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India has a slight surplus in petroleum refining today with installed capacity of 126 million tones a year as opposed to the demand of 111.7 million tones a year (roughly 2.5 million barrels a day processing capacity- mbd). The surplus has been exported in last two years. Worldwide there is a huge demand for the refined petroleum products, especially the middle distillates – gasoline, jet fuel, diesel etc., but capacity to deliver the refined products has been lacking behind demand. The latter came to a sharp focus with the rise of crude oil prices in last one year (from about $ 35 a barrel to current $65 a barrel) and during the hurricanes Katrina and Rita in the US Gulf Coast. Although refining capacity had not been a public issue in last 25 years in US, lack of capacity drove up the prices when the hurricanes shut down the refineries. All over the World, national economies in past 50 years have been built on the availability of cheap crude oil and downstream products. Today, China and India are competing with the developed West for oil. Both of these developing economies have their back to the wall. Expensive oil is seriously denting their economic development and exports. Other developing countries suffer from a double whammy i.e. crude oil is expensive and refining capacity to refine into primary, secondary and tertiary products does not exist. China in last 20 years has gone from a net crude exporter to a net large importer. They have one satisfaction i.e. they have enough refining capacity to refine both internally and externally procured crude. India is also very much in the same state. Although India’s crude demand is half of China, yet it has adequate refining capacity. The same is not true for the other Indian Ocean Littoral states (excluding the Gulf region). Pakistan suffers from perpetual shortage of petroleum products. So do other countries in the region. Major economies like Japan, South Korea and at times China import petroleum products from the open market to relieve spot shortages. Hence it makes sense for India to become a refining hub. Crude oil is expensive but it will continue to be the basis of national prosperity for the next 40 to 50 years. Hence this opportunity i.e. to become a merchant refiner for Asia cannot be allowed to slip by. India has the infrastructure to build and operate enhanced refining capacity. Also India’s west coast is not far away from the main crude oil producing centers of Persian Gulf. This is an advantage, which will reduce the transportation costs.

India has to Duplicate the US Gulf Coast Refining Hub

There are 34 refineries, which dot the US Gulf regions from Mississippi to Texas. 50% of US oil is produced and refined in this region. Pipelines carry the products three thousand miles away to New York and Chicago’s industrial hub. There is something learn here. US Gulf Coast oil boom became a reality with the discovery of oil in Texas in thirties. Later more oil was found in the shallows of the Gulf Coast. Hence a huge refining infrastructure was built around the oil discovered. At times, there was a refining overcapacity. Since there were no takers for the refined products in the vicinity, the Gulf region refineries operated at about 80% of the capacity. Today it is different. Demand has caught up with the supply and there is a shortage of refining capacity. But that is a local US issue. Soon it will be redressed. For India there is something to learn i.e. build an infrastructure like the US on the Gujarat coast to refine and distribute petroleum products to the rest of Indian Ocean states. In order to keep the costs down, use the existing or expanded maintenance and operations infrastructure. When fully operational it becomes an efficient means for uninterrupted product distribution. Already the region is a hub for refining and distribution for internal supply (Jamnagar). Geographically the coast is ideally situated on the major crude oil shipping route to the East and Pacific region. A concerted effort to develop refineries for export could go a long way to supply the region with the value added finished products instead of transporting crude and building expensive refineries in every country. There is an additional advantage i.e. sea in the vicinity is deep; hence large ships could be berthed for incoming and outgoing traffic.

What is the Current Status of Refining In India?

There are 18 refineries in India operating both in public and private sector with a total capacity of 2.5 mbd (million barrels per day). Reliance refinery at Jamnagar is the biggest. As a matter of fact this refinery is the fourth largest in the world. After expansion in four years, this refinery will process 1.2 million Barrels a day. The smallest refinery is in Guwahati, Assam with 0.1 million barrels a day capacity. Other refineries are medium sized with high cost of production and are spread all over the country to facilitate distribution. Reliance of its own is not a petroleum marketing organization. It supplies the marketing network of Bharat Petroleum, Indian Oil, Hindustan and others. With huge capacity and concentrated effort in refining only, the company is a low cost producer. Essar in Jamnagar is also in the same position. Its refining capacity is not as big as Reliance, but at about 0.7 million barrels a day, it is close behind. This location together with all existing refineries is sufficient to meet India’s demand. A 10% surplus is exported out. In the current year, statistics indicate that about 0.15 mbd of petroleum products were exported. The value added contents of exports earn about $3 to 4 per barrel margin. This is a significant hard cash earned from the existing infrastructure. What gives India the edge is its lower crude shipping cost and lower labor costs.

In four years, India’s demand will boost to about 3.2 mbp. The capacity at that time is expected to be about 3.6 mbd. This will allow the country to export about 0.4 mbd of the petroleum products. It is a significant boost to the county’s value added exports (diamond cutting and polishing industry operates on a similar value added structure, although at a bit higher margins).

Economics of Refining and Export

Economics of a large export oriented refinery is a complex mixture of product up-gradation, shipping costs, type of crude processed, local labor costs, capital involved, taxes etc. The crude oil has a direct impact but its cost is passed on to the buyer directly. A well-run refinery generates about $ 8 to $16 margin per barrel of crude processed (Singapore is the key example). Indian refineries have the margin at about half the above amount, primarily due to all the above factors except the shipping costs. Downstream product mix and capability to switch between product mix at the manufacturing site is the dominant factor, which enhances or reduces the margin. Hence if export oriented refining capacity is to be built then it has to have a flexible production capability. These days, gasoline and aviation fuel prices have surged far ahead of others, due to supply shortage. At other times it is the fuel rich products, which may be the dominant need. An export-oriented refinery has to be able to deliver either of the product mix without a serious disruption.

A brown field refinery in around Jamnagar may cost about 15% less to build. A 1.0 mbp refinery at a brown field site today will cost about $ 2.5 to $3.0 Billion. This is a very large capital investment. Indian interests alone cannot undertake it. FDI (Foreign Direct Investment) and imported technology will play an important role. Already Government of India under the leadership of its Petroleum Minister has initiated studies to investigate all possibilities. Surprisingly external interests in setting up exported oriented refineries have been well developed. Shell Global and BP are the primary candidates. They may also participate financially in these ventures. For external interests to participate, it is important that India offer them incentives, tax breaks and a welcome mat.

Smaller refineries farther from coast can be expanded to meet the local demand with internal resources.

Future of this business for India

If India is to be an exporter then export oriented refineries are to be built immediately. Current export orders, to develop the supply chain can be met from the existing refineries. But a serious effort to become an exporter will require a serious rethink on the part of Government of India. All impediments to this business will have to be removed. A green field refinery on Gujarat coast will cost about $3 Billion. It will earn its investment back in about five years. This is a good return, which should interest a lot of investors. Hence with financing available these large projects should be on the same priority as the rest of the infrastructure modernization in India. Moreover, India’s capital involvement will be low as external interests are financing the expansion. India will be sharing the benefits, just like China where FDI has created a manufacturing export heaven.

In all GOI has planned five new refineries. Of them, Jamanagar on the west coast and Pardeep on the east coast are likely be export oriented. Others will supply the local demand.

Nuclear Energy as opposed to Fossil Fuel

India voted for Nuclear Energy at Vienna last month when it voted against Iran at the IAEA meet. Hence the Iran – India gas pipeline is on a hold. It could regain life should the US Congress refuse to back President Bush in his effort to put India at par with other nuclear nations to share the nuclear technology. The piped gas if the pipeline becomes a reality will generate power and supply thermal energy to the industry and homes. Crude is still needed to drive the other components of the economy, which cannot use gas in place of petroleum products like the transportation sector or the military preparedness or the current jet travel. If India’s civilian nuclear ambitions fail then a gas pipeline from Iran is a sure bet? A crude oil pipeline could follow the gas pipeline. Iran has plenty of both. For exports, the crude oil pipeline could be sized to meet India’s internal as well as external needs. The shipping cost of crude by pipeline will be halved, giving Indian refiners a definite cost advantage. In any case whether crude arrives at the refinery by ship or by a pipeline is immaterial. It is the requirement of the finished petroleum products in the region, which will drive the growth of this sector.

Competitive Advantage

If a medium sized 1 mbd refinery is built elsewhere in the region (Gawadar in Pakistan or in Thailand), it will cost about 30% more, because these locations lack the infrastructure not only to refine crude but also to deliver it to the markets. Factors like these give India a definitive capital cost advantage. A.T. Kearney in its report highlighted that cheap labor; simultaneous engineering and local sourcing of supplies are definite pluses for India. Places like Gawadar, although closer to the source of crude, have a definite disadvantage as the local consumption center is far away in West Punjab and Karachi and for exports a much larger infrastructure is needed at location which will cost billions and 10 to 12 years to build. The latter will eat up the margin rendering it to the lower end of profitability. In all India has something positive going for itself.

In short an opportunity has emerged for India, all effort has to be made to take a full advantage of this.

Hari Sud

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