Ajay Modi: Refineries and the boon of over-capacity

India’s petroleum sector may be consumed by debates over the costs of imported fuel, but there is one section of the industry that has reason to cheer rising global oil prices: refineries.

As an increasingly green-conscious western world starts closing old, polluting refineries, developed countries like India and China are seeing a rapid expansion of capacity and, with it, forex-earning potential. Indeed, India currently enjoys a surplus of refining capacity of about 70 million tonnes, a figure that has steadily increased since the year 2000.

The country currently has 22 refineries with a total capacity of 213 million tonnes. By 2017, the country will add another 97 million tonnes, taking total refining capacity to 310 million tonnes. Additions are expected from IndianOil (15 million tonnes at Paradip, another project of similar capacity project is being considered along the western coast, an addition of 4 million tonnes in Koyali and 3 million tonnes in Mathura), Nagarjuna Oil (6 million tonnes at Cuddalore), and private sector Essar Oil (2 million tonnes at Vadinar), among others.
 

Considering an annual growth of six to seven per cent to the domestic demand base of 148 million tonnes, the country will be requiring an additional 9 million tonnes annually every year — leaving plenty of refining capacity to spare.

But unlike other industries, no one is dismayed by this over-capacity. That’s because of the overseas, forex-earning demand potential that refineries offer. Domestic restrictions on fuel prices have meant that private refiners like Essar and Reliance Industries (RIL) export their entire capacity, mainly to Asian markets, Europe and North America. Increasingly, public sector refiners have been doing the same to offset the losses from selling domestic fuels — exports now account for around 10 per cent of their sales.

With no new capacity coming up in Europe and several refineries being phased out, Indian refiners have seen their export market grow sevenfold over the past 10 years. Most Indian refineries are new and, therefore, meet the norms and standards for exports to the West. As a result, petroleum and oil products account for 19 per cent of the country’s $303 billion exports, up from 3.8 per cent a decade ago and India has been a net exporter for the past 10 years.

“Petroleum products are the second-most exported product after engineering goods. But in the current fiscal alone, they may overtake engineering goods on account of rising exports and higher prices,” says Ajai Sahai, director general of the Federation of Indian Export Organisations. So much so that the government is seriously considering promoting India as a competitive refining destination to service the export market for petroleum products as well as integrating it with the petrochemical and chemicals businesses to produce and export higher revenue-generating value-added products.

India is not alone in expanding capacity. China, too, has spotted the opportunity and is, in fact, well ahead in terms of capacity, though not exports. In 2011, China’s total refining capacity was 459.8 million tonnes, of which the domestic market accounted for over 90 per cent. By 2016, China is expected to add 122.4 million tonnes, according to a recent report by New York-based business intelligence firm GlobalData. In 2010, China exported 29.4 million tonnes petroleum products compared to India’s 57 million tonnes.

According to the report, China and India were among the top markets for refining in Asia-Pacific during 2011, with national oil companies having played a key role in the two countries’ refining markets. Asia-Pacific alone will witness the addition of 21 new refineries during 2012-2016, accounting for approximately one third of all refinery capacity additions planned across the world. China and India will lead the refinery capacity additions in the region during the period, with China scheduled to add seven refineries by 2016. Indonesia, Malaysia, Mongolia and Pakistan will also add two refineries each.

Volumes, though, are part of the story; it’s the margins that could be the big challenge going forward. Refining margins have been under pressure in recent times for refiners like Reliance owing to the narrowing gap between crude oil and product prices. RIL’s gross refining margins, which grew significantly from $6.6 per barrel in FY10 to $8.4 in FY11, were a flat $8.6 in FY12. With the recovery of the world economy still uncertain, refining margins are expected to remain under pressure in the near future.

So the big question is how far this export market can be sustained, given slowing growth in Europe and growing domestic demand. According to GlobalData, increasing demand for refined petroleum products, especially in fast growing countries such as China and India, will grow the Asia-Pacific’s share in the global refining market. The share of the region’s refining capacity in the global refining capacity was 31.4 per cent in 2011, and is anticipated to increase slightly to 31.7 per cent by 2016.

The other issue is whether the trend towards cleaner fuels like shale gas and non-fossil fuel will impact the refinery business. Experts say this will take time. “From the Indian perspective, shale gas is still away and non-fossil fuels are not sizeable. On the export front, too, transportation fuel will continue to be dominant as shale gas in the US and Canada is mainly used for heating purposes,” said Sameer Bhatia, senior director, Deloitte Touche Tohmatsu India. In other words, India can build on a significant competitive advantage for some years to come.