Thursday, April 21, 2005

Offshore Refineries
I missed seeing it the other day, but a colleague pointed out this announcement by Saudi Aramco that it intends to build a new 400,000 barrel per day (BPD) refinery at Yanbu, on the Saudi side of the Red Sea. This would augment the existing, comparably-sized Yanbu refinery joint venture with ExxonMobil and push the Kingdom's total refining capacity over 2 million BPD. The project would have lots of interesting implications, if it goes ahead.

There are at least three reasons why the Saudis might want to build a new refinery now. The first and most obvious is that global refining capacity has gotten extremely tight, and refining margins reflect this. Simple refineries that used to make a dollar a barrel are now earning $3, and more complex plants that made $2 or $3 per barrel are making $6-12. Of course, there's a long industry history of destroying attractive margins by building projects that bid up the price of the inputs and flood the market with products. At the moment it would take more than one new refinery to do that.

A more fundamental reason for the Saudis to expand their refinery capacity comes from Econ 101. Traditionally, the producer of a raw material should integrate up the value chain to capture more of the value added on the product. This argument is somewhat shaky in the case of oil, though, because the global oil market isn't in pure competition; the Saudis are price-makers, not price-takers, and as such, they already extract a healthy "rent" from the resource. Until recently, refining margins were depressed globally and earned pitiful returns on capital. And one of the biggest chunks of value in the entire chain isn't available to them at all. A few years ago, the German government took in more money from gasoline taxes than the Saudis made selling petroleum, and this might still be true, as taxes have followed prices higher.

The third rationale may be the most compelling for Aramco, however. It relates to fundamental differences between the crude and product markets. First, when Saudi Arabia exports crude oil, it is subject to their OPEC quota. Although they've been able to produce above that level recently without any repercussions, that's not always the case. Product exports, however, don't count with OPEC.

In addition, most of Saudi Arabia's incremental wells produce heavy, sour oil. This sells at a discount at the best of times, and when the global capacity to handle the residue from refining it maxes out, Saudi Heavy can be hard to sell at all. A new, complex refinery gets around this problem and makes lemons from lemonade: premium products that are in demand everywhere from a feedstock that isn't attractive without a lot of additional investment. The indicated $4-5 billion price tag for the new plant certainly suggests something more than a simple "topping" refinery.

The one piece of advice I'd give anyone looking to partner with Saudi Aramco on this project is not to expect a quid pro quo in terms of access to upstream oil opportunities. That didn't pan out for Mobil or Shell, when they invested in the Jubail and Yanbu refineries in the 1980s, nor are the companies that have signed up for natural gas projects getting any noticeable consideration on the crude side. But perhaps the likeliest partners for this refinery haven't studied that history, having come from a state-controlled company mentality.

No comments: