Growth through Energy Products

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

A Year of Two Halves

Refining margins during the year witnessed extreme volatility globally. They remained healthy for the first half of the financial year due to booming middle distillate cracks. However, margins dropped significantly thereafter and lower demand resulting in weaker product cracks. Gasoline crack margins remained weak throughout the year due to low global demand, particularly in the US.

The year also witnessed unprecedented crude price volatility. Crude oil prices peaked during the first half of the year, with WTI touching $ 145.3 /bbl in July '08. The surge in demand from China, Middle East, Australia and Latin America and geopolitical events played a significant role in driving prices higher. What followed was plunging prices with WTI averaging at $51 /bbl in the second half of the year. This reflected a fall of 58% compared to the average for the first half of the fiscal.

In times of turmoil, what set RIL apart was the complexity and ability to maintain high operating rates. RIL altered the petroleum refining scenario in India by building the world's largest greenfield refinery The two Jamnagar refineries that the Company operates are not only among the largest in the world, but also among the most complex, with a combined average complexity of more than 12.0 on the Nelson Complexity Index. Following the merger, RIL is among the Top 10 private sector refining companies globally. It owns 25% of the world's most complex refining capacity. RIL has become the world's largest producer of ultra-clean fuels at a single location reaffirming the Company's ambition of enhancing lives of millions of Indians and tilting the energy balance in India's favour.

Global Industry Overview

The global petroleum market has been significantly affected since the summer of 2008 by the impact of earlier high prices, an economic slowdown and the credit crisis. As per the IEA, global petroleum product demand for 2008 declined by 0.2 MBPD. This was earlier projected to grow by approximately 2.0 MBPD.

The year 2008 witnessed unprecedented crude price volatility with prices peaking in the second quarter of FY 2008-09. The spurt in crude prices was due to a sudden surge in demand from China (pre-Olympics), Middle East (power generation), Australia and Latin America (gas outages) and combination of geopolitical events. In the third quarter of FY 2008-09, crude prices plunged to lower levels with WTI, Brent and Dubai averaging $ 59.1, $ 55.5 and $ 52.8 /bbl respectively, almost half of that of the previous quarter prices of $ 118.1, $ 115.1 and $ 113.6 / bbl respectively. The depressed price outlook for crude continued in Q4 FY 2008-09 with WTI, Brent and Dubai averaging further down to $ 43.2, $ 44.5 and $ 44.3 /bbl respectively.

Average Crude Oil Prices ($ / bbl)

Demand for Petroleum Products

For the first time since 1983, according to IEA, global demand for petroleum products contracted from 86.5 MBPD in 2007 to 86.3 MBPD in 2008, a decline of 0.3 %. Non-OECD countries, driven primarily by China, India, Middle East and Latin America, showed a demand growth of 1.4 MBPD for the same period. In contrast, demand in OECD countries shrunk by 1.6 MBPD.

Oil demand in 2009 is expected to fall by 2.4 MBPD to 83.9 MBPD, a decline of 2.7% from 2008, as per IEA. This decline is in addition to the reduction of 0.2 MBPD seen in 2008. Majority of the demand-decline is expected to come from OECD countries, while demand in non-OECD countries is expected to remain flat.

IEA forecasts global oil product demand to grow by 1.4% per year and reach 87.9 MBPD by 2013 reflecting an increase of 4.7 MBPD over 2009. Demand growth is expected mainly from non-OECD countries, with a growth of 5.2 MBPD during this period. Asia, Middle East and South America are expected to account more than 80% of growth in global demand during this period. In contrast, demand in OECD countries is expected to decline by 0.5 MBPD. Even with likely economic recovery from 2010, demand fundamentals are expected to remain modest in the medium term, as per the IEA forecast.

Diesel Demand

Diesel margins have been impacted by weak demand as a result of economic slowdown, sluggish industrial activity, capacity additions and growing distillate stocks. US distillate stocks are at their highest level in two decades, while the implied demand for distillates has declined 10% this year, which is much more severe than the 0.8% decline in US vehicle miles travelled. US vehicle miles travelled have been fairly resilient despite US gasoline demand being down 1.8% year-on-year and diesel demand also down. Many industrial companies have stated that recent performance was impacted by destocking among customers, as well as by weak demand. This has effectively exaggerated the drop in end-market demand, which should rebound once industrial destocking stops.

A major factor weighing on global diesel margins this year is the increased production capacity in India and China. Though short term economics weighs less on investment decisions than long term economics, global demand has been weak and margins have been below reinvestment levels. Much of the global refining capacity additions coming online in 2009 are located in Asia, with a significant proportion already operational, start-up dates for several refineries' have been pushed back. 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 too, China and India are expected to see the most significant increase in global market share.

Jet Fuel Demand

The sharp decline in international trade had a severe impact on the demand for air transport; jet fuel has been a drag on world oil demand for several months now. The airline industry consumes about 6.0% of the world's oil in the form of jet fuel. Physical exports of goods by major exporting countries around the world (Germany, Japan, Korea and Taiwan) declined at extraordinary rates last year resulting in a near-complete collapse in road, sea and air freight traffic.

Broadly, demand for jet fuel is linked to variables such as industrial production and GDP. Upward revisions to GDP growth for 2010 by international agencies suggests that demand could strengthen in the coming months.

In the medium term, structural drivers of demand could continue to undergo considerable change. Gasoil is expected to remain the growth engine followed by naphtha and gasoline. Residual fuel oil is expected to see the lowest growth due to continued substitution by natural gas in power generation and heavy industrial
applications.

Light products driving the growth

Demand for gasoline, which currently constitutes 25% of the world petroleum market, could see a slowdown from current levels. Growth in demand for gasoline is expected to primarily come from non-OECD countries while OECD countries are likely to show a reduction in demand. The reduction is more likely in the US as the impact of the US Energy Independence and Security Act of 2007 comes into force in 2011. Higher proportion of diesel cars is also likely to impact demand for gasoline in Europe. Japan is also projected to experience a reduction in gasoline demand as vehicle efficiencies improve. Increase in demand from non-OECD countries is expected to be underpinned by rapidly growing vehicle population in China, India, Brazil and other emerging markets.

Changing trends

High oil prices and unprecedented price volatility led to two energy shocks - the first for consumers and the second for producers. Since the last quarter of 2008, OPEC was faced with shrinking oil revenue after a fiveyear price boom. By January 2009, OPEC reduced its output target by 4.2 MBPD below the September 2008 level in order to stabilise declining crude prices.

In December 2007, US introduced the 'Energy Independence and Security Act' which mandates CAFÉ (Corporate Average Fuel Economy) to increase to 35.0 miles per gallon (MPG) by 2020 from existing 22.0 MPG for light trucks and 27.5 MPG for cars. The US administration recently announced the acceleration of the U.S motor fuel economy standards, increasing the CAFÉ target from approximately 26.0 MPG to 35.5 MPG by 2016. This advances the previous rule by four years.

Meanwhile, product specifications continue to become more stringent in several regions of the world. 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 mandated maximum content of 10 ppm. In USA, this is now 15 ppm for diesel and 30 ppm for gasoline whereas Canada already has a 15 ppm limit for both. Gasoil is also being targeted, with Europe reducing the maximum limit on sulphur from 2000 ppm to 1000 ppm from January 2008 and further to 50 ppm from January 2009. This continuing global trend of tightening of product specifications across regions may present new trade opportunities for global complex refiners like RIL, who have ultra-clean product capabilities.

Demand for Petroleum Products in India

Domestic demand for petroleum products increased during the year from 118.8 million tonnes to 124.1 million tonnes, reflecting a growth of 4.5% in FY 2008-09. The demand for transportation fuels like diesel and gasoline continues to grow with higher automobile sales, improved road network and overall economic activity.

Gross Refining Margins

Refining margins remained strong during the first half of the year on the back of stable volumes and rising middle distillate cracks. Refining margins came under pressure during the second half following a marked slowdown in demand that resulted in weak product cracks.

Gasoline cracks remained weak throughout the year due to low global demand. Crack spreads touched new highs for distillates whereas HSFO cracks touched new lows during first half of the year. In sharp contrast, cracks for distillates narrowed due to lower demand for products like diesel and jet kero in the second half of the year. For the year under review, RIL's gross refining margin (GRM) was $ 12.2 /bbl, a premium of $ 6.4 /bbl over the Singapore complex margin.

The medium term outlook for complex refining margins remains positive, as modest demand could potentially pressurise simple refiners to lower utilisation rates further. Expectations that many of the new projects are likely to be delayed puts strain on petroleum product supply thereby supporting margins. In the coming years, besides the supply-demand dynamics, refining margins could be significantly influenced by the cost efficiency of sourcing crude oil, manufacturing reliability, crude oil and product evacuation infrastructure and the ability to produce high quality transportation fuels. The complex configuration of both refineries, experience in global crude sourcing and product placement, technical capability to process heavy and sour crude and skilled manpower is likely to give RIL a unique advantage positioning it for top quartile margins in the industry.

Complex refiners like RIL could gain further from (i) higher premiums for ultra-clean products in the Western markets, arising from stringent product specifications and (ii) changing crude dynamics, resulting in wider Light- Heavy differentials.

Refinery Capacity and Utilization Trends

Growth in crude distillation capacity continued with refiners adding more capacity than the past two years, according to Oil & Gas Journal's world refinery survey. Refinery capacity increased from 85.3 MBPD to 85.6 MBPD. In the year 2008, the only new capacity to start operation was Sinopec's Quingdao refinery with a capacity of 0.2 MBPD. There was some creep capacity addition by players like Valero's Quebec facility, LG Caltex's Yosu and Nippon Oil's Oita.

Refiners all over the world are reducing operating rates following a drop in demand and lower margins. The average capacity utilisation rates in 2008 for refineries in North America, Europe and Asia were at 83.6%, 82.8% and 83.2% respectively as compared to 86.9%, 83.8% and 85.9% respectively for the year 2007.

Regional Operation Rate %

Source : ESAI

Global refining capacity is expected to increase by 1.8 MBPD in 2009, with Asia accounting for 80% of the increase, as per IEA. Forecasts for investments in the industry are to add 6.9 MBPD of crude distillation capacity between 2009 and 2013, which significantly outpaces expected demand growth. However, projects beyond 2009-2010 face the risk of getting cancelled or deferred due to credit crunch and weak economic outlook.

The ensuing supply overhang is likely to result in reduced refinery utilisation rates across the globe leading to capacity shutdowns at simple topping refineries.

Performance Review

The consolidation of RPL's refining assets with RIL's existing refining business gives RIL a capacity of 1.24 MBPD. What sets RIL apart in the context of global refining is the complexity of its refineries. RIL owns 25% of the world's most complex refining capacity. RIL has also become the world's largest producer of ultra-clean fuels at a single location.

Since inception of its refining business a decade ago, RIL has been able to outperform the benchmark Singapore complex refining margin.

RIL has been able to consistently outperform the Asian benchmark due to the complexity, which allows it to process heavy and sour crudes. RIL also has the proven ability to place products in Europe, Asia and the U.S. which has helped it capture the best net back.

RIL processed 32.0 million tonnes of crude and clocked an average utilisation of 97%, which is significantly higher than the average utilisation rates for refineries globally.

Exports of refined products were at $14.0 billion. This accounted for 21.0 million tonnes of product as compared to 22.1 million tonnes in the previous year.

Production of petroleum products (in KT)

RIL is increasing the competitiveness of the DTA refinery in order to improve crude processing flexibility, meet more stringent fuel specifications and improvement in yields and efficiencies. The coker heavy naphtha hydrotreater (CNHT) being set up will help produce downstream products like gasoline, paraxylene and orthoxylene from heavy naphtha. Additionally, the kerosene hydrotreater will help meet the dual requirement of higher ATF production and to produce ATF which can meet the changing stringent quality requirements, This will upgrade the quality of ATF and help realize higher premium apart from increasing the production capability.

Simultaneously, RIL also upgraded some of the existing facilities like the light naphtha unionfining unit (LNUU) and the fluidised catalytic cracking unit (FCCU). LNUU was upgraded to improve availability of captive feed stock for petrochemical units and to update the light naphtha. The FCCU was modernised to reduce the consumption of low sulphur waxy residue (LSWR) and to optimise the production of low-sulphur gasoline. Domestic Petroleum Marketing.

Domestic Petroleum Marketing

RIL's EOU refinery was converted to non-EOU status in April 2009 and sales of MS/HSD to PSU oil companies commenced from May 2009. To a limited extent, RIL has also restarted retail operations in southern and western states of the Country.

RIL forayed into petroleum retail in the year 2004 and made significant success achieving a market share of 14.3% in April 2006. However, RIL decided to suspend the operations due to rising crude prices and lack of a level playing field in the domestic market. While there has been no change in the pricing environment, falling crude and product prices have provided windows of profitable operations.

Aviation Turbine Fuel (ATF) demand has seen a dramatic fall with negative growth of 1.9% in FY 2008-09 as against ATF demand growth of 14.4 % in FY 2007-08. During FY 2008-09, passenger traffic reduced by 6.9% in India due to economic slowdown. This reduction in traffic has affected the demand for ATF in the Country. RIL entered this segment a few years ago and may expand its network with a view to addressing this growing segment.

The demand of petcoke in India is presently around 7 million tonnes per annum with Gujarat and Rajasthan accounting for 75% of domestic demand. Petcoke is used largely in the cement industry as a feedstock. Current demand in India exceeds overall production capacity despite the start-up of the coker at the new refinery at Jamnagar. During the year 2008-09, RIL sold a total of 3.18 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 various industrial units, the demand for petcoke is expected to increase.

Gulf Africa Petroleum Corporation (GAPCO)

RIL took majority control over GAPCO in 2007. GAPCO owns and operates large storage terminal facilities and a retail distribution network in several East African countries. This acquisition has enabled RIL to expand its footprint in the petroleum downstream sector. GAPCO consolidated its position in East Africa during the year. The terminals in Dar Es Salaam (Tanzania), Mombasa (Kenya) and depots in Uganda and Tanzania were fully operationalised, including commissioning of white oil facilities and rail/road loading facilities in Mombasa.

GAPCO emerged as the market leader in the retail segment in Tanzania and was also successful in winning several contracts for gas oil and jet kero in Kenya. Significant reductions were achieved in supply chain cost and the operations were integrated into the RIL system.

The new SEZ refinery at Jamnagar

RIL's new refinery in the Special Economic Zone at Jamnagar, is the world's sixth largest and has a Nelson Complexity Index of 14.0, making it the largest and most complex refinery globally. The refinery has a capacity of processing 580,000 barrels of crude oil per stream day (BPSD). In addition to size and complexity, the SEZ refinery has several advantages:

All key processing units, including the Fluidised Catalytic Cracking Unit (FCCU), Vacuum Gas Oil (VGO), Hydrogen Manufacturing Unit (HMU), Diesel Hydro De-Sulphurisation (DHDS), Propylene Recovery Unit (PRU), Coker unit and the Polypropylene complex are operating close to their respective design capacities. All the support units and utilities are fully operational and presently the refinery is operating at its design capacity.

The refinery has successfully processed more than 20 types of crude oils, including difficult crude oils within a few months of its start-up, thus reflecting superior quality of assets and capabilities. Exports have commenced to 26 countries, including to the US and Europe.

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

RIL's objective is to maximise the advantages of its high quality complex assets and realise the synergies of the combined operations of both refineries towards overcoming the ongoing challenges in the industry and
sustaining superior margins.

The Company's focus will be on sustaining high operating rates, improving efficiency and reducing operating costs. RIL can leverage the benefits of combined refining operations that can result in unprecedented level of product flexibility and swing capabilities.

From a marketing perspective, RIL aims to expand its global reach in order to ensure efficient product placement, maximise net backs and achieve premium for ultra-clean fuels. The continuing growth in India also presents an opportunity to enhance volumes.