Global downturn will narrow 2009-10 margins, utilizations for Asia-Pacific

June 1, 2009
The subprime crisis that began in the US continues its domino effect on all sectors, including the oil industry in Asia-Pacific.

The subprime crisis that began in the US continues its domino effect on all sectors, including the oil industry in Asia-Pacific. Slowing economies in the US and Europe reduce the demand for exports from the Asia-Pacific, which in turn reduces manufacturing output, investment, and economic growth in this export-dependent region. Asia-Pacific demand for oil products will decrease by 414,000 b/d in 2009.

The extent and duration of the impact of the credit crisis on oil product demand may differ widely among countries, depending on future economic developments and past and future domestic pricing policies. Despite substantial uncertainty, it is critical to reevaluate the outlook for product demand, trade balances, and refinery utilization.

Hard landing

The slowdown in demand growth could not have come at a more inopportune time, with Asia-Pacific adding 2.7 million b/d of refining capacity over 2009-10. Fig. 1 shows there will be 1.6 million b/d of new capacity coming on line in 2009 vs. the decrease of 414,000 b/d in demand. Center stage is the start-up of the new Reliance Petroleum Ltd. refinery, launching 580,000 b/d of new capacity and contributing to more than a third of the refinery addition in 2009.

Click here to enlarge image

Start-up of RPL, which was developed as an export refinery, occurs at a time when the window of opportunity for exports to the US and Europe is closing. FACTS Global Energy data show that, in 2008, US oil demand declined by 1.1 million b/d to 19.6 million b/d, pulled down by a decrease in demand for gasoline and diesel. We expect oil demand in the US to continue its slide in 2009, but more slowly. This year, the US could shed an additional 0.5 million b/d. Driven by the crisis, European demand will fall by around 0.4 million b/d in 2009.

Click here to enlarge image

With so much new capacity coming on as global demand is decelerating, many refineries in the region will experience a hard landing in terms of refining margins. In 2009, we estimate that the regional cracking margin will decline by around 50% vs. 2008 (i.e., down to around US $3.0/bbl) and further down to $1.60/bbl in 2010 (Fig. 2).

Click here to enlarge image

Refiners will have to make difficult strategic adjustments, including running their refineries at significantly lower throughputs, delaying construction plans, or worse, closing existing refineries. Fig. 3 presents FGE’s outlook for average utilization of refineries in the Asia-Pacific. Which path refiners choose much depends on a variety of factors such as domestic demand, import protection, access to credit, and even the timing of refinery upgrades.

Export-oriented refineries will have to bear the brunt of the impact of the downturn in demand because they will be hard-pressed to find a home for their surplus production.

The impact on the domestic refineries, however, varies. Those refineries that are more complex obviously can weather the downturn better than less sophisticated ones. Refineries that just finished (or will complete) upgrades in 2009 will also have the means (and the pressure from the investors) to at least maintain their throughput.

Regional variations

The following sections provide a rundown on how refineries in different countries are coping with the surplus refining capacity that is afflicting the region.

Australia

The Australian refining sector continues to face the challenges of changing fuel needs and fierce import competition. As part of regional supply optimization, oil companies in Australia have the option of importing products from elsewhere in the region. In fact, Singapore is already one of Australia’s main suppliers of refined products.

Restructuring of the sector is inevitable if returns are not maintained. We expect utilization to drop to an average 84% in 2009 from 91% from 2001-08.

China

FACTS Global Energy’s fall 2008 Databook forecast China’s crude runs in 2008 and 2009 at 6.96 million b/d and 7.4 million b/d, respectively. Our latest assessment put 2008 crude runs at more than 6.8 million b/d and 2009 runs at nearly 7.3 million b/d. The respective cuts were 137,000 b/d and 133,000 b/d. The overriding reason for the reduction in crude runs is the rapid deterioration in oil demand since October 2008.

Sinopec has had to reduce its crude runs the most.

Not only does the company face incursions into its territory from local refineries and other state oil companies, but it also had built high inventories of both crudes and products as it faithfully followed government orders to import massive amounts of gasoline, diesel, jet fuel, and crude oil in the months leading up to the Beijing summer Olympics. As of December 2008, Sinopec had about 43 million bbl of product inventory and more than 80 million bbl of crude stock.

China National Petroleum Co./PetroChina have also had to cut crude runs for similar reasons. Because it is less downstream focused, however, the impact on the company is less pronounced.

When the fall 2008 Databooks were prepared, local refineries were being hit hard by low administered product prices and high crude cost that led to widely negative margins. Sinopec and CNPC/PetroChina continued to process crude at the request of the government, but many local refiners shut down.

The situation for private refiners has since improved, as international crude and fuel oil prices dropped. The increase in crude runs of the local refiners, however, is estimated to have been marginal. Those refiners continue to have difficulties accessing crude oil in a tightly restricted domestic market.

For 2010, we continue to see lower utilization for China but the magnitude of the cut is minor. As far as the running mode is concerned, diesel maximization as well as maximum production of petrochemical feedstock is targeted. Overall, the result is higher exports/lower imports.

India

In India, utilization will decline to the high 90% of nameplate capacity from more than 100%. We understand that Reliance’s new Jamnagar refinery may run at less than 100% utilization for first-half 2009, in view of the regional and global economic downturn.

Furthermore, mechanical completion for Reliance’s fluid catalytic cracking unit and coker will occur late in second-quarter 2009. Our estimates are that Reliance’s utilization may be in the range of 75-80% for first-half 2009, slowly ramping up to 95-100% by 2010.

For existing and older refineries in India, utilization rates will vary between 85-90% in 2009 and 2010. For India as a whole, refinery utilization will decline to 97.0% in 2009 and 96.5% in 2010 from 109.1% in 2008.

Why will India’s refinery utilization remain relatively high? In India, there is duty protection for the domestic refining sector owing to the positive differential between product and crude import duties (currently averaging 2.5%). The government-regulated domestic retail prices help ensure high utilization rates among public-sector oil marketing companies. Also, there are localized product deficits (especially for diesel) in India that allow such private-sector OMCs as Essar and Reliance to sell their products partially to public-sector OMCs at import-parity prices. Lastly, the high level of sophistication and complexity in Reliance and Essar refineries gives them a competitive edge in exports vs. Singapore and Europe refineries.

Notably, Reliance will have a distinct advantage over other refineries in the region in its ability to process extra heavy crude grades. Reliance’s crude diet is to include extra heavy crudes such as Syrian, Mexican, Venezuelan, and heavy Middle Eastern grades (Soroush, Arab Heavy, etc.) with a general API gravity of 22-24°.

In comparison, the crude slate of Singapore and South Korean refiners is likely to be in the range of 32-34° API. Reliance will have a $3-4/bbl advantage on crude costs over a generic Asian refinery running on typical Middle Eastern grades.

Reliance also has a 93% overall distillate yield vs. some 80-85% for other Asian refineries. In view of the projected light-heavy differentials, the company will have a $1/bbl advantage over a generic Asian refinery in terms of gross product worth. The high diesel yield of the RPL refinery will also be advantageous in view of strong diesel prices going forward.

Indonesia

Indonesia will remain as the largest importer of gasoline and diesel in the Asia-Pacific in 2009 and 2010. Pertamina’s refineries cannot cope with the domestic demand for petroleum products.

Pertamina will try to maintain a high throughput for its refineries in 2009 and 2010 because this year Pertamina has been chosen again to be sole distributor and marketer of subsidized products in the country.

Japan

Among countries in the Asia-Pacific, Japan will be one of the worst hit by the global slowdown, as Japan’s economic growth is led mainly by external demand. Contraction of demand for automobiles, electronics goods, and other machinery products in overseas markets are adversely affecting the manufacturing industry. Furthermore, because of structural demographic factors, demand for petroleum products in the domestic market is contracting drastically. Serious demand deterioration at home likely will force refiners to reassess how to deal with excess capacity.

Almost all refiners are trying to export products as a means to avoid closures. Total exports increased from 266,000 b/d in 2007 to some 375,000 b/d in 2008, of which diesel is estimated to account for 200,000 b/d.

Export growth will likely lose momentum in the coming years, however. Demand slowdown in Asia and a series of new and large export refineries in Asia and the Middle East entering the global market will intensify competition in the export market. In 2009, Japanese exports will likely fall to 280,000 b/d. Because export margins will remain weak, Japan’s exports will likely decline for the medium term. Pressure will mount for additional closures.

Nippon Oil, the biggest Japanese refiner, plans to restructure its business and operation through a planned merger with Nippon Mining Holdings. By achieving extensive integration in oil refining and marketing, Nippon Oil and Nippon Mining hope to achieve savings of at least 60 billion yen ($662 million)/year. The merged entity plans to reduce refining capacity by 400,000 b/d, which is about 20% of current total refining capacity of 1,852,000 b/d. Closing of an additional 400,000 b/d is possible. Even assuming they will remove the suggested capacity, we believe there still remains excess capacity.

Japanese refiners are facing a surplus at a time of massive global refining surplus. The need to optimize production, logistics, and commercial competitiveness requires strategic and innovative decisions. Forming alliances and joint ventures will become more important for the industry in order to help ease the costly, as well as socially and culturally complex processes of closing regional refineries

Malaysia

Malaysian refineries in aggregate are likely to cut throughput by only 30,000 b/d to reduce naphtha and middle distillate production. Malaysia is a net exporter of naphtha and kerosine and jet fuel, but because Malaysia is heavily gasoline deficit, refineries only cut rates marginally to avoid sacrificing gasoline production.

Although Esso Port Dickson is a simple hydroskimming refinery, it will only cut rates a little, given that it has a large reformer. Similarly, Shell Port Dickson is likely to cut rates marginally because it also has a reformer and a residue-cracking unit to meet gasoline deficits, although Shell is sensitive to refinery economics.

PSR-2 is highly complex and will not cut rates, although it is undergoing expansion to increase its crude distillation capacity by 30,000 b/d at the moment. PSR-2 has sizeable upgrading units that are underutilized due to its relatively small crude unit compared with the size of its upgrading units. In addition, PSR-2 is also able to keep its feedstock costs low by having Sudan’s acidic Dar Blend as part of its crude diet.

Because PSR-1 has just had lubes installed, it is unlikely to cut rates much. The refinery also has a large reformer to meet gasoline deficits.

Petronas’s Kerteh refinery will likely cut rates due to the petrochemicals downturn.

Philippines

Philippine refineries in 2008 were already running at a low 66% utilization, partly due to the cat cracker expansion in Petron. In 2009, refineries will increase their throughput to 72%, just enough to fill the upgrading units.

Petron Corp. is unlikely to cut too much because it just installed a new resid-cracking unit in 2008 and this year is installing an aromatic plant.

Singapore

With their cracking margins expected to fall sharply to a level last seen in 2001, export-oriented refineries in Singapore will have to cut crude runs sharply. They will likely only fill upgrading units.

Total crude runs in Singapore refineries will come down to around 910,000 b/d in 2009, from a high of 1.24 million b/d in 2008. Given a lower cracking margin and a negative hydroskimming margin, both ExxonMobil and Shell refineries will be forced to reduce utilization to around 50-60%. Their refineries have comparatively large crude distillation capacities compared with upgrading units.

Having a higher complexity, Singapore Refining Co. will have to cut but only to around 75-80% utilization.

Singapore’s refineries will continue to rely on both the domestic market and neighboring countries in Southeast Asia that are net deficit of oil products, particularly Indonesia, Malaysia, and Vietnam.

South Korea

Because Korea is a large product exporter, the impact of the crisis will be sharply felt. South Korean refiners will have to reduce throughput by close to 200,000 b/d in 2009 compared with 2008, which means they will run at about 84%. Incheon and Hyundai face the greatest cuts due to relatively low complexity.

In accordance with its respective complexity, the response of each refinery in South Korea will vary. SK Incheon has simple hydroskimming and may temporarily shut down a crude unit of around 60,000 b/d. S-Oil, in contrast, is highly upgraded but exports a lot of oil products. Instead of shutting down one of its crude units, therefore, SK will likely reduce crude throughput. Hyundai is very sensitive to margins. Until the company completes its planned resid and atmospheric resid distillation units, Hyundai will lower its crude throughput also in 2009.

Because SK Ulsan completed a 60,000-b/d resid unit in mid 2008 and GS Caltex just completed a large hydrocracking unit and lubes, they may largely maintain output.

Taiwan

FGE’s fall 2008 Databook projected Taiwan’s crude runs to be 955,000 b/d for 2008 and 970,000 b/d for 2009. The latest assessment for 2008 put crude runs averaging only 900,000 b/d. For 2009, crude runs will come down further, to 890,000 b/d. Drastic reductions in domestic demand and worsening refining margins in Asia-Pacific are the main reasons for the cuts in refining throughput.

CPC should be able to maintain its overall refining utilization at slightly more than 70% because state-owned CPC Corp. holds about three quarters of the domestic market. CPC exports only around 15% and 25%, respectively, of its gasoline and diesel output.

For the privately owned Formosa Petrochemical Corp., on the other hand, the impact of the slowdown is more severe. Formosa exports around 50% of its gasoline output and 85% of its diesel output and will consequently be more affected by the weak transport fuel export market this year. Utilization at Formosa’s 504,000-b/d refinery will remain at less than 70%.

Beyond 2009 will see a gradual recovery of the refining business in Taiwan in 2010. Net increase in crude runs, however, will be moderate through 2012. By 2015, if the new CPC refinery is operating, there will be a lift in Taiwan’s crude throughput. With a significantly lower demand, Taiwan is likely to remain a net product exporter throughout the forecast period by 2015.

Thailand

In 2009, Thailand’s refining sector faces the challenge of operating in an environment of flat to declining demand for all products except for LPG. The initial response of the refining sector is to export production surpluses into the region, which already has a surplus in petroleum products. Thailand will need to keep utilization low at 81%.

The global economic downturn might force Integrated Refining and Petrochemical Co. to shelve or defer its crude unit’s expansion. Having a less complex refinery that serves mainly downstream chemicals, the company may have to cut its crude runs by around 40,000 b/d.

In contrast, Thaioil is well upgraded and has a history of running at more than 100% of nameplate capacity. Thailoil may have to reduce its utilization slightly. Chevron’s refinery has upgrading plans also but is sensitive to economics. We expect it to reduce crude throughput.

In early 2009, Bangchak completed its long-awaited hydrocracker that will shift it close to maximum capacity. PTT Aromatics and Refining Public Co. Ltd. will bring its condensate splitter and aromatics complex on line during the downturn.

Vietnam

Dung Quat started up in February 2009 (OGJ Online, Feb. 27, 2009). The refinery will start up at around 30%, reaching full capacity by yearend 2009. Vietnam has sharply reduced its products import program in anticipation of lower demand and refinery startup.

Vietnam is product deficit and its refinery has a massive residue cracker and reformer. The assumption we made was that Dung Quat will run at maximum in second-half 2009.

Product balances

Despite the reduction in utilization, Asian crude throughput in 2009 and 2010 will still be higher than seen in 2008 due to the increased refining capacity coming on stream in 2009. The major changes to refinery capacity are in China and India. Tables 1 and 2 show calculations on product balances for China and India.

Click here to enlarge image

Between 2008 and 2010, China will reduce its import requirements by around two-thirds due to increased refining capacity and lower demand growth. China is adding 776,000 b/d of crude capacity in 2009, while its demand will grow by only 182,000 b/d. Despite a reduction in refinery utilization, China will still have more product output in 2009 and 2010, compared with 2008.

Click here to enlarge image

China will be self-sufficient in diesel, which is the aim of government planners. Import requirements for fuel oil will also be reduced from around 390,000 b/d in 2008 down to 310,000 b/d in 2009.

Despite a reduction in utilization, India will also increase its product exports in 2009 and 2010. India is adding 674,000 b/d of refining capacity, while its demand will increase by only 66,000 b/d in 2009. Because import requirements from Northwest Europe and the US are falling, India will have to export more petroleum products to the Middle East, Africa, Southern Europe, as well as Asia.

Implications

On average, Asia-Pacific refinery utilization in 2009 and 2010 will fall to levels last seen in 2002. For those refineries that operate where domestic demand can absorb the refinery output, however, the downturn in utilization will be less dramatic (Fig. 4).

Click here to enlarge image

Despite the current credit crisis, the future is not all gloom and doom: Demand for oil products, especially in the developing countries in Asia-Pacific, will increase. The regional demand for oil products will catch up again with the growing refining capacity.

On positive impact of the crisis lies in the reality check it has brought to the exuberance that led to some refiners to expand capacity at breakneck speed. Witnessing the drop in refinery margins, national oil companies, and private and local refiners have begun to rethink their growth strategies.

Furthermore, those refiners that are still gung-ho to expand for political, strategic, or whatever reasons may face difficulties in getting the necessary financing from banks that are more conservative in their lending practices.

Due to delays in refinery buildup beyond 2010 and the expected recovery in oil demand, existing refineries should expect a mild recovery in refining margins after 2010. Unfortunately, this window of improved margins may close as Middle East expansions come on line middecade.

The authors

Ibnu Bramono ([email protected]) is senior consultant and head of the product trade analysis team for FACTS Global Energy, Singapore. He holds an MEng in chemical engineering from Cornell University and an MBA in finance from Nanyang Technological University, Singapore. He previously worked for the Singapore Refining Co. Pte. Ltd. and PT Chandra Asri Petrochemical Center.

Praveen Kumar ([email protected]) is a senior consultant and head of the South Asia oil and gas team. He holds a PhD in materials science, an MSc (with distinction) in technology management, both from Queen Mary, University of London, and a bachelor’s in chemical engineering from the Institute of Chemical Technology, Mumbai.

Jit Yang Lim ([email protected]) is a senior consultant and head of the price analysis team for FACTS Global Energy, Singapore. He holds a PhD in economics, an MSc (with distinction) in operations research, an MBA as well as a Graduate Diploma in computer programming, and a BSc in mathematics. Before joining FGE, he worked for UTC Systems as an analyst programmer, joined Advanced Micro Devices, and then Goodyear Tire Co.

Kevin McConnachie ([email protected]) is principal consultant and head of the refining team for FACTS Global Energy, Singapore. He holds a master’s in applied finance and investment from the Securities Institute of Australia and a BS in chemical engineering (honors) from the University of Cape Town. Before joining FGE, he held various positions with Singapore Refining Co., BP, and UOP.

Vijay Mukherji ([email protected]) is a senior consultant and head of the Middle East/South Asia oil team of FACTS Global Energy, Singapore. He holds a degree in chemical engineering from the National University of Singapore and has held positions at Royal Dutch Shell PLC and Foster Wheeler and served as a process engineer for Shell Global Solutions.

Tomoko Hosoe ([email protected]) is a project specialist at the East-West Center, Honolulu. She holds a master’s in public affairs the School of Public and Environmental Affairs—Public Management—Indiana University.

Kang Wu ([email protected]) is a senior fellow at the East-West Center in Honolulu. He holds a PhD in economics from the University of Hawaii.