Dim prospects for capacity expansion
By SHABBIR H. KAZMI
Jul 28 - Aug 03, 1997
The installed oil refining capacity in Pakistan has remained stagnant for many years in spite of increase in consumption of energy products. To meet the increasing domestic demand of energy products the country is dependent on imports. The industry experts attribute this to many factors including limited production of indigenous crude that too contains very high percentage of wax, the pricing formula, an acute shortage of capital required to build modern refining complex and establishment of large scale refineries in the Middle East and Singapore. While the refineries in the Middle East have the advantage of indigenous crude at very low price the refineries in Singapore enjoy the advantage of their scale of operation and efficiency. Pakistan enjoying very cordial relationship with the Middle Eastern countries continue to import bulk of its requirements from Kuwait and Saudi Arabia.
As a result of getting cheap and guaranteed supply from the Middle East Pakistan was contended with the small refineries operating in the country. At present there are four refineries operating in the country. These are Attock Refinery (ARL), Dhodak Refinery, National Refinery (NRL) and Pakistan Refinery (PRL) with a total capacity to refine over 6.5 million tonnes of crude per annum. While ARL is wholly dependent on indigenous crude, NRL and PRL use both locally produced and imported crude and condensate. Dhodak only uses the condensate produced at Dhodak oil field. ARL is more than fifty years old and both NRL and PRL are over thirty years old whereas Dhodak has started operation in December 1994.
The scale of operation of refineries in Pakistan is very small and units are old. These units were established at relatively low capital expenditure and have nominal depreciation expense and are therefore able to survive. The government has guaranteed a minimum rate of return on equity. However, in order to attract fresh investment in the refining sector it is necessary that ROE of the new refineries should be comparable to that being earned in other countries of the region.
The sort of incentives a foreign investor in oil refining industry in Pakistan is looking for are evident from the proposal submitted by Supaveri Finance and Holding Company of Liechtenstein to the Board of Investment. They want to establish a refinery with a capacity to refine 7 million tonnes of crude per annum at a total cost of nearly 2 billion dollars. Their demands include:
Exemption from payment of all taxes plus turn over tax, stamp duty octroi etc.,
Exemption from payment of import duty and all other surcharges on cars, buses, wagon imported for foreign executives,
A suitable plot with developed infrastructure at concessional price
Full security to all those working for the project
Grant of permission from all respective agencies on priority
Waiver of the condition of 80:20 debt equity ratio
Guaranteed minimum rate of return on investment @ 25% on net equity in US dollars
Guarantee from the government to buy-back the total production
These are not new demands. The petroleum policy announced by the government in 1994 already provides many such incentives for the refining industry. However, it is expected that the present government will shortly announce a revised petroleum policy and some of the outstanding issues will be tackled appropriately.
It will not be out of context to mention here that initially there were four projects under consideration, but none has reached the stage of financial close. The government has extended the period for financial close but industry experts say that except one, no other will be able to reach the financial close and therefore the prospects for establishment of these refineries are bleak.
Pakistan State Oil (PSO) is setting up a refinery as a joint venture with Kuwait and Korea in Sindh at Badin. It will have an annual refining capacity of 4.8 million tonnes and will be capable of processing waxy crude produced in the region. The estimated cost of the project is US$ 800 million.
Pak Arab Refinery (PARCO) is a joint venture between Pakistan and Abu Dhabi with a designed capacity to process 100,000 barrels a day. It will be located near Multan. The estimated project cost is US$ 760 million. This will be an execution of unfinished agenda of the sponsors. PARCO had a plan to lay down a pipeline from Karachi to Multan and establish a mid-country refinery. However, after completion of pipeline project the sponsors decided not to establish the refinery.
Pak Iran Refinery is a joint venture between State Petroleum Refining and Petrochemical Corporation (PERAC) of Pakistan and National Iranian Oil Company. It will have a designed refining capacity of 6 million tonnes of crude per annum. It will be located at Khalifa Point near Hub in Balochistan. The estimated project cost is US$ 1.2 billion. At present no infrastructure exists at Khalifa Point. For the provision of infrastructure additional investment will be required.
The fourth refinery a joint venture between Schon group of Pakistan and Hobbs Bannerman of the US may not become a reality. The proposed capacity of this refinery was 1.5 million tonnes per annum and the estimated project cost was US$ 300 million. The US Export Import Bank has stopped processing of a loan application for the refinery because of some irregularities. It was found by the bank that a kickback of US$ 50 million was taken by the sponsors and the refinery was not only second hand but also not according to the specifications provided in the loan application.
PARCO seems to enjoy the highest probability of becoming a reality as Abu Dhabi government is serious about the project. However, the financial close has been delayed mainly because the government of Pakistan wanted to off-load its shareholding in the company. The ground is almost ready for transfer of government of Pakistan's share to the Middle Eastern counterpart.
The need for a mid-country refinery has been felt for a long time. In the northern part of the country only ARL has been in operation where the refining of crude has virtually gone down. Dhodak is too small a refinery and therefore the POL products refined at Karachi as well as imported one have to be transported to upcountry.
The Punjab province, having the largest population, has the highest consumption of energy products. The products have to be transported to NWFP and Balochistan. This creates not only logistic problems but the government spends over Rs. 3 billion annually towards freight charges. Government bears the freight cost to keep the prices of POL products uniform throughout the country even at the remotest places.
To improve the transportation of energy products to upcountry a solution was found in the shape of a white oil pipeline from Karachi to Multan. This project is also sponsored by PARCO. After the completion of the proposed pipeline the existing pipeline, which has been extended up to Lahore will be used exclusively for the transfer of crude mainly for PARCO's proposed refinery.
While Pak Iran Refinery has the financial support of the Iranian government which has also promised supply of crude and the sponsors are really not worried about the rate of return the project may be delayed for a long time due to pressure from the US government.
The refinery planned by PSO has support from other oil marketing companies and Kuwait and Korean plant supplier, Hyundai. All the participants are serious about the project, the only insurmountable obstacle is the assurance about rate of return on equity. While the government of Pakistan has guaranteed minimum 25% rate of return on paid-up capital, in rupee terms, for new refineries for the first eight years, if sponsors offer a definite logistic advantage and the refinery is set up by the year 2000, the sponsors are still insisting on 25% return in dollar terms. This debate has caused delay in achieving financial close of PSO refinery but also all other projects.
A data about production of crude oil in Pakistan indicates that the level of output has actually gone down over the years from 64,349 barrels in 1990-91 to 57,549 barrels in 1995-96. This was mainly due to lower production at oilfields operated by Occidental of Pakistan. While the production by Oil & Gas Development Corporation and Union Texas Pakistan has increased production by Pakistan Petroleum after touching 2,804 barrels in 1992-93 has reduced gradually. Crude production of Pakistan Oil Fields has also registered marginal reduction.
For the present situation and heavy dependence on imports only policy planners of the country are to be blamed. The policies which could attract foreign investment in oil and gas exploration sector were missing. This kept the exploration activities in the country at a disappointing level. The first exploratory well was drilled as back as in 1867 in the region but only 420 wells were drilled during last 50 years after independence. Out of these 123 wells were drilled during July 1990 to June 1996. There were 50 oil and 62 gas discoveries during the period. The overall success rate comes to 1:3.8.
In the absence of sufficient availability of indigenous crude the proposal of establishing a refinery in the country has to be weighed against import of finished products. Looking at the Pakistan's relationship with the Middle Eastern countries the opinion is divided. One group believes that since the market size is small establishment of even a medium scale refinery will not be feasible. Whereas the other group believes the country must be self-sufficient in energy supply. Oil still meets nearly 43% of the energy requirement of the country. Whereas about 36% requirement is met through gas, while 14.3% is met by hydel electricity. The balance is met by LPG, coal, and nuclear power.
In this context the importance of oil is high in the country. The demand for POL imports has been increasing constantly. The quantum of import has increased because of government's decision not to allow use of gas in cement industry and for power generation particularly in the private power plants. It is estimated that import of furnace oil alone will cost over 1.5 billion dollars in the current financial year.
Realising the fact the government has once again decided to allow use of gas by the power plants. But for the units which have already started power generation or for which the letters of credit for import of machinery have been established switch over from oil to gas will not be easy and therefore the country will be forced to continue to import furnace oil.
The reason use of gas is once again preferred over oil is that rate of gas discoveries in the country is higher as compared to oil, it spreads less pollution and the infrastructure for transmission and distribution already exists. Therefore various proposals for import of gas are actively considered. It is yet to be seen how these projects move. The pipeline for import of gas from Turkmenistan has to pass through war- ridden Afghanistan. Qatar has already abandoned the project because of inability to raise the required funds. Raising funds for pipeline for import of gas from Iran seems to face serious impediments.
A book Power Surge written by Christopher Flavin and Nicholas Lenssen has predicted a turbulent next decade for the energy sector, as large energy companies struggle to preserve the current status quo and newer firms and their environmental allies fight to change government policies and open up energy markets to greater competition. In spite of efforts to encourage greater use of gas even by its import oil use will continue to dominate all other types of commercial energy in Pakistan.
Although, heavily dependent on import of energy products Pakistan has never experienced any serious problems in getting the supplies. But surges in international oil prices, fear of sudden stop of supplies from the conventional sources as has happened during Iraq'a attack on Kuwait and devaluation of local currency demand from the policy planners to redefine country's energy policy. The situation would have been worse had Pakistan did not have cheap indigenous supply of natural gas. However, it would not be wrong to say that availability of low cost gas has a negative impact on the expansion of refining sector in the country.
For the last 30 years total import of energy products has remained in the public sector. The government has allowed PSO and Kuwait Oil Company to handle country's entire import of these products. PSO also has the first right to lift products from local refineries. This has helped the company to achieve 80% share of the total market.
However, lately the government has decided to de-regulate pricing of energy products from July 1, 1998. This will enable the oil marketing companies operating in the country to import their own products and sell them at prices to be determined by themselves. It will put PSO at a disadvantage because both Shell and Caltex have their own refining facilities in the Middle East and Singapore and may enjoy a cost benefit. Therefore, the complete picture will emerge only after the announcement of new petroleum policy. However, it is expected that if pricing is deregulated and oil marketing companies import their own products the scenario will be very different to the prevailing one.
The government has decided to restore the tax incentives granted in 1994 Petroleum Policy which were withdrawn subsequently. This is in fact redressal of the long-standing demand of oil and gas exploration companies. However, this is only one part of the story. If the country wishes to lessen its dependence on imported energy products, it has to announce an integrated 'energy policy' covering all the sub-sectors. This include oil and gas exploration, oil refining, pricing of gas and other energy products, ROE for refining units and power generation. The policy is like a jigsaw puzzle even if a very small piece is missing the picture is incomplete.
LOCAL CRUDE PRODUCTION
Year Quantity Daily Averag 1995-96 21,062,995 57,549 1994-95 19,857,877 54,405 1993-94 20,674,576 56,643 1992-93 21,895,396 59,987 1991-92 22,468,739 61,396 1990-91 23,487,446 64,349
Source: Directorate General of Oil
Year Quantity (Tonnes) Value (Million US$) 1995-96 4,230,820 538.02 1994-95 3,867,975 490.60 1993-94 4,191,804 457.77 1992-93 3,998,127 526.99 1991-92 4,047,965 542.97 1990-91 3,972,544 633.49
Source: Directorate General of Oil
OIL REFINERIES PRODUCTION
(Energy products only)
1995-96 1994-95 1993-94 1992-93 1991-92 1990-91 Aviation fuels 585,149 526,577 567,461 572,299 559,362 517,844 HOBC 62,156 57,182 70,072 71,003 119,154 105,884 Kerosene 506,748 463,281 487,774 511,309 480,087 531,483 HSD 1,439,802 1,349,822 1,442,178 1,359,332 1,438,884 1,448,299 LDO 253,917 265,210 318,740 289,089 279,696 277,159 Furnace oil 1,916,387 1,721,868 1,878,290 1,796,841 2,014,880 2,093,778 Motor spirit 968,814 865,326 1928,320 959,555 873,708 820,331 Naphtha 104,596 147,523 108,271 98,927 150,636 195,889 LPG 36,130 36,844 40,326 36,056 44,818 44,973 Total 5,873,699 5,434,233 5,841,432 5,694,411 5,961,225 6,035,640
Source : Oil Refineries
ENERGY PRODUCTS IMPORT
1995-96 1994-95 1993-94 1992-93 1991-92 1990-91 100/LL Nil Nil 2,445 1,292 1,559 3,181 HOBC 3,937 Nil 52,167 88,972 81,956 120,336 Kerosene 87,855 145,389 118,767 163,702 55,745 416,826 HSD 5,093,588 4,485,342 4,377,068 3,909,952 3,312,594 2,631,191 Furnace oil 4,748,892 3,865,436 3,243,999 2,447,719 1,823,370 1,138,494 Motor spirit 106,122 156,988 56,094 Nil Nil Nil MTBE 94,499 83,707 59,550 Nil Nil Nil Total 10,134,893 8,736,862 7,910,090 6,611,637 5,275,224 4,310,028
Source: Directorate General Oil
LISTED REFINERIES AT A GLANCE
ARL NRL PRL Paid-Up capital (Rs. in mln) 348.4 988.8 340.3 Market Capitalisation (Rs.in mln) 1,500 1,882.5 1,037.4 Profit after tax (Rs.in mln) 183.5 279.0 81.8 EPS (Rs.) 9.8 4.2 4.1 P/E (x) 8.2 6.7 12.7 BVS (x) 18.6 14.8 17.1 P/BVS (Rs.) 4.3 1.9 2.3 Dividend yield 2.5 0.0 7.7 ROE (%) 52.7 NM 24.0
Based on annual reports for 1996
NM: Not mentionable
Source: Taurus Securities