Growth through Energy Products

Petroleum Refining and retailing is the second link in Reliance's drive for growth and global leadership in the core energy and materials value chain. Reliance’s refinery, located in Jamnagar in Northwest India, has a capacity of 33 million tonnes per annum. It is the first refinery established by the private sector in India and is the third largest single location refinery in the world.

Industry overview and prospects

Demand was robust throughout the year even as crude prices climbed over $ 100 /bbl; despite the looming threat of global slowdown. OPEC’s reluctance to increase global oil supply and tightening of product specifications added pressure to an already stretched refining system. Rising costs and project delays continued to hamper growth in new refinery capacity additions. Complex refiners continued to gain due to wide light-heavy differentials and higher light product margins. High oil prices however put simple refining margins under pressure.

Prospects for the sector remain positive given the robust demand outlook and continuing delays as well as cancellation of several planned projects. Outlook for margins remains positive for complex refiners.

Resilient demand despite high oil prices

According to the International Monetary Fund (IMF) global economy grew by an estimated 4.9% in 2007 despite concerns of tighter financial market conditions, high oil prices and inflation. A key contributor to the positive growth trend remained the Asian region, with China and India registering an impressive 11.4% and 8.7% economic growth respectively. In addition, Middle East and CIS countries grew by 6% and 8.2% respectively.

In 2007, global demand for petroleum products grew to 86.0 million BPD from 84.9 million BPD in 2006. The demand came in stronger from the Non-OECD countries, driven primarily by China, Middle East and Latin America, as compared to the OECD nations where the demand was lower due to weaker economic activity, higher oil prices and mild weather conditions particularly in OECD Pacific. The economic expansion started showing signs of slowdown after a strong growth in the third quarter of the calendar year 2007.

IMF estimates the global growth to decelerate to 4.1% in 2008 due to financial strains originating in the US sub-prime sector and a continued slow growth in Europe and Japan.

Even with a potential of a slower economic expansion, the International Energy Agency (IEA) expects stronger growth in global demand for petroleum products and forecasts it to grow by 1.5% to 87.2 million BPD in 2008, driven mainly by demand growth centers of China, India, the Middle East and Africa, where the economic growth projections continue to remain robust. In the medium term, petroleum product demand is expected to clock a compounded annual growth rate of 2.2% during 2008 - 2012, as per projections of IEA Mid Term Outlook. IEA expects the petroleum product consumption to increase to 95.82 million BPD in 2012. Concerns of a tight crude oil market and supply disruptions will continue through the next year.

Transportation fuels driving the growth

Several populated economies are at threshold levels of per capita income, beyond which mobility and transportation fuel requirements tend to grow exponentially. Given this intrinsic linkage between the economy and mobility, the world is expected to undergo considerable shift in favor of lighter transportation fuels. Asia (led by India and China), Middle East and Africa have emerged as new economic centres and are expected to drive demand growth for petroleum products in the foreseeable future. This should call for matching growth in refining capacities in the region that are suitable for meeting growing transportation fuel demand.

In 2007, aggregate demand for transportation fuels comprising gasoline, diesel and jet kerosene grew by an average 1.2% against a decline of 0.1% for fuel oil. The trend of faster growth in transportation fuels is likely to continue. According to the World Refining and Fuel Service (HART Publishing), gasoline, diesel and jet kerosene are expected to grow at a compounded annual rate of 1.7%, 2.5% and 2.2% respectively till 2010. Growth in residual fuel oil is expected to be the least due to ongoing substitution with natural gas in power generation and heavy industrial applications.

Policy responses to high oil prices

Faced with the low prospect of oil prices easing in the absence of higher production, governments have reached a tipping point that forces them to address demand-side energy policy. The USA introduced its energy bill “Energy Independence and Security Act” which mandates the CAFE (Corporate Average Fuel Economy) to increase to 35 miles per gallon by 2020 from existing 22 miles per gallon for light trucks and 27.5 miles per gallon for cars. The Renewable Fuel Standard (RFS) sets annual requirements for the amount of renewable fuels produced and used in motor vehicles.

In addition to the USA, several large consuming countries have already come up or are in the process of formulating their own policies that revolve around efficiency improvements and mandating alternative fuels. The mandated bio-fuels would be blended with the petroleum products in varying quantities.

Greening of fuels

During the past two decades, global planners and related stakeholders have painstakingly worked towards making petroleum products cleaner and greener. The refining industry has also taken proactive steps in co-operating towards this global cause. A large portion of investments made in the refining industry are aimed at producing fuels with low sulphur content and cleaner burning in order to reduce emission levels.

In most of the major oil consuming countries like EU, Japan and some Asian countries, sulphur will be virtually eliminated from gasoline and diesel by the year 2009 with a mandated maximum content of 10 parts per million (ppm). The current standard is 15 ppm in the case of diesel and 30 ppm for gasoline in the United States, whereas the standard is 15 ppm for both in Canada. Gasoil is also being targeted, with Europe reducing the maximum limit on sulphur from 2000 ppm to 1000 ppm from January 2008. This ongoing trend will present new trade opportunities for global complex refiners like Reliance. The society at large stands to be the leading beneficiary of this trend.

Refinery capacity and utilization trends

During 2007, global refining capacity grew marginally, from 85.1 million barrels per day (BPD) to 85.3 million BPD. According to Oil & Gas Journal’s Worldwide Refinery Report, the rise in capacity was only through creep by few players. No refineries closed down in 2007, mainly due to high refining margins that made even the smallest plants profitable. This meager capacity rise resulted in additional pressure on the global refining system that was already stretched to operating rates of about 85.3%, which are amongst the highest levels witnessed in the last two decades. The average capacity utilization rates in 2007-08 for refineries in North America, Europe and Asia were at 86.2%, 83.9% and 85.7% respectively. This set the stage for continued strength in refining margins, well above historical averages, for two consecutive years of 2006 and 2007.

IEA estimates an additional global crude distillation capacity requirement of about 9.7 million BPD towards meeting the estimated global demand by 2012. Though several large capacity announcements have taken place in recent years, their progress has been slow on account of rising costs and manpower shortage. In an already stretched refining industry, it has raised concern over the ability to meet incremental demand growth and improved
prospects for refining margins, especially for complex refiners.

Gross Refining Margins

Refining margins witnessed significant volatility during the year. Margins peaked in the second quarter of the year due to high light product cracks and tightened product markets but dropped in the third quarter mainly due to increased crude prices and reduced cracks. In the fourth quarter, US Gulf Coast margins continued to decline due to weak gasoline cracks whereas Singapore complex margins increased on the strength of high jet fuel / kerosene and gas oil cracks

Refinery Gross margins ($ / bbl)

Margins for complex refineries continue to remain strong, supported by tightened product markets, strong margins for light products and unplanned outages by large refiners. However, margins for simple refiners dropped on the back of improved utilization, lower turnaround rate and fuel switching in China and US.

Reliance’s Jamnagar refinery achieved superior gross refining margins due to scale, complexity, higher yields, superior product mix and a wide crude slate.

Product margins remained healthy with crack spread for gasoline in Singapore averaging at $ 13.5 /bbl in 2007 as against $ 10.9 /bbl in 2006, while that of gas oil at $ 16.7 and $ 15.3 /bbl respectively. Fuel oil crack margins averaged at $ (-) 10.3 /bbl in the year 2007 against $ (-) 12.7 /bbl in 2006, leading to improved margins for simple refiners.

The medium term outlook for refining margins looks positive, due to robust growth in demand, stretched utilization levels and lagging new capacity buildup. Refining capacity bottlenecks are also unlikely to reduce prior to 2012 on account of project delays. In addition to supply-demand dynamics, refining margins are influenced by the cost efficiency in crude oil sourcing, manufacturing reliability, material evacuation infrastructure and the ability to produce transportation fuels.

Changes in product specifications are also leading to lower yields of clean products as the refiners reconfigure themselves in order to meet specifications. Complex refiners stand to gain from (i) higher premiums for ultra-clean fuels in the western markets and (ii) changing crude oil dynamics.

The complex configuration of Reliance’s refinery gives it the ability to process both heavy and sour crude. Incremental oil supplies through new discoveries are in the “challenged-category” and require unique capabilities for processing. These factors continue to support a high level of light-heavy differential and provide an advantage to complex refineries.

Crude price movements and outlook

Crude prices continued to rise and touched a new high, with the WTI peaking at $ 120 / bbl in April 2008. Spurt in crude prices were due to a combination of geopolitical events and unplanned outages of some of the oil production fields. The prices continued to hover at historically high levels with Brent, WTI and Dubai crude prices still averaging at $ 82.8, $ 81.6 and $ 76.5 /bbl for FY 2007-08. This reflected an increase of 29%, 26% and 25% respectively over the corresponding levels of FY 2006-07.

Demand for petroleum products in India

During the year, domestic demand for petroleum products increased from 111.7 million tonnes to 118.8 million tonnes - a growth of 6.3%. Transportation fuels grew faster at over 10%. The consumption of HSD (High Speed Diesel), which accounts for more than a third of the total consumption, grew at 11.1%. Growth in MS (Motor Spirit) was at 11.2% and that of ATF (Aviation Turbine Fuel) was at 14.1%. Demand for LPG (Liqueified Petroleum Gas) was up by 7.5% while sales of Naphtha and Kerosene declined by 14.8% and 0.6% respectively. Aggregate Indian refining capacity remained unchanged at 149 million tonnes.

Performance review

During FY 2007-08, the refinery processed 31.8 million tonnes of crude and had a high utilisation rate of 96.4%. The utilisation rate could have been higher but for the planned maintenance shutdown of one unit of crude distillation of the refinery in October 2007.

Production details of Reliance’s petroleum products are as follows:

For the year under review, average gross refining margin stood at $ 15 /bbl, reflecting a premium of $ 7.4 /bbl over the Singapore Crack Margins. Reliance’s consistent performance over the benchmark reflects the benefits of higher complexity, capability to process heavier / sour crude and produce superior product quality. Reliance’s refinery has particularly benefited from tightening of product specifications around the world and has been able to capture the ‘Clean and Green’ premium of supplying products to the most quality conscious markets across continents.

Petroleum products marketing

The Company has 1,432 retail outlets in India. Expansion plans of the network are affected primarily due to under-recoveries and an uneven level playing field for private players.

Aggregate export volumes of refined products grew by over 25% to 22.1 million tonnes from 17.7 million tonnes in the previous year. Exports account for 67% of aggregate refinery product volumes and export revenues were at $ 16.1 billion, reflecting a growth of 43% as compared to the previous year. For the very first time, Reliance’s refinery at Jamnagar exported high quality 50 ppm Ultra Low Sulphur Diesel to European markets. Asia accounted for 55% of overall exports; Europe accounted for 20% followed by Africa which accounted for 18% of the overall petroleum products exports.

During the year, Reliance took over majority control of Gulf Africa Petroleum Corporation (GAPCO). GAPCO owns and operates large storage terminal facilities and a retail distribution network in several East African countries. This acquisition is a strategic step for Reliance towards achieving its global vision in the petroleum downstream sector by integrating the entire value chain consisting of refining, shipping, trading, terminal and marketing through retail and wholesale segments.

After acquisition of GAPCO in August 2007 supply, infrastructure and retail network have been strengthened to achieve distribution efficiency, superior productivity and higher throughputs. Sales and cash profits have grown significantly under Reliance’s management.

The East African countries have seen rapid economic growth and demand for petroleum products. Import of petroleum products in these countries is also expected to rise in the near future and Reliance is now strategically positioned to capitalise these opportunities.

Reliance entered the high-growth aviation fuel segment this year and has presence at 14 airports in India.

Reliance plans to sharpen its focus on global markets for a significant part of petroleum products produced at the refinery. Towards this end, Reliance converted its Jamnagar complex as an Export Oriented Unit (EOU) in April 2007.