Explained: Why RIL-Aramco deal could be a template for refinery sector

There are still many meetings and miles to go for the proposed investment by Saudi Aramco in Reliance Industries Limited (RIL) to come through. The $15-billion deal is still “at the very, very early stages”, as Khalid al-Dabbagh, Saudi Aramco’s senior vice- president for finance, strategy and development, said at the company’s first-ever earnings call on Monday. A report by Seeking Alpha also quoted him as saying lower Saudi exports to the US and Europe is the result of slowing demand from these regions and growing demand from Asia. An International Energy Agency (IEA) report of 2019 notes around 70 per cent of the investment in refining units in 2018 were in Asia (where regional product demand is growing). 

The big question is how far India has become a favoured destination for the oil refineries to uproot their investments from Europe and elsewhere to plug and play here. What happens with the RIL-Aramco deal will answer many of those questions. The signs are propitious principally because this is a brownfield investment. It is far easier to invest in an existing refinery in India than a greenfield one, principally because policy conditions, including those on land acquisition, do not favour the latter. 

For instance, just as discussions about the RIL-Aramco deal began, the chances of the competing greenfield refinery in Maharashtra appear bleak. This is a proposed deal among state-owned Indian Oil Corporation, Bharat Petroleum Corporation, and Hindustan Petroleum Corporation with Aramco and Abu Dhabi National Oil Company in Ratnagiri Refinery and Petrochemicals (RRPCL). That project has suffered a setback because the site had to be relocated following protests by local residents. The expected cost for the refinery has shot up to $ 60 billion from $44 billion, and will certainly rise further. 

Instead, buying a stake in an operational refinery comes far cheaper. Last year a consortium led by Russian giant Rosneft paid $12.9 billion for the Essar Oil refinery at Vadinar, Gujarat. Aramco, despite the warning noises, has made the same calculations. There are 20 more state-run refineries up and running in India according to the ministry of petroleum and natural gas with an annual capacity of 249.366 million metric tonne (mmt). Of these 18 are solely run by the state-owned oil companies (two are joint ventures — Bharat Oman Refinery Ltd and HPCL Mittal Energy Ltd).

 

Selling them outright to foreign bidders should be one of the easiest policy actions to do. The refinery sector was delicensed in 1998, which means any public or private sector entity can set up a refinery, depending on the project’s techno commercial viability. These refineries cost a lot but there is no strategic reason for the state oil companies to invest money in setting them up or even to keep them going. The same money must be used to invest in oil and gas exploration, where the government has repeatedly drawn a blank in attracting foreign majors. Yet there is still some degree of hesitation in selling 100 per cent stake in state-run refineries to foreigners. But as the RRPCL and the proposed RIL-Aramco deals show, this is the path to take. 

One example of the risks of greenfield proposals is the centre’s plans to set up a refinery and petrochemical complex in Andhra Pradesh (AP). It is an absurd commitment written in as part of the Andhra Pradesh Reorganization Act of 2014. The petrochemical complex will produce 1.7 mmt of products a year. This is one of the smallest state-run refineries but an Engineers India feasibility report says it will cost a massive Rs 32,901 crore to build. To become feasible it will need to provide at least a 14 per cent rate of return, the petroleum ministry estimates, even though the state government has asked that it be reduced to 10 per cent. The 14 per cent IRR is the same ballpark used for HPCL’s Barmer refinery project in Rajasthan. And that project did not look feasible until it was assured of processed crude supply from Cairn’s Rajasthan fields. It is only now that HPCL has indicated that there are no further roadblocks in setting up the 9 mmtpa refinery-cum-petrochemical complex for Rs 43,129 crore at Pachpadra in Barmer. The AP project (the second one in the state after Tatipaka) has no such nearby sources. Uttar Pradesh (UP) has made a copycat demand. Incidentally, the states need to provide viability gap funding. In AP’s case, the amount in question is Rs 5,000 crore but here too it is asking for exemption. 

The eight public sector refineries are feeling the heat of international competition. A Parliament reply on the issue notes the need for these refineries to adopt the best-in-class technologies to increase distillate yield and reduce energy consumption. The government is committed to spending Rs 87,121 crore to modernise and expand seven of them, money that is clearly well spent elsewhere (and it excludes investment in the AP project). The task at hand for the government is to tell states that want refineries to explore the FDI route. It is possible. After all, the RIL-Aramco MoU will be the Saudi Arabian companies’ biggest-ever M&A deal, dwarfing its previous largest $4.9 billion 28.4 per cent stake in South Korea based S-Oil Corporation in 2016. For the RIL deal, Aramco will need to be absolutely sure of India’s political commitment to backstop it. Which is why Riyadh is still calling it a “very, very early” move.