of the funds required for the projects in Table 4 (27072 bytes) are slated to come from foreign participants. The biggest commitments so far have come from Saudi Aramco, Royal Dutch/Shell, Elf Aquitaine, Amoco Oil Co., and Yukong Ltd.

"Some companies are looking at China as they look at India," says ESAI. "Aside from the political risk - about which people disagree violently when it comes to China - there is the concern about regulatory risk.

"If China proves incapable of imposing 'rational' petroleum product prices," says the report, "if China's government after Deng mismanages the economy in such a way as to depress the currently buoyant demand growth, if the yuan becomes nonconvertible so that domestically generated profits cannot be repatriated, then the right to export part of the refinery's output will be the critical element of the project's return."

A more detailed description of China's refining industry can be found in the article beginning on p. 42.

FUTURE

ESAI believes state regulation in these countries will die hard and, as a result, too much capacity likely will be built. In addition, says the company's report, "The reaction of many countries to the coming (continuing) decline in refining margins will be to pull up the drawbridge, to slow down deregulation, to protect their national companies from bankruptcy. In so doing, they will reduce the size of the regional product market, thereby diminishing the volumes of trade, and perpetuating low refining margins for the other export-oriented refiners.

"Put most bluntly, we believe few Asian governments are willing to do to their refining companies what the United States did in the 1980s: turn a blind eye to their economic despair, and let the least efficient of them go out of business. But by not being willing to do so, Asian governments are setting themselves up for a decade of more of continued regulation and, inevitably, subsidization of a relatively inefficient domestic industry."

ESAI sees two ways out of this trap:

• Oil demand that grows faster than refined products supply

• The establishment of an Asian free-trade area for refined products.

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