Petroleum Refining and Marketing :: Reliance Industries Limited.

Petroleum Refining and retailing is the second link in RIL's drive for growth and global leadership in the core energy and materials value chain. RIL has 1.24 million barrels per day (MBPD) of crude processing capacity, the largest at any single location in the world

With the commissioning of the new refinery in its Special Economic Zone (SEZ), Jamnagar has now become the petroleum hub of the world. With 1.24 Million Barrels Per Day (MBPD) of nominal crude processing capacity, it is the single largest refining complex in the world. This is equivalent to 1.6% of global capacity or one third of India’s capacity, and places RIL amongst the top ten private refiners globally.

The second refinery, of larger scale and complexity, was commissioned in a record time of 36 months despite the fact that it had to be executed under the most-challenging conditions of scarce availability of project execution resources due to overheated market conditions from 2005 to 2008. Building two of the largest and most complex refineries at the same location, in a decade, is unique in the world of global refining.

The SEZ refinery achieved a flawless start, and the entire complex at Jamnagar was synchronised in record time. All the processing units of the SEZ refinery were successfully commissioned and the facility operated in a stable manner. It achieved peak capacity utilisation rate of 120% during the year.

The new refinery has been designed to be more complex and flexible as compared to the first refinery. This enables the new refinery to capture more opportunities in value upgradation – from the bottom-of-the-barrel to highly value added products. The new refinery has the world’s largest Coker and Fluid Catalytic Cracker (FCC) plants. In addition, it also has the world’s largest alkylation unit.

This was undoubtedly one of the toughest years for the refining business globally. Refining margins dropped to their lowest in a decade. Weak demand, high level of inventories and high crude prices led to weakening of product cracks and refining margins across regions. The industry also witnessed a sharp reduction in refining runs and operating rates in addition to prolonged maintenance shutdowns and permanent closures. It was also a period that witnessed the highest ever annual decline in oil demand. Crude oil and product inventories were at the top end of 5 year average.

Improved economic outlook, positive industrial data and higher demand led to an improvement in refining margins globally in recent months.

There was a disproportionate impact on oil prices on the back of high demand. There was a quick recovery from the lows of $ 35/bbl in December 2008 to the high of $ 85/ bbl in April 2010; one of the highest rises in the last decade. The first half of the year saw crude price sharply increase from around $ 50/bbl to $ 70/bbl. Demand concerns, supply overhang and the strengthening of the US dollar resulted in subdued oil prices in the second half which remained range bound between $ 70/bbl and $ 80/bbl. Crude price closed at $ 80.7/bbl in March 2010, an increase of 66% on a y-o-y basis.

In this context, what set RIL apart was the complexity of its refineries, highly competitive operating costs and the ability to maintain high operating rate of over 100%. The Jamnagar refineries are among the largest in the world, and also the most complex, with an average complexity of over 12.0 on the Nelson Complexity Index. RIL is among the top 10 private refining companies globally and owns 25% of the world’s most complex refining capacity. RIL has also become the world’s largest producer of ultraclean fuels at a single location. This resulted in RIL delivering the best refining margin and achieving the highest operating rate of any large refining system globally.

The world oil demand in 2009 stood at 84.9 MBPD, a decline of 1.28 MBPD over 2008. As per the IEA, OECD demand in 2009 for oil fell by 4.4% to 45.5 MBPD on a y-o-y basis while the non-OECD demand rose by 2.1% to 39.5 MBPD. In January 2009, IEA had forecast world oil demand to contract by 0.51 MBPD to 85.3 MBPD whereas the actual decline was 1.28 MBPD.

OPEC responded and targeted a compliance of 80-85% to the production cut levels. However, some countries increased their production towards the end of the year resulting in the compliance level dropping to 55% by the end of the year.

The world witnessed low levels of industrial production and global trade. The economic downturn reduced light product demand and resulted in high light product stocks which have weighed on margins. Strategic stockpiling of crude by China, as well as companies playing the contango trade resulted in a recovery in crude demand and prices.

Light-heavy crude and product differentials have been compressed throughout 2009, resulting in much weaker complex refining margins. This has been driven by lower crude prices, reduced heavy crude production and an increase in upgrading capacity. Differentials are likely to remain muted in the medium term due to a lighter crude slate and increased upgrading capacity.

Arab light-heavy differential averaged around $ 1.72/bbl making fuel oil crack stronger than the previous year. While the global crude and petroleum product markets continue to tighten, the recovery is not even. Petroleum demand is growing stronger in Asia and other emerging markets as compared to those in the Atlantic basin. Moreover, demand for light, higher quality sweet crude is recovering faster than the demand for medium, heavy and sour crude.

Before the recession, when a lack of sophisticated refinery upgrading capacity boosted the demand for light crude oil, light-heavy crude oil spreads widened to record levels. But as the economic downturn reduced demand, PEC cut back output of medium-sour grades and new refinery upgrading capacity came on line in 2009. This combination resulted in a collapse of the spread between light and heavy grades. More recently, light-heavy spreads have widened as demand and utilisation rates have started to improve.

There are four main drivers that continue to support a trend for modestly wider light-heavy spreads in 2010. First, demand for gasoline and gas oil at the light end of the barrel is recovering. Secondly, high inventory level and lower demand for fuel oil in the cargo and bunker market is impacting heavy-sour crude. Third, as OPEC increases output to meet rising oil demand, supply of heavy-sour crude barrels has increased, putting downward pressure on prices and fourthly, temporary and permanent shutdowns at refineries due to both seasonal maintenance and low margins have reduced demand for heavy-sour crude.

As per IEA estimates in April 2010, the fall in OECD demand was largely attributed to Europe and North America. Oil demand in OECD Europe fell by 5.2% to 14.5 MBPD whereas demand in North America fell by 3.7% to 23.3 MBPD in 2009. On the contrary, demand in non-OECD markets remained resilient with Asia, including China and India growing at 5.1% to 18.5 MBPD. Demand in other non-OECD markets including Latin America, Middle East and Africa remained stable to marginally positive by 1.2% at 16.4 MBPD.

As per IEA estimates, world oil demand in 2010 is expected to rise to 86.60 MBPD, an increase of about 1.67 MBPD over 2009. Demand growth in non-OECD markets is expected to remain robust and is expected to rise by 1.78 MBPD, an increase of 2% to 41.24 MBPD. Asia, Middle East and South America are expected to account for over 83% of global demand growth.

USA’s gasoline consumption has declined by around 3% in 2008 and remained flat during 2009. The decline in US gasoline demand could be due to increase in passenger fleet’s fuel efficiency gain and high prices of gasoline during 2008. Loss in gasoline demand in the US demand also reflects the high unemployment rate and consumers’changing driving pattern. These trends are cyclical in nature and at least part of the demand loss could return under an improved economic environment wherein USA gasoline demand could grow 0.5-1.0% a year in 2010 and 2011. Although advanced bio-fuels using bio-waste or algae as feedstock, CNG vehicles, hydrogen fuel cells and electric cars all hold interesting promise, none of these technologies represent a real threat to the gasoline market over the next decade.

Equally important is the growth in demand for gasoline in the non-OECD markets, large parts of which are witnessing significant economic development and increase in personal vehicle growth in Asian, Latin American and Middle Eastern countries. There is strong correlation between the non-OECD gasoline demand growth and their GDP. As a result, worldwide gasoline consumption could increase by an average of 1.6% annually over the next 2 years.

Naphtha crack continues to dominate the South East Asian markets with increasing Chinese demand for naphtha crackers. With increased demand and a relatively low rate of refinery capacity utilisation, naphtha stocks have started to draw down across all OECD regions and are below the seasonal averages. As tighter supply and demand balance has driven down inventories, naphtha cracks have continued to appreciate in recent months.

A surge in petrochemical demand and a steeply backwardated naphtha market suggest that, in absence of major external shocks, a cyclical recovery for the broader economy is imminent. Historically, demand for naphtha, a key input into petrochemical processes, has led demand for other petroleum products.

Diesel margins were impacted by weak demand in 2009 as a result of economic slowdown, sluggish industrial activity, capacity additions and distillate stocks. Distillate stocks in North America are at their highest levels in two decades, while implied OECD distillate demand has contracted 6% in 2009.

The first half of the year showed stocking of middle distillates in anticipation of an economic recovery. However poor demand prevented draw downs, resulting in massive inventories and this impacted diesel cracks. Towards the end of the year, a colder than normal winter triggered inventory draw down and hence improving the cracks. Diesel demand in Asia Pacific, particularly India over specification changes from April 2010, helped push the diesel cracks in the region to double digits.

Diesel will be the growth fuel going forward, since most of the incremental demand is expected from non-OECD countries such as China and India. The importance of diesel and gas oil should not be underestimated, both in terms of refining profitability and the impact on oil prices.

While oil prices are driven by a variety of factors including strategic stockpiles, OPEC spare capacity and strength of the US dollar, it is clear that diesel demand is also a major driver of oil prices. Diesel/gas oil demand is likely to gradually recover in line with the global economy, but given the existing level of diesel production capacity and new capacity additions coming online globally, diesel margins could recover slowly.

China and India are the only countries that are set to grow distillation capacity and increase their global market share. In terms of upgrading capacity, it is China and India that should see the most significant increase in global market share.

As per IATA, passenger demand that fell by 2.9% in 2009 is expected to grow by 5.6% in 2010. Cargo demand, which fell by 11.1% in 2009, is expected to grow by 12.0% this year. A strong year-end recovery pushed load factors to record levels when adjusted for seasonality. By January 2010, the international passenger load factor was 75.9% while cargo utilisation was at 49.6%. On the other hand, tighter supply and demand conditions are expected to see yields improve 2.0% for passenger and 3.1% for cargo. Asia, Middle East and Latin America are driving the recovery followed by North America and Europe.

Global trade is recovering and with it, so are jet-kero margins which are now at cycle average levels. Economic activity in emerging economies and higher global industrial production is providing support to jet-kero demand. Industry estimates indicate that industrial production tends to have a stronger impact on jet-kero than on distillate demand. Once inventories come down to more normal levels, crack spreads could strengthen rapidly on the back of a sustained upturn in global manufacturing in 2010 and beyond.

Strong non-OECD oil demand growth and discipline regarding the ‘closed’ capacities remain critical to the sustained recovery of the refining cycle. While around 1.67 MBPD of global oil demand growth (largely non- OECD) is expected in 2010, about 1.0 MBPD of refining capacity is estimated to ramp up in 2010, almost qually spread over the four quarters. An estimated 1.43 MBPD of refining capacity has been permanently shutdown. However, some of this capacity could be resumed in the future as many of the sites have not been dismantled.

About 2.5 MBPD of refining capacity have been cited as potential closure candidates or been put up for sale. Most of these refineries are located in Europe, and are more likely to be sold than shut down due to non-commercial considerations.

While refining utilisation could show improvement, more meaningful improvement in utilisation rates is expected only in 2011, as oil demand grows further. Despite divergence in oil demand between OECD and non-OECD regions, it may be early to differentiate refinery outlook between geographies as the Asian refiners continue to export to the West. Surplus in new refining capacity will begin to get consumed by oil demand growth over the next two years.

While the refining sector is moving through a trough, without any of the closed capacities coming back into operation, strong global oil demand growth could pull refining into a sustained cyclical recovery from 2011 onwards. Additional capacity closures would auger well for the industry outlook in 2010 as well.

In the medium term, structural drivers of demand will continue to undergo change. Gas oil will continue to be the growth engine followed by naphtha and gasoline. Residual fuel oil is expected to grow the least due to continued substitution by natural gas in power generation and industrial applications. By 2015, demand for gas oil is expected to grow by 2.7 MBPD. The combined demand for naphtha and gasoline is slated to increase by 2.0 MBPD while demand for fuel oil is expected to grow by 0.4 MBPD.

Demand for gasoline, which currently constitutes 25% of the world petroleum market could see slow growth. The reduction in demand is more likely in USA due to the impact of regulatory changes that come into force in 2011. Higher penetration of diesel cars could also impact demand for gasoline in Europe. Japan could also experience a
reduction in gasoline demand as vehicle efficiency improves. Increase in demand from non-OECD countries will be underpinned by the rapidly growing vehicle population in China, India, Brazil and other emerging markets.

Demand for gasoline in USA is expected to shrink over the medium term primarily because of structural changes affected by the ‘Energy Independence and Security Act’ bill which was introduced in 2007. Another factor is the announced acceleration of the USA motor fuel economy standard that increases the Corporate Average Fuel Economy (CAFÉ) from approximately 26.0 Miles Per Gallon (MPG) to 35.5 MPG by 2016.

From 2009, the European Union (EU) has, in a phased manner, migrated to 10 Parts Per Million (PPM) sulphur gas oil. In addition, all ships entering EU ports from 2010 are required to use the fuels with a maximum level of 0.1% sulphur. This change has allowed modern refineries like RIL to place products in EU markets that have already implemented the changeover.

China is likely to switch over to lower sulphur transportation fuels in 2010 with mandated 150 PPM in gasoline (earlier limit of 500 PPM) and 150 PPM in diesel (earlier limit of 500 PPM).

In 2010, in a phased manner, India will also migrate towards using transport fuel that is compatible with Euro IV vehicle emission standards in 13 major cities, while the rest of the country will migrate to fuels that match Euro III specifications.

Meanwhile, product specifications have become more stringent in several regions of the world. In most of the major oil consuming regions like the EU, Japan and some Asian countries, sulphur is virtually eliminated from gasoline and diesel has maximum content of 10 PPM. In USA, this is now 15 PPM for transport diesel and 30 PPM for gasoline whereas Canada already has a 15 PPM limit for both. In USA, most of the off –road diesel will also be subject to the 15 PPM maximum limit for sulphur in 2010. Also the Emission Control Areas (ECAs) along the USA and Canadian coastline proposed sulphur dioxide (SOx) limitation in bunker fuel from current 15,000 PPM to 10,000 PPM starting July 2010. The European limit on sulphur in gas oil has also been reduced to 1000 PPM from January 2008. This continuing global trend of tightening of product specifications across regions will present new trade opportunities for global complex refiners like RIL, with its ultra-clean product capabilities.

In response to the global recession, China announced a stimulus plan that included $ 73 billion for refining and petrochemical industries. The funds were to be used not only to increase the amount of refining capacity but also to upgrade existing capacity to produce cleaner fuels. The stimulus funds were intended for projects that were already under construction or at advanced planning stages. This along with higher refinery run rates in China has added pressure on refineries in the OECD region thereby increasing the likelihood of further closures.

During the year, domestic demand for petroleum products increased from 124.1 million tonnes to 130.5 million tonnes, reflecting a growth of 5.1% in FY 2009-10. Indian refining capacity increased to 179.96 million tonnes from 177.9 million tonnes during the year.

Though signs of economic recovery supported crude prices steadily, poor demand for products kept the cracks lower than FY 2008-09 levels.

Gasoline cracks improved marginally by $ 0.2/bbl to $ 6.7/ bbl in FY 2009-10, while both jet-kero and gas oil cracks reduced by 67% individually to $ 7.9/bbl and $ 7.3/bbl respectively. Naphtha cracks improved from (-)$ 5.5/bbl to (-)$ 0.4/bbl while Fuel Oil (FO) cracks became stronger by $7.8/bbl to close at (-)$ 4.1/bbl.

Naphtha cracks recovered during the year due to increased demand from crackers in the Asia Pacific region. Demand for gasoline remained steady in Asia, led by China registering record growth in automobiles. Reduced air
travel and air cargo movements impacted the jet-kero cracks. Gas oil cracks were under pressure due to supply overhang on account of huge inventories of middle distillates. The situation improved from December 2009, first on the back of a spell of cold weather in the Northern Hemisphere and thereafter with improved demand. This helped drawdown inventories resulting in ongoing improvement in gas oil cracks. FO cracks remained strong throughout the year.

RIL’s Gross Refining Margin (GRM) for the year was at $ 6.6/bbl, a premium of $ 3.1/bbl over the Singapore complex margin and an ongoing outperformance of key global benchmarks.

Refinery Capacity and Utilisation Trends

Several refinery projects planned and under construction prior to the world recession have come online in 2008 and 2009. As per E.M.C., total new primary distillation capacity commissioned in these two years is over 4 MBPD, with most of them getting operational in 2009, located in Middle East and Asia.

With drop in demand and low refinery margins, refiners all over the world are reducing operating rates. The average capacity utilisation rates in FY 2009-10 for refineries in North America, Europe and Asia were at 81.2%, 75.8% and 82.0% as compared to 83.6%, 82.8% and 83.2% respectively.

Performance Review

The consolidation of Reliance Petroleum Limited’s refining assets with RIL’s existing refinery in Jamnagar gives RIL a capacity of 1.24 MBPD, which is about 1.6% of the world’s refining capacity.

What set RIL apart in the context of global refining is the complexity and the scale of its refineries. The two Jamnagar refineries that RIL operates are not only among the largest in the world, but also are the most complex, with an average complexity of more than 12.0 on the Nelson Complexity Index. Following the merger, RIL now owns 25% of the world’s most complex refining capacity and has become the world’s largest producer of ultra-clean fuels at a single location.

To support India’s strong growth with a drop in global demand, RIL surrendered the Export Orientated Unit (EOU) status for its 660,000 barrels per day refinery. This has maintained high utilisation.

Since inception a decade ago, RIL has been able to outperform the benchmark Singapore complex refining margin. Margins have been comparable with other complex refiners globally and significantly higher than refiners in China, where margins are regulated by the Government.

There are two ways in which RIL has been able to outperform the benchmark index. The complexity of the Jamnagar refineries allows the Company to process heavy and sour crude from all over the globe reducing its feed costs. RIL also has the ability to place products in the markets of Europe, Asia and USA to generate the best margins.

RIL processed 60.9 million tonnes of crude and clocked an average utilisation of 98.3%, significantly higher than the average utilisation rates for refineries globally. Exports of refined products were at $ 20.9 billion. This accounted for 32.8 million tonnes of product as compared to 22.6 million tonnes in the previous year.

Production of Petroleum Products [in Kilo Tonnes (KT)]

Product	FY 2009-10	FY 2008-09
Gases & distillates	51,400	28,000
Fuel oils and solids	9,400	4,450
Total production	60,800	32,450

Technology Development and Innovation

At RIL, a team of more than 100 engineers and scientists is driving various Research and Technology (R&T) efforts in the refining arena. Jamnagar refinery has set up a full scale FCC pilot plant for evaluation/selection of FCC catalysts and additives, along with the state-of-the-art laboratory/analytical facilities for advanced crude characterization, NMR /Infrared Spectroscopy, Inductively Coupled Plasma (ICP) analyzer etc.

R&T has been making extensive use of various advanced techniques like simulation, mathematical modeling, Computational Fluid Dynamics (CFD) modelling, and many others to support refining operations, improve product quality, optimise yield of high value products like propylene/LPG/gasoline from FCC unit and enhance bottom-of-the-barrel processing. Further to improve refinery margin, R&T has developed technology for processing heavy and high TAN opportunity crudes.

RIL’s SEZ Refinery

RIL commissioned its new refinery in the SEZ at Jamnagar. This refinery has the capacity to process 580,000 barrels of crude oil per stream day. The facility also has the capacity to produce 0.9 million tonnes of polypropylene per annum. The new refinery is the sixth largest in the world and has a Nelson Complexity Index of 14.0, making Jamnagar the largest and most complex refinery site in the world. This refinery has more than 40 process units apart from a large network of offsites, utilities and other Infrastructure facilities.

The SEZ refinery has a unique design and path breaking configuration with ‘Clean Fuels’ process plant. It is designed with high level of flexibility to change grades based on economy and to capture margins based on market dynamics. The new SEZ refinery is the first refinery in India to produce Euro-IV grades of gasoline and diesel. The refinery has been the first in India to produce large number of US grade gasoline such as R-BOB, RFG, US conventional, 95 Oxy-free and Ultra Low Sulphur Diesel (10 PPM Sulphur) which are being supplied to the US and European markets.

The new refinery has some of the world’s largest units:

The refinery complex is designed for total water conservation. It has its own desalination plant and carries out complete recycling of effluent with zero discharge. It has a state-of-the-art centralised control centre, laboratory, fire station and a large green belt. The green belt has been developed across the boundary of the refinery and has got 2.3 million trees and 0.8 million mangroves. It has over 1 million mango trees – probably the largest mango plantation in Asia.

It has been an exemplary, historical and a flawless start-up of a chain of plants in a safe, secure and an incident free manner. The activities were carried out in a seamless manner such that not even a single day was lost between construction completion and commissioning of the refinery. All units were commissioned in shortest possible time schedule in spite of the tight interdependencies between various units.

The refinery attained a significant milestone by fully stabilizing the operations in a record time. All its process units have successfully demonstrated their ability tooperate smoothly and safely, producing high quality transportation fuels. All key processing units at the refinery are operating at their peak design capacity. The refinery has successfully processed more than 60 types of crude oils, including difficult crude oils within a few months of its start-up, thus reflecting superior quality of assets and capabilities.

Viewed in the context of market conditions, this is a significant achievement and reflects RIL’s ability to produce and place high quality, value-added products in a challenging market environment.

Domestic Petroleum Marketing

Consistent high rate of growth over the past few years resulted in deficit of key petroleum products in the country. With planned introduction of Euro-III and Euro-IV grade of transportation fuels, these deficits are likely to increase going forward. RIL decided to convert its refinery from EOU to Domestic Tariff Area (DTA) to meet these domestic deficits and commenced supplies to PSU oil companies from May 2009.

With softening of crude and product prices last year, RIL restarted domestic petroleum retail operations in southern and western states. Domestic retail marketing however continues to suffer due to lack of level playing field to private oil marketing companies. Hence operations in all geographies and scaling up of sales would only be possible once prices are market determined or level playing field is brought for private players as well.

In February 2010, the Kirit Parikh committee made recommendations to the Government to allow free market pricing for gasoline and diesel, and to raise administered prices for kerosene and LPG. The report recommends raising LPG prices by Rs. 100 per cylinder and at least Rs. 6/litre for kerosene. It is yet to be seen whether any of these suggestions will be put into practice and what affect that will have on petroleum product demand in India.Any positive step by the Government along the lines of these recommendations will give a positive thrust to RIL’s retail business.

Aviation Turbine Fuel (ATF) demand has seen some stabilisation with a growth of 3.9% in FY 2009-10 as against negative growth of 1.9 % in FY 2008-09. RIL is present at 24 airports in India which collectively account for 30% of total ATF demand in the country. RIL is seeking to expand its network aggressively to have its presence at 30 airportswhich will cater to 95% of total civilian air traffic demand.

The demand for petcoke in India is presently about 8 million tonnes p.a. with Gujarat and Rajasthan accounting for about 75% of the domestic demand. Current demand in the country exceeds overall production capacity despite the commissioning of the Coker at the new refinery in Jamnagar. During FY 2009-10, RIL sold a total of 5.34 million tonnes of petcoke. With the commissioning of new capacities in the cement industry as well as the setting up of captive power plants by several major industrial units, the demand for petcoke is set to increase.

The annual sulphur demand of 3.4 million tonnes in India is met from domestic production as well as imports. RIL Jamnagar production of 0.85 million tonnes in FY 2009-10 was sold primarily in domestic market supplemented by some exports. The fertilizer sector consumes sulphur in various forms and the demand for elemental sulphur in this sector, particularly from Single Super Phosphates (SSP) is likely to increase due to the encouraging Nutrient Based Subsidy (NBS) policy announced by the Government that has introduced subsidy for sulphur as a nutrient in fertilizers to improve the sulphur deficiency in the soil.

GAPCO

RIL consolidated the operations of its GAPCO subsidiaries in East Africa. GAPCO owns and operates large storage facilities and has a retail distribution network in several countries including Tanzania, Uganda and Kenya. It owns and operates large coastal storage terminals in Dar-e-Salaam (Tanzania), Mombasa (Kenya) and an inland terminal at Kampala (Uganda) besides having well located depots in East Africa. It also has a well located network of retail outlets in Tanzania, Uganda and Rwanda.

Special initiatives to improve the supply infrastructure and sales volumes have led to superior productivity and higher throughputs. The Mombasa terminal has been augmented to receive Premium Motor Spirit (PMS), thus enabling GAPCO Kenya to make a combined diesel and petrol offering to the retail and independent sectors in Kenya.

GAPCO is also emerging as a key supplier to neighbouring countries and has signed a term contract for supplies to Zambia from its Dar-e-Salaam terminal in Tanzania.