By John Mayes and John Auers
Last year (May 10, 2016) we wrote a blog describing the success that Indian private refiners Reliance and Essar have had in building and operating large, complex refineries. This success truly has been exceptional, especially compared to the track record of refiners in most other developing countries. In several recent blogs we have noted these failures and the positive impact that has had on the ability of U.S. refiners to dramatically increase refined product exports. In contrast, India, led by the mega-refinery projects, efficiently constructed and subsequently operated at very high utilization rates, has become a major player in global product markets. Indian refining capacity has increased by 55% in the last decade and despite meager oil production and growing domestic demand, has become the third largest net exporter of refined product in the world. It hasn’t only been the private refiners that have participated in this development, as India’s government-owned refiners have also added capacity, although not with quite the same success as Reliance and Essar, but their contribution to the Indian refining renaissance could take a major leap forward if the recently announced mega-mega project in the state of Maharashtra comes to fruition. In today’s blog, we discuss that project and put into context why it should be taken very seriously and not discounted like Jamal (the “slumdog” character) was in the movie, solely because of his humble background.
“Let’s Play Who Wants to be a Millionaire” – Or Rather, “Who Wants to Build a Million+ BPD refinery?”
Three government-owned oil companies, Indian Oil Corp. Ltd. (IOCL), Bharat Petroleum Corp. Ltd. (BPCL), and Hindustan Petroleum Corp. (HPCL) have recently entered into an agreement to construct an unprecedented 1.2 million BPD refinery/petrochemical complex in the state of Maharashtra. This would be the single largest refinery in the world. Reliance Industries Ltd. already operates a similar-sized complex in Jamnagar in the form of two distinct refineries completed in 1999 and 2008. Their competitor, Essar Oil, Ltd., operates a 400 MBPD refinery in nearby Vadinar and as noted earlier, Reliance and Essar are both privately owned entities.
The new refinery is proposed to be built in phases at an estimated total cost between $30 billion and $40 billion. While the government-owned companies will provide the primary ownership, the consortium is intending to bring in additional partners. An official associated with the venture has stated,
“The primary structure has been formed and we have offered the refinery to Saudi Aramco as a prospective partner.”
The venture is already running into problems, however, because of its sheer size. The JV is seeking a parcel size of 12,000 to 15,000 acres. This is proving difficult, and the state of Maharashtra is urging the group to reduce its land requirements. The first phase of the complex will include crude-processing of around 800 MBPD, a naphtha cracker, and aromatics and polymer units which are to be completed around five to six years after land acquisition.
“It’s Getting Hot in Here” – Refinery Construction Cost Overruns
Costs overruns are common in the construction of refineries around the world. This tends to be particularly true in regards to the construction of government-owned facilities, which are often plagued by substantive graft and corruption. Even with privately owned projects, costs overruns frequently occur as a result of the myriad of problems and issues which are often not anticipated during the design phase. A 1.2 million BPD mega-refinery could easily become the poster child for unanticipated costs, but again, this is in India which has a history of constructing refineries at very competitive costs and in an efficient manner.
In 1999, the first Reliance refinery (660 MBPD) was built at a cost of $6 billion. This equated to slightly under $9,100 per barrel of crude-processing capacity. The second phase (580 MBPD) was completed in 2008, also costing $6 billion which was equivalent to about $10,300 per barrel of crude-processing capacity. The first phase of the Essar Vadinar refinery was constructed in 2006 (205 MBPD initially) at a cost of $10,400 per barrel. All of these projects compare very well with similar projects around the world (Figure 1).
The three Indian refineries are shown in red and are substantively below other global historical and planned projects (in blue). The Maharashtra refinery is shown in yellow and is based on a $30 billion cost. At $40 billion, the relative cost would rise to over $33,300 per barrel of crude processing capacity. It should be noted that the Reliance and Essar refineries were constructed by private companies where the control of costs are likely to be aggressive while the Maharashtra facility will be government-owned. As a result, the low cost structure of the Reliance and Essar facilities may not be a good indicator of the Maharashtra costs.
“I Hope You Sing Better Than You Dance” – Operating Can be Just as Difficult as Building
While it is critically important to control construction costs, it is equally important to demonstrate an ability to maximize the use of assets after the project completion. In this regard India also excels (Figure 2).
While operating rates are in the 80%-90% range throughout most of the developed world, throughput rates in India were at 107% of reported capacities in 2016. This indicates crude rates are aggressively pushed to the highest possible levels to achieve the maximum levels of optimization. Utilization rates around 90% were reported ten years ago which is a reasonable indicator of current levels using more realistic operating capacities.
Much lower utilization rates, however, are seen in developing economies. These lower rates tend to retard future refinery construction by depressing expected monetary returns. Conversely, high historical rates in India bode well for the Maharashtra refinery by demonstrating to lenders and prospective partners an ability to extract the maximum returns for the capital employed.
“And the Winner is ______”
At 1.2 million BPD, if the proposed Maharashtra refinery does get completed (in whole or in part), it will certainly have a major impact on global refined product balances. Global petroleum demand is expected to increase by about one million BPD per year (plus or minus), meaning this refinery could solely supply the world growth for over 14 months. The facility would also dramatically increase India’s product export capabilities and solidify western India as one of the dominant refining centers of the world.
The recent track record for construction costs (for privately owned refineries) bodes well for the new facility. Whether this can be translated into minimizing construction costs for a government-owned plant remains to be seen. Equally supportive, is the history of excellent operating rates which will provide confidence to lenders and potential partners. With this proven track record, the Maharashtra refinery is likely to be a force to be reckoned with, if and when, it is built.
Refinery capacity additions and modifications have a major impact on both crude and product supply and as a result on crude differentials and refining margins. Turner, Mason & Company continuously tracks the progress of refinery projects around the world, both grassroots and expansions of existing facilities. We include an analysis of this effort in both our Crude and Refined Products Outlook (C&RPO) and our World Refinery Construction Outlook (WRCO). Both of these studies are issued on a semiannual basis, with the next edition of each due at the end of July. The WRCO includes a comprehensive project list of every minimally legitimate project announced, while the C&RPO focuses on the projects we feel are most likely to be constructed over the next five years. In both publications, each project is listed by region and ranked based on its probability of success. Details are provided on the impacts on crude balances (by type) and product supplied (by category) that each of the projects can be expected to effect. In the WRCO, a detailed discussion of the regional factors and trends that are affecting refinery construction activity is also provided. The C&RPO uses the impact analysis as key inputs to both crude and product price forecasts, detailed versions of which are provided on a global and regional basis. If you would like more information on either of these products, or for any specific consulting engagements with which we may be able to assist, please go to our website, send us an email or give us a call.