Asian Refiners May See Relief On Margins As Capacity Additions Ease

July 7, 1997
Comparing 1997 regional refining capacities [33127 bytes] Asia-Pacific refining complexity [55428 bytes] Singapore crude processing [34234 bytes] Distillation capacity [33996 bytes] Refining Capacity vs. Demand [34964 bytes] Singapore cross refining margins [75019 bytes] Continued weak Asian refining margins in 1996 prompted postponements of planned capacity additions, which may ease pressure on the region's refiners. That's the conclusion of a report by the Honolulu think tank
Continued weak Asian refining margins in 1996 prompted postponements of planned capacity additions, which may ease pressure on the region's refiners.

That's the conclusion of a report by the Honolulu think tank East-West Center.

Major refining capacity additions came on stream in Asia last year, while the region's refining margins experienced another record low, noted EWC analysts Fereidun Fesharaki and Sara Banaszak.

As a result, new capacity planned for 1997-99 now reflects the delay or postponement of major projects.

Among the report's key findings:

  • Growing oil demand, along with postponed refinery projects, will lead to less pressure on the market than previously expected and could enable refining margins to "recover somewhat" from the past 2 years.

  • The region's demand is strong enough to absorb the addition of significant capacity in 1996.

  • Rising Singapore margins early in 1997, while not expected to continue unabated, show the potential for a recovery.

Other factors influencing a recovery are lower crude prices and effective cost control by refiners.

Still, with major refining capacity hikes already planned for 2000-05, "further grassroots refineries will not be justifiable without the right incentives, which could range from guaranteed margins to product import tariffs," as well as having sponsors cover offsite costs or interest payments on non-recourse financing.

Market conditions

Strong demand underpins the Asian market, the EWC report noted.

Regional oil demand, excluding Japan, grew by 5.8% in 1996 and 7.3% in 1995. When Japan is included, regional growth still amounted to 4.1% in 1996.

During 1995-2005, Asia will add 7-8 million b/d to world oil demand, accounting for roughly half of the world's entire increase during this period.

"Yet regional refining margins were particularly low in 1995 and 1996," the report said, adding, "The unusual highs of world crude prices were one important influence, while major additions of new capacity to Asia's refining industry played the expected role of further tightening the margins."

Delays in major new additions will limit the growth of Asian refining capacity during 1997-99 and "could help create an environment for recovering refining margins," the authors said. "However, new capacity currently planned for 2000 and beyond will shrink the gap between the region's demand for oil products and its basic crude distillation capacity."

Asia's refiners will remain under pressure to be flexible and efficient, and expansion projects will be favored over new refinery construction, the authors predicted. New construction will be best-suited for areas of captive demand and/or areas where the right incentive or subsidies are made available.

Meanwhile, more stringent product specifications will significantly influence the market in years to come, the report concludes.

Asia refining overview

The Asia-Pacific has now surpassed North America as the region with the most refining capacity in the world, when measured as basic crude distillation capacity.

However, Asia's refining system is relatively simple, with much less hydrocracking, cat cracking, cat reforming, and coking capacity than North America or Western Europe, and less ability to produce light and middle distillate fuels.

In recent years, the report noted, strong fuel oil prices denied decent margins to refineries with the most cracking capacity. As a result, recent new capacity additions have a relatively small cracking component.

It follows that while Asia has more crude distillation capacity than North America, it has only half as much fluid catalytic cracking (FCC), resid cat cracking (RCC), hydrocracking, and naphtha treating capacity.

Regional imbalances exist as well. China houses more than 40% of the region's FCC/RCC capacity and more than 25% of hydrocracking capacity, much of it underutilized. Moreover, Asia's cracking capacity is based on FCC and RCC, technologies aimed at maximizing gasoline production. This is a poor fit in a region where diesel consumption dominates the market, EWC contends.

Recent capacity increases have included the following:

  • More than 85,000 b/d of hydro cracking capacity has been added since 1995, primarily in China and Thailand; in China, increases include "newly discovered" capacity within the existing system.

  • South Korea made the greatest contributions to Asian capacity hikes in 1996, with a 180,000 b/d increase at Yukong Ltd.'s Ulsan complex, now the world's largest refinery; a 180,000 b/d crude distillation unit at Hyundai Oil Refinery Co. Ltd.'s Daeson site; a 200,000 b/d expansion of LG-Caltex Oil Corp.'s Yocheon refinery, plus additional cat cracking and desulfurization capacity hikes to meet South Korea's increasingly stringent product specs.

  • Thailand's Rayong and Star refineries and Taiwan's Chinese Petroleum Corp. also undertook major capacity additions.

Besides spurring a capacity building boom, the increase in Asian demand has affected the refining industry in other ways. For instance, Singapore's merchant refiners have responded to demand growth by reducing crude processing deals to expand their own product supply.

Global markets and depressed transportation costs are encouraging more trade to meet Asian demand, hiking pressure on Asia's merchant refineries.

"In fact, the Asian refining industry may well be experiencing a set of globalization shocks, which should ease over time as players learn and adjust to the global marketplace."

Asian refining outlook

The region's planned 1997 capacity additions are less than half of 1996 additions, or 577,000 b/d of crude distillation capacity this year vs. more than 1.2 million b/d of crude distillation capacity added last year.

This implies a 3.2% growth rate in crude distillation capacity, suggesting that the Asian refining industry will grow at a slower pace than the past 2 years, when average annual capacity growth was more than 5% and outpaced the region's concurrent 4.3% rise in oil demand.

In 1998, Asian crude distillation capacity is expected to rise at an even slower pace of 344,000 b/d, or 1.85%, while the region's oil demand continues to rise at a rate of 4.2%/year. After 2000, projects currently on the drawing board imply a demand growth rate of 4.6%, but demand is only expected to gain by 3.5%. These projects are not yet under construction, and many may never proceed.

If all planned projects are completed on schedule, Asia's crude distillation capacity would match or surpass product demand by 2005. Even so, this would not eliminate product imports into the region. By 2005, nearly 45% of Asian demand will be kerojet and gas oil, causing continued product imbalances.

Refinery construction reacts to the sector's profitability, one measure of which is refining margins. In the past, construction was spurred by strong margins, along with forecasts of strong demand and short supply. Slower growth in capacity additions in the next few years may reflect low margins in 1995-96, the authors noted.

At the same time, postponing construction, along with continued strong demand, "contributes to a favorable environment and window of opportunity for recovering margins," they added.

Recent market uptick

The addition of significant refining capacity last year weakened the 1997 market, but the region's strong demand shows the potential to offset much of this weakness.

For example, Singapore's refining margins made a strong recovery in first quarter 1997. In early April, margins climbed even higher, aided in part by Singapore's trading activity (Fig. 7). While this uptick hasn't continued since then, it does leave room for overall 1997 refining margins to improve compared with 1995-96.

Continued product imbalances point to an improvement in margins that would support expansions and upgrades "but not for stand-alone refineries unless they received adequate incentives."

The report projects long-term cracking margins at around $7/bbl, which is not too much higher than early 1997's $6/bbl margin.

A variety of factors will influence how well the margins recover in the future. These include: crude prices; heavy/light product differentials, freight rates, product specifications, and refiners' ability to control costs and respond flexibly to market conditions.

Construction plans

Projects slated for completion this year will add as much as 670,000 b/d more crude distillation capacity.

Half of this will be in China, where major units will come on stream at Maoming, Daqing, and Lanzhou.

In Malaysia, Petronas Carigali Sdn. Bhd. is adding capacity at its Melaka II refinery. In India, Cochin is due to complete a 60,000 b/d project at Ambalamugal. Smaller additions also will begin in Singapore, Thailand, New Zealand, Australia, and the Philippines.

In 1998, 344,000 b/d will come on stream, most of it in China, Indonesia, and India. Additions during the subsequent 2 years are limited, relative to new capacity expected between 2000-2005.

By 2000, Taiwan's first private refiner, Formosa Plastics Group, hopes to start first-stage units, without any hydrocracking now planned. India also hopes to complete a number of projects, as do Indonesia, Pakistan, China, and Malaysia. Both Formosa Plastics and India initially planned to complete major projects before 2000, but construction delays have made this unlikely.

At present, about 1.3 million b/d of additional refining capacity is slated to come on stream during 1998-2000, and while addition of secondary processing units such as hydrocracking will not be enough to outstrip North America in terms of refining complexity, the gap will shrink, and Asia will overtake Western Europe in secondary capacity.

During 2000-05, more than 5 million b/d of new capacity has been proposed. Of this, India's plans account for 1.4 million b/d, but concerns are widespread over the lack of political stability, as well as price subsidies and the lack of incentives to attract foreign investment.

Following India, additional capacity in China could reach 1.3 million b/d, so that China and India together account for more than half of all new refining capacity planned during the 5-year period.

Taiwan, Thailand, Indonesia, and Malaysia each plans 300,000-500,000 b/d of additions; in South Korea, Hyundai plans to add 200,000-300,000 b/d.

Plans by Mobil Corp. and the Pennar Group to ship a cracking refinery from Europe to India by 2001 show another direction the market could take. "The shipping of refineries from a region such as Europe, which is undergoing rationalization, could impact the economics and pace of capacity additions in Asia," the report noted.

Product specs tighten

Product specifications in Asia have been evolving rapidly, but in many different directions, the authors observed (see related story, p. 35).

For instance, Japan's membership in the Organisation for Economic Cooperation & Development has led to some of the world's most stringent specs, whereas China's and India's are considerably more lax.

Some countries that have experienced recent strong economic growth are embracing environmentally more benign products faster than their lagging counterparts. Thailand, for instance, has per capita gross domestic product about a third of South Korea's level but has regulated its sulfur content in diesel fuel to meet the same standards as South Korea and Japan by 2000.

It's still not clear whether the product-standard targets set by governments will be met. On the other hand, governments play a relatively strong role in most Asian countries, which enables them to reach goals faster than seems possible elsewhere, the report noted.

Japan, South Korea, and Thailand all use unleaded gasoline. Taiwan is proceeding rapidly with a lead phase-out program. Malaysia now has 30% of its gasoline unleaded but plans to reach 100% by 2000. India also hopes to have all gasoline unleaded by 2000, although 95% was still leaded in 1996. Singapore expects to make more modest progress. By 2000, leaded's share there will drop to 10% from 35%.

China already produces a large volume of 70 MON (motor octane number) unleaded gasoline for trucks and commercial vehicles-56% of all the gasoline produced in that country is unleaded. This is because the lead additive for gasoline is relatively expensive and in short supply. However, China plans to complete the phase-out of 70 MON completely and push unleaded's share to 80% by 2000, with those remaining to have lead content of less than 0.1 g/l.

Concerning diesel, Japan has the strictest sulfur spec in Asia, at 0.05 wt %. South Korea follows at 0.1 wt %, moving to 0.05 wt % in 2000, which Thailand and Taiwan plan to adopt the same year, as well. Elsewhere, India plans the most aggressive program to raise its average cetane index to 48 from 42 before 2000.

The strictest fuel oil specifications are in South Korea and Taiwan. South Korea plans to lower the level of sulfur in fuel to 0.3 wt % from 0.5 wt %. Taiwan has deferred its planned cut to 0.05 wt % sulfur to 2000 from 1998.

One trend that will come more into play is a growing sulfur premium that differentiates the prices of products with higher and lower sulfur content. At the same time, refiners in the region face a slate increasingly high in high-sulfur sour crudes, as reliance on Middle East sour crudes rises.

Future specifications probably will regulate how gasoline is blended, including levels of benzene and other aromatics. Regulations also are likely to control plant emissions and require stricter waste management, the report predicted.

All told, the authors forecast, Asian refining will remain competitive, with more product-specific shortfalls and more opportunities for profits.

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