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According to Herodotus (an ancient Greek historian), more than 4000 years ago natural asphalt, also known as bitumen was employed in the construction of walls and towers of Babylon. References of usage of oil is found across numerous ancient scripts across the last 2 millennia. The ancient Chinese writing of Yi Jing cites that petroleum was used in China as early as first century BC (over 2000 years ago) and the earliest known oil wells were drilled in China in 347 AD. Distillation of petroleum is detailed by Arabic and Persian chemists in the 9th century. With such modest beginnings, by the 19th century petroleum entered mainstream energy and within decades become the single largest source of energy.
Today O&G is among the largest industries in the world. 6 of the top 10 Fortune 500 are O&G companies. O&G have traditionally been high profit making companies, however looking closely, it is observed that profits are largely amassed by upstream and downstream businesses whereas profits of midstream (refining) are largely marginal. It is the continuous growth in demand of refined products and the desire to limit import bills by oil importing countries that has driven new investments in refining capacities world over. The increase in demand of refined products has sustained refiners so far but with the world trying to move to a greener future, refiners at some point of time in the not so distant future will be forced to explore alternate sources of revenue
Gross Refinery Margin, GRM (the realization from turning a barrel of crude oil into finished products) simply put is the gross profit of a refiner. GRM not only determines the current health of the refining industry but also governs future expansions and investments in the space. GRM has traditionally always been volatile. If we look closely at Singapore GRM (a benchmark GRM in the industry), it can be observed that over the last decade the GRM has slowly been declining (if inflation is taken into account, it would portray a further grim picture).
Fig.1 Singapore GRM ($/barrel)
Global refining capacity has almost always exceeded the actual throughput by over 20%, however if we look closely, the gap has been narrowing since 2009. In 2009, the surplus capacity stood at 26% which has now reduced to 20.6% in 2018. It is further to be noted that in the same period, the refinery capacity has grown by 8.2% against throughput growth of 13.4%. This signifies a slowdown in new capacity additions.
Fig.2 Global refining capacity and throughput in 1000 bpd
One could argue that this is part of the boom-bust cycle wherein refinery capacities are being rationalized. However the increased focus on alternate energy, the declining trend of GRM and slowdown in global capacity additions cumulatively signifies a negative investor sentiment
It is well known that global warming is one of the biggest concerns of the day and there is lot of focus across the world to move towards a greener future. As per IEA 2018, under the scenario where the world achieves sustainable development, demand is expected to peak in nearly all countries except India and Sub-Saharan Africa by 2030. Demand in India and Sub-Saharan Africa is expected to grow till 2035. By 2040 50% of global car fleet is expected to be electric and the ICE engines of the balance 50% are expected to be 40% more fuel efficient. Energy transition in detail will be covered in the next issue of the Matter of Fact, Volume 1, Issue 4.
IHS Markit on the other hand forecasts the demand to peak in 2037 with larger proliferation of electric vehicles, inclination in customer’s preferences towards shared mobility, increased fuel efficiency and increased use of bio fuels. Though there are differences in opinion on the timelines of achieving the sustainability goal, everyone agrees that the world will most likely move to a sustainable future and the demand for refined products will reduce.
In addition to road transportation, petroleum products are used in a plethora of sectors.
Fig.4 Usage of Petroleum, Sector wise
Source: Opec, World Oil Outlook 2040
After road transportation, the petrochemical industry is the largest consumer of oil. Oil products are the key feed stocks for all petrochemical products. By 2030, when the oil demand is expected to peak, petrochemicals are set to account for 33% of this growth. Aviation followed by shipping are expected to have the highest growth rate of 34.8% and 28.6% respectively, but in absolute volumes, petrochemicals will be the largest contributor to the growth (WOO 2040, OPEC).
Fig.5 Sector wise consumption mb/d
Source: IEA, Future of Petrochemicals
Similar projections are also made in the World Energy Outlook 2018, and IHS Markit wherein petrochemicals are projected to register the largest growth. Though plastic recycling is expected to increase significantly offsetting demand of around 1.5 mbpd of oil. However with few alternatives available, use of crude as petrochemical feed stock is expected to grow by 3.3 mbpd.
Fig.6 Index of Base Chemicals & Refined Products Growth
Source: IHS Markit, Insights 2018 Base year: 2010
Petrochemical in the strictest sense are chemicals derived from petroleum and natural gas. However the definition has been broadened to include aliphatic, aromatic and naphthenic organic chemicals. In many instances, some of these chemicals may also be obtained from other sources such as coal, coke or vegetable products (Oil & Gas produces ≈ 90% of the petrochemicals). Products made from petrochemicals include items such as plastics, soaps & detergents, solvents, drugs, fertilizers, pesticides, explosives, synthetic fibres, paints, foam, insulation material, tyres, etc. Plastics form ≈ 50% of the demand for petrochemicals.
These products are intimately engrained in our daily lives. Combination of plastic and electronic equipment are elemental in conveying information in the digital world. Modern agriculture systems will crumble without fertilizers and other agrochemicals. Medicine & Pharmaceutical sector as we know it will cease to exist without petrochemicals. Plastics are used throughout the global food system in transportation, preservation and consumption. Further facilitating a sustainable future relies heavily on petrochemicals. Using plastic based materials will reduce the weight of vehicles thereby reducing fuel consumption. Insulation materials derived from petrochemicals will reducing demand of heating and cooling in buildings driving energy efficiency.
Fig.7 Consumption Breakup by Industry
The demand growth for plastic has surpassed not only Global GDP but also other key bulk materials including steel, cement, aluminum, etc. Regional Consumption patterns show that as GDP increases, the demand for plastics and fertilizers keep increasing.
Fig.8 Demand Growth of select Bulk Materials
Though in developed countries like USA, Japan and Western Europe the fertilizer demand appears to have been saturated at 85-135 KG per capita, the consumption in rest of the world ranges from 12-60 KG per capita and is growing continuously. Similarly consumption of plastics in countries like the USA is 109 KG per capita whereas that in India is approx. 9 KG only.
Fig.9 Per Capita Demand of Plastics in KG
Source: BCG
The global petrochemical market size was valued at $ 539.3 billion in 2018 and with is anticipated to register a CAGR of 8.5% over 2019-2025. By 2040 with the world population reaching 9.2 billion and with billions of people joining the middle class by then, the growth in demand for petrochemicals is expected to grow at 1% above the world GDP.
Petrochemicals are largely intermediates and the value chain is similar to most other manufacturing sectors. The first element in the value chain are the Manufacturers of Feed Stocks. Feed stocks here are largely Naphtha, condensates, natural gas and organic products like sugarcane, cassava and palm fruit. Over 50% of petrochemical production capacity uses Naphtha as feed stock and less than 3% use other organic products.
Upstream petrochemical industries then use these feed stocks to produce precursor or preliminary petrochemical products. These are largely in two groups based on their molecular structure: (1) Olefins, which include ethylene (C2), propylene (C3) and butylene (C4) and (2) Aromatics, which include benzene, toluene and xylene. These are often referred to as building blocks / primary petrochemicals.
Intermediate petrochemical industries consume these building blocks (both olefins and aromatics) and through chemical conversion, manufacture complex derivative products. Primary petrochemicals contain only carbon and hydrogen and through chemical reaction incorporate chlorine, nitrogen or oxygen to produce the finished derivative. Examples include vinyl chloride, styrene, ammonia, ethylene glycol, methanol, propylene oxide, etc.
Downstream petrochemical industries takes upstream and intermediate products and make final products for use in related sector. These products are largely divided into 4 groups: (1) Plastic Resins which include polyethylene, polypropylene, polyvinyl chloride (PVC), acrylonitrile butadiene styrene (ABS), polyethylene terephthalate (PET), polystyrene (PS), etc. They are used in packaging, automotive sector, building materials, consumer goods, etc. (2) Synthetic fibres which includes polyester, nylon fibre, etc used in textile and packaging. (3) Synthetic rubber/elastomers which includes styrene butadiene (SBR) and butadiene (BR) used in tyres, auto industry and consumer goods. (4) Coatings and Adhesives which includes polycarbonate and polyvinyl acetate used in construction and a variety of other industries.
Feed stocks and primary petrochemicals are largely produced in petroleum refineries as distillates or by products from various units. Refiners are already deep-rooted in the petrochemical value chain. With slowdown in growth of refined fuel products and peak demand expected in a decade, deeper integration into intermediate and down steam petrochemicals is a natural fit for refiners.
Petrochemicals are deeply engrained in every aspect of our daily lives and has had a healthy demand growth till date. Demand projections remain undisputed. Petrochemicals has traditionally been a high margin business and the complex technical knowhow has largely remained closely guarded secrets with very limited licencors across world over. Other constraints including feed stock availability and supply security of the feed stock has created large entry barriers to the industry. An indicative economics for fuel and petrochemicals in Europe based on price data from Argus in 2018 clearly shows that the gross margins of producing ethylene from a naphtha cracker and then further manufacturing polyethylene is exponentially higher.
Fig.10 Margins in Various Products
Source: IHS Markit, Insights 2018
For refiners, integrating petrochemicals brings in certain additional unique advantages making them more cost competitive over standalone players.
They not only have feedstock supply security but can also draw synergies from their refinery complexes in terms of shared utilities, reduced logistics costs, shared administration costs and overall yield optimization based on economics. The actual benefit realized will however depend on the extent of integration. Reliance Industries in India has a EBIT of 19.8 k Cr. from its refinery business and 32.1 k Cr. from its petrochemical business.
There are numerous examples across the world of both forward and backward integration into the petrochemical value chain. Companies like Reliance Industries in India, Hengli Group in China and HengYI Petrochemicals have diversified starting from textiles to petrochemicals to refineries and upstream crude production. Others like Sinopec, Exxon, Shell, Petronas have diversified from Oil & Gas and built a strong petrochemical portfolio.
Fig.11 Petrochemical Capacities
Source: BPCL Corporate Strategy Analysts
In the last 5 years, Shell has divested in 9 refineries having lower %age of petrochemicals at the same time augmented petrochemical processing from 10.7% to 12.2% in other refineries. Numerous other investments by other major refiners are in various stages of commissioning including a $ 10 b plant by Exxon at Texas, $ 1.8 b plant by BP in Turkey, $ 27 b integrated complex by Petronas in Malaysia, etc.
In India, IOCL already has a presence in the petrochemicals sector and is further augmenting its capacity both at Panipat and Koyali. BPCL is entering into the space both at Kochi and Mumbai. HPCL has investments laid down at Bhatinda and Barmer.
A new technology called crude to chemicals, CTC has evolved over the recent past wherein refinery and petrochemical operations are integrated with the objective of converting 70% of the crude barrel into feed stock. This means refiners have a potential to unlock more than double the value from a barrel of oil. China has been aggressively pursuing CTC and over 5 projects in China are at various stages of commissioning with estimated conversion of over 40% of barrel into petrochemicals.
Refineries: The demand-capacity gap in India is very similar to the global scenario. The refinery capacity outpaces national demand for petroleum products by 17% currently and with new refineries RRPCL (60 MMTPA), Barmer (9 MMTPA) and with capacity expansions in many of the others, the total capacities will increase considerably. Further as per Fitch Solutions, India’s oil demand forecast has been reduced from 5% to 3% for the next year (a 6 year low). With this the gap is expected to increase substantially which will adversely affect the refiners. Since India is a huge exporter of refined petroleum products, Indian refiners for the last decade have always enjoyed over 100% capacity utilization, but in days to come, the picture may change drastically.
Fig.12 Petroleum Consumption and Refining Capacities in India
Petrochemicals: The outlook for petrochemicals in India is very bright. The current percapita consumption is 1/3rd of the global average of 30 KG. Demand in India is expected to grow with a CAGR of 10% over the next decade, far above the global average. The business has been hugely profitable for the existing Indian players (gross margins from petrochemicals business in FY 18 are: RIL – 17%, IOCL – 19%, GAIL – 15%).
With Surplus capacities (both in India and abroad), entry of private players in fuel business with highly relaxes entry barriers, margins of refiners in India are likely to be under pressure. Petrochemicals is a great diversification opportunity for Indian refiners.
It is true that plastic pollution is one of the biggest environmental challenges of the day. Plastics are inexpensive and highly durable. Their chemical structure renders them resistant to natural degradation. Due to inappropriate disposal of plastics, they affect land, waterways and oceans. Living organisms particularly marine animals get entangled and due to ingestion of plastic, the chemicals within plastics interfere with their physiology and disrupts various hormonal mechanisms.
However it is also to be noted that plastics are deeply integrated into our lives and we cannot avoid plastics, at least not in the near future. Plastics in itself are not bad, mismanagement of plastic waste is the source of the problem. The primary culprit is the light weight plastic bags, also called single use plastics (largely less than 50 microns thick and made primarily of LDPE). These plastics often do not make it to recycling and largely due to mismanagement end up in landfills, waterways and oceans (these single use plastics are ~5% of the entire petrochemicals in the world). Most governments are trying to address this issue by banning the use of these single use plastics to nip the problem at the bud. However other plastics are here to stay, at least until an inexpensive alternate is available.
It is very clear that refineries in India will face a challenge of excess capacities and strained margins, similar to its global peers. Expanding into petrochemicals is the most lucrative diversification strategy for Indian refiners. Petrochemicals have a strong fundamental outlook and is a natural fit with refinery business.
BPCL realized this way back and in 2011 started working towards diversifying into petrochemicals with a strategy of setting up niche petrochemicals portfolio at Kochi and bulk petrochemicals at Mumbai. BPCL is investing heavily in capex to realize the aspiration of having petrochemicals as 15% of its total portfolio. After a detailed study on the subject and conducting due diligence, BPCLs first foray into petrochemicals through its Propylene Derivatives Petrochemical Plant, PDPP at Kochi is to commence commercial sales shortly. PDPP plant will produce 6 key petrochemical products namely Acrylic Acid (AA), Butyl Acrylate (BA), 2 Ethly Hexyl Acrylate (2EHA), I Butanol (IB), n Butanol (NB), and 2 Ethyl Hexanol (2EH). These products are largely used in the paint industry, textiles, detergents, pulp & paper, coatings, printing inks, resins, sealants, pressure sensitive tapes, plasticisers, adhesives and solvents. PDPP plant at its full capacity will produce 329 TMT of these products. Currently for AA, BA and 2EHA, India is 100% import dependent. 60% of demand for the remaining 3 products is met with imports. The project will reduce India's import bill by over $ 400 million per year.
BPCL is additionally in the process of setting up polyol project at Kochi which will have various grades of polyol, mono-ethylene glycol (MEG) and propylene glycol (PG) in its portfolio. Polyol is largely used in all types of foams (seats, cushions, mattresses, etc), insulation for refrigerators, water heaters, insulation, coatings, sealants, adhesives and elastomers. MEG and PG are used in textiles, paints, antifreeze, coolants, etc to name a few. Currently over 75% of domestic demand for polyol and 80% of PG is met through imports.
At Mumbai, BPCL has plans to set up units of polypropylene and ethylene cracker. Feed stocks from ethylene cracker will be used to then make high density polyethylene (HDPE) and linear low density polyethylene (LLDPE). These products are used in the automobile industry, FMCG packaging, cable insulation, household articles, bottles, tubes, pipes, chemical drums, plastic containers, food packaging, lamination, etc. It is to be noted that BPCL does not have single use plastics in it product portfolio.
BPCL through all these strategically planned mega projects has stepped on the pedal to diversify into petrochemicals in a big way to insulate itself from the uncertain times ahead for refiners.
Pankaj Muley and Ankur Rustgi(Team Corporate Strategy)
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