PETRO ECONOMICS

~CHALLENGES OF INDIAN REFINERIES

ASSIGNMENT - 02


DATE OF SUBMISSION:
22
ND
AUG 2011


SUBMITTED TO:
MS. SURBHI ARORA
SUBMITTED BY:
KARTIKAY SHARMA
R240207027
INT. BTECH + MBA(O&G)
9
TH
SEM


Challenges of Indian refineries


INTRODUCTION

The oil reIining industry is the cornerstone oI a modern economy. ReIined Petroleum
products remain Iundamental to our economic liIe in everybody`s daily liIe and economic
activities oI the nation ranging Irom domestic cooking to transportation, employment, etc.
Rapid economic growth in many developing countries has led to increased demand Ior oil
products. As such, the reIining industry has grown rapidly in such countries whether or not
there is crude oil production in the domestic scene.

Asian developing nations have experienced signiIicant growth in petroleum product demand
and reIinery expansion over the years (Tang, 1994). Between 1976 and 1993 Ior instance, oil
product demand and reIinery capacity expansion recorded average annual increases oI 5.2
and 4.3 respectively. Though in comparison with world Iigures, there was in eIIect no
change recorded Ior the same period, the considerable gains in the region`s crude oil
production in the 1970s are believed to have also Iacilitated reIinery expansion.

This trend oI rising demand Ior petroleum products coupled with the concentration oI
petroleum reserves in Iew geographical areas as well as the diIIerence in crude quality and
environmental legislations amongst other Iactors pose challenges as well as opportunities Ior
the global petroleum reIining industry as a whole. The ability oI India`s reIining industry to
meets its economic challenges will likely determine, in part, the nature oI the energy
challenges Iacing India, taking cognisance oI the Iact that it is a developing country with
growing demands.

PETROLEUM REFINING IN INDIA: AN OVERVIEW

India`s downstream reIining sector has the eighth largest reIinery capacity in the world.
India`s oil reIining sector is dominated by state-owned enterprises, though the market share
oI private companies has increased oI late. The Indian Oil Company (IOC) is the largest
state-owned company, and it operates 10 oI India`s 18 reIineries. Reliance Industries, a
private Indian Iirm opened India`s Iirst privately-owned reIinery in 1999, and has gained a
signiIicant market share in India`s oil sector.

As oI January 2008, the country had 2.26 million bbl/d oI crude oil reIining capacity
according to the Oil and Gas Journal. Reliance Industries, a privately owned petroleum
company in India has the largest reIining complex in the world with a capacity oI 1.24
million barrels per day (bbl/d) the Jamnagar reIinery. India plans to add 1.6 million bbl/d oI
reIining capacity through 2015 based on current proposed projects. Anticipated high demand
Ior petroleum products in the region makes Iurther investments in India`s reIining sector
likely.

India is steadily emerging as an international destination Ior oil reIining with investment
requirements lesser by 25 to 50 compared to its Asian counterparts6. Being the IiIth
biggest nation in the world in terms oI reIining capacity, it enjoys 3 oI international
capacity share and is expected to enhance its reIining competence by 45 in the next 5 years
according to Deutsche Bank`s analysis7. In a bid to make their presence Ielt strongly in the
global market, Indian petroleum Iirms are also considering increasing their reIining capacity
Irom the existing 149 Million tonnes per annum (mtpa) to 243 mtpa by 2011 and 2012.

India is a net importer oI crude oil. Figure 1 below shows the domestic crude production and
imports in India.

Figure 1 shows a wide disparity between domestic production and imports, an indication oI a
high degree oI crude import dependence over the years. Being a largely import dependent
nation, is a challenge Ior India`s reIining industry in a number oI ways. First, this trend
makes it more vulnerable to international crude price shocks. Next, depending on the sources
oI crude imports, quality issues arise. Coping with domestic demand increases with
petroleum products heavily subsidized, is another. However, India`s strategic location in a
major maritime route Irom Middle East to Far East gives it a geographical advantage to serve
western and eastern markets and as transit landIall Ior Middle East crude.

Figure 2 below shows India`s production and consumption oI petroleum products over the
period 1990 2009


A steady increase in oil consumption as against a quite stable production level is evident in
the above diagram. Though other Iactors such as increase in population may be responsible in
part Ior this signiIicant increase, the role oI the government`s pricing policy cannot be
undermined. The retail prices cut Ior instance in December 2008 and January 2009 by about
12 Ior diesel and over 20 Ior gasoline Iollowing the 15 price increase in the Iirst halI oI
2008 all in a bid to stimulate the domestic economy which depicts the practicality oI the
government`s pricing policy.

Figure 3 below shows India`s crude oil imports Irom other countries. A large percentage oI
India`s oil imports are sourced Irom the Middle East whose crude quality is sour.



CHALLENGES OF PETROLEUM REFINING IN INDIA

Key changes Iaced by the reIining industry have come with challenges alongside. First is the
increase in demand Ior light petroleum products gasoline, diesel, jet Iuel and kerosene.
Regulations on product speciIications are also stricter. SpeciIications on sulphur, aroma and
oleIin Ior gasoline, and sulphur, cetane number and poly-aroma Ior diesel are strengthening.
The implications Ior the Iuture being the tightening oI the supply - demand balance Ior high
quality gasoline and diesel, with the situation Ior diesel being more serious as its demand is
almost double that oI gasoline.

Studies by Zhang (2008) oI the changes and challenges oI Asia`s reIining industry revealed
that sharp increases in demand Ior light petroleum products as a result oI advances in the
transport sector has been recorded over the years. He identiIied limited proved oil reserves
alongside increasing demand as drivers oI increase in volume oI the region`s oil imports9.
Tightening regulations on petroleum product speciIications and dependency on oil supplies
Irom the Middle East are challenges peculiar to the region`s reIining industry.

Furthermore, as part oI India`s 11th Five Year Plan Irom 2007 to 2012, the government
aspires to promote India as a competitive reIining destination, and industry experts postulate
that the country would be a signiIicant exporter oI reIined products to Asia in the near Iuture.
However, the lingering challenge in this regard will be obtaining secure supply oI crude oil
Ior its reIineries considering the Iact that it is highly dependent on crude oil imports mainly
Irom a particular region.

The resultant challenges Irom these major changes would be discussed in more details in the
Iollowing subsections:

The Need to Invest

The need to invest in capacity expansion Ior the Iuture in India is important considering
expected demand increase and current capacity utilisation at about 90. India`s reIining
capacity based on Institute oI Electrical Engineers oI Japan (IEEJ) report is expected to
increase to 4472 thousand bbl/d in 2015. There is also need to invest in all-inclusive
approaches like the DuPont acid plant to equip reIineries with a twoIold capability to process
acid gas and sulphuric acid regeneration which would enable maximizing a reIinery`s sulphur
recovery unit capability, emissions reduction, and direct manpower and capital towards
hydrocarbon processing projects (Ye, 2006).

Technological investments can improve reIinery economics by allowing reIiners to use
cheaper heavy, sour, crude oils as inputs and still produce a light, high value mix oI products.
He Iurther stresses that investments must be undertaken to keep both the reIinery site and the
products it produces in compliance with evolving environmental standards. The relationships
between crude oil quality, product price mix, and technological improvement make capital
investment management important to the reIining industry as well.

In reIining, there are several competing demands Ior investment Iunds and capacity
expansion is necessary to keep pace with growing demand. The siting oI a new reIinery is a
long and expensive process. These thus present a challenge Ior investing in reIinery building /
capacity expansion. As a result, most capacity expansion projects oI late have been in the
Iorm oI enhancing and modiIying existing reIineries.
Finally, ReIining projects in India being assessed by international investors the same way
comparable projects elsewhere in the world are assessed that is, based on their expectations
about returns on investment. Investment decisions in India`s reIining sector must thereIore
careIully weigh market Iundamentals, the business environment, and likely investment
perIormance. ReIiners now must earn market rates oI return Ior investors, as well as returns
suIIicient to make investments in expansion, technological improvements, possible business
restructuring, and to meet environmental regulations, both with respect to reIined product
speciIications and reIinery site operations and expansion.



Effect of Subsidies on Product Pricing

The process oI price and market liberalisation is another issue to be addressed. Petroleum
products prices in India like in many developing countries are controlled through subsidies.
Petroleum product prices in India were regulated through the Administered Pricing
Mechanism. From 2002, the Indian government introduced measures designed to deregulate
the downstream oil sector. This enabled private reIiners to directly trade petroleum products
to customers.
The APM operated such that reIineries, Oil Marketing Companies (OMCs) and pipelines
were assured a 12 post tax return on net worth and were reimbursed Ior operating costs. A
selI balancing oil pool account was used to balance prices oI petroleum products as well as to
protect customers Irom volatility in international crude prices. The oil pool account however
ran into deIicit whenever domestic prices were not raised in line with prolonged international
crude price increases. The assured 12 post tax return however did not promote eIIiciency,
or the most eIIicient investment decisions.

The Administered Price Mechanism (APM) on petroleum products was gradually removed
and replaced by the new Market Determined Price Mechanism (MDPM) which is
hypothetically benchmarked to international oil prices. However, diesel, LiqueIied Petroleum
Gas (LPG), and kerosene which still remained heavily subsidized undermined this new
pricing policy. The result being a signiIicant rise in demand Ior petroleum products,
particularly diesel whose price is much lower than other Iuels.
These were back drops oI the mechanism which led to its gradual and eventual withdrawal in
2002 aIter which Ior a while, domestic prices oI diesel and gasoline moved together with
international crude prices. This encouraged entry oI private companies to set up retail outlets
in the market. However, this was short-lived as continuous crude price increases since 2005
led government to decide the prices oI petroleum products in a bid to protect consumers Irom
the international price shocks. Under-recoveries by OMCs are compensated through Oil
Bonds and crude price discounts Irom state-owned upstream oil companies.
These are however not extended to the private investors. The consequence oI the price
controls being that private companies are unable to sustain operations when international
crude prices are very high thus having to shut down their retail operations, and those who
have restarted have no conIidence to invest in capacity expansion or upgrade their operations
as crude price increases could render them unproIitable since they have no protection Irom
international crude price changes. Figure 4 below shows the Indian Basket oI Crude Oil in
dollar per barrel Irom 2002 when the APM was dropped, to 2009.



Petroleum product prices are also dependent upon and vary with taxation. Government tries
to reduce taxes during periods oI crude price increases to protect consumers Irom the eIIects
oI ad-valorem taxation. Average taxation levels are 49 on gasoline, and 25 on diesel.
Kerosene and LPG prices have remained the same Ior a long period. Table 1 below presents
petroleum product prices in India and neighbouring countries whose per capita income is
much lower than what obtains in India. Kerosene and LPG prices in India are substantially
lower than their prices in these neighbouring countries.



Cost of Product Refining

The cost oI reIining petroleum products is oI concern, as can be seen Irom data presented in
earlier sections. India`s oil consumption exceeds what is available or produced locally and
this is a pointer to the Iact that in order to maintain the same level oI consumption, it has to
resort to imports which have got their cost implications. Historically, reIining has been
signiIicantly less proIitable than other segments oI the petroleum industry. As such, reIiners
have had to be careIul to control costs to make a proIit . In some countries, reIineries are not
productively utilized. Since reIineries make low proIits, investors may not be willing to
engage in competition. This aIIects both investments in inIrastructure as well as in reIinery
capacity expansion.
Government controlled low prices also cause another problem. This is because in order to sell
reIined petroleum products at a better price, national oil companies tend to export as much as
they can, and this can cause supply shortage on the domestic market16. Though, to combat
this, the government has issued emergent policies such as imposing export taxes to limit
export, the situation depicts pricing not being reIlective oI the true cost oI product reIining. It
is a Iurther indication that the prevalent pricing need be addressed. The supply and demand
balance thereIore shows random Iluctuations which inhibits the market`s ability to represent
Iundamental demand and supply.

"uality of Petroleum Products
The quality oI petroleum products is also oI concern. In line with climate change objectives
and environmental legislations, every country is to cut down its Carbon dioxide (CO2)
emissions and make Iossil Iuels more environment-Iriendly. The quality oI crude oil imports
to India mainly sour` is a challenge as a result oI the stringent product quality requirements
currently in place. A reorientation oI consumption towards light Iractions, or installation oI
hydro cracking plants Ior heavy Iractions is thus required.

OPPORTUNITIES OF PETROLEUM REFINING IN INDIA

There are ample opportunities abounding in India`s petroleum reIining industry. The creation
oI additional reIining capacity during the near Iuture oI 110 million tonnes per annum will
require an investment oI over US$22billion18. This will cause a remarkable growth in the
reIinery sector, transIer oI technologies and export oI capital goods etc., to India. It is
designed that the technologies will be Ior upgrading the bottom oI the barrel and to meet the
pressing demand Ior middle distillates which will improve the quality oI petroleum products
to make them globally competitive and environment-Iriendly.
The strategy behind the new capacity addition is to locate the new reIineries on the coasts
while the main centres oI demand Ior the petroleum products are in the inland locations,
particularly in North/North-West regions. This leaves India with the opportunities oI building
inland reIineries. The government also allowed the existing reIineries Iorward integration in
the Iields oI petrochemicals etc., Ior better value addition, which opens up another area Ior
investment19.
India also is adopting strict measures that will increase the quality oI Iuels which will make
them environment Iriendly. These measures include phasing out lead, reducing benzene in
gasoline, cetane improvement oI diesel and sulphur reduction. Although the up gradation oI
Iuels will require huge investments oI about US$2.5billion, it has added advantages
considering that reIinery operating cost are low. This will make India`s reIineries to be
economically attractive Ior the domestic markets as well as Ior exports. Government
promotion oI joint sector and private sector participation could also potentially lead to growth
in the reIining industry.