PAKISTAN'S REFINING SECTOR

AROOJ ASGHAR (arooj.asghar@crosby.com)
Oct 22 - 28, 2007

Pakistan's oil sector in general and oil refineries in particular have a considerable impact on the economy as this sector is attracting by far the highest level of foreign direct investments in the country, and raises significant tax income for the government. At the same time, high imports of crude oil and petroleum products affect the balance of payments adversely. Import of petroleum products registered sharp increase of 38.6% in fiscal year ended June 30, 2007 on account of massive surge in furnace oil import, primarily for electricity generation purpose. Whereas imports of crude petroleum declined by 6.7% because refineries were not operating at their full capacity. Thereafter, production of local oil refineries' registered a growth of 13% to 855, 000 tons during the month of July 2007 as compared to 759,000 tons in July 2006. It is important to note that since refineries were not operating at their full capacity, their import of crude was lower and accordingly their production of petroleum products was lower too. Low production of petroleum products within the country forced the government to import more petroleum products putting pressures on the country's balance of payments.

Substantial progress has been made in recent years in the restructuring and reform of the oil sector, deregulation of prices, and privatization of selected assets. The reforms have enhanced transparency, making decision makers aware of the various aspects of the business. The inherent risk associated with oil exploration and development can be fairly high, but successful upstream projects can generate healthy economic rates of return.

Maintenance work being carried out at domestic refineries has affected their working as they have registered a 0.3 million metric ton decline in the growth of non-energy products in 2006-07. According to figures issued recently by the Oil Companies Advisory Committee (OCAC), local refinery production has decreased to 9.2 million metric ton in the outgoing fiscal year as against 9.5 million metric ton in 2005-06, suggesting a dip of 3.15%. The refineries production of furnace oil declined to 3.21 million metric ton in 2006-07 as compared to 3.37 million metric ton in 2005-06. Refineries earn huge profits on the advantage of import price parity, as the furnace oil prices were touching height during February to July 2007. Similarly, high-speed diesel (HSD) production was down by 3% to 3.2 million tones in 2006-07 from 3.3 million tones in 2005-06. However, reduced local production has not resulted in increased import, as HSD consumption has also slipped by one percent to 7.3 million metric tones in FY07 from 7.4 million metric tones the previous year, primarily on account of penetration of smuggled Iranian diesel in the market. Thus, imports of the fuel stayed at around 4 million tones. During the period, local refineries produced only 46% of the total local demand for HSD and FO, owing to capacity constraint, while the rest was met through imports. However, National Refinery Limited (NRL), the only lube refinery in Pakistan, experienced a slight decline of 2% in production in the recent past. On the other hand, local demand for gasoline (petrol) is met through indigenous production.

Refinery industry has had a very consistent production level in the previous three years but the slump in the production of fiscal year 2006-07 is mainly attributed to major maintenance works undertaken by two refineries that resulted in a complete production shutdown. According to reports, Pakistan Refinery Limited (PRL) underwent a shutdown for 28 days in August 2006. Similarly, Pak Arab Refinery Limited (PARCO), which is the largest fuel-refinery in the country, conducted maintenance work in March 2007. As a result, it remained out of production for about 26 days. Experts in the petroleum industry said that this was a major maintenance shutdown of the companies observed in the last four years. Reduced demand for jet fuels resulted in a production decline of 7% in FY07, mainly due to restrictions imposed on PIA fleet for flying to European countries in Mar 2007. Its production plunged to 0.9 million metric tones in the outgoing fiscal year against 1.09 million metric tones in the previous fiscal year. Moreover, the refinery production of light diesel oil (LDO) declined by 12,227 metric tones. Production of kerosene oil decreased by 11,872 metric tones. Pakistan's current crude oil production meets only 17% of the total demand for domestic consumption. The balance requirement is imported involving large expenditures of foreign exchange. According to the latest available Pakistan Energy Year Book 2006, there are 7 refineries operating in Pakistan with the total capacity of 12.88 million tons/year in 2006 against 11.28 million tons/year in 2001 which shows that refinery capacity remains stagnant since long as also shown in Table A. All these refineries are operating in the private sector. The Book also shows that Average Compound Growth Rate (ACGR) of refining capacity is 2.7% which is less than the global benchmark and doesn't support the huge growth in gross domestic product. In order to meet domestic demand of petroleum products, Pakistan is significantly dependent on imports.

Most of the crude oil is bought from Saudi Arabia under government-to government contracts. The terms of the contracts are not disclosed but refineries pay the full international price, and any benefit or discount accrues to the government. The remaining crude requirements are procured directly by the refineries, virtually all from Abu Dhabi, Iran, and Oman. Crude oil is transported by the national shipping company on the basis of a negotiated long-term contract. While the rates are said to be acceptable to the refineries, it is unclear whether it will be advantageous to them in the long-run, especially since discounts on average freight rate assessment are generally available in the international market. Industry experts believe that this dependence is due to various factors including limited production capabilities, poor quality of raw material, price setting mechanism, reluctance by investors because of lack of capital to build refinery facility. Besides this, one must not forget the establishment of new refineries in Middle East. It wouldn't be wrong to say that refineries in Middle East are enjoying best pricing due to availability of crude oil at a much cheaper price having huge capability of operations and efficiency. Kuwait is planning to build the Middle East's largest refinery at an estimated cost of US$14.29 billion. The cost of building new refineries has increased as the energy industry strains to increase capacity to meet rising global fuel demand. The Gulf's top oil producers are all building new refineries and expanding old plants where costs are hurting budgets and delaying plans.

OIL REFINERIES IN PAKISTAN

Pakistan's refineries have a total capacity of 12.88 million tons. Domestic refinery production increased following the commissioning of the PARCO refinery in 2001-02. Refinery production generally follows domestic demand patterns, although naphtha and, more recently, gasoline are in surplus and need to be exported. HSD and FO combined account for about 60% of total refined output. The refineries produce a full range of products, including lube base oils and asphalt. However, only 60% of their production is HSD and FO, resulting in a significant mismatch between refined product output and market profile. Pakistan exports surplus gasoline and naphtha, and is self-sufficient in other petroleum products, such as kerosene and aviation fuels.

The history of oil refineries in Pakistan started when Attock Refinery (ARL) began its operations in 1922 in Rawalpindi with a small capacity of 119 thousand ton per annum and has now reached 1.82 million per annum. ARL's configuration enables it to process the lightest to the heaviest indigenous crude and produce a complete range of both energy and non-energy products (Non-energy products include lubes and greases, asphalt, solvent oil, Mineral Turpentine (MTT), Benzene Toluene Xylene (BTX), jute batching oil, processing oil, carbon oil, and wax). It is also a hydro-skimming refinery with a capacity of 1.7 million tons, and was designed initially to process local crude. Due to inadequate crude production in the northern area, crude from the south (Badin) has to be shipped to ARL to fill the refining capacity. Another plant in the north, the Dhodak distillation plant, was constructed to process condensate at the Dhodak field. It produces about 0.2 million tons of motor spirits, kerosene, and diesel.

National Refinery Limited (NRL) was incorporated as a public limited company in Karachi in 1963 and government took over its management under the Economic Reform Order, 1972. NRL has now been privatized and management has been handed over to new owner (Attock Oil Group) in 2005. Being the only refinery in Pakistan that produces LBO, the NRL enjoys a competitive edge over other refineries. NRL is the largest coastal refinery with a capacity of 2.8 million tons, and processes largely imported crude oil to manufacture the entire range of fuel products, lube base oils, specialty products, and asphalt. Imported crude oil is received at Karachi Port and is pumped to NRL's hydro-skimming plant through dedicated pipelines.

Pakistan Refinery Limited (PRL) was incorporated as public limited company in 1960 and is listed at the Karachi and Lahore stock exchanges. The company is situated in Karachi and engaged in the production and sales of petroleum energy products as well as MTT, its only non-energy product. Its present design capacity is 2.1 million tons per annum. It processes Arabian Light (20%), Iranian Light (60%) and local crude (20%). Imported crude is pumped from Karachi Port (Keamari), and finished petroleum products are pumped to oil marketing companies (OMC) terminals by dedicated pipeline systems.

Pak-Arab Refinery Limited (PARCO) was incorporated in Pakistan in 1974 as a public limited company. The shares of the company are owned by the Government of Pakistan (GoP) and Abu Dhabi Petroleum Investment Company, LLC (ADPI), based in Emirate of Abu Dhabi. In year 2000, PARCO's oil refinery, the largest in the country commissioned, with a refining capacity of 4.5 million tons per annum. It operates under a 25% guaranteed rate of return where annual subsidy is of around Rs. 8 billion per annum.

Bosicor Pakistan Limited (BPL) was incorporated in the country as a public limited company in 1995. The principal business of the company is refining and marketing petroleum products. The refinery has a designed capacity of 1.5 million tons per annum. After the completion of its trial run form November 2003 to June 2005, the company started commercial production in July 2005 and produces a wide range of petroleum products, including LPG and naphtha. It has a long-term sale and purchase agreement with the Pakistan State Oil Company (PSO) for the marketing of its products. This privately owned hydro-skimming refinery had been mothballed in the U.S. It also takes crude from Qatar, while PSO handles crude delivery and product off-take.

IMPACT FOR REFINERY PROJECTS

The GoP is committed to accelerate an exploration and development program in order to reverse the decline in crude oil production, to increase the domestic gas production and supply and to reduce the burden of imported energy which otherwise will have adverse effect on the balance of payments and trade. Moreover, policy makers are also planning to increase the oil refining capacity with the setting up of new refineries to answer growing energy requirements in the wake of high economic growth rate. Pak-Iran Refinery Project. For several years, the governments of Pakistan and Iran have been discussing possible construction of a 6 million tons cooking refinery close to Hub near Karachi. It would take Iranian heavy crude, and 60% of its output would be HSD. The joint 50/50 project is on hold as Iran would like a 25% guaranteed return similar to PARCO's. However, the GoP is not offering guarantees anymore, and discussions are continuing. In addition to making efforts to enhance refining capacity of present refineries, foreign investment is being tapped for setting up oil another oil refinery at Port Qasim.

GoP has a significant stake in the existing four refineries, which has the largest market share as shown in Table B. The government is, therefore, able to exercise considerable influence on the refining (and in the marketing) operations.

I - Contribution to Domestic Resource Development Developing oil and gas reserves toward alleviating imports, or strengthening hard currency exports; Promoting favorable energy-mix strategies, e.g. promoting gas development as a source of relatively cheaper and more environmentally friendly fuel, Creating access to relatively more cost-effective sources of energy for consumers.

II - Contribution to Government Revenues Payments to governments in the form of royalties, bonuses, profit oil or gas, and taxes, Contributions to special purpose funds, e.g. research and development, training, etc., Mandatory contribution toward social welfare programs.

III - Contribution to Communities and Linkages Creating new national/local jobs, Fostering technology transfer, local skills development, and training, Sourcing national/local goods, Generating direct contributions to welfare of local communities and shared infrastructure.

IV - Other Long-Term Benefits-Growth in enabling infrastructure, Promoting wider participation and creating depth in the domestic oil and gas sector. Creating a more vibrant environment for investments, Potential demonstration impact of successful projects.

Summing up, GoP should take this sector seriously as Pakistan spent considerable amount on the import of oil. It should also be considered that Iran, the world's fourth biggest producer of crude oil and second biggest oil producer in OPEC, lacks oil refineries and exports crude oil and thereafter imports oil for their domestic usage. Being situated next to Iran, Pakistan should utilize this by giving attractive package to investors so that new oil refineries could be established here and get Iranian market at maximum, a 100,000 barrel ton refinery needs investment of around US$1.5 billion and in order to attract investors globally, GoP should give tax holidays till the pay back of equity. Maximum relaxation in duties and taxes including reduction in import duties can boost profitability. Presently, oil is touching 80 dollar a barrel and the day is not far away when it will cross 100 dollar a barrel. Pakistan can't afford negligence in this respect whereas policy makers should take this on urgent basis otherwise that day is also not far away when entire nation would be regretting on missing the opportunity.

TABLE A: REFINING CAPACITIES AS ON JUNE 30TH

UNIT: MILLION TONS/YEAR

REFINERY

2001

2002

2003

2004

2005

2006

Attock Refinery

1.66

1.66

1.66

1.66

1.8

1.82

Bosicor Refinery

-

   

1.5

1.5

1.5

Dhodak Refinery

0.12

0.12

0.12

0.12

0.12

0.12

ENAR Petrotech Refinery

--

--

--

--

--

0.13

National Refinery

2.8

2.8

2.8

2.8

2.7

2.71

Pak Arab Refinery

4.5

4.5

4.5

4.5

4.5

4.5

Pakistan Refinery

2.2

2.1

2.25

2.15

2.2

2.1

Total

11.28

11.28

11.33

12.73

12.82

12.88


TABLE B: OWNERSHIP OF REFINERIES (%)

COMPANY

ARL

PARCO

NRL

PRL

GOP

26

60

55

0

Public

11

0

18

13

Oil Companies

52.5

11

0

60

Others (Banks etc...)

10.5

29

27

27