Although refinery margins are on an upswing currently, the risk of a downturn in the long term remains, says LK Gupta, director-finance, MRPL
How is the current gross refining margins (GRMs) situation? Given that several new refinery projects have been launched globally, how will the global benchmark GRMs behave in future?
Mangalore Refinery and Petrochemicals’ GRMs have been fluctuating between $4 and $8 per barrel during the last couple of quarters. We generally track the benchmark Singapore GRMs unless the gasoline cracks are very high, as Singapore refineries produce higher gasoline in their product mix.
Given the current global refining capacity of above 4,000 million tonnes per annum (mtpa), new additions of 200-250 mtpa in the next few years are not expected to have much negative impact on refining margins. Hence, going forward, I think the GRMs are likely to remain high compared to what they used to be in the past.
At what GRM levels will investment in a new refinery be justifiable?
In the past, refineries could work with GRMs at $2-3 per barrel levels. Over the past year or so, the cost of setting up a refinery has gone up substantially with a number of new refinery projects coming up globally. Today, to set up a 15-mtpa refinery, the capital cost will be around $5 billion, taking a conservative estimate. Assuming just 10% return on investment and 5% depreciation, it should generate at least $750 million at the EBIDTA level annually. This translates into refining margins of $6.8 per barrel. Hence, I feel that if in future, the GRMs fall below these levels, no new capacity addition will be feasible. Reliance Industries (RIL) commenced its refinery project just before this spurt in capital costs, which helped it to keep the cost low.
Refining is often termed as a cyclical industry. Currently, where does the global refining industry stand with regard to business cycles?
Currently, we are on an upswing in refinery GRMs. During ’00-03, the global refining industry was going through bad times. No investments were being made in this industry. At times, even the cost of crude oil and processing was not recovered from the selling price of petroleum products. Though the scene has improved in the past three years, the risk of a downturn in the long term remains.
How is MRPL’s capacity utilisation currently? Going forward, what will be the sustainable level of capacity utilisation?
Our nameplate capacity is 9.69 mtpa, but we are operating at around 12.5 mtpa currently. However, in running our refinery at higher capacity, at times, energy efficiency and product slate is not at the most optimal levels. Under the current expansion and upgradation plan, we will increase the sustainable capacity to 15 mtpa by ’10. Then we will benefit not only from higher production, but also from better yields and improved product mix.
What are MRPL’s current capex plans? How does the company plan to expand its refining capacity?
We have planned a capex of around Rs 8,000 crore for our refinery upgradationcum-expansion project, which will be financed through Rs 5,300 crore of debt and Rs 2,700 crore of internal accruals. The project includes an increase in the refining capacity from the existing 9.69 mtpa to 15 mtpa to be completed by ’10. The upgradation will increase the distillate yield by about 10%, eliminating the low-value black oils, and enable processing of higher quantities of cheaper sour and heavy crude oils. Once this upgradation project is completed, MRPL’s refinery complexity and refining margins will be comparable with the best refineries.
What is the current status of your plans to build refineries in Rajasthan and Kakinada?
For the Rajasthan refinery, we have conducted feasibility studies which reveal that without fiscal incentives, it won’t be economically sustainable. If we build this refinery, it will have to be primarily for exports. This is mainly due to the fact that no oil marketing company will buy from us, as their own refineries already exist in nearby states. Discussions with the state government are continuing. As regards the crude oil to be produced by Cairn, we are in discussions with Cairn for finalising the pricing. We understand that a pipeline is being set up to evacuate that crude oil to a western port location by Cairn and ONGC. As of now, MRPL is the government’s nominee for processing this crude. We are also talking to other PSU refineries. A detailed feasibility report (DFR) for a 15-mtpa refinery at Kakinada is being prepared by Engineers India. We will take a decision on implementation after receipt of the DFR.
What are the company’s plans with regard to expanding into the petrochemicals space?
The aromatic complex to produce valueadded products like paraxylene and benzene from surplus naphtha from MRPL is being set up by ONGC Mangalore Petrochemicals (OMPL), a separate special purpose vehicle company of ONGC and MRPL at Mangalore SEZ, with an estimated project cost of Rs 4,852 crore. ONGC will hold 46% of the equity, MRPL will hold 3% of the equity, while the balance 51% will be raised through IPO/strategic investments/product offtake. This project is expected to be completed by December ’10. We are also examining the feasibility of setting up an olefins complex at Mangalore.
How does the depreciating dollar affect your business? What is your take on the rupee-dollar exchange rate over the next two years?
We are a totally dollar-based company, i.e. crude purchases and product sales, both domestic or from/to international markets, are based on the US dollar. Hence, the depreciating dollar affects us mainly to the extent of our GRMs. Due to a depreciating dollar, our margins get impacted adversely when converted into rupees. Going forward, I don’t see the rupee depreciating against the dollar. From the macroeconomic perspective, the country is currently facing a trade deficit mainly due to petroleum imports. However, India’s dependence on import of petroleum products is expected to go down in the long term, given the inclusion of new oil and gas capacities. Gas production by RIL is scheduled to start in ’08, which is equivalent to almost 25 mtpa of crude oil. Similarly, Cairn India/ONGC’s Rajasthan field production of about 7.5 mtpa is likely to start in ’09. India’s exports of petroleum products will also move up significantly due to addition of fresh refining capacity in the next couple of years. A few sectors such as textiles are facing a decline in exports in the current scenario, but this may not pose a major challenge for the strengthening rupee. On the whole, the fundamentals indicate a strong rupee.
The Reserve Bank of India (RBI) has recently allowed domestic refiners to hedge the value of their inventories. How does that help?
RBI has recently come out with guidelines allowing oil companies to hedge their inventories against any substantial fall in prices. The industry operates on $5-7 per barrel margins and if crude oil prices fall suddenly in the global markets, oil companies’ profitability may take a severe hit if they’re stuck with a high-cost inventory. Oil companies can now hedge up to 50% of their average inventory of the previous quarter, which will help them to safeguard the value of their inventories.
How is the current gross refining margins (GRMs) situation? Given that several new refinery projects have been launched globally, how will the global benchmark GRMs behave in future?
Mangalore Refinery and Petrochemicals’ GRMs have been fluctuating between $4 and $8 per barrel during the last couple of quarters. We generally track the benchmark Singapore GRMs unless the gasoline cracks are very high, as Singapore refineries produce higher gasoline in their product mix.
Given the current global refining capacity of above 4,000 million tonnes per annum (mtpa), new additions of 200-250 mtpa in the next few years are not expected to have much negative impact on refining margins. Hence, going forward, I think the GRMs are likely to remain high compared to what they used to be in the past.
At what GRM levels will investment in a new refinery be justifiable?
In the past, refineries could work with GRMs at $2-3 per barrel levels. Over the past year or so, the cost of setting up a refinery has gone up substantially with a number of new refinery projects coming up globally. Today, to set up a 15-mtpa refinery, the capital cost will be around $5 billion, taking a conservative estimate. Assuming just 10% return on investment and 5% depreciation, it should generate at least $750 million at the EBIDTA level annually. This translates into refining margins of $6.8 per barrel. Hence, I feel that if in future, the GRMs fall below these levels, no new capacity addition will be feasible. Reliance Industries (RIL) commenced its refinery project just before this spurt in capital costs, which helped it to keep the cost low.
Refining is often termed as a cyclical industry. Currently, where does the global refining industry stand with regard to business cycles?
Currently, we are on an upswing in refinery GRMs. During ’00-03, the global refining industry was going through bad times. No investments were being made in this industry. At times, even the cost of crude oil and processing was not recovered from the selling price of petroleum products. Though the scene has improved in the past three years, the risk of a downturn in the long term remains.
How is MRPL’s capacity utilisation currently? Going forward, what will be the sustainable level of capacity utilisation?
Our nameplate capacity is 9.69 mtpa, but we are operating at around 12.5 mtpa currently. However, in running our refinery at higher capacity, at times, energy efficiency and product slate is not at the most optimal levels. Under the current expansion and upgradation plan, we will increase the sustainable capacity to 15 mtpa by ’10. Then we will benefit not only from higher production, but also from better yields and improved product mix.
What are MRPL’s current capex plans? How does the company plan to expand its refining capacity?
We have planned a capex of around Rs 8,000 crore for our refinery upgradationcum-expansion project, which will be financed through Rs 5,300 crore of debt and Rs 2,700 crore of internal accruals. The project includes an increase in the refining capacity from the existing 9.69 mtpa to 15 mtpa to be completed by ’10. The upgradation will increase the distillate yield by about 10%, eliminating the low-value black oils, and enable processing of higher quantities of cheaper sour and heavy crude oils. Once this upgradation project is completed, MRPL’s refinery complexity and refining margins will be comparable with the best refineries.
What is the current status of your plans to build refineries in Rajasthan and Kakinada?
For the Rajasthan refinery, we have conducted feasibility studies which reveal that without fiscal incentives, it won’t be economically sustainable. If we build this refinery, it will have to be primarily for exports. This is mainly due to the fact that no oil marketing company will buy from us, as their own refineries already exist in nearby states. Discussions with the state government are continuing. As regards the crude oil to be produced by Cairn, we are in discussions with Cairn for finalising the pricing. We understand that a pipeline is being set up to evacuate that crude oil to a western port location by Cairn and ONGC. As of now, MRPL is the government’s nominee for processing this crude. We are also talking to other PSU refineries. A detailed feasibility report (DFR) for a 15-mtpa refinery at Kakinada is being prepared by Engineers India. We will take a decision on implementation after receipt of the DFR.
What are the company’s plans with regard to expanding into the petrochemicals space?
The aromatic complex to produce valueadded products like paraxylene and benzene from surplus naphtha from MRPL is being set up by ONGC Mangalore Petrochemicals (OMPL), a separate special purpose vehicle company of ONGC and MRPL at Mangalore SEZ, with an estimated project cost of Rs 4,852 crore. ONGC will hold 46% of the equity, MRPL will hold 3% of the equity, while the balance 51% will be raised through IPO/strategic investments/product offtake. This project is expected to be completed by December ’10. We are also examining the feasibility of setting up an olefins complex at Mangalore.
How does the depreciating dollar affect your business? What is your take on the rupee-dollar exchange rate over the next two years?
We are a totally dollar-based company, i.e. crude purchases and product sales, both domestic or from/to international markets, are based on the US dollar. Hence, the depreciating dollar affects us mainly to the extent of our GRMs. Due to a depreciating dollar, our margins get impacted adversely when converted into rupees. Going forward, I don’t see the rupee depreciating against the dollar. From the macroeconomic perspective, the country is currently facing a trade deficit mainly due to petroleum imports. However, India’s dependence on import of petroleum products is expected to go down in the long term, given the inclusion of new oil and gas capacities. Gas production by RIL is scheduled to start in ’08, which is equivalent to almost 25 mtpa of crude oil. Similarly, Cairn India/ONGC’s Rajasthan field production of about 7.5 mtpa is likely to start in ’09. India’s exports of petroleum products will also move up significantly due to addition of fresh refining capacity in the next couple of years. A few sectors such as textiles are facing a decline in exports in the current scenario, but this may not pose a major challenge for the strengthening rupee. On the whole, the fundamentals indicate a strong rupee.
The Reserve Bank of India (RBI) has recently allowed domestic refiners to hedge the value of their inventories. How does that help?
RBI has recently come out with guidelines allowing oil companies to hedge their inventories against any substantial fall in prices. The industry operates on $5-7 per barrel margins and if crude oil prices fall suddenly in the global markets, oil companies’ profitability may take a severe hit if they’re stuck with a high-cost inventory. Oil companies can now hedge up to 50% of their average inventory of the previous quarter, which will help them to safeguard the value of their inventories.
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