“Slumdog Millionaire” – How Underdog Indian Private Sector Refiners Have Been the Surprising Winners in the Game of Refining

By: Ryan M. Couture and John R. Auers

Over the last few weeks we have taken a trip around the world, examining how efficiently refining projects are executed in different regions and the reasons for the differences.  In last week’s blog, we focused on Asia Pacific, a huge area with significant diversity in all aspects impacting refining dynamics. We looked at the contrasts between developing versus developed Asia, and how China, as the powerhouse of the developing nations, has dominated the region’s growth in recent years in both petroleum demand and refinery construction.  We purposefully left out India, both because of its emerging importance in downstream markets and the key differences in results refiners in that country have had in building and running refineries compared to refiners in other parts of world.  One major and important difference is that unlike in China, the country is not controlled by a central planning group that dictates the entire market.  Although there are controls, and the majority of refining capacity is state owned, those controls are being relaxed and there is a significant and growing private sector.  This has led to project concepts that are market driven, more efficient execution of those projects and better operations once those refineries are started up.  In fact projects sponsored by the Indian private refiners, Reliance and Essar, have rivaled those built in the U.S., a true “Slumdog Millionaire” story.

The Indian refining market is comprised of two parts, one consisting of various government owned entities and the other made up of two privately owned companies, Reliance and Essar.  For years, the price of fuel in India was regulated by the government, with fuel sold through oil marketing companies (OMCs) run by the state oil companies.  The OMCs receive subsidies to cover the cost of selling products at a loss; this subsidy comprised of payments from both the government and state owned upstream companies.   With this arrangement, state owned refiners would be compensated when they sold their products at a loss, however private refiners cannot sell directly to the Indian market and receive such compensation.  Private companies could sell their oil to the state run marketing companies based on an export parity formula, but this volume is only what is needed to bridge any demand shortfalls and is inconsistent.  This also means private refiners have to essentially depend on export markets for their production, and means they operate in markedly different ways, using different refining configurations and produce different product slates.  After the collapse in crude prices in 2008-2009, the government worked to deregulate prices of first gasoline in mid-2010 and then diesel by early 2015.  Today, gasoline and diesel are sold at market prices, but LPG, kerosene, and natural gas continue to be controlled.

“Ladies and gentlemen, what a player!”

While the markets for the state owned and private sectors are converging as deregulation has progressed, the legacy of the past has left the two industry segments in vastly different competitive positions.  State owned refiners in India are smaller, less complex, more costly to operate and produce lower quality fuels.  It is important to note that the fuel regulations in India lag behind that of other Western countries, with diesel at 350ppm and gasoline at 150ppm levels nationwide, and only select cities having a lower 50ppm level for both fuels.  Since many export markets now require ULSD in the 10-15ppm range, and gasoline in the 10-50ppm range, most of the production from India’s state owned plants isn’t directly exportable.  However, since the private refiners are “locked out” of the domestic markets, they have had to build facilities capable of producing those higher quality fuels.   Forced to compete in the free market, they have also had to build and run plants in more energy efficient ways, at lower costs and with the ability to run more difficult to refine crude oils.  The private firms were forced to compete, and much like the U.S. refiners (see “Better in the USA”), have become stronger and better for it.

And just like U.S. refineries, the plants operated by Reliance and Essar have truly become “lean, mean refining machines.”  The average size of the privately owned plants is over 350% larger than the state owned facilities (see Table 1 below).  Additionally, they are much more complex, having 65% of the cat cracking, 67% of the hydrocracking and 52% of the total coking capacity in the country, despite having only 37% of the total refining capacity.

Table 1 - India Refinery Overview

“This is our destiny”

At TM&C we are currently tracking 20+ potential projects in India with a capacity of over 2.7 million BPD and cost totaling nearly $73 billion.  Our analysis shows that well over 1/3rd of these projects are likely to be built, or about 1 million BPD in the next several years.  However, there is a strong potential for much more capacity to be added, as India has one of the fastest growing economies in the world.  The IEA has projected petroleum demand will grow from current levels of less than 4 million BPD to 10 million BPD by 2040, taking over the role as the biggest engine of global product demand growth from China.  This provides Indian refiners significant opportunities to expand from their current 4.3 million BPD of capacity, just to satisfy domestic demand.

Figure 1 - Demand Growth Sel Regions

A majority of the proposed projects today are with one of the several state owned oil companies.  All but two of the projects are expansions and upgrades of existing refineries.  As the regulations continue to progress towards clean fuels production, billions in investment will be required in the older, state owned refineries to bring them up to global standards.  Additionally, as markets become deregulated, the state owned companies will be forced to compete increasingly in the global marketplace and will need to not only meet the global fuel standards, but also improve energy efficiency and compete on economies of scale.

Both state owned and private companies have an array of projects on the table (which we outline in our Comprehensive Refining Construction Outlook).  A majority are incremental crude expansions and upgrades to existing refineries, but there are a couple grassroots refineries proposed.  While many of the projects are progressing, several have faced delays for a variety of reasons.  One of the largest projects facing delays has been the 108 thousand BPD grassroots refinery sponsored by Nagarjuna Oil Corporation Limited in Cuddalore.  This project, with an estimated cost of around $1.8 billion, was begun in 2010, but has faced a series of challenges.  Hit by a cyclone which did physical damage and also impacted by the global economic slowdown which hampered funding, the project has been sitting in financial limbo for the last few years sitting at around 50% completion.  NOCL continues to seek investors to fund completion of the project while trying to remain in control of the increasing costs.

There is one other significant proposed project, the announced expansion of the Reliance Jamnagar facility.  Already the largest refining complex in the world, this project, targeted for 2020 completion, would increase capacity by 400 MBPD, with much of that capable of running heavy crudes.  The $13 billion project will not only include processing units but also add five mooring points and other logistical infrastructure to allow for the required increases in crude imports and product exports.

“What the hell can a slumdog possibly know?”

Free market exposure for the private companies and subsidized protection for the state owned companies has only served to make the private companies stronger and the state companies weaker.  This is particularly telling in the results each of these sectors has had in executing refinery projects.

State owned IOCL completed their 254 thousand BPD grassroots refinery in Paradip in 2015, at a cost of $5.2 billion; a globally respectable $20,500/BBL.  The refinery is a modern facility designed to process both light and heavy crudes, with a Nelson complexity index of 12.1.  In late 2014 state owned MRPL completed a 100 thousand BPD expansion and upgrade to their existing Mangalore refinery.  Dubbed “Phase 3” the expansion allowed for heavy, high TAN crude processing as well as the addition of an FCC and coker.  The $1.8 billion expansion came in at $18,000/BBL, on par with other large-scale state owned refinery projects in the country.

When comparing this to the private sector projects in India, though, this is somewhat less impressive.  Reliance’s last expansion of their Jamnagar refinery set a standard for excellence in refining construction.  The $6.3 billion expansion which increased capacity by 580 thousand BPD was commissioned beginning in late-2008 and set a global benchmark of excellence for cost and execution at less than $10,000/BBL for a complex, integrated refinery.  As mentioned earlier, Reliance is planning to add significant capacity at Jamnagar, along with associated logistics assets.  The estimated cost will be higher than this, but it will be worth watching what the ultimate costs for refining assets come out to when the project is complete.

Reliance has proven to be a very adept operator as well.  The Jamnagar complex has been able to achieve operating utilization rates of 110% average for FY15, and well over 100% in the beginning of FY16.  When comparing this to other refining regions where much above 95% is considered rare, this is a significant achievement.

But Reliance is not the only private operator in India that has enjoyed success in building refineries.  Essar has operated its refinery in Vadinar since 2006.  Undergoing a series of expansions from 2009-2012, the capacity has doubled to 400 thousand BPD today.  The project cost $1.8 billion, coming in at about $9000/BBL and included not only expansions to the crude unit but a revamp to the FCC and SRU, as well as a new coker, hydrotreaters, isomerization unit and supporting units.

Essar’s execution and operation extends outside of just India.  In 2011, Essar purchased the Stanlow, UK refinery from Shell.  Since then, they have turned the refinery which was operating at around one third of its 210 thousand BPD capacity to 200 thousand BPD in FY16.  The refinery has worked to optimize both the crude slate and energy consumption, creating a single train refinery and shutting down lower profitability units, and managed to achieve a reported advantage of $3/BBL above the Northwest Europe benchmark gross refining margins.  Essar has invested hundreds of millions in the refinery thus far, and has plans to continue investing during the next major turnaround to continue to improve the sites competitive position.

“So are you ready for the final question for 20 million rupees?”

With India one of the fastest growing petroleum markets, the continued expansion of their refining industry is a certainty.  As regulations change and the government removes itself from controlling the petroleum product markets, the state owned refiners will be forced to adapt to the changing market.  At the same time, Reliance and Essar who are leaders in the art of low-cost refinery construction will be at an advantage as they can leverage their competitive positions to expand amid the growth that the markets will see.  Ultimately, India has the chance to become an even bigger force in the downstream industry, supplying not only rapidly growing domestic demand but also competing in the export markets with crude advantaged Middle East refineries and the super competitive U.S. refining system.

Turner, Mason & Company tracks projects around the globe as part of our monitoring and analysis of the national and international refining markets.  We incorporate this into our Crude & Condensate Outlook and Comprehensive Refining Construction Outlook products.  This summer, we are expanding our Comprehensive Refining Construction Outlook, providing additional detail and analysis of prospective refinery projects around the world and their impact on global crude and product markets.  For more information on these publications or any other specific consulting services that we may be able to provide, please feel free to contact us.