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Ban on import of furnace oil: a good omen or disaster?

The Government of Pakistan (GoP) has notified an immediate ban on import of furnace oil (FO) and ordered all the refineries to utilize billions of rupees in annual deemed duty collected on petroleum products to upgrade their refining facilities. The GoP has also ordered immediate reduction in the FO production to a minimum and to enter into commercial agreements with power producers for utilization of their capacity for FO storage. The GoP has imposed ban on import of FO with immediate effect, except for the K-Electric. Previously, in similar situations the GoP has allowed the K-Electric to run their plants on FO instead of gas from the Sui Southern Gas Company, and picked up the difference of cost as subsidy under the Gas Load Management Plan (GLMP).

In light of the current situation, the Economic Coordination Committee (ECC) and cabinet have been requested that decision for diversion of gas to other sectors should be reviewed and urged to maintain the allocated priority of gas to the power sector. It has been requested, that in case gas was required to be diverted, running cost of equivalent MW of generation of RFO be subsidized, the sources added. The decision taken to cut the import bill by banning fuel oil import would also impact the fragile power sector of the country. In Pakistan, 54 percent of total power generation depends on oil or gas, while of these, 26 percent operate on Re-liquefied Natural Gas (RLNG).

With the introduction of RLNG in the power system as fuel, sector dependency on imported RLNG as a fuel for generating electricity has increased manifold. Since water was not available in reservoirs, after coal, nuclear and local gas, power plants were dispatched RLNG. No FO based generation had been envisaged from November 2018 to March 2019.

However, they added that to maintain strategic reserve at FO-based power plants, and to handle the high inventory of furnace oil at refineries, FO and Low Sulphur Furnace Oil (LSFO) supplies were requested at Muzaffargarh, Jamshoro, HUBCO, KAPCO, at a steady rate. This was communicated to the Petroleum Division on November 22, 2018.

The gas requirements presented during the CCOE meetings held on November 28, December 5, and December 26, 2018 were based on the forgoing parameters. But, during December 2018, only 180 to 200 MMCFD gas was allocated to the power sector, which was sufficient for generating only 1,200MW average instead of 2,600MW planned and projected. This resulted in a daily average of 1,600MW FO-based generation through RLNG between December 6, 2018 and January 1, 2019. As a result FO consumption which started from 4,200 ton/day to about 18,000 tons/day till January 1, 2019, has adversely impacted the stock strategic building exercise for plants running during the high demand months.

They cautioned the situation would further aggravate with the diversion of gas required by the power sector to the other sectors, which were at low priority for gas. This diversion with the differential that has already been accrued due to running of RFO-based power plants will result in about Rs10 billion of differential to be passed on the end consumer in form of Fuel Price Adjustment till January 12, 2019.

Recent developments surrounding the procurement, storage and refining of RFO has tangled mid-stream petroleum dynamics. On the basis of prevailing negative cracks between HSFO 180CST (global benchmark for FO pricing domestically) when matched by the likelihood of diminished spreads continuing (global demand for FO receding, international regulations) make for hampered profitability, even without maritime freight or handling charges. Taking a comprehensive view of prevailing refinery production slates, refining yields for major products and FO in particular between major refiners highlighting players being better off in terms of cutting lower FO refining yields. From a global context, we were hard-pressed to find regional markets where FO imports are expected to climb (Bangladesh and Saudi Arabia), further signifying the clatter global landscape of FO fuel demand.

 

Demise of FO was a long time coming

Decline in generation on FO to 11.5 percent as compared to 26.6 percent in CY18, has routed the power chain, reflected in falling consumption. The fuel has reversed the trend of demand exceeding domestic supply. Hence to cope with excess supply, the GoP is considering a slew of major policy shifts, where global cracks and demand dynamics make decision making a lose-lose proposition.

FO cracks and spreads are negative

Contrasting Asian benchmark HSFO 180CST prices with Brent average reveals CY18 average discount of US$9.64/bbl bottoming at US$13.8/bbl in Apr’18 and resting at US$5.15/bbl of Dec’18. Prevalence of negative cracks in global FO market is largely a factor of International Maritime Organization Regulation 2020, aiming to reduce high Sulphur FO (currently capped at 3.5 percent) usage as bunker fuel by 2020 (to be brought down to 0.5 percent). Global refiners have already expressed their plans to cut FO refining output, investing in deep conversion, delayed coking and residue fuel catalytic cracking to reduce FO output and upgrade Gasoil/HSD yields. The shift away from FO to HSD in terms of demand is signified by the spreads between their international benchmarks, widening to average negative US$20.9/bbl during CY18, resting at US$14.3/bbl for December 2018, incidentally making up 25 percent of the average price of Brent in Dec’18.

Refiners are still RFO-Heavy

Bifurcating total domestic refinery production, FO made up 27 percent of total refinery output during 5MFY19, was in-line with 5-year average of 29 percent, where HSD/MS contribute 44/17 percent on average amongst energy product outputs. In terms of refining yields, analysts find a similar breakdown of refinery output, with HSD/RFO/MS yields at 15.9/23.7/38.2% for FY18 indicating the relatively high share of FO yields.

Loss from cracks and imported fuel

Based on the prevailing scenario, analysts indicate a negligible room for exporting FO in FY19, as refinery production and severely slowed consumption keep the lid on excess supply. In the case FO based power generation falls further (assumed to fall 63%YoY), for every 5 million bbls of FO exported (25 percent of total domestic production) additional income of US$277 million is generated. The potential loss on a macro level arises from the negative spread between Brent and HSFO cracks, where bifurcating the cost of crude imports (assumed through refining yields at 23.7 percent) would result in a loss of Rs2.83 million for every 5 million bbls of annual exports.

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