INVESTING IN OIL REFINERY IN VIETNAM

Transcription

1 FULBRIGHT ECONOMICS TEACHING PROGRAM Jul 21, 2001 Rev: Jan 27, 2007 DAVID DAPICE NGUYEN XUAN THANH INVESTING IN OIL REFINERY IN VIETNAM Oil Refining Basic Oil refining is a complex series of processes that manufactures finished petroleum product out of crude oil. Crude oil is a complex mixture of hydrocarbons, which have different molecular weight distribution and boiling point ranges. The process typically starts with crude oil being vaporized in the distillation tower under high temperatures and pressures, so that various components can be recovered when their boiling points are reached. Lighter products - liquid petroleum gases (LPG), napththa, and gasoline are vaporize at lower tower temperatures and are drawn off from the top of the tower. Middle distillates, including jet fuel, kerosene, diesel fuel and heavy gas oils, vaporize at moderate tower temperatures and are drawn off from the side of the tower. The heaviest products (residuum or residual fuel oil) are withdrawn from the bottom of the tower, sometimes at temperatures over 1000 degree F. Additional refining may sometimes be required to crack the heavier products into lighter products, or to create the mix of products that the market demands. Refining processes include hydrotreating, cracking, reforming and alkylation. In addition to crude oil that runs through a simple distillation, refiners also use a variety of other specialized inputs, such as partly refined oil or blending components that includes oxygenate, to make the desired mix of products. Generally, refining develops in consuming areas rather than near the oil wellheads, because it is cheaper to move crude oil to refineries than to move products to markets. The proximity to consuming markets also makes it easier for refiners to adjust their production plan in respond to seasonal changes in demand. This explains why the largest concentration of refining capacity is in the United States, Europe or Asia. Most refineries are built to meet their local demand first, but sometimes also engage in temporary export to balance supply and demand. A notable exception is Singapore, where most of refineries were built for product export from its efficient and well-located port. This case study was prepared by David Dapice and Nguyen Xuan Thanh, lecturers at Fulbright Economics Teaching Program. Fulbright Economics Teaching Program s cases are intended to serve as the basis for class discussion, and not to make policy recommendations. Copyright 2001 Fulbright Economics Teaching Program

2 Petroleum experts sometimes use different variables as measures of how much profit was made per barrel of crude oil processed. These variables vary in what are included and subtracted in the calculation of revenues and costs of the refining processed. Crack spread is the difference between spot wholesale prices of petroleum products sold at the gate of the refinery and the delivery price of crude oil as input to the refinery. Crack spread only takes into account the cost of crude oil and excludes other costs incurred during the refining process. The revenues and raw material costs are calculated per barrel of crude oil charged to the refinery. Refining margin is similar to a crack spread, but takes into account all product revenues, raw material input expenditures and all other operating costs incurred during the refining process. Raw material input costs include the costs of crude oil and other feedstock such as MTBE (an additive for gasoline) and purchased butane and iso-butane. Variable operating costs typically accounts for 5% of product price and include fuel burned during processing and steam, cooling water, electricity, catalysts and chemicals costs. Other operating costs accounts for 2% of product price and include maintenance materials, labor, tax and insurance. 1 Price of crude oil is the most important determinant of the refining margin, as it is the largest component of the costs of raw material inputs. Thus, during the period of high crude oil prices and sluggish petroleum product demand, refining margin will be small, even some times become negative. Crude oil prices have been very volatile during the period of Prices fell to $10 per barrel in 1998 due to low demand caused by the Asian economic crisis. In 2000, prices went up strongly, reaching daily peak of $37 per barrel, as a result of OPEC s tightening of production and the strong demand in Asia s recovering economies. World oil prices are projected to reach $36 per barrel in nominal dollars in the year of Crude oil is the major part of the cost of refined products, as the crack spread is usually only $1-5 per barrel at world prices. During the 1990 s, refining has been significantly less profitable than other segments of the oil industry due to growing operating costs and additional investments required to meet more stringent environmental regulations. The Oil Refining Industry in Asia Oil demand is expected to be strong as the region recovers from the Asian financial crisis. Strong expected economic growth in developing Asia fuels the demand for additional consumption of petroleum products, especially for transportation sector energy use and for other industrial, electricity sector and building uses. Asia has surpassed Europe as the world s second largest oil refining center after North America. Countries that have significant refining capacity are Japan, Singapore, India, Malaysia, China, and South Korea. (See Exhibit 1.) 1 Source: US Department of Energy 2 Source: US Department of Energy Page 2 of 12

3 Significant regional players in Asia s refining industry are China, Japan, India, South Korea, Indonesia and Malaysia. As of January 2001, Japan had about 5.0 million bbl/d capacity at 35 refineries. Due to stagnate consumption of petroleum products in Japan in recent years, the country s refining industry has suffered from overcapacity. Singapore is one of the major oil refining centers of Asia, with total crude oil refining capacity of about million barrel per day. During the Asian economic crisis, the declining demand for petroleum products in the region had a negative impact on Singapore s refining industry. Although the region is recovering from the crisis, recent expansions constructions of new refineries in India and Malaysia have reduced demand for imports refined products from Singapore. On average, the refining utilization rate of Singaporean refineries is only at 60% in the first half of Although recent world oil shortages have helped boost up margin, it was considered as a short-term effect only. The long-term trend, however, is toward lower margins. Net margins in the Singaporean refining center traditionally languish below $2 per barrel, but they can still be profitable due to their large scale operations. Large refineries have lower costs. Singapore refineries can convert several hundred thousands of barrels of crude oil per day. It is a different story for the refiners in Korea during the year of 2000 and the first half of Despite slowing domestic economy, weakening oil demand, deregulation and tightening product specifications, local refiners are enjoying a gross margin of over 9$ per barrel (or approx. $68 per ton) by deciding to pass on al crude oil price increases to consumers. According to analysis estimates, average domestic margins in Korea are well over $6 per barrel-an exceptional level compared to Singapore. In the late 1990s, India has turned from a products importer to a net exporter of gas oil and other petroleum products. The country s largest independent refiner, Reliance Petroleum ( RPL) is planning to expand its capacity from 540,000 barrel per day to around 900,000 b/d, which could cost the company more than $1 billion in investment. RPL s monstrous refinery capacity allows it to add capacity at less than half the cost it takes to build a green field refinery. RPL s 540,000 b/d refinery in Jamnagar runs at near full capacity and exports several different petroleum products. The Petroleum Market in Viet Nam Viet Nam s economic growth rate is forecast to be averaging 6% annually. To meet economic growth targets, petroleum supplies will need to grow about 50% faster than GDP (electricity supplies will have to grow 80% faster). Petroleum demand will triple to around million tones per annum and natural gas use grow to 7.5 billion cubic meters/year over the next decade. To meet these targets, annual investments in exploration alone will be about $120m-$m170. Investments required for oil and gas exploration would be at least $600 million. Additional investments of $ billion would be needed to build refineries. Adding other investments necessary to ensure access to the latest technologies, total investments of the magnitude of $1 billion a year will be required for the energy sector. (See Exhibit 2.) Viet Nam is important to Asia Pacific energy market because of its potential to become a regional oil and natural gas supplier. The country currently has 600 million barrels of proven oil reserves, and crude oil production is growing quickly, reaching 160,000 barrels per day in July Page 3 of 12

4 Viet Nam currently has no refining capacity, therefore most of its oil production is exported, mainly to Japan, Singapore, and South Korea. Oil exports are one of the country s largest foreign exchange earners, raking in $1.4 billion in the year 2000, as higher world oil prices were responsible for the 67.5% rise of oil receipts. Because Viet Nam has no refineries, domestic demand for petroleum products has to be met by imports. In the same year, the country spent $.9 billion on petroleum product imports, which accounted for 16% of total imports. The substantial rises in the imports of petroleum products, steel, motorcars and chemicals were responsible for the country s trade deficit of $1.2 billion. Viet Nam s domestic consumer prices of petroleum products are higher than international import prices. Prices of gasoline, diesel, and kerosene are under the control of the government. Maximum bulk and retail prices are fixed based on the c.i.f price of imported products, plus distribution margin and taxes. (Exhibit 3) The government of Viet Nam currently imposes an export duty of 4% on crude oil. Petroleum products are also subject to a 20% excise tax. Petro Vietnam (PVN), the country s state oil company, has long been Viet Nam s biggest foreign currency earner, with revenue of $1.4 billion in the year 2000, mostly from crude oil and natural gas exports. The company operates in all major segments of the domestic energy market, taking advantage of its role as part regulator and part operator. PVN is currently working on a bond issue to raise about US$300 million by the start of 2002 and will use the raised funds to invest in various oil and gas projects. Dung Quat Oil Refinery The idea of building the first oil refinery suggested by PetroVietnam began to take shape in It would be located in Ba Ria Vung Tau, the oil city of Vietnam which is 120km away from HCMC, or in Dong Nai, which has witnessed a quick rate of industrial growth in recent years and which is adjacent to HCMC. In August, 1993, Total Group of France was officially assigned to make a feasibility study on the investment of the first oil refinery in Vietnam. After that, Total and PetroVietnam reached an agreement to establish a joint venture in building and operating the oil refinery at Long Son, Ba Ria Vung Tau province, which is 140 km away from Bach Ho oil well. Total investment cost of the factory, whose capacity was estimated at barrels/day, would be about 1,3 billion USD. The factory location would be near the source of crude oil, which mainly came from Bach Ho well, and near the consuming market in HCMC and the adjacent areas which account more than half of the national consumption of oil and gas. Therefore, as calculated by Total, the project of the oil refinery was financially sound. The internal rate of return of the project in accordance with the basic financial model was 15%. However, the site for the oil refinery was ordered to be relocated after it had been approved and the plan had been about to start. The Vietnamese Government thought that the project should be located in Central Vietnam, which has so far had difficulties in attracting investments and has fallen behind compared with the economic center of HCMC and HN. The oil refinery located in Dung Quat Page 4 of 12

5 industrial zone of Quang Ngai province would be an important launching-pad to speed up the economic development of the central area. Concretely, the investment in the oil refinery would bring about the development of the heavy industry, especially the petrochemistry, which would accelerate the industrialization of the coastal part in Central Vietnam. Total itself thought that it would cost USD 500 million more to build the oil refinery in Dung Quat instead of Ba Ria Vung Tau because they would have to invest more in the infrastructure of the place. Moreover, the refinery in Dung Quat would cost a great deal in the transportation for the crude oil from Bach Ho well to cover the 1,000 km distance to reach Quang Ngai. Total thought that the transportation cost of the crude oil would increase by USD 28 million/year. In addition, as the consumption market of gasoline and oil in the Central is only 12% of the domestic aggregate demand, most of the oil products processed would have to be transported 800 km up to Hanoi and its the surrounding areas, or 800 km down to HCMC and its surrounding areas. In short, transporting either by pipeline or by ship, the production cost would increase at least by 5%, which meant from USD 10 to 15/ton. Therefore, the finished price would be higher than the import price. In 1995, Total officially withdrew from the project. Three months after Total s withdrawal, LG group of Korea and Petronas of Malaysia showed interest in the project. After carrying out the feasibility study, these companies asked for a price support for the products so that the project could keep its foothold in finance. However, the Vietnamese government rejected every suggestion of subsidy. In 1997, after 2 years of fruitless negotiations, these two companies also gave up. For the third resuscitation of the project, the Government of the Soviet Union assigned the Zarubezhneft state-owned oil company, the Soviet Union s partner Vietsovpetro joint venture, to cooperate with Vietnam to deploy the Dung Quat oil refinery. The VietRoss joint venture between PetroVietnam (50%) and Zarubezhneft (50%) was set up in December, 1998 after an official approval based on the policy of building the oil refinery 3 from the government in July, The total investment was adjusted from USD 1,3 to 1,5 billion. As planned, the refinery would be completed in 2001 and put into operation in The total capacity of oil refining would also be barrels/day, or 6,5 million ton/year. According to the leaders of PetroVietnam, due to the joint venture capital structure of of VietRoss, every decision to be made would have to be agreed upon by both sides. Therefore, any disagreement upon the choice of technology and auctions for providing the equipments could not be solved when both partners of the joint venture had the same right to vote. It took 1 year to get the procedure of setting up the joint venture finished and 9 months to select the technology, said Mr. Pham Quang Du, Chairman of the Management Board of Vietnam. In 2001, in spite of keeping on participating in the project as a contractor to construct the crude oil container, Zarubezhneft suggested withdrawing from the joint venture VietRoss. At the end of 2002, Vietnam agreed to refund USD 235 million, which Zarubezhneft had invested in the joint 3 Decision no. 514/TTg dated on July 10, 1997 of the Prime Minister. Page 5 of 12

6 venture. In February, 2003, the joint venture VietRoss was officially dissolved. PetroVietnam became the only investor of the Dung Quat oil refinery. Two more years were spent on a reconsideration of the whole project and Vietnam was the investor by itself. In mid-2005, the feasibility study of Dung Quat oil refinery was submitted to the eleventh National Assembly and discussed during the 7 th session. In June of that year, the Prime Minister officially signed the decision to adjust the project. 4 The total investment was raised from USD 1,5 billion to 2,501 billion. The capacity of the project was also 130,000 barrels of crude oil/day or 6,5 million ton/year. At the beginning, 100% of the source of the crude oil would be Bach Ho sweet oil. For the long term, the source of the crude oil would be Bach Tho sweet oil as well as the sour oil from the Middle East. The product structure of the oil refinery would include gasoline without lead (1,8 million ton/year), jet fuel and household kerosene ( ton/year), diesel oil (3 million ton/year), liquefied petroleum gas LPG (280,000 ton/year), F.O. ( ton/year) and propylene (108,000 ton/year). PetroVietnam gave two reasons for the USD 1-billion increase in investment cost while the project scale did not change. Firstly, it was influenced by the world s oil price. In the calculation at the end of the 90s, the prices of the machinery and equipments were low because there was not any big project of oil refinery newly invested when the price of oil was still low. During the past time, the oil price rocketed up and therefore many investors rushed into building the oil refinery. The demand of the machinery and equipments increased as a result. Secondly, the increase in the investment cost was due to the change in the overall design. In 1997, one of the main products of the refinery was the A83 gasoline and industrial diesel oil. The A83 gasoline was no more circulated currently and the products of the refinery would be A90/92/95. The industrial diesel oil, according to the former calculation, was aimed at serving the thermo-electric plants which are mainly in the Phu My, Ba Ria Vung Tau industrial zone(!) and which have up till now turned to using gas. 5 Of the capital structure, the equity of PetroVietnam was about USD 226 million (of investment) and 800 million USD would come from the revenue of the crude oil. The rest of the investment cost would be funded by a loan. A USD 1 billion loan would come from the credit source of the investment in development. 6 Vietcombank would loan 250 million USD. Other three stateowned commercial banks (BIDV, Incombank and VBARD) would give a loan syndication of 225 million USD. The oil refinery would occupy an area of 338ha on the ground and 473ha on the surface of the ocean in the Dung Quat industrial zone. The big selective items are the main factory 7, the crude oil container, the product container, the pipeline system for crude oil, the construction port, the product 4 In accordance with the decision of the adjustment of the investment project of Dung Quat oil refinery no. 1 of the Prime Minister dated on June 17, Website of the People Committee of Quangai province, Total investment of Dung Quat project has to be increased up to 1 billion USD, 8/6/ Interest rate 3,6%/year, 16 year maturity, grace period during the construction is 4 years. 7 Including the factories: crude distillation unit (CDU); naphtha hydro treatment (NHT); reforming continuous catalysis; LPG treatment (LTU); propylene retrieval (PRU); kerosene treatment (KTU); naphta treatment from RFCC (NTU); treatment of sour water; sour water (SWS); amine regeneration (ARU); pincers neutralization (CNU); sulphur retrieval (SRU); isomerization (ISOM); LCO treatment by hydro (LCO-HDT). Page 6 of 12

7 export port, the system of oil pour buoy (SPM), the undersea pipeline and the rotating area of ships, the road to the oil refinery and the residential area. The technical contract of purchasing the equipment and building (EPC) for the main factory implemented under the build-transfer strategy, the most important item of the project, was signed with a group of companies led by Technip (France) at USD 1,56 billion. The main contractors of the group include Technip (France), JGC (Japan), and Reunida Technica (Spain). On November 28, 2005, the Dung Quat oil refinery project was officially begun. According to the Minister of Industry, Mr. Hoang Trung Hai, at the National Assembly, 8 the project has the internal rate of return of 6%. At present, the government is determined to complete the construction by 2008 and put it into operation in Also, the government has made decisions about the choice of locations for three more oil refineries during the deployment of the Dung Quat project (named the oil refinery number 1): the oil refinery number 2 in Nghi Son, Thanh Hoa, the oil refinery number 3 in Long Son, Ba Ria Vung Tau (the location which was selected by Total at the beginning of the 90s) and the oil refinery number 4 in Nhon Hoi, Binh Dinh National Assembly XI, the 7 session, 8/6/ Until the time the Prime Minister came and checked the project in August, 2006 the main contractor Technip was slow compared with 10 week rate of progress (the gate of electronic information of the government, Prime Minister Nguyen Tan Dung: The key projects of petroleum must be on schedule and the quality standard, 7/8/2006). 10 Quang Ninh, Phu Yen, Binh Dinh, Khanh Hoa and Can Tho are considered to be the location for building the oil refineries. Page 7 of 12

8 Exhibit 1: World Crude Oil Refining Capacity - January 1, 2000 Crude Oil Distillation Region/Country Number of Refineries ( 000 Barrels Per Day) North America ,049 Western Europe ,902 Asia: ,734 China 95 4,347 India 17 1,858 Japan 35 4,998 South Korea 6 2,540 Singapore 4 1,255 Indonesia Malaysia Sri Lanka 1 48 Bangladesh 1 33 Taiwan Thailand Source: US Department of Energy. Exhibit 2: Projected Investment In Downstream Petroleum (Millions of US Dollars) Sector Product storage and distribution Lubricant storage and distribution Refining ,200 LPG production LPG storage and distribution Total 1,100 1,100 2,260 Exhibit 3a: Forecast (a) of Viet Nam s Oil Sector Exports And Imports (In million US$ unless otherwise indicated) Year Total M$ Crude Oil Exports Volume (000 s ton) Unit Value (US$/ton) Petroleum Product Imports Total M$ Volume (000 s ton) Unit Value (US$/ton) ,170 7, , ,529 10, , ,617 11, , ,600 12, , ,860 13, , ,295 14, , ,380 16, , ,752 17, , ,640 18, , ,612 20, ,540 6, ,435 21, ,708 7, * 4,790 23, ,879 8, * 7,040 34, , * 10,343 50, ,055 17, * Estimated at 8% per annum growth rate for production and 10% for consumption. (a) Forecast based on local data. Page 8 of 12

9 Exhibit 3b: Forecast Differences in Import Prices and Export Prices (In US Dollars) Exhibit 4: Viet Nam s Oil Exports and Petroleum Product Imports 50,000 45,000 Exports Imports 40,000 35,000 In Million US$ 30,000 25,000 20,000 15,000 10,000 5, * 2025* 2030* Year Exhibit 5: Viet Nam s Oil Export and Import Trends 60,000 50,000 Exports Imports 40,000 In Million US$ 30,000 20,000 10, * 2025* 2030* Year Page 9 of 12

10 Exhibit 6: Project Financial Analysis A project can be evaluated from the point of view of different interest groups, such as the government, the bankers who lend money to the project, or the project owner. Financial analysis is carried out from the point of view of either the banker or the project owner. The banker s point of view, usually called total investment point of view, first evaluates the project s cash flows 11 without considering the impact of financing. Then it compares cash flows with debt payments with an eye to ensuring that any loans can be repaid. The project owner s point of view, also called the equity holder s point of view, is identical to the total investment point of view, except that the project owner must also consider the debt payments in calculating the rate of returns to equity. The project resource statements for financial analysis should include all the financial resource costs and resource benefits, evaluated at market prices. All cash flows are assumed to occur at the end of the period. Exhibit 7: Project Economic Analysis Economic analysis is used to refer to project analysis from the government s point of view, or the national economy point of view. Economic analysis differs from financial analysis in that the project resource statement is drawn up using a different set of prices called shadow prices. This is because the market prices do not always correctly reflect the opportunity cost of resources from the point of view of the national economy as a whole. Under economic analysis, project inputs and outputs are valued based on the alternative production forgone or the cost of alternative supplies. For traded goods the alternative source of supply is through international trade. If a project input had to be imported, it should be evaluated at its import price. If a greater use of the good led to a reduction of export, then it should be evaluated at export price. Similarly, if production of a project output led to a saving in imports, then it should be evaluated at its import price. Otherwise if the project output is used for export, then it should be evaluated at its export price. In the project resource statement for economic analysis, items that do not represent the use of a resource but only a transfer of purchasing power from one group within the national economy to another will be excluded. These transfers can have direct or indirect form. Examples of direct form transfers are payments of taxes and tariffs, the receipts of subsidies, or rent payment. Indirect transfers refer to the case when these items are embedded in the prices of the project inputs or outputs and adjustments will need to be made to remove them from economic calculation. However, care should be taken in determining the shadow prices in the presence of export and import duties. Export duty is paid for by the foreign buyer and therefore is a resource benefit to the national economy, to the extent it reduces the foreigner s net income. On the other hand, any import duty is merely a transfer within the national economy and should be excluded from shadow prices. 11 Here for simplicity we define cash flows of the project as equivalent to earnings before interest, tax, depreciation and amortization (EBITDA). Page 10 of 12

11 In addition, financing items of a domestic nature, such as the receipt of a domestic loan, or domestic interest payment also represent a transfer of purchasing power within the national economy and not the use of a resource. These items also need to be excluded from economic analysis. However, the opportunity cost of capital (its returns in its next best use) is a relevant economic cost. Interest is, of course, a financial cost. The indirect effects of a project should also be considered from a national point of view. Harmful environmental consequences are a cost to society as a whole and should be included in the economic costs of the project. A refinery that discharges its industrial waste into the sea will affect the catch of the local fishing industry. Similarly, indirect effect such as the generation of additional employment by the project should be included as it was a benefit to the national economy. The input for the project is crude oil and its output is petroleum products. Both are considered traded goods because the project s demand for crude oil as input will alter the quantity of crude oil exported. Similarly, the project s production of petroleum products will alter the quantity of the good imported into the country. There is significant international trade taking place between countries for these goods. Crude oil, which is used as input in this project, has a financial price made up of producers price, applicable taxes, transport and handling costs. However, it would be incorrect if we just simply adjust these items from the financial price to arrive at the economic cost of crude oil. In this case, it is the economic benefits foregone by reduced exports of crude oil that should be used to measure economic cost of this exportable input. In other words, while Viet Nam s oil exporter receives a price of P1 at the border of the country, Viet Nam s economy as a whole will receive the fob price P2, which is equal to P1 plus any export duties, which are paid by the foreign importer. It is this P2 that is the correct measure of economic cost of crude oil to the refinery. Because PVN is both oil producer and exporter, it is reasonable to assume that the producer s price of crude oil already includes freight charge to port and the handling charges at the port. From the national economy point of view, economic and financial costs of transportation might be significantly different, due to the fact that the transport sector pays taxes on fuel which are financial but not economic costs. In the case of Viet Nam, economic costs of domestic transportation typically equal to 67% of its financial costs. For simplicity, assume that all capital costs and their terminal values have an equal value at market and at shadow prices, so that no income effects are created through capital expenditure. Exhibit 8: Nominal Financial and Economic Opportunity Cost of Capital In financial and economic analysis of a project, the Net Present Value is calculated by discounting the net flow of benefits using the appropriate discount rate or interest rate. In financial analysis, the discount rate used is the equity holder s discount rate or the financial cost of capital. However, in economic analysis, capital must be valued from the national economy point of view. Economic opportunity cost of capital is determined by capital supply and demand in the economy after adjustment for distortions, such as taxes and subsidies. Page 11 of 12

12 In the presence of expected inflation, the interest rate used can be nominal rate or real rate. The nominal interest rate is thought of as having two components and is equal to the real rate plus expected inflation. This relation between nominal and real interest rate and expected inflation is called the Fisher Effect. (That is, the real interest rate plus expected inflation is equal to the nominal interest rate.) With nominal cash flows, the discount rate used should be the nominal discount rate. With real cash flows, the discount rate used should be a real discount rate. In the Golden Pagoda project, it is assumed that the nominal financial and economic opportunity cost of capital are the same and equal to 10%. Expected inflation is 3% per annum. All cash flows from the project are expressed in nominal terms. Page 12 of 12