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Do we need more refineries?, Rahul Prithiani, Director, CRISIL Research

Majority of the global oil and gas majors such as Exxon, BP, Shell, Chevron, etc, are reducing their focus on the refining business and are, in fact, scaling down their refining capacities either through sale of assets or mothballing due to very weak GRMs and changing environmental norms.

Global refiners recorded a very strong performance during 2003-07due to robust demand and high capacity utilisation rates. As a result, refiners globally announced significant capacity expansion plans during the same period. Many of these refining capacities got commissioned post 2008. In India too, the refining capacity rose to 213 million tonnes per annum (mtpa), increasing by nearly 40 per cent in the Eleventh Five-Year Plan (2007-08 to 2011-12). The capacity additions were led by the private sector, which contributed nearly 70 per cent of the incremental capacity. The expansion of the Public Sector Units (PSUs) was relatively slower as compared to the private sector. Major Indian private refiners like RIL and Essar Oil added large capacities to cater to the growing domestic demand and attractive export markets.As a result of these expansions, India’s refining surplus increased to 56 mtpaby March 31, 2012, from around 19 mtpa on March 31, 2007.

However, post 2008, the growth in global demand for petroleum products has fallen substantially, leading to erosion in refining margins. While domestic refiners are still tapping export markets to sell their excess production, demand growth in key export markets of the US and Europehas slowed down considerably.Moreover, the capital costs have doubled over the last 4-5 years. Given the weak demand and soaring capital cost, it is no longer feasible for these refiners to put up a new refinery or undertake any further capacity expansions in the present scenario. Hence, after a spate of capacity expansions in the Eleventh Five-Year Plan, the need for more refineries in India has dried up.

Refining margins narrow as capacity utilisation rates fall

Global capacity utilisation rates vs GRMs

Source: BP Statistics
USGC: US Gulf Coast

During 2002-07, the demand for petroleum products grew faster (CAGR of 1.9 per cent) than the supply (CAGR of 1 per cent). Global capacity utilisation rates increased to ~86 per cent in 2007 from 81 per cent in 2002, thereby resulting in stronger GRMs. In order to cater to the rising demand (both domestic and global), companies, mostly from the countries like India, China and Saudi Arabia, laid out refinery expansion plans.  Most of these capacities got commissioned between 2008 and 2011. Following the global economic downturn in 2008, the demand growth for petroleum products declined considerably. Weak demand, coupled with increasing supply, has forced global capacity utilisation rates back to 81-82 per cent. With slowing demand, the GRMs have dropped sharply and the returns from these new refineries have deteriorated significantly. Going forward too, we expect global refinery utilisation rates to remain at low levels of 81-82 per cent over the next 4-5 years, given the weak operating environment.

Cost of major refineries in India
Refinery Year of Commissioning Capacity (mtpa) Cost (Rs billion) Cost per tonne (Rs)
Bharat Petroleum Corporation Ltd, Bina 2010-11 6 120 20,000
Hindustan Petroleum Corporation Ltd, Bhatina 201112 9 189 21,000
Indian Oil Corporation, Paradip 2013-14 15 300 20,000

New refinery projects weighed down by high cost structure

Apart from low demand, returns have also declined due to high capital cost for the newly commissioned refineries. Over the last 4-5 years, the capital cost of setting up a new refinery has risen sharply, doubling from Rs 10,000 per tonne to around Rs 20,000 per tonne of annual capacity.The capital costs have risen sharply due to higher steel prices and increased technology licensing cost especially for the more complex refineries.

To fund their capital costs alone, these new refineries will need GRMs of at least $8-10 per barrel. Assuming $1-2 per barrel for operational costs, the new refineries will need GRMs of at least $10-11 per barrel in order to break even. As per our outlook on GRMs, the new refineries will find it tough to break even in the current environment and will fall short by $1-2 per barrel.

Refinery expansion plans of global oil and gas majors are slowing down

Aggregate capital expenditure by global oil and gas majors towards their refining business

Note: Companies considered include Exxon Mobil, BP PLC, Total SA, Chevron and Shell
Source: Company reports

Majority of the global oil and gas majors such as Exxon, BP, Shell, Chevron, etc, are reducing their focus on the refining business and are, in fact, scaling down their refining capacities either through sale of assets or mothballing – an indication of the worsening profitability in the refining business. Moreover, around 2 mbpd of refining capacities have already been shut down in the past 2 years, primarily in Europe and the US, due to very weak GRMs and changing environmental norms.

No need for capacity addition as refiners grapple with excess capacities, thin margins

Refining capacity in India

E: Estimated
Source: Company reports, Crisil Research

Given the already existing surplus refining capacity and pressure on GRMs globally, we expect the pace of capacity addition in India to slow down considerably. The surplus capacity was built in the past as the export markets offered attractive opportunities for refiners. Going forward, the refinery capacity additions are expected to grow at a meager rate of 2.5 per cent compounded annually to 245 mtpa in the Twelfth Five-Year Plan from a CAGR of 7.4 per cent during the Eleventh Five-Year Plan. This capacity addition would be supported by additions from PSU companies which conceptualised projects during the pre-2007 period, primarily focused towards feeding their marketing network.

Going forward, PSU refiners adding capacity are likely to cater to the incremental domestic demand resulting in increased dependence of the private sector refiners on the export markets. But, the demand growth in the export markets is expected to be tepid due to the weak economic environment and improving efficiencies in fuel consumption over the next 4-5 years. Given the weak operating scenario, private refiners will find it unviable to set up new refineries and sell their surplus in the export markets. This is evident in the fact that private players are no longer looking to expand their refining capacities. Even PSU refiners, who are expanding their capacities in order to feed their marketing network, are expected to go slow on their expansion plans.