Asia Pacific Equity Research18 November 2014 Global Refining outlook 2015-16 Margins under pressure until industry addresses overcapacity, we prefer US>Asia>Europe Refiners operate in a global market with little product differentiation, Asia Regional Petrochemicals and AC which means that unit costs remain the main profitability driver. Key costs Samuel RefiningLee, CFA (852) 2800-8536 include crude feedstock, energy and logistics which are unitized by scale
[email protected] and availability/utilization (bigger and more reliable the better). Assuming Bloomberg JPMA SLEE <GO> J.P. Morgan Securities (Asia Pacific) Limited the US crude oil export embargo remains in place, US refiners will remain Scott L Darling AC the most advantaged given cheaper crude feeds, lower energy costs and a (852) 2800 8578 product deficit market. Asian refiners have scale and a growing market to
[email protected] sell to but their competitive landscape is deteriorating given the startup of Bloomberg JPMA DARLING <GO> J.P. Morgan Securities (Asia Pacific) Limited mega-refineries in ME. European refiners lack any competitive advantage, Parsley Rui Hua Ong AC so their profitability will continue to languish until there is very material (852) 2800-8509 capacity rationalization. We introduce JPM’s proprietary Global Refining
[email protected] J.P. Morgan Securities (Asia Pacific) Limited Model, which forecasts regional margins based on supply/demand Yuji Nishiyama AC scenarios that can be used to quantify the required capacity retirements. (81-3) 6736-8617 US will retain its structural cost advantage with lower crude oil/gas
[email protected] JPMorgan Securities Japan Co., Ltd. prices, while products are priced globally based on higher priced Brent. Neil Gupte AC Additionally, with growing logistics businesses being valued at higher (91-22) 6157 3592 multiples and monetized through MLPs, US refiners are capturing
[email protected] J.P. Morgan India Private Limited greater value from the sum of their parts. The risks are an end to the Shaun Cousins AC crude export ban, narrower crude price differentials if Brent is lower for (61-2) 9003-8623 longer and declining domestic supplies if the lower oil price curtails rates
[email protected] of reinvestment. Top Picks: PSX/MPC. J.P. Morgan Securities Australia Limited Asia remains the main growth driver for global product demand. Europe Fred Lucas AC However, GRMs are likely to be under pressure due to new capacity not (44-20) 7134-5943 only in the region but also in ME, which will likely grab export market
[email protected] share from Asian refiners. New condensate splitting capacity startup will Bloomberg JPMA LUCAS <GO> J.P. Morgan Securities plc also pressure middle distillates margins where Asian refiners have the US most exposure. Near term, a narrowing of the Brent-Dubai spread may Phil Gresh, CFA AC drive profitability lower. Preferred: HPCL/Caltex/JX Holdings/RIL/ (1-212) 622-4861 Sinopec. Least Preferred: S-Oil/SPC/Idemitsu Kosan.
[email protected] Bloomberg JPMA GRESH <GO> Aside from old age and lack of scale, European refineries will continue J.P. Morgan Securities LLC to struggle given relatively expensive crude, high energy costs, high/ Latam inflexible labor costs, tough emission standards/product specs, high plant Felipe Dos Santos AC closure costs and declining end-market demand. The European refining (55-11) 4950-3796
[email protected] system will also be under attack from rising volumes of refined product Banco J.P. Morgan S.A. exports from ME and as India. Utilization rates will continue to fall CEEMEA which mandates further capacity rationalization. Preferred: RD Andrey Gromadin, CFA AC Shell/Novatek/Tupras. Least Preferred: Galp/Rosneft/PKN. (7-495) 967-1037 JPM Global Refining Model: We introduce our proprietary model
[email protected] Bloomberg JPMA GROMADIN <GO> based on JPM’s latest global refining capacity data and product demand J.P. Morgan Bank International LLC outlook which we use to predict regional GRMs. In the most bearish Neeraj Kumar AC case, our model shows that unless there is sizable incremental capacity (971) 4428-1740
[email protected] retirement, Asia and NW Europe margins may reach historical trough JPMorgan Chase Bank, N.A., Dubai Branch levels by 2016 ($0.3/bbl) and 2017 (c$0.8/bbl) respectively. See page 78 for analyst certification and important disclosures, including non-US analyst disclosures. J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. www.jpmorganmarkets.com Samuel Lee, CFA (852) 2800-8536
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[email protected] Table of Contents Summary ...................................................................................3 Global choices to play the theme............................................6 Introducing the JPM Global Refining model ........................11 Results – 5 possible outcomes for margins ........................14 US – Cost advantage, logistics value creation ....................21 LatAm – Moving Ahead with Capacity Expansion...............29 Asia – Flat or lower GRMs likely for 2015.............................31 China – Managing over-supply with slowing demand ........34 Japan – Can Japan remain an independent market? ..........37 India – Overcapacity remains; prefer marketing..................40 Australia – domestic refining shifting to product imports..42 Europe – refiners’ graveyard .................................................43 Russia – Slow upgrading in changing tax environment .....49 Poland/Turkey – Fuel importers ............................................52 Appendix I: Downstream glossary of terms.........................54 Appendix II: Investment Thesis, Valuation, Risks ...............64 2 Samuel Lee, CFA (852) 2800-8536
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[email protected] Summary In September 2011, we predicted tough years ahead for refiners....in November 2014, we predict much the same with the exception of the US. This note is the first comprehensive update to our research piece on global downstream (Global refining - a long and painful sunset for many, 8 September 2011). In that note, we concluded: “….any potential for a meaningful cyclical recovery in gross refining margins will be suppressed by excessive spare capacity that looks set to build as National Oil Companies aggressively add new capacity and incumbent International Oil Companies refuse to retire marginal capacity…we see a risk that a significant refining glut will materialize that will flatten regional refining margins on a 'bathtub' bottom for some years to come. The outlook is ominously similar to the late 1970s when surplus refining capacity destroyed refining economics for several years – 40 years on, history may be about to repeat itself.” Since then refining has been a very bad industry. Over three years on our outlook for refining remains as grim as ever. The only exception has been and remains US refining, which has experienced a renaissance due to unexpectedly strong growth in shale oil, hence depressing the cost of US crude feedstock and shale gas, and thus depressing plant energy costs. Europe has been bad and, as we show, will remain the most challenged region for refiners. Low unit cost is the biggest profit driver for refiners given that they sell a globally fungible product with little differentiation. Refiners operate in a global market with very little product differentiation, which means that unit costs remain the main profitability driver. Key costs include crude feedstock, energy and logistics, which are unitized by scale and availability/ utilization (the bigger and more reliable the better). Assuming US crude oil exports remain constrained, US refiners will remain the most advantaged given access to cheaper crude (mainly WTI), lower energy costs (from shale gas) and a product deficit market. Asian refiners have scale and a growing market to sell to but their competitive landscape is deteriorating given the startup of mega-refineries in ME. European refiners lack any competitive advantage, so their profitability will continue to languish until there is material capacity rationalization. 2014 refining margins have been disappointing for both Asia and Europe – the lower oil price has not helped. Therefore, we believe tough times lay ahead for refiners outside of the US. 2014 refining margins have sunk to the lowest levels since 2010 (Asia) and 2003 (Europe), while the US remains the only sole bright spot due to cost-advantaged crude. The last refining renaissance occurred between 2003 and 2007, when a combination of persistently strong global product demand growth, hurricanes and MENA supply disruptions pushed crude prices up by 186%, while oil product prices rallied harder. For every $1/bbl increase in crude, global margins rose $0.1/bbl, peaking at $7.9/b in 2007. Today, they are languishing around $5/bbl. After adjusting for inflation and rising energy costs, this is a very weak number indeed. 3 Samuel Lee, CFA (852) 2800-8536
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[email protected] Figure 1: NW Europe cracking and Asia hydrocracking margins - 2014 near historical lows $/bbl NW Europe cracking margin Singapore hydrocracking margin 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 16 14 12 10 8 6 4 2 0 1992 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 USGC cok margin (Rhs) Source: Bloomberg, BP, IEA, J.P. Morgan estimates. JPM Commodities Research latest forecast for 2015/16 global oil demand growth is c900 kbd for both years, higher than 620 kbd demand growth for 2014. Recently, J.P. Morgan Commodities Research published their latest outlook on global oil supply/demand and prices. Global oil demand growth in 2014 will likely remain depressed (at around 620 kbd) on the back of declining demand in many DM countries with the US being the exception. They expect European demand to slow in 2015 and be almost flat in 2016 Y/Y. Consequently, given growth in most other DM, OECD demand should be less of a drag on the global growth rate over the next two years. EM demand is expected to grow by 1 million bpd in 2014, with similar rates forecasted for the next 2 years. New Brent oil price forecast is $82/bbl and $87.75/bbl for 2015/16 respectively. In terms of oil prices, Commodities Research is now forecasting an average of $80/bbl for Brent in Q4 2014, with the possibility of going as low as $65 in 1Q 2015 if OPEC does not cut production. For 2015, the full year average is now forecast to be $82 (previously $115) and for 2016 $87.75 (previously $120) per barrel. The lower oil price deck forecast is mainly a function of continued growth in shale oil in the US and higher spare capacity within OPEC vs. previous expectations. We now forecast global product surplus of 1.9mbd for 2015-16, a situation which we think must enforce further capacity rationalization. Over the next 2 years, global refining capacity growth is set to outpace demand growth by 1.5 million bpd, driven by capacity growth in Asia (+1.4 million bpd, 39% of total) and the Middle East (+1 million bpd, 29% of total). A potential 1.5 million bpd product surplus is untenable – we believe marginal refiners will likely be forced to close. Most of the new Chinese capacity will be expansions rather than greenfield plants, as Chinese product demand growth has slowed down significantly from previous years (YTD diesel demand is flat Y/Y). Therefore, many previously planned new projects by Sinopec and Petrochina have been delayed, but expansions are still going ahead as gasoline demand remains relatively robust. Mega-refineries in the ME will make up the bulk of the new capacities there. They will compete for market share with both European and Asian refiners in their home markets. In order to identify the amount of closure necessary to shore up margins and to identify capacity at risk and forecast margins through 2017 under different scenarios (e.g. upside or downside demand surprise, or US policy shift), we have developed a proprietary Global Refining Model. Based on historical correlations, we can calculate future regional refining margins based on forecast operating rates, which are in turn a function of our forecast regional refining supply/demand. We note that while in the most bearish case of no further capacity rationalization aside from the ones we have identified, refiners are not likely to operate at negative margins and therefore, run rates will be cut even if plants are not permanently retired. 4 rh.Samuel Lee. Morgan estimates. comes to a market already suffering from a surplus kbd 5000 Scale of potential capacity growth this decade marks a return to the 1970s build out.sw. J. Figure 3: Persistent capacity growth.lee@jpmorgan.. although not as high as the 1970s.. IEA. 5 .majority from Asia and Middle East 2015 to 2016 scheduled net capacity additions: +3.P. Morgan estimates. BP..which destroyed industry profitability and necessitated years of net capacity retirements 4000 3000 2000 10% 8% 6% 4% 1000 2% 0 -3000 -4% Global net capacity growth (kbd) 06 08 10 12 14 16E -2% 90 92 94 96 98 00 02 04 -2000 74 76 78 80 82 84 86 88 0% 70 72 -1000 % change (RHA) Source: J.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley.6 mbd (global) 2% 10% 29% 20% 0% 14% North America ex US Asia ex CN Middle East US China Africa 25% South & Central America Europe Source: Bloomberg. CFA (852) 2800-8536 samuel.P.com Figure 2: 2015 to 2016 net capacity additions .ong@jpmorgan.
[email protected] P/B. we also see the lowest downside risk at PSX in a scenario where the crude export ban gets lifted (~15% EPS downside.com Global choices to play the theme By region we list JPM analysts’ most / least preferred names to play our refining theme. group average ~26%). Latam ideas Petrobras (N) – We rate Petrobras Neutral due to: 1) uncertainties on short-term production and a miss on the 2014 production guidance. As a result of its diversity.4x P/B for 2015.sw. MPC also has several refining projects under way to drive controllable EBITDA growth. we still see many value levers to pull. Caltex (OW) – CTX is the only publicly listed refinery operator in Australia.lee@jpmorgan. We note that analyst recommendations are set according to their broader local coverage universe. Leverage is likely to decline quicker than earlier anticipated. Given the relatively advantaged status of US refining. Finally. We see a strong backlog of MLP drop down opportunities (to PSXP) within Midstream. 2) non-compelling trading multiples of 12. Ecopetrol (N) – We rate Ecopetrol Neutral due to: 1) small reserve lifetime of ~7 years. CTX is undergoing a repositioning and one we believe will increasingly be considered by a broader range of investors including consumer focused investors due to its 6 . We expect the private players to take an 8-10% share as a consequence. CFA (852) 2800-8536 samuel. We would avoid exposure to Ecopetrol as we consider the company’s main challenge remains long-term sustainability of reserves that currently reaches eight years. 2) FX devaluation impact on fuel import costs and leverage. 3) lack of clarity on fuel price readjustments and a specific price readjustment policy that would allow prices to be readjusted according to international parity.7x P/E and 2.Samuel Lee.5x P/E and 1. this is the only region where we have two preferred plays (no least preferred). This is why some of the least preferred names may still be rated Neutral. Asia Preferred HPCL (OW) – With our expectation of a more benign crude price environment. development of unconventional potential and acquisition. with a consequent reduction in interest costs as well. Marathon Petroleum (OW) – We see MPC as a solid way to play the most favorable themes in US refining. and a gradual expansion in diesel marketing margins. US Preferred Philips 66 (OW) – While shares have underperformed recently on concerns about the impact of lower oil prices on Chemicals. However. MPC is diversifying its portfolio into higher-multiple logistics and retail businesses (~22% of 2016E EBITDA). as PSX has the most diversified portfolio in the group and the highest potential for more growth outside of refining (Midstream and Chemicals). given that all of MPC’s exposure is in the US central corridor.rh. We highlight Ecopetrol’s initiatives to boost its reserve level on four fronts: exploration.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. amidst low replacement ratios. we see no single source as enough to deliver the likely volumes required. which we expect to remain crude cost advantaged. both of which have non-macro levers for growth and significant MLP opportunities. compared to global peers selling at 11. improvement of recoverable factor. we highlight that the state owned oil marketing firms are likely to see a quicker roll off of subsidy losses. the ratio has decreased to 6-7 years currently. Sinopec Shanghai Petrochemical (UW) – Sinopec Shanghai Petrochemical (SPC) is one of the top five largest refineries owned by Sinopec Corp (51% shareholding). it also is exposed to commodity chemicals which have seen a collapse in profitability this year. This also reflects lower utilization at its refinery due to a moderation in oil product demand and lower refining margins as well as weak chemical margins. S-Oil is a simple refinery with large exposure to PX. Reliance Industries (N) – In light of the weaker Y/Y refining outlook in 2015.sw. and the opportunity to participate in the early stage of a business improvement programme. RIL buys its crude from wherever it can secure an attractive price. unlike other Asian refiners where most of the crude is sourced from the ME. where they have good access to high growth demand centres. Despite fairly robust Asian GRMs for most of 2013-14. middle and lower reaches of the Yangtze River and North China. It also suffers limited product grade portfolio/feedstock flexibility to partly mitigate the current chemical environment.com increasingly stable earnings profile as refining becomes less influential (given recent closure of the Kurnell refinery). Sinopec (N) – Sinopec is China's largest refiner with refining capacity at 5.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. 63% owned by Saudi Aramco. We value S-Oil on 0. but we believe this is a short term issue. Finally we believe significant capacity expansion in its petchems businesses over the next 12-18 months will help RIL offset declines in refining earnings. In addition. Although its refineries are upgraded for high oil product specification largely directed into the Shanghai market. Refining profitability has been weak with cuts to oil product pricing and moderation in oil demand growth. JX Holdings is currently struggling to expand copper mine and petrochemical operations and the share price is low. which still exhibits strong volume growth (gasoline sales rose 11% y/y last year) and margins. However. CFA (852) 2800-8536 samuel. JX Holdings (N) – JX Holdings already has a dominant market share and can be distanced from concerns about market realignment uncertainty. with the program’s start date now in question and the company’s fundamentals 7 . Asia Least Preferred S-Oil (UW) – We believe with the emergence of new mega-refineries from the ME.6x 2015 BV as we forecast 2015-16 ROE to only average around 6%. weak business environment outlook and increasing capital expenditure for 2017-18 for expansion/upgrading projects. We believe RIL will fare better relative to peers in a weak GRM environment due to its scale and complexity.lee@jpmorgan. which include upstream oil operations and a copper mine development.7 million bpd (43% domestic capacity share). a product on which we are also bearish. Sinopec’s refineries are mainly located in China's southeast coastal area. S-Oil refining business has been lossmaking on an OP basis for the last 7 quarters. we believe it is best positioned to benefit from the margin improvement that is likely to accompany consolidation measures by other refiners. Taiwan and Singapore will be under increasing margin pressure. we currently do not have any OW stocks in our coverage and therefore RIL is preferred on a relative basis.Samuel Lee. traditional export refiners in South Korea. In the past. Even if petroleum product supply capacity continues to decline. although the company continues to shift product mix toward gasoline (yield was c46% in 2013. but we think that is also at risk now given our forecast of FY14 losses. an increase from c37% in 2011)
[email protected]. Also. JX Holdings can expand through its nonrefining businesses. S-Oil was seen as a dividend play. the largest in Asia and one of the largest in the world. Yet SPC shares have outperformed in 2014 reflecting anticipation of the HK-SH connect program (SPC-H currently trades at a c30% discount to SPC-A). Samuel Lee, CFA (852) 2800-8536
[email protected] Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509
[email protected] increasingly challenged, we continue to view the shares as overvalued against regional peers. Idemitsu Kosan (N) – Idemitsu’s position in its domestic market is stable, but it is moving forward with a US$9 billion refinery/petrochemical plant project in Nghi Son, Vietnam. Returns on this investment are at risk from a slump in refining margins in Asia, which we have identified as a possibility. Idemitsu plans to refine Kuwaiti crude oil in Vietnam and sell petroleum products in the local market, but if the price of crude increases sharply it is unclear whether Idemitsu could pass on the cost to sales prices. Petroleum products are much more of a necessity good in emerging markets than they are in developed economies, and if large increases in crude prices were passed on directly to sales prices it could cause political unrest. Europe Preferred RD Shell (OW) – RD Shell continues to shrink its refinery portfolio. In 2003, it had interests in 55 refineries. If it sells its Fredericia refinery in Denmark, it will have downsized to just 27 refineries by 2015. At the same time, RD Shell has repositioned its refining exposure away from Europe, the most challenged region. In 2005, 46% of its total net refining capacity was in Europe; by next year this could be just 26%. This portfolio shift has also skewed its refinery exposure more to the US, the more advantaged region, to 36% 2015E versus 23% in 2005. The performance of its core refining portfolio continues to improve, most notably Motiva, RD Shell’s 50:50 JV with Saudi Aramco which owns 3 US refineries. At YE 2013, refining capital employed was around $33bn or just under 15% of group capital employed. We expect refining capital employed to shrink in absolute and percentage terms as working capital efficiency improves and capital expenditure trends down (given fewer assets and better capital discipline). Combined with reduced costs and higher plant availability / utilization, this will drive this sub-segment’s improvement in ROACE from around 2% in 2013 (given -3% in Merchant Refining and 6% in Integrated Refining & Marketing Value Chain) and lift through cycle free cash flow generation. This will ultimately help RD Shell to better cover its dividend – a key consideration for investors. Europe Least Preferred Galp (UW) – Galp has evolved from a pure play Portugal-focused refining company (pre-IPO in 2006) into an Integrated name driven by its exploration successes in Brazil (and more recently in Mozambique). Galp still retains an above sector average exposure to European downstream – which accounts for 13% of our Galp SOTP of €16.6/share. We believe that the outlook for this business remains challenging (downstream reported operating losses in 2 of the 3 quarters in 2014) – an ongoing negative for Galp's equity story, in our view. Russia Preferred Novatek (OW) – Novatek has the lowest refining exposure in the Russian oil and gas universe. The company operates the Pur gas condensate stabilization plant (upgraded to 11 mn tons) in West Siberia and the Ust Luga gas condensate processing facility (6 mn tons) located on Baltic Sea, where it refines gas condensate mainly into naphtha and light products. Given a light oil feedstock at Ust Luga, the company will not have to upgrade the facility if there is higher taxation on heavy products. 8 Asia Pacific Equity Research 18 November 2014 Samuel Lee, CFA (852) 2800-8536
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[email protected] Russia Least Preferred Rosneft (UW) – Although Rosneft has invested more than $17 bn in the refining segment capex for the last five years, the key upgrade projects are yet to start. Roughly half of the spending was allocated on building new Tuapse refinery and terminal. We believe that the rest of the money was mainly spent on light product quality improvements. We believe that the company is likely to spend no less than $25 bn on the refining segment (excluding Far East green field projects) within the next four years. New unit launch delays and capex overrun risks are substantial. CEEMEA Preferred Tupras (OW) – We are OW on Tupras due to: 1) Potential for margin improvement by more than 150bps due to the Residuum Upgrade Project (RUP); 2) Tupras’s capex cycle is nearing its end, so increasing dividend potential; 3) Tupras’s key demand drivers are still intact, i.e. low autos penetration (120 cars per 1,000 person vs. average 450 for EU); 4) Increase in fuel demand. Diesel demand consumption grew by 7% in 2013 and > 5% in 1H14. There was an increase in gasoline consumption by 1-2% in 2013 and 1H 2014. CEEMEA Least Preferred PKN (UW) – We forecast an EBITDA increase over 2014-17 of PLN1.6bn, c20%, below company guidance, mainly on a lower contribution from the downstream business. We forecast Petrochemicals will be the biggest contributor to 2014-17 EBITDA (c42%), with retail (c27%) in line with company guidance and upstream benefiting from the recent acquisitions in Canada. We are cautious on shale production in Poland. We believe low refinery margins will remain a drag on downstream performance. We think downstream margins are likely to remain under pressure and forecast average model downstream margin of $9.9/bbl, below guidance of $11/bbl over 2014-17. Downstream business contributes c70% of 2014-17E EBITDA (LIFO). In our view, capital discipline remains key as the energy and upstream businesses get an over-proportionate share of development capex (c60%) vs. limited contribution (c6%) to 2014-17E EBITDA. Table 1: Global refining valuations Preferred Ticker Phillips 66 Marathon Pet. HPCL Caltex RD Shell Novatek Tupras JX Holdings Petrobras Reliance Ind. Sinopec YYY Least Preferred PSX MPC HPCL.BO CTX.AX RDSa.L NVTKq.L TUPRS.IS 5020.T PBR RELI.BO 0386.HK S-Oil Shanghai Pet. PKN Rosneft Galp Ecopetrol Idemitsu Kosan 010950.KS 0338.HK PKN.WA ROSNq.L GALP.LS EC 5019.T Ticker Rating OW OW OW OW OW OW OW N N N N Rating UW UW UW UW UW N N Price (LC) 71.78 92.38 549.85 31.45 2,202 98.13 49.70 436.50 9.96 985 6.22 PT (LC) 96.00 118.00 690.00 28.44 2,500 130.00 57.00 480.00 17.00 1,080 7.00 MktCap USD mil 41,007 26,698 3,020 7,429 218,105 29,795 5,551 9,333 64,962 51,637 69,545 PE (x) FY14e FY15e 11.1 13.3 11.6 13.9 10.5 8.5 33.3 17.6 9.5 13.6 12.4 8.7 18.4 9.2 12.3 6.9 7.8 9.2 12.6 11.9 8.3 9.7 PB (x) FY14e FY15e 1.9 1.8 2.4 2.4 1.2 1.1 NM NM 1.1 1.1 2.6 2.1 1.8 1.6 0.4 0.4 0.5 0.6 1.7 1.5 0.9 0.9 EV/EBITDA FY14e FY15e 7.7 9.6 6.1 6.5 7.4 6.1 10.5 8.3 5.0 5.4 8.2 7.6 13.8 6.5 11.0 7.7 7.2 8.8 8.1 7.5 4.0 4.1 ROE (%) FY14e FY15e 16.8% 13.4% 21.0% 16.9% 11.4% 12.9% 13.7% 16.8% 12.3% 8.2% 22.2% 27.0% 11.3% 18.6% 3.7% 5.7% 6.0% 5.9% 14.5% 13.6% 11.5% 9.1% Yield (%) FY14e FY15e 2.6% 3.3% 2.0% 2.3% 2.9% 3.5% 1.3% 2.7% 5.4% 5.5% 0.2% 0.3% 4.5% 7.0% 4.1% 4.1% 7.0% 3.0% 1.1% 1.2% 5.1% 4.3% Price PT (LC) (LC) 42,500 29,000 2.43 1.50 45.45 38.00 4.98 5.00 11.07 11.50 24.81 30.00 2,018 2,100 MktCap USD mil 4,347 3,384 5,757 52,725 11,634 51,004 694 PE (x) FY14e FY15e (124.0) 15.9 144.0 27.6 (6.4) 14.2 7.6 4.2 33.9 29.5 9.7 12.5 10.7 7.9 PB (x) FY14e FY15e 0.9 0.9 1.2 1.1 0.8 0.8 0.7 0.6 1.4 1.4 2.1 2.3 0.4 0.4 EV/EBITDA ROE (%) FY14e FY15e FY14e FY15e 25.1 9.1 (0.7%) 5.6% 23.5 17.4 0.8% 4.1% (33.6) 6.6 (12.3%) 5.8% 4.1 4.3 14.2% 13.3% 10.8 10.2 5.3% 6.1% 5.1 6.6 17.2% 17.9% 7.8 7.3 4.0% 5.2% Yield (%) FY14e FY15e 2.2% 2.5% 0.2% 1.1% 3.3% 3.5% 2.8% 6.0% 3.1% 3.1% 8.6% 6.4% 2.5% 2.5% Source: J.P. Morgan estimates, Bloomberg. Priced as of Nov 15, 2014. Note: FY14e represents end-March 15 for HPCL, JX Holdings, Reliance Ind., and Idemitsu Kosan. 9 Samuel Lee, CFA (852) 2800-8536
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[email protected] In order to expand the remit of this report for investors, we also include a schematic which shows a broader set of choices within the global refining theme. We include potential beneficiaries in the Engineering & Construction space as well as plant software and hardware suppliers (Figure 4). Figure 4: Exposure to the refining space aside from refiners SOFTWARE & HARDWARE PROVIDERS Europe Aveva Group [AVV LN] IMI [IMI LN] Invensys [ISYS LN] KBC Advanced Technologies [KBC LN] Rotork [ROR LN] Siemens [SIE GY] Weir Group [WEIR LN] Developed Europe ERG [ERG IM] Neste Oil [NES1V FH] Saras [SRS IM] Developing Europe / Russia Novatek [NVTK LI] PKN Orlen [PKN PW] Rosneft [ROSN LI] Tupras [TUPRS TI] Asia ex-Japan Bangchak Petroleum [BCP TB] BPCL [BPCL IN] Caltex Australia Ltd [CTX AU] Essar Oil [ESOIL IN] HPCL [HPCL IN] Reliance Industries [RIL IB] S-OIL Corp [010950 KS] SK Innovation [096770 KS] PR CHINA Shanghai Petro. [338 HK] Sinopec [386 HK] JAPAN Idemitsu Kosan [5019 JT] JX Holdings [5020 JT] Showa Shell [5002 JT] Tonen General [3402 JT] Source: J.P. Morgan estimates. 10 USA Aspen Technology [AZPN US] Dresser-Rand [DRC US] Honeywell International [HON US] GLOBAL INVESTMENT THEME Refining capacity growth REGIONAL WINNERS ADVANTAGED PLAYERS USA Alon USA Energy [ALJ US] Delek US Holdings [DK US] HollyFrontier Corp [HFS US] Marathon Petroleum Corp [MPC US] Phillips 66 [PSX US] Tesoro Corp [TSO US] Valero Energy Corp [VLO US] Western Refining [WNR US] INDIRECT beneficiaries EPC PROVIDERS Europe & North America Amec [AMEC LN] Chicago Bridge & Iron [CBI US] Fluor Corp [FLR US] Jacobs Engineering [JEC US] Petrofac [PFC LN] SNC-Lavalin Group Inc [SNC CN] Technip SA [TEC FP] Tecnicas Reunidas SA [TRE SM] Asia ex-Japan Daelim Industrial Co. Ltd [000210 KS] Daewoo E&C [047040 KS] GS E&C [006360 KS] Hyundai E&C [000720 KS] Samsung Engineering [028050 KS] Worley Parsons Ltd [WOR AU] Japan Chiyoda Corp [6366 JP] JGC [1963 JP] Samuel Lee, CFA (852) 2800-8536
[email protected] Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509
[email protected] Introducing the JPM Global Refining model Our bottom-up approach highlights the amount of refining capacity closures needed to balance aggressive world-scale refinery startups, the regions most at risk, and what happens to regional margins under bull, bear and base case demand scenarios. Our proprietary model forecasts refining margins under multiple scenarios, based on a baseline, bull and bear case supply/demand outlook. The demand forecast is provided by JPM Commodities research, and tracks global oil product demand on a country-level basis, based on factors like GDP, oil price elasticity, tax policy and structural factors like nuclear capacity and vehicle sales. Refining capacity forecasts are based on company announcements and our conversations with industry contacts on capacity expansion plans. We note that startups from 2017 onwards are more susceptible to further delays and cancellations. While we adjust for this in our model to give our most realistic assessment, history has shown that forecasting new refining capacity more than 2 years out has a high degree of uncertainty. Model methodology 1. Track global refinery capacity additions by country and project 2. Track historical refinery throughput by region 3. Using #1 and #2, compute historical utilization rate by region and establish correlation to margins 4. Forecast oil product demand by country and region through 2025 5. Forecast global refinery maintenance through 2025 6. Forecast throughput for price-insensitive markets (US, ME, China) 7. Forecast throughput and utilization rates for rest of world based on demand growth and competitive positioning through 2025 8. Using forecast utilization rates, derive margins using historical correlation 9. Identify required amount of capacity closures or expansion delays needed to balance market Model limitations 1. Requires manual judgment of US, ME and Chinese refinery utilization 2. While near-term refinery maintenance forecasts are based on reported maintenance activity, longer term maintenance forecasts are derived based on a % of refining capacity 3. Assessment on impact of crude differentials on US margins is done separately 4. Margin forecasts assume typical yields for a USGC coking refinery, NW Europe cracking refinery, and SG hydrocracking refinery, and do not adjust for evolving complexity over time. The model does not adjust for the grade of crude being processed 5. Condensate splitters are treated like CDU units in the model. Realistically, output from condensate splitters will have much higher naphtha and gasoline yields 11 CFA (852) 2800-8536 samuel. Asian utilizations have declined steadily from 2008 highs. Chinese refineries have the home advantage of being located in the hub of global demand growth. 2. RIL) are so complex they can process 10 to 13 API crude.0 70% 72% 74% 76% 78% Source: Bloomberg. In 2012 to 2014.lee@jpmorgan. Strong historical correlation between refinery utilization and margins The relationship is especially significant for marginal refineries in Northwest Europe and Asia ex China.P Morgan estimates. Going forward. $/bbl (y-axis) 8. Not all refineries are created equal – separating price-insensitive refiners In a low margin environment. IEA. Essar. Singapore medium sour hydrocracking margin Utilization rates (x-axis). 17% Japan. Similarly. Saudi Arabia’s new Jubail and Yanbu mega refineries (400 kbpd each) are already sufficient to offset 1 year’s worth of global demand growth.0 2012 3.0
[email protected] 2013 4.0 2013 2. we saw 3.0 2014 1.0 0. our model embeds the assumption that utilization rates (and margins) in the US.0 5. In NW Europe. and likely to run at high utilizations even if demand disappoints. light sweet cracking margins have only averaged $6/b to $7/b (annual basis) twice since 1992. 80% 82% 84% 86% 80% 82% 84% 86% 88% 90% 92% Source: Bloomberg. some Indian refiners (eg. Middle East and China are likely to outperform. Lastly.0 2012 7.0 6. Taiwan and South Korea in times of margin pressure. when a spate of capacity closures lifted European utilizations to 82% (Figure 5). complex Middle Eastern refineries with ready access to ME crude will run harder than simple Asian or European refineries. in turn. Meanwhile. IEA. BP. with run cuts in Singapore.6 million bpd of global capacity closures (32% Europe.0 2014 2. As the world's ability to absorb product output is limited by demand growth.Asia Pacific Equity Research 18 November 2014 Samuel Lee.P Morgan estimates. 6% Australia). 12 .0 7. J.com Theory behind the model 1.0 0. the least competitive refiners will be forced to lower utilization.0 1. NWE light sweet cracking margin Figure 6: 1992 to 2014 Asia ex-China utilization vs.0 5. that are typically the first to cut runs when margins are poor. This occurred in 2008.0 3. and in 2012.rh. $/bbl (y-axis) Utilization rates (x-axis). yet produce negligible fuel oil. are driven by end-user demand and available refining capacity.0 2008 2008 6. when utilizations were 84%.com Parsley Rui Hua Ong (852) 2800-8509 parsley.sw. BP. J. Figure 5: 1992 to 2014 Europe utilization vs. US refiners are well positioned to withstand a hostile margin environment due to cheap domestic crude and higher output of diesel and gasoline. with the rest of the world competing for the remaining market share. Utilization rates. The aforementioned refineries are less price-sensitive. P. we allocate remaining throughput using an adjusted capacity weight. as well as our assessment of current refining margins and competitive positioning in each refinery. Based on our understanding of the conditions in each region. based on factors like refining complexity.5 3. RHS: $/bbl Capacity closures & delays likely 4500 3500 4. 13 . Morgan estimates. a secondary layer of inequality exists.5 2009 2010 2011 Net capacity additions 2012 2013 2014 Demand growth 2015 2016 2017 Singapore hydrocracking margin Source: J.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. tax.5 -1500 -2.rh. CFA (852) 2800-8536 samuel.Europe has most of world’s IOC capacity.5 2. Highlighted portion shows margin stress – further closures and delays needed. ME and China. In regions
[email protected] 2500 1. Adjusting the world ex-US. NOCs not always driven by economics kbd 35000 30000 25000 50% 20000 15000 10000 5000 59% 17% 27% 14% 52% North America Europe 33% 0 Asiapac 35% 12% 6% 82% 13% NOC Middle East IOC 26% 8% 67% 4% 4% 92% FSU Latin America 13% 8% 79% Africa Independent Source: J.5 500 -0.sw. Morgan estimates.5 -500 -1.com Figure 7: Net capacity additions look set to outpace demand growth through 2017 LHS: kbd. ME and China for complexity and policy Simply deducting price-insensitive throughput from global throughput and allocating the rest to remaining regions based on capacity weight is insufficient. 3. country-specific policy/subsidies and NOC versus IOC versus independent ownership. Figure 8: Refinery ownership
[email protected] Lee.5 1500 0. 1 4. US margins rise to the highest levels since 2007. but remain near multi-year highs. Morgan.1 9.8 8. -ve demand shock 5.3 1.3/bbl to $1/bbl. help balance the market and avert a 2017 margin crash.1 4.1 NW Europe cracking margin 2014E 2015E 2016E 2.com Results – 5 possible outcomes for margins Table 2: Summary of key assumptions for the 5 scenarios Scenario # 1. the lowest level since 2002.1 1.2 1.0 Source: J. US margins will falter. we expect scheduled capacity growth of 1.0 9. while European margins decline to the lowest level since 2002.47 mbd +0.3 0.4 .2 9.1 8.1 1.1 2.9 1.4 mbd +3.2 0.8 2. Scenario 3: +ve demand shock Stronger demand growth in China.5 9.9 8.4 mbd of capacity closures or cancelled expansion plans. while US margins remain strong. CFA (852) 2800-8536 samuel. 48% above the 880 kbd baseline. +ve demand shock 4.1 8.9 1. Barely balanced 3.3 2. Table 3: Results – even US margins will fall in the Margin Crash (base case) scenario with Europe/Asia suffering the most $/bbl Scenarios #1 #2 #3 #4 #5 2013 8.6/b.P.8 10. See Page 16 for details of the individual scenarios.3 2.5 8.sw.9 2.7 Singapore hydrocracking margin 2014E 2015E 2016E 2017E 1.3 mbd yoy on average.9 8. ME and US lift global demand growth to 1.88 mbd +1. Scenario 1: Margin crash Assuming trend demand growth of 880 kbd yoy on average between 2014-17.Samuel Lee.2 2.7 2.4 mbd +3.0 9.3 2017E 0. while European and Singapore margins rise by $0.5 1.7 1. if demand growth disappoints by 47% (+470 kbd yoy instead of +880 kbd yoy baseline).88 mbd +0.4 mbd +3.0 10.1 4.5 8.5 9.9 1.5 8.1 8. Scenario 5: US policy shift We attach a very low probability for meaningful volumes of US crude to hit global markets by 2017. 14 2017E 7.7 2.1 1. Morgan estimates.P.3 mbd +0.3 9.8 2.4 mbd Source: J. incremental capacity closures or expansion delays mentioned in Scenario #2 are still necessary to sustain refining profitability.3 9.9 0.0 mbd +3.5 2.1 1.3
[email protected] 1.7 2. Weighted average global margins will decline to $2. Scenario 2: Barely balanced 3. these closures/delays will lift European and Singapore margins to near 2014 levels.4 0.6 2. on top of those already announced.9 0.9 mbd yoy on average will overwhelm product markets and flip most refiners ex-US into loss-making territory by 2017. Our balances indicate that this shift will be insufficient to meaningfully diminish US crude surplus and significantly damage US refiners' advantaged position.0 2.ong@jpmorgan. Margin crash 2. versus our baseline of 250 kbd of condensate exports. US policy shift 2014-17 avg annual demand growth +0. Singapore margins will struggle to breakeven by 2017.0 2013 4.9 2.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley.3 2.rh. Assuming trend demand growth of 880 kbd yoy. Even with stronger demand growth.3 0.5 8.2 2013 2.5 1.1 1.5 10. The policy shift scenario assumes an aggressive 1 mbd of US condensate exports by 2017.2 0.1 1.2 2.7 2.1 USGC coking margin 2014E 2015E 2016E 8.1 4.4 1. Scenario 4: -ve demand shock Even with the incremental capacity closures.88 mbd Retirements incremental to those already announced +0.1 8. instead of +0. the outcome will be somewhere between Scenario #1 and #2. A positive demand surprise (global growth of +1. Australia 2015 Total Shuaiba 2016 Total Tobangao.477 165 200 240 140 300 150 121 140 1. will occur by 2017 (see Table 4 and Table 5 for list of announced expansions and closures). We believe that in reality. margins are most likely to average slightly above scenario 2. or between 0-3. which assumes 3. Table 4: List of global capacity additions (>100 kbd).000 230 100 100 100 100 130 300 417 1. Hokkaido Kawasaki.rh. France Total unconfirmed date Capacity -120 -180 -67 -38 -135 -540 -200 -105 -135 -118 -558 -200 -200 -96 -109 -160 -205 -65 -635 Owner Idemitsu Kosan Nippon (JX Holdings) TonenGeneral TonenGeneral Caltex Region Asia ex CN Asia ex CN Asia ex CN Asia ex CN Asia ex CN CPC ENI Murphy Oil BP Asia ex CN Europe Europe Asia ex CN KNPC Middle East RD Shell Chevron (Caltex) MOL Statoil / RD Shell Petroplus Asia ex CN Asia ex CN Europe Europe Europe Source: J. CFA (852) 2800-8536 samuel. 2014 to 2016 Kbd Year 2014 2014 2014 2014 2014 2015 2015 2015 2015 2016 TBD TBD TBD TBD TBD Refinery Tokuyama Muroran. Tokyo Bay Japan Wakayama West Japan Kurnell. Morgan estimates.47mbd yoy.88 mbd baseline) could be most destructive for European and Asian margins. Norway Cressier.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley.lee@jpmorgan. 15 .4 mbd of incremental retirements. though Europe would also benefit. a negative demand surprise (global growth of +0.Samuel Lee. Sicily Milford. Morgan estimates. Haven Bulwer Island. Table 5: List of global capacity retirements. on top of those already announced.P.456 Operator Sinochem PetroChina Sinopec Aramco/ Sinopec Country China China China Saudi Arabia Petrobras Zhuhai Baota CNPC Sinopec Sinopec NOC / TIDCO / Tata Petrodyne IOC ADNOC Brazil China China China China India India UAE Petrobras CNOOC Sinopec Sinopec SCOP Oil Ministry BPCL PDVSA Brazil China China China Iraq Iraq India Venezuela Source: J. Hungary Mongstad.3 mbd yoy. Sydney Australia 2014 Total Kaohsiung. 2014 to 2016 Kbd Year 2014 2014 2014 2014 2015 2015 2015 2015 2015 2015 2015 2015 2016 2016 2016 2016 2016 2016 2016 2016 Refinery Quanzhou Pengzhou Yangzi Yanbu 2014 Total Abreu e Lima Zhuhai Baota Huabei Jiujiang Hainan Cuddalore Paradip Ruwais 2015 Total Comperj Huizhou Zhenhai Shanghai Gaoqiao Nassiriyah Missan Kochi El Palito refinery 2016 Total Capacity 240 200 160 400 1.88 mbd yoy baseline) would lift US and Asian margins the most.com Conclusion: Of the 5 scenarios listed in Table 1.4 million bpd of capacity delays/ retirements.sw. Philippines Lytton. versus +0.ong@jpmorgan. Australia Szazhalombatta. Taiwan Gela. Meanwhile.P. 5% yoy.1% net increase +1. The prognosis is very much similar in Europe where NW Europe cracking margin will barely breakeven at $0.5% +1. 16 NWE cracking Singapore hydrocracking margin 2016 2017 2014 2015 2013 2011 2012 2009 2010 2008 2006 2007 2004 2005 2003 2001 2002 1999 2000 1998 1996 1997 1994 1995 1993 1992 15 13 11 9 7 5 3 1 -1 -3 World ..P.4% 10 11 North America 12 Latin America 13 Europe 14 Africa Middle East +1... Given that we expect refinery capacity growth to outpace refined product demand growth by c1mbd in 2014-17. most notably the +230 kbd Abreu e Lima refinery in Brazil. global net capacity additions have grown by a steady +1% yoy to +1.5% +1. of which 115 kbd (phase 1) is >95% complete. margins in the world exUS could collapse as early as 2017 $/bbl USGC cok margin Source: J.8/b by 2017 if there are no further capacity cuts. Morgan estimates. Another big contributor to new refining capacity is the ME. CFA (852) 2800-8536 samuel..4 mbd must be closed or delayed by 2017 to raise global utilisation rates to 78%
[email protected] Scenario 1: No additional capacity retirements Between 2010 and 2014. with 3 new plants starting up during 2014-15 (2 in Saudi Arabia and 1 in UAE). Largest capacity growth aspirations 20142016 located in Asia and Middle East NOC sponsored. Figure 9: Scheduled net capacity additions and retirements kbd 6000 5000 4000 3000 2000 1000 0 -1000 -2000 JPM estimates 3.rh.. with the remaining 115 kbd expected to be commissioned by end 2015(Figure 9). In 2015 and 2016.6%
[email protected]. While we highlight up to 635 kbd of potential incremental retirements in Table 5. SG hydrocracking margins could very well end up in negative territory if there are no further cuts in Asian capacity.. these retirements are yet to be confirmed but could be accelerated if margins remain weak. The Latam additions will add to Atlantic surplus.Samuel Lee. Morgan estimates.P.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. +1. Figure 10: Worse case scenario – without further capacity retirements. a larger than usual proportion of expansions will come from Latin America.4% +0.1% 15E 16E Asia Retirements Source: J. Morgan estimates. and 900 kbd per year in Asia. PNG. Figure 13 shows the relative complexity of refineries in Asia. Asia accounts for 44% of 2013 to 2017 global net capacity additions. though required. 800 kbd of capacity will need to be retired or delayed per year in Europe.sw. Morgan estimates. we identify regions with relatively high refining capacities that may face margin pressure or threat of
[email protected] million bpd of additional closures or delays to refining capacity expansions over the next two years will help avert the 2017 margin crash seen in Figure 10 and support margins around 2014 levels.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. with Singapore and Taiwan under the most pressure. Bangladesh. Figure 12: Scheduled net capacity additions and retirements kbd 8000 7000 6000 5000 4000 3000 2000 1000 0 -1000 Asia: 44% of global total (2013 to 2017E) 30% 12% Asia Middle East 2013 Latin America 2014 2015E 8% Africa 2016E 4% North America 2% Europe 2017E Source: J.P. Simon Henry (CFO) indicated that the group is reviewing its global distillation capacity and may close one of three CDUs at its Bukom refinery in Singapore (total capacity 462 kbd). while Europe only accounts for 2%. Figure 11: Capacity closures and delays to expansion plans help support margins $/bbl USGC cok margin NWE cracking Singapore hydrocracking margin 2017 2014 2015 2016 2012 2013 2009 2010 2011 2006 2007 2008 2003 2004 2005 2001 2002 1998 1999 2000 1995 1996 1997 1992 1993 1994 15 13 11 9 7 5 3 1 -1 -3 World Source: J.P. while European closures. Indonesia). We identify Asia and Africa (2017) as the most likely regions for closures and delays to expansion plans. In Figure 14. will be limited by labor unions and the fact that IOCs like RD Shell have already retired or sold a lot of capacity in the region (see page 43). CFA (852) 2800-8536 samuel. In both 2016 and 2017. While many countries have refineries with below average complexity (eg.com Scenario 2 (base case): 3.rh. North Korea.ong@jpmorgan. In RD Shell’s Q3 2014 results conference call. those that have captive markets or are state run are unlikely to shutter anytime soon.Samuel Lee.4 million bpd of closures (barely) balance the world Based on our analysis and assuming trend demand growth. 17 . 3. Wood Mackenzie.P.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. If demand continues to disappoint.P. better margins 1400 1200 Taiwan Philippines Australia Singapore Vietnam Thailand New Zealand Malaysia Indonesia Brunei Bangladesh Sri Lanka Myanmar PNG North Korea Source: Bloomberg. 400 200 0 Pakistan 1000 800 600 PNG North Korea Myanmar Pakistan Sri Lanka Brunei Bangladesh Malaysia Indonesia New Zealand Vietnam Thailand Australia Singapore China Philippines Asia Oceania Taiwan South Korea India Japan 9 8 7 6 5 4 3 2 1 0 Source: Bloomberg.P.4 million bpd closures. a bear demand scenario will push Singapore margins into negative territory by 2016 (negligible impact on USGC). company data. more than an additional 3. company data.Samuel Lee. +ve/ -ve demand surprise While the +2-3 million bpd yoy demand growth phase of the commodity supercycle is well behind us. while a positive demand surprise will help European and Singapore margins stay near 2014 levels (Figure 16 to Figure 19). Wood Mackenzie. Figure 15: Yoy global demand growth (kbd) 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 3500 3000 2500 2000 1500 1000 500 0 -500 -1000 -1500 Base Source: J. over the next 3 years we are still likely to see +600 kbd to +1mbd yoy of demand growth.ong@jpmorgan. Morgan Scenario 3 & 4: 3. along with our bull and bear demand scenarios.rh.com Figure 13: Refining complexity by country in Asia Figure 14: 2014 select Asian refining capacities (kbd) Index: higher = more complex. Light blue bar denote forecast 18 Bull Bear
[email protected] million bpd of capacity will need to be delayed or shuttered.4 million bpd of delays/ additional closures. Morgan estimates. J. Figure 15 shows historical global demand growth. CFA (852) 2800-8536 samuel.sw. Assuming 3. J. Morgan Note: Based on universe of 220 Asian refineries totaling 32 mbd of CDU capacity. 0 2.rh.4 mbd of additional closures/delays by 2017 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 7.0 8.0 2. Note: Baseline assumes 3. Morgan estimates.0 5.0 1. Morgan estimates.0 4.sw. Even so.0 6.0 2.0 0. Note: Baseline assumes 3. we view +1mbd of condensate exports as insufficient to significantly diminish US surplus.0 7.0 3.4 mbd of additional closures/delays by 2017 Figure 19: Singapore medium sour hydrocracking margin ($/bbl) BASE Bear Bull Source: J. Our baseline assumes 250 kbd of condensate exports by 2016.0 -1. which we have incorporated into scenario 5. so the “US policy shift” scenario is significantly more aggressive.0 10.Asia Pacific Equity Research 18 November 2014 Samuel Lee.4 mbd of additional closures/delays by 2017 Figure 18: NW Europe light sweet cracking margin ($/bbl) Bear Bull Source: J. Note: Baseline assumes 3.0 6.0 0.0
[email protected] 2. Morgan
[email protected] 6.0 1. Morgan estimates. the lift in condensate exports will be insufficient to significantly damage US refining profitability.0 4.com Figure 16: Capacity weighted world average margin ($/bbl) 8. Cheap condensate will mostly go to Asia.P.4 mbd of additional closures/delays by 2017 Scenario 5: US export policy shift We view a full reversal in crude export policy and a removal of the Jones Act requirement as unlikely before 2017.0 3.0 5.0 3.com Parsley Rui Hua Ong (852) 2800-8509 parsley.0 4.0 BASE BASE Bear Bull Source: J. but attach a slightly stronger likelihood of +1mbd of condensate exports by 2017.0 1. 19 .0 4.0 5.0 Bull Source: J.0 0.0 Figure 17: USGC heavy sour cracking margin ($/bbl) 14. Note: Baseline assumes 3.P. giving a slight boost to margins for refiners processing condensate. Overall. CFA (852) 2800-8536 samuel.0 7.0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 8.0 12.0 BASE Bear 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 0.P.P. Source: J.P. Source: J.P.com World scheduled capacity vs. demand growth (kbd.P. Morgan estimates. Figure 26: Europe Figure 27: Middle East 300 200 100 0 -100 -200 -300 -400 -500 2015 2016 2017 Demand growth 1000 800 600 400 200 0 2011 2012 2013 2014 Net capacity additions Source: J. CFA (852) 2800-8536 samuel.P. yoy) Figure 20: Global Figure 21: United States 600 3500 3000 2500 2000 1500 1000 500 0 400 200 0 -200 -400 2011 2012 2013 2014 2015 2016 Net capacity additions Demand growth 2017 -600 2011 2012 2014 2015 2016 2017 Demand growth Source: J.P. Morgan estimates. Source: J.Asia Pacific Equity Research 18 November 2014 Samuel Lee. Morgan estimates. 2014 2015 2016 Demand growth 2017 . 20 2013 Net capacity additions 2015 2016 Demand growth 2017 2011 2012 2013 Net capacity additions Source: J.rh. Figure 22: North America ex-US Figure 23: South and Central America 300 250 200 150 100 50 0 -50 -100 -150 600 400 200 0 -200 -400 -600 -800 2011 2012 2013 2014 Net capacity additions 2015 2016 Demand growth 2017 2011 2012 2013 2014 Net capacity additions Source:
[email protected]. Morgan estimates.com Parsley Rui Hua Ong (852) 2800-8509 parsley. Morgan estimates.P. Morgan estimates. Morgan estimates. Figure 24: Asia-ex China Figure 25: China 1000 1200 800 1000 2015 2016 Demand growth 2017 800 600 600 400 400 200 200 0 0 2011 2012 2013 2014 Net capacity additions 2015 2016 2017 2011 Demand growth 2012 2013 2014 Net capacity additions Source: J. Morgan
[email protected]. driven by tighter capacity at Cushing). in our view. with growing logistics businesses being valued at higher multiples and monetized through the MLP structure.50/bbl in the near term. Transportation costs and quality differentials drive long-term crude pricing/differentials. and thus Brent/WTI at ~$7-9/bbl (we use $8/bbl). narrower crude differentials if Brent is lower for longer.com US – Cost advantage.com J. Within this framework. Morgan estimates. and. to some degree. Overview US cost advantages allow for sustainable margin benefit versus global peers. For our base case scenario. On the West Coast.rh. diesel. Note that we also provide a forecast for Houston (HLS) at a $1.P. global peers as a result of the shale oil & gas revolution: (1) increased access to abundant domestically sourced crude oil. with certain regions more advantaged than others. Figure 29: Transportation costs between key US regions $/bbl Source: J. A refinery buys a globally traded commodity input (crude oil) and converts it into a basket of globally traded commodity outputs (gasoline.P.50/bbl discount to LLS based on pipeline transportation costs. the chart below summarizes our key assumptions for transportation cost driven crude differentials. light versus heavy) differentials.P. in line with rail economics. reducing the amount of crude that has to be purchased at a global price plus transportation costs. with the degree of the crude input cost benefit contingent.ong@jpmorgan. Additionally. lower absolute oil prices reduce US crude supply.Samuel Lee.50/bbl). the US has recently developed two major competitive advantages vs. 2015-16 Key Issues/Risks: Potential crude export ban lift. etc). a refiner’s gross margin is a function of the price it pays for crude relative to the revenues it can obtain for the products that it yields. That said. For Maya. while products are priced on the global markets based on higher priced Brent crudes. US refiners are capturing greater value from the sum of their parts. which implies ANS/Bakken at ~$14/bbl (similar to rail economics to California).m. Product yields are also important. oversupply in global refining weighing on product prices. MPC. Morgan (Green = Positive. where soft demand and capacity increases could limit Source: J. is how close a refinery is to where the crude is produced (shorter distance equals lower transport costs).e.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. Red = Negative). (2) lower natural gas operating costs. We believe that the main factors driving regional crude differentials will be transportation costs and crude quality (i. the biggest margin differentiator. on the existence of the crude export ban (discussed later). where the crude export ban is not lifted. which places Brent/Bakken at ~$15/bbl.lee@jpmorgan. Thus. Global product pricing is typically based on (currently higher) international crude costs and related transportation costs. as well as a table with our forecasts. net of transportation costs. logistics value creation further US market share gains in export markets without weighing on pricing. we are somewhat cautious that product yields could tighten as more product tries to find a home in international markets. We believe that these advantages are sustainable. allowing cost advantaged US producers to make a healthy spread to global product pricing. Within the US. we assume an 21 . we have WTI/Bakken at ~$7/bbl. Morgan Securities LLC 2014 Overview: US enjoys a structural cost advantage with lower crude oil and natural gas prices. Some of the key longer term differentials that we would point out are Brent/LLS at $3-4/bbl (we use $3. Next. we have Brent/ANS at $1/bbl. Figure 28: Refining margin framework highlights US costs advantages Phil GreshA C (1-212) 622 4861 phil.gresh@jpmorgan. LLS/WTI at $4-6/bbl (we use $4. Key Stock Picks: PSX. CFA (852) 2800-8536 samuel.sw. 28 0. 3) replacing light sour/medium crudes. Light crude outlet valves suggest significant oversupply less likely in 2015.50 15. Flint Hills) ~100 kbpd of condensate splitters Table 6: J.29 0.25 14. which could lead to a “blow out” (significant widening) of crude differentials. receiving a ~9.84 8.30 11.13 11. This does not include other crude exchange/swap/export opportunities (100+ kbpd). Morgan Crude Differential Forecasts ~250 kbpd of minimally processed condensate exports $/bbl Brent/LLS LLS/HLS LLS/WTI Brent/WTI Brent/Bakken WTI/Bakken Brent/ANS ANS/Bakken LLS/Maya Maya/WCS Cushing WTI Cushing/Midland 2011 -0.7x Source: Company reports and J.36 10.sw. the US West Coast (175 kbpd).50 8. Table 7: Light sweet crude and condensate outlets.40 2015E 2. Table 8: MLP creation history . refiners to create an MLP structure for its logistics assets in 2004.88 0. with a $15/bbl spread between Maya and WCS based on transportation cost differentials to the Gulf Coast.219 955 EBITDA 30 53 105 75 59 Multiple 9. EIA and J.5x multiple. This displacement can come in several forms.05 9.P.Asia Pacific Equity Research 18 November 2014 Samuel Lee.50 2016E 3.50/bbl quality discount to LLS (recently in the $1015/bbl range). the largest is the US Gulf Coast (950 kpbd).55 4.rh.00 13. Parent/MLP HFC/HEP TSO/TLLP MPC/MPLX PSX/PSXP VLO/VLP Asset Value 288 670 1. Note: light sweet crude (35+ API).20 16. Cash received from MLP creation has been utilized by refiners to fund debt reduction (TSO).40 4. end-2014E kbd Region Potential Commentary Gulf Coast 950 kbd ~75 kbpd of import displacement ~100 kbpd in higher utilization rates ~220 kbpd in new light capacity (VLO.P.50 1. while WTI Midland is currently at a large discount to WTI Cushing.96 n/a 17.72 2014E 2.00 -3. Note: Valuations excludes value of future GP distribution rights.) was the first of the major U.92 14.74 5. increases (~50kbpd) Exports Mexico) Total 1750 kbd Source: CAPP. All valuations exclude additional value from GP distribution rights. Morgan estimates.51 12.2x) in 2013. ~200 kbpd through displacement of light sour/medium blending Eastern Canada 325 kbd ~275 kbpd displacement of foreign light imports by US exports ~50 kbpd displacement of Eastern Canadian offshore (exported elsewhere) West Coast 175 kbd ~75 kbpd displacing non-Canadian. 4) condensate exports and other crude exchanges/swaps.424 1.5x multiples received by refiners in subsequent years.00 15. Dividend N/A N/A .79 13.31 3.17 27.97 1. lower than the ~12.6x).5x-22. The creation of the MLP structures typically have resulted in the receipt of a combination of an equity interest in the LP and cash representing a portion of the of the IPO proceeds.75mmbpd at year-end 2014E) to absorb US light sweet crude production growth (estimated at ~1.50 15.85 1. dividends (MPC)
[email protected] 13.67 15.64 6. Morgan estimates. Morgan estimates.2x 13.58 19. MPC in 2012 (13. N/A means that Platts did not have this crude price historically. and PSX (16. including: 1) replacing foreign imports in US and Canadian refineries.com Parsley Rui Hua Ong (852) 2800-8509 parsley.24 1.53 2012 -0.12 n/a 17. followed by Eastern Canada (325 kbpd). non-Hawaii foreign lights ~100 kbpd in higher runs and medium displacement East Coast 125 kbd ~125 kbpd displacement of non-Canadian foreign lights Mid-Continent 75 kbd ~75 kbpd in higher runs (~25kbpd) and capacity Swaps/Other 100 kbd ~100 kbpd opportunity for crude exchanges/swaps (
[email protected] 4.50 4.00 14.04 23.00 1.06 2013 1.P.20 12.00 1. One big question that remains with respect to US crude input cost advantages is whether there will be light crude oversupply.S.25 11. Logistics Value Creation Opportunities MLPs have typically led to cash inflows for refiners… HFC (then Holly Corp.00 Source: Platts and J.2x) and VLO (16.6x 16. Finally.25 7. Holly’s MLP creation was followed several years later by TSO in 2011 (12. 2) investment in new light crude processing and condensate splitter capacity.50 7.75mmbpd cumulatively in 201516E for API 35+ crudes) before the market becomes over saturated.57 17. By region. and share repurchases (HFC).P. the US East Coast (125 kbpd) and the Mid-Continent (75 kbpd).70 13.7x 12. We believe that there are still several outlets available (estimated at ~1. CFA (852) 2800-8536 samuel.com $11. 22 Cash Rec’d 126 330 203 0 0 Principal Cash Use Buyback Debt Red.45 22.2x 16.24 13.74 2.00 7. we assume it normalizes over time (by 2016) to ~$1/bbl.00 1.large US refiners $ in millions Date Jul-04 Apr-11 Oct-12 Jul-13 Dec-13 Avg.97 13.00 4.7x).g.63 10.05 6.00 11.50 4.75 1.54 22. Medford Spheres 700 68 10. Wynnewood Products System Bayway and Ferndale rail unloading facilities. the Energy Conservation Program for Consumer Products. the EPCA established the Strategic Petroleum Reserve (SPR). Morgan estimates. respectively. PSXP. with MPLX and PSXP showing the highest potential. Morgan MLPs analyst Jeremy Tonet.P.0x Oct-14 PSX/ PSXP 1 Asset Lovington and Artesia intermediate feedstock pipelines Avg 9.3x Mar-14 PSX/PSXP 5% of Pipe Line Holdings Carson logistics assets (first portion) Carson logistics assets (remainder) Gold Line System. petroleum products. Cheyenne assets 340 N/A Apr-12 TSO/TLLP N/A Martinez crude marine terminal 75 8 9. Morgan). WNR/CST) and chemicals (e. PSXP and VLP.2x Pipeline and tankage assets Jun-09 HFC/HEP Lovington to Artesia pipeline 180 20 9.com …with further dropdowns also creating cash inflows and capturing value… Each company in our refining group has dropped additional assets down to the MLP level subsequent to the initial IPO.P.5x.g.0x VLO/VLP 13% of Pipe Line Holdings McKee Crude System.5x Jun-13 TSO/TLLP 640 63 10. MPC’s two dropdowns have consisted of stakes in a joint venture entity between MPC and MPLX (the MPLX’s vast majority of MPLX’s current asset base). We note that HFC was not included in the analysis (HEP Not Covered by J. 1 EBITDA and multiple represents only rail unloading facilities. with seven in total. TSO. The most recently created MLPs. Crude Export Ban Analysis Why does the US have a crude export ban? The ban on US crude oil exports began as a reaction to the oil embargo in the early 1970s and later was put into law in 1975 as part of the Energy Policy and Conservation Act (EPCA).sw.4x Jul-12 HFC/HEP Sep-12 75% of UNEV Pipeline Long Beach marine terminal and LA short-haul pipelines 315 N/A N/A TSO/TLLP 210 22 9. well below that of initial dropdowns. Table 9: MLP post-IPO dropdown history – large US refiners $ in millions Date Jul-05 Parent/ MLP HFC/HEP Asset Value EBITDA Multiple 82 10 Mar-08 HFC/HEP 8.4x Mar-14 MPC/MPLX 31 10.ong@jpmorgan. MLP MLP Opportunities exist in several areas We see further upside potential from the MLP structure not only in logistics. CFA (852) 2800-8536 samuel. …while each company still has significant opportunities for further dropdowns In order to compare each company’s future dropdown potential and the effect it theoretically could have on their financials. while TSO has performed five in three years. WLK).P. have undergone two and one dropdowns in 2014. Three Rivers Crude System. The primary goals of EPCA were to increase energy production and supply. HFC underwent dropdowns roughly annually through 2012. Morgan estimates. provide energy efficiency.5x May-13 MPC/MPLX 100 11 9. but that HEP is the most mature of the refining group’s MLP entities and is currently maintaining a focus on organic growth. We make several assumptions designed to present the companies on an apples-to-apples comparison basis (but not reflecting a realistic scenario). and Corporate Average Fuel Economy regulations.5x Nov-12 TSO/TLLP Anacortes rail unloading facility 180 19 9. Houston 310 Jul-14 154 15 10. using cash raised from the initial IPO (as equity only was used in the initial dropdown).0x 34 N/A Aug-09 HFC/HEP N/A Tulsa unloading facilities 18 N/A Apr-10 HFC/HEP N/A Additional Tulsa assets 93 N/A Nov-11 HFC/HEP N/A Ed Dorado. The EPCA vests the secretary of 23 .com Parsley Rui Hua Ong (852) 2800-8509 parsley.Asia Pacific Equity Research 18 November 2014 Samuel Lee. Most notably. requiring lower multiples to remain accretive.2x Dec-13 TSO/TLLP 650 70 9. and natural gas or petrochemical feedstocks.rh. we examine the forecasted future dropdowns for MPLX.” as well as crude oil if s/he determines such action to be in the national interest. but also other areas like fuels distribution (e.g.P. and VLO per J. which could be due to the fact that subsequent drops having a growing IDR burden. Figure 30: Several MLP’able opportunities EBITDA Multiple 18x 16x 14x 12x 10x 8x 6x 4x 2x 0x Refining Ethanol Fuels Chemicals Midstream Distribution (non-MLP) Base Case MLP Upside Potential Source: Company reports and J. “coal.lee@jpmorgan. We examine future dropdown value simply as a percentage of 2013 market capitalization. Valuation of subsequent dropdowns have averaged ~9.5x Source: Company reports and J.0x 340 33 10. and give the executive branch additional powers to respond to disruptions in energy supply. whereby all dropdowns from 20142024 are paid in cash to the parent company. Who can change export policy? This EPCA instills the president with the authority to restrict the export of. reduce energy demand. the US Senate held a full sub-committee hearing on the topic. given the highly political nature of the debate. 6) if it is provided for in certain international agreements. 2) from Alaska’s Cook Inlet. the BIS rulings are based on the fact that the processed condensate has been “processed though a distillation tower” in the CDF. which we assume the government will wait on before moving forward with the debate. Canadian crude passing through the US) and can be proven to not have been co-mingled with US crude. as reconfiguring these refineries would require significant investment that likely will not happen with the potential overhang of the export ban going away. we do not believe this is an issue that will be resolved in 2014. which are now looking less favorable based on the recent BIS ruling that “processed condensate" can now be exported. even if additional producers are given approval to export condensate. A good example of this would be condensate splitters. This ruling initially led to significant confusion about what “processed condensate” actually is.000 8. CFA (852) 2800-8536 samuel. . Specifically. the Commerce Department has given some exceptions to the crude export ban. white papers have been written by several think tanks on the topic of the crude oil export ban. and. A few overarching themes related to the debate. Why are we talking about crude exports if the US is still a net importer? As discussed throughout this report. What exports are allowed? Since the ban was put into place. but mandates that both the president and the secretary of commerce shall. particularly in the Gulf Coast. 24 2013 All Other Light 2014e Medium 2015e Heavy 2016e Whether the US export ban is lifted or not would likely not impact the US importation of heavy barrels in a meaningful way in the near term. Figure 31: Light sweet self-sufficiency close. while the US is still importing crude oil. 7) if it is consistent with presidential findings under certain legal statutes. are: 1) the potential impact on domestic gasoline prices if crude exports were allowed (would it really lead to lower prices?). when imposing restrictions. which has since been clarified.000 4. which are not particularly surprising.com Parsley Rui Hua Ong (852) 2800-8509 parsley.000 5. Energy security. such as the Jones Act (discussed later). in late January 2014. gasoline prices and the economy are key topics of debate Growing domestic crude oil and condensate production has recently led to a re-opening of the crude export ban debate. ensure that the national interest is left “uninterrupted or unimpaired.Asia Pacific Equity Research 18 November 2014 Samuel Lee. but only for consumption within Canada. leading to lower returns on such investments.000 0 2011 2012 Canadian Light Source: EIA. 4) if it is Californian heavy. 3) the potential benefits to the US economy in terms of job creation and trade flows if the ban is removed. Bush and Clinton) on five different occasions. As discussed in the recent Brookings Institute report that has been made publicly available. the first such discussion in 25 years.000 2.com commerce and the Department of Commerce’s Bureau of Industry and Security (BIS) with the responsibility to implement any rules stipulated in the legislation. These export exceptions are discussed next.000 3. 2) the need for US energy security and energy independence.rh. the EIA has been tasked with doing its own analysis on some elements of this debate as well. and. 3) in conjunction with refining or for the exchanges of oil in the SPR.000 1. it is also approaching selfsufficiency on light sweet crudes.lee@jpmorgan. but medium/heavy imports still necessary Kbd 10. As mentioned above. with certain restrictions around route of travel. while still importing medium and heavy crudes. and 4) the need to consider other policy changes that should also be taken into account.sw.g. In fact.” Therefore.000 7. While there are many different distillation-based equipment and technologies. it was reported by the Wall Street Journal that two companies (Enterprise and Pioneer) received a letter of approval from the Department of Commerce's Bureau and Industry and Security (BIS) to export “processed condensate”.000 9. 5) if it is foreign oil being re-exported (e. This is important because the US refining system is still dependent on imported heavy barrels based on the optimal configuration of its crude slates. Background on BIS “processed condensate” ruling On the evening of June 24th. Only three presidents have exercised this authority (Presidents Reagan.ong@jpmorgan. While the crude export ban has been hotly debated.000 6. ultimately the president retains the power to allow exports of all energy forms and to restrict exports of energy currently allowed if the president finds it necessary due to national circumstances. not in excess of 25kbpd. at its essence a distillation tower involves the use of heat. crude oil can be exported: 1) to Canada. to some degree. We assume some condensate exports and crude-forcrude exchanges Despite the existence of the export ban. these uses support the rulings that the distillation in the CDF produces a product (processed condensate) which is distinctly different from the lease condensate feedstock. while this outlet valve could be leveraged. Industry participants.g.lee@jpmorgan. named after Senator Wesley Jones) governs the movement of goods between US ports. light for heavy). it is likely to be fairly minimal (<100 kpd). Either way. Mexico recently opened up its energy industry to outside participants (besides Pemex). We believe that the idea of using general market conditions (e. upstream producers have been exploring what other alternatives might exist to bypass the crude export ban.com evaporation. with the belief that having a strong domestic shipbuilding industry is a critical element to national security. Figure 32: Despite crude export ban. Given the stringent conditions imposed by the Jones Act. we see processed condensate exports stepping in as the next meaningful opportunity.g. especially after the political backlash that has occurred with the processed condensate export approvals. we see opportunities for exports kbd 1. which we expect to continue into 2015 then level off in 2016. leaving Mexico as the primary additional alternative. such cargo must be transported on US flagged ships that are USbuilt. and condensation to fractionate the lease condensate into separate petroleum products. The Act promotes the maintenance of a strong merchant marine industry. Therefore. such as PSX and VLO. etc). to Canada. have seen significant growth in 2014. From a regulatory perspective. Importance of the Jones Act Background on Jones Act vessels The Merchant Marine Act of 1920 (commonly known as the Jones Act.200 1. readily exportable products. As it relates to the movement of crude and petroleum products between US ports. Total transportation costs from the Gulf Coast to the East Coast are estimated to be $56/bbl. CFA (852) 2800-8536 samuel. while allowing freely the export of petroleum products. such as natural gasoline.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. chartering such vessels can become expensive. Two such options are crude-for-crude exchanges and crude swaps. we believe that there should be plenty of opportunities for US producers to leverage the existing exceptions and licensing opportunities to find incremental outlet valves for US crude. and at times moving crudes from the Gulf Coast to its Bayway refinery in New Jersey. Finally. Crude swaps likely to be a more difficult pitch In additional to crude-for-crude exchanges. particularly given that the applicant must prove that the domestic crude oil cannot reasonably be marketed in the
[email protected]. However. into the East Coast (New York Harbor). and in some cases. For example. Crude-for-crude exchange licenses can be obtained if the transaction promotes “efficiency of transportation” or “convenience. The overall limited supply of Jones Act tankers and growing demand for crude transportation via water has led to a rapid increase in day charter rates. and refinery-produced naphtha.sw. Morgan estimates. However. the BIS apparently based its rulings on the fact that the regulations are designed to restrict the export of crude oil. with the BIS ruling. in particular. Crude-for-crude exchanges possible with Mexico Following the BIS approval of processed condensates.” Such licenses for exports to Canada are freely granted. there is currently no BIS precedent for what constitutes a permissible exchange. owned and operated. We also think that it is possible that crude-for-crude exchanges with Mexico and/or crude swaps could start to occur by 2016. PSX has two Jones Act tankers moving Eagle Ford crude into the Gulf Coast. significant light crude discounts in the US) may face a fairly high bar for a swap. That said. around which we would expect to potentially see more activity in terms of crudefor-crude exchanges (e.P.1mmbpd. Exports to Canada.000 800 600 400 200 0 2011 2012 Exports to Canada 2013 Condensate Exports 2014e 2015e 2016e Crude Exchanges and Swaps Source: EIA and J. the possibility could exist down the road to conduct crude swaps. with 100-150kbpd of light processing. the steps required to obtain a crude swap license seem likely to be more difficult. we estimate that the refining system in Mexico is currently only ~1.Samuel Lee. produced in a gas processing plant. We believe this transportation cost may play a role in setting the Brent/LLS differential as some refiners seek to move light sweet crudes from the Gulf Coast to 25 . are chartering Jones Act compliant vessels with the intent of moving Eagle Ford crude from South Texas into the Gulf Coast. BIS recognized that processed condensate is much like other. aside from the few exceptions noted above (from Alaska. but Jones Act still in place $/bbl Eastern Canada New York Harbor Houston St. Crude export ban important to cost advantage One important factor in currently strong refining profitability is the existence of the crude oil export ban.com Parsley Rui Hua Ong (852) 2800-8509 parsley. while Eagle Ford can take a ~$5-6/bbl Jones Act vessel.00 2016E No Ban 2. shipping crude to the East Coast on Jones Act vessels would still cost the same $5-6/bbl from prior examples given. Bakken = Clearbrook price. 26 $2 ship $2 ship . Refining Downside Scenario Analysis from Lifting Ban Whether the Jones Act remains in place will be key to trade flow impacts One of the more common topics about the potential lifting of the export ban is the US refiners' desire to have the Jones Act repealed at the same time. and. but the Jones Act remained in place. Morgan estimates. despite the similar haul distance.50/bbl in our base case). In comparison.P. which highlights the ripple effects of a potential tightening of Brent/LLS and WTI/Bakken on other crude spreads.00 13. particularly if Bakken is incentivized to flow south to a location of potentially higher netbacks.P. In a world where transportation costs are the primary driver of crude differentials.00 12. Table 11: JPM crude differential forecasts – with and without crude export ban $/bbl Brent/LLS LLS/WTI Brent/WTI WTI/Bakken Brent/Bakken Brent/ANS ANS/Bakken 2016E Current 3.00 4. Industry sources estimate that the cost is roughly half. The Jones Act significantly raises the cost of shipping crude between two US ports. so the quality could be perceived to be lower than Bakken. Thus.50) n/c (2.lee@jpmorgan. Figure 33: Crude export ban removed.com displace Brent-linked imports on the East Coast. where the current discount to Brent could fade. the Eagle Ford quality can vary meaningfully throughout the basin.50) n/c (1. Morgan.50 Difference (1. Assuming regional US crudes still discount to LLS using transport differentials. However.50 6. For our export ban downside scenario. James (LLS) $5 JA ship Source: J.ong@jpmorgan. That said.00 7. replacing light sweet crude exported from the Gulf Coast. shipping crude from the Gulf Coast to Eastern Canada (e.P. Quebec) in the cases where an exception to the crude export ban has been granted. On speaking with refiners.00 10.50) (1.50) Source: Platts and J. if the export ban was lifted. we have run a scenario in which crude oil exports are allowed to a high enough degree to impact crude differentials.00) (2. CFA (852) 2800-8536 samuel.50 4. the key difference is that Bakken costs ~$15/bbl by rail. Table 10: Comparison between Bakken and Eagle Ford crude $/bbl Eagle Ford Hypothetical Cost Bakken $94-95 Implied Differential $85 $10 Transportation Cost $5-6 $15 Total Cost to Refiner $100 $100 Source: J. it could make sense.rh. Eagle Ford is also more paraffinic (waxy). it could result in a scenario in which crude is incentivized to move to export markets instead of other US refineries.sw.50 2. is notably cheaper than moving crude to the US East Coast. Below we show possible normalized crude spreads in this scenario.50 6.g.50 8.00 2. For the East Coast. we believe that the primary deciding factor for whether Bakken or Eagle Ford barrels end up on the East Coast is price and transportation cost differentials. we believe that Bakken spreads could also narrow. So as long as Eagle Ford is within $10/bbl of Bakken. as increased outlet valves decrease the amount of excess crude on the Gulf Coast.00 15. We provide one example below where crude exports from the Gulf Coast can be shipped to overseas markets for $2/bbl (roughly the same cost as shipping Brent to the US).Asia Pacific Equity Research 18 November 2014 Samuel Lee. we assume that the LLS discount will be $2/bbl (versus $3. Morgan estimates. We believe that one of the biggest impacts would be on the Gulf Coast. with VLO pegging the cost from Corpus Christi to Quebec at ~$2/bbl. in part due to the growing availability of cheaper domestic crudes.P.com Jones Act repeal could make domestic waterborne competitive with export If crude exports are allowed.56 82.lee@jpmorgan. Table 14: JPM cracking margin differentials – export ban downside case scenario (West Coast Bakken) $/bbl Source: J. PADD III refineries likely would not achieve the same margins on exports. PSX would be 15%. As a result. depending on (a) whether cheaper pipelines are built to the Gulf Coast relative to the rail costs to the East/West Coast.50) 12. we see a scenario where Gulf Coast crude could then be sent to the East Coast for the same ~$2/bbl that it would cost to send to an export market. if crude exports were allowed and LLS traded closer to Brent.01 86. The largest impact would be to VLO (35%) and MPC (35%). where most of the exports are currently occurring. given that they have heavier exposure to the Gulf Coast.01 Source: Platts and J.01 (0. Morgan. which would compare with ~$2/bbl for exports. particularly in PADD III.rh. then we believe that the shipment of oil between US ports could become more competitive with exports.50) (1. On the West Coast. As discussed previously. US refining margins could weaken.P. Morgan estimates.50 11. EPS impact could be in the ~25% range Using the crude and product price forecasts mentioned above. However. we ran our earnings models to show what would hypothetically happen to refining earnings in 2016 under the scenario that crude exports are allowed. Thus.00 77.ong@jpmorgan. while HFC and TSO would see 20-30% impact. relative to our base case scenario. we also see a scenario where crude could be sent from the Pacific Northwest to California for <$1/bbl.50 88.01 12.56 (1. 27 . we have factored in a modest reduction to cracking margins in our crude export ban removal downside scenario.50) 13. Morgan estimates.56 96. Refined product exports/margins could also be negatively impacted A secondary impact of a potential relaxation of the US crude export ban could be on refined products exports/margins. the US has become a net refined product exporter in recent years.sw.51 100. Morgan estimates.06 Source: Platts and J.50) 8. and the Jones Act is repealed.00 14.00 8.50 15.56 13. Jones Act repealed $/bbl Table 12: JPM cracking margin differentials – export ban downside case scenario (Mid-Con WTI) $/bbl Cracking Netback Crude Cost Cracking Margin Base Case Cracking Margin Netback Impact Crude Cost Impact Downside Case Cracking Margin Mid-Con WTI Base Case ban lifted 97.00 0. refiners on the East and West coasts could still receive Bakken crude.01 14.00 83.00) (1.50 Source: Platts and J. making the East Coast at least on par with export.00 86.00 (2.50 11. Specifically. Thus.P. and/or (b) whether ocean freight costs from the Gulf Coast to the East/West Coast can compete with other international markets.Samuel Lee. Figure 34: Crude export ban removed. given its more diversified business mix. CFA (852) 2800-8536 samuel. We see a potential ~25% downside risk to group EPS. refiners might choose to either shift more refined products to the domestic markets (which may not need the product) or be forced to cut production. particularly on the Gulf Coast.P. Cracking Netback Crude Cost Cracking Margin Base Case Cracking Margin Netback Impact Crude Cost Impact Downside Case Cracking Margin West Coast Bakken Base Case ban lifted 86.06 15.00 75. In either case.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. Table 13: JPM cracking margin differentials – export ban downside case scenario (Gulf Coast LLS) $/bbl Cracking Netback Crude Cost Cracking Margin Base Case Cracking Margin Netback Impact Crude Cost Impact Downside Case Cracking Margin Gulf Coast LLS Base Case ban lifted 100. 8x 6. MPC is diversifying its portfolio into higher-multiple logistics and retail businesses (~22% of 2016E EBITDA).50 $7. Second Pick: MPC (OW. Table 16: US refining valuations JPM EV/EBITDA Rating 2014E 2015E 2016E N 6.0x 3.2x Phillips 66 OW 5. 2014. group average ~26%). As a result of its diversity. concerns have re-emerged in September.6x 6.00 $6.7x 5.51 -34% $2.37 -21% $4. the stocks have recovered some of their losses on good 3Q results and a focus by investors on the value of logistics assets.ong@jpmorgan. Priced as of November 14.01 -26% 100 100 95 95 $4.4x 6.29 $5.4x 6.82 -35% $5.1x Valero N 4.32 $5. with additional analyses being published around the potential benefits of lifting the ban (e. On a valuation basis.32 Aug-14 $8. For example. refining stocks are trading at ~6x 2015E EBITDA.0x Marathon Petroleum OW 5. as it created significant uncertainty about whether this would be the first step in lifting the entire crude export ban.com Table 15: Potential impact on operating margins and EPS from no export ban Figure 35: Refining stock performance reflects degree of uncertainty around export ban $/share Index = 100 = 12/31/2013 Price $4. we still see many value levers to pull. which we think is a function of the growing value of the logistics assets on a sum of the parts basis. .45 -23% $5. J.P.No Export Ban % Earnings Impact MPC Dec-13 2016E Op Margin/bbl – Current 2016E Op Margin/bbl .35 $5.). which was followed by another reversal in the refining stocks. CFA (852) 2800-8536 samuel. Average Source: Bloomberg. both of which have non-macro levers for growth and significant MLP opportunities. Finally.5x 5.5x 5. since then. given that all of MPC’s exposure is in the US central corridor.19 Sep-14 $5.8x 5. which we expect to remain crude cost advantaged.16 -22% $4.39 105 105 $6.15 -32% $3.99 -27% $4.8x 6.com Parsley Rui Hua Ong (852) 2800-8509 parsley.rh.38 -15% $3. Company Oct-14 $3. the refining group traded down ~6%.No Export Ban % Impact HFC Top Pick: PSX (OW. which is above the longer term average in the 4-5x range. as concerns eased around the full ban being lifted.sw. Refiners Conclusion Since the initial sell-off. which we think is largely a function of the concerns of the crude export ban potentially being lifted in years ahead.1x 6. PT $96) While shares have underperformed recently on concerns about the impact of lower oil prices on Chemicals. Morgan estimates.82 Jul-14 110 Jun-14 110 May-14 Average Apr-14 VLO Mar-14 TSO Feb-14 PSX Jan-14 2016E EPS – Current 2016E EPS .00 90 90 $3. Morgan estimates. 28 S&P 500 Source: Bloomberg.S.9x 5.g.50 $9. MPC also has several refining projects under way to drive controllable EBITDA growth. we also see the lowest downside risk at PSX in a scenario where the crude export ban gets lifted (~15% EPS downside. the group recovered most of its initial losses through early September. etc. overall US GDP growth. However. as PSX has the most diversified portfolio in the group and the highest potential for more growth outside of refining (Midstream and Chemicals).0x Tesoro N 5. However. on the day after the Wall Street Journal reported the “processed condensate” approvals. PT $118) We see MPC as a solid way to play the most favorable themes in US refining.55 -35% 85 85 -27% Source: Company reports and J. We see a strong backlog of MLP drop down opportunities (to PSXP) within Midstream. Brookings Institute noting the potential benefits to consumers with lower gasoline
[email protected] Pacific Equity Research 18 November 2014 Samuel Lee. Refining stocks feeling the impact of political swings Refining stocks have underperformed the S&P 500 on a YTD basis.88 -22% $3.P.0x HollyFrontier U. despite the sell off in the energy group more broadly. 000 50.com 60. The two refineries will be constructed in single-trains of 300 kbd each.000 40. their Solomon Index will jump to 9.000 - 2010 2011 2012 Daily Imports of Diesel 2013 2014 - Daily Imports of Gasoline Source: ANP. Paradip Banco J. with maximization of energy generation while using the best technology for each single unit. In the case of Ecopetrol.severine@jpmorgan. Increase capacity in Brazil is particularly important as reduces imports needs.6bn.2 $1.lee@jpmorgan. Morgan estimates Based on informed investments for each refinery and considering the production capacity divided by released Solomon index.000 30.000 20. COMPERJ construction has reached 66% of completion while the investment in COMPERJ is around $13.0 $0. Investment in RNEST refinery investment is around $18. Brazil has been importing on average 225kbd of diesel and gasoline. $8. In that sense.4 while Barrancabermeja will reach 10.rh.000 100. or RNEST. Essar I LatAm – Moving Ahead with Capacity Expansion Source: J.000 40.000 180. Petrobras is currently building two new refining facilities: Figure 36: Diesel and Gasoline Imports Garyville 2014 Overview: Latin America refining business was marked by Petrobras losses during 9M14 on its downstream unit due to lack of prices alignment to international market and importing needs to supply Brazil. kbd Port Arthur Next couple of years will be marked by refining capacity expansions in LatAm: In our view.5bn to increase and upgrade its refining capacity between 2014 and 2020. the company is expanding capacity of its REFICAR refinery from 80 kbd to 265 kbd in 2015 while the product mix will also change with more focus on mid-distillates and gasoline. will start up at end-2014 with a total processing capacity of 230 kbd of crude oil and with production capacity for 162 kbd of low sulfur diesel. further capacity expansion plans would come only if capex estimates for those refineries decline. Essar I I Marcos Severine (55 11) 4950-3796 (55 11) 4950-4297 felipe.000 20.000 160. Morgan S.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley.000 120.dossantos@jpmorgan. one of the world’s largest refiners. 200.9 previously.6 in 2016 70. with throughput production of low sulfur diesel with similar throughput capacity of ~300 kbd each.000 60.000 Bina 1) Complexo Petroquímico do Rio de Janeiro or COMPERJ is an integrated refining and petrochemical complex (165 kbd) with startup expected for 2016 and a second trench with additional 165 kbd expected to start up in 2018. CFA (852) 2800-8536 samuel.5 $2. In our view.8 Reficar And also increase quality of refined products: We believe the LatAm oil & gas companies are investing to upgrade their fuel output to international standards.P.0 $1. A.9 $0. including additional petrochemicals capacity.000 140. The company will likely be investing ~$6. power generation units and other related capex contributes for refining capex increase. In the case of Ecopetrol. with RNEST start up the diesel importing level is likely to reduce this number in to ~40kbd of
[email protected] $1.Samuel Lee.com marcos.com Jamnagar Felipe Dos SantosA C from 8.3 in 2012 with total investments in the quality upgrade likely to reach $15bn between 2014 and 2018. Figure 37: Capex per complexity barrel Thousand dollars/complexity barrel Note: The company has informed the infrastructure costs with ports. Petrobras has been investing in refineries to improve both gasoline and diesel quality and to increase crude slate flexibility in order to be able to process more Brazilian crude. Petrobras has a dominant market share in the Brazilian market owing 12 refineries.000 Comperj In the case of Ecopetrol. 2) Abreu e Lima Refinery. Petrobras has indicated that after the upgrades.0 Pernambuco $3. 29 .P.3 vs.000 80. with a total net distillation capacity of 2. 6. 2014 was marked by almost zero margins.6bn. We believe Petrobras is not likely to move ahead with Premium I and II refineries projects unless capex estimate of $20bn reduces. pretty much reducing PBR’s diesel importing gap. 2015 and 2016 will mark a transition as Petrobras and Ecopetrol expand their refining capacities. In our view.4 from 5.000 10.2 $9.sw. The two refineries are in their design phase to process 20° API heavy crude oil.9 $1.1 mmbopd. the company’s Solomon index at Cartagena Refinery will jump to 10. Table 17: Latam refining valuations Company PETROBRAS ON ADR PETROBRAS PN ADR PETROBRAS ON PETROBRAS PN YPF Ecopetrol ADR Rating N N N N N N Price (LC) 9. Petrobras and Ecopetrol have the benefit of supplying a captive market that is growing in terms of consumption on a yearly basis.6 0.2 8. PT $30) We rate Ecopetrol Neutral due to: 1) small reserve lifetime of ~7 years.00 14. We would avoid exposure to Ecopetrol as we consider the company’s main challenge remains long-term sustainability of reserves that currently reaches eight years.2% 17.00 EC US Equity PBR US Equity Source: Bloomberg. but for different reasons.6 9.6% 1.5 PB (x) FY14e FY15e 0.0% 5.7 12.7% 4.27 12.0 22. Please see below the absolute and adjusted cost per capacity of the ongoing and planned refinery expansions in Latin America.5% 1. compared to global peers selling at 11. Priced as of November 14.8 9. Currently.1 11.0 38.P.6 ROE (%) FY14e FY15e 6.0 36.8% 2.1% 9.5 0.7% 0.1 2.00 MktCap USD mil 64.0% 6. The first will process Marlim's field heavy crude (26º API) while the second will process Venezuelan synthetic heavy crude (16º API).0 28. Figure 38: YTD share price performance 40. both gasoline and diesel are virtually at parity however. J.81 PT (LC) 17.8% 6.4x P/B. 2014.0% 14.00 18.0 26. In our view.5 0.7 8. 3) lack of clarity on fuel price readjustments and a specific price readjustment policy that would allow prices to be readjusted according to international parity. we see no single source as enough to deliver the likely volumes required. 2) FX devaluation impact on fuel import costs and leverage. 2) non-compelling trading multiples of 12.6% 6.0 10.4 5. PT $25) We rate Petrobras Neutral due to: 1) uncertainties on short-term production behavior and a miss on the 2014 production guidance.5 0.0 We have a Neutral rating for both Petrobras and Ecopetrol.00 10.9% 17.2 1.9% 6.5 1.5 0.00 41.3 EV/EBITDA FY14e FY15e 7.6 0. Petrobras conceived RNEST in two different units of 115kbopd. However.3 8.5 0.2 8.0% 0.00 25. the expensive downstream investments might not increase the companies’ value but are necessary for companies as Ecopetrol and Petrobras that have the mandate to supply the domestic market with refined products.9 7. Morgan estimates.0 24.962 66.00 18.7x P/E and 2.3 3.0 34.9% Yield (%) FY14e FY15e 7.00 8.5x P/E and 1.96 10.8 3.20 32.0 30.0 20.8 7.964 51.951 64.lee@jpmorgan. Least Preferred: Ecopetrol (Neutral.9 9. the ratio has decreased to 6-7 years
[email protected] 8. the main risk for Petrobras Downstream unit is that selling prices lag international ones.1 6.96 24. 30 PE (x) FY14e FY15e 7.0% 8. We believe investors would like to see a fuel policy increase rather than a sporadical price increase. On the other hand.00 16.004 Source: Bloomberg.8 7.9% 4.00 20.0 32.1 9.079 66.0% 5.6 8.4% . over the last years.com RNEST’s total cost could have been lower if it was not designed to process Venezuela's synthetic oil. 22. We believe that downstream investments are inevitable as otherwise fuel imports would skyrocket over time. improvement of recoverable factor.00 12. In our view.4x P/B or 2015. the discount to international prices widened whenever Brent and BRL/USD parity moved. amidst low replacement ratios. We highlight Ecopetrol’s initiatives to boost its reserve level on four fronts: exploration.9% 5. CFA (852) 2800-8536 samuel. development of unconventional potential and acquisition.185 12.Asia Pacific Equity Research 18 November 2014 Samuel Lee.0% 5.0% 3.6 8.rh.00 24.1 2.com Parsley Rui Hua Ong (852) 2800-8509 parsley.6 8. Petrobras (Neutral.78 13.sw.8% 6.00 30. CFA (852) 2800-8536 samuel. Morgan 31 .com (852) 2800 8509 parsley.rh. with limited heavy crude supply growth but strong development of deep conversion assets in East of Suez. while lowering exports to China to 15% of total. This might result in Asian refiners processing sub-optimal feedstock. particularly for diesel and kerosene/jet fuel. We see numerous operational disadvantages refineries face: (1) slowing demand in China of c200 to 300 kbd and gradual uptick in product exports.Asia Pacific Equity Research 18 November 2014 Samuel Lee. the Asian market looks saturated and we anticipate a challenging refining environment that will suppress margins and utilizations. India and the Middle East.ong@jpmorgan. which lowers the value of their upgrading projects and competitiveness. versus the 2013 average of $6/bbl (Figure 40). (4) increasingly tough emission standards and refined product specifications. Figure 40: Asia gross refining margins $/bbl 10 8 6 4 Nov-14 Sep-14 Jul-14 May-14 Mar-14 Jan-14 Nov-13 Sep-13 Jul-13 May-13 2 Mar-13 2014 Overview: Asia sits at the heart of global demand growth. Korea customs.P.8/bbl). Figure 39: South Korea product exports by destination 25% 2015-16 Key Issues/Risks Our global refining model suggests that Asia refiners will face extreme margin pressure as more competitive refineries are commissioned in China. while between 2000 and 2013. Jan-13 J. 2014 Figure 41: Asia refinery utilizations 23% 21% 23% 23% 20% 18% 15% 37% 46% 44% 45% 43% 41% 51% 11% 3% 12% 15% 3% 15% 14% 6% 16% 15% 6% 17% 2010 2011 2012 2013 Japan Other China 10% 3% 28% 9% 4% 21% 2008 2009 Singapore Indonesia 12% 7% Source: JODI. versus 23% in 2008 (Figure 39). exporters have struggled to find new markets (China became a net product exporter in 4 out of 9 months in 2014. Likewise.P.com 2014 started off with robust
[email protected]@jpmorgan. but they have struggled to stay above $5/bbl (2Q-to-date avg: $4. (3) crude quality imbalances. Asia has the world's largest naphtha deficit.sw. India has increased its European market share. With China largely self-sufficient. China and the Middle East have stolen market share and called the economics of marginal refineries into question. Asia ex-China accounts for 19% of global capacity. (5) 95% 85% 75% 65% 55% 45% 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% BASE BEAR BULL Source: J. Morgan estimates. (2) high percentage of NOCs in the region with lower price sensitivity. Samuel LeeA C Parsley OngA C (852) 2800 8536 samuel.com Parsley Rui Hua Ong (852) 2800-8509 parsley. Fuel oil has generally been weak in 2014 as more Chinese teapots can import crude directly. and necessitate further closures. but cost pressure from world-scale refinery startups in India.com Asia – Flat or lower GRMs likely for 2015 Commissioning of significant condensate splitting capacity and CTL projects. with their products likely flooding Asian markets initially during the test run and ramp up phases. 2 mega-refineries totaling 800 kbd of capacity will start up in the ME over the next 12 months. J.P. Morgan
[email protected]. with a total of 504 kbd of import licenses awarded to independents in 2014.sw. Morgan Securities (Asia Pacific) Limited Source: J. but the startup of 3 large condensate splitter projects in 2014 have weakened naphtha cracks. this occurred in only 2 out of 168 months). Diesel has declined throughout the year due to the start up of new ME capacity in 4Q13 and +67% Y/Y increase in YTD Chinese diesel exports. but only 11% of demand. Korea has raised exports to countries like Singapore and Indonesia. Most notably. Given tepid demand growth.rh. CFA (852) 2800-8536 samuel. The Brent-Dubai spread is important as most of the Asian refiners’ crude costs are based on Dubai while product prices are more of a function of Brent prices. one of which had been planned since 1991. Morgan. While Chinese margins will see moderate support from the displacement of teapot capacities and domestic demand. Saudi has been cutting its OSP with the decreasing spread. though no concrete dates have been fixed.ong@jpmorgan. >1. Year 2014 2014 2014 2014 2014 2015 2015 TBD TBD Jul-11 Operator Sinochem PetroChina Sinopec IRPC IRPC Zhuhai Baota CNPC Sinopec Sinopec NOC / TIDCO / Tata Petrodyne IOC Cilacap BAPCO CNOOC CNPC / RD Shell / Qatar Petroleum Sinopec Sinopec BPCL Oct-11 Capacity 240 200 160 50 50 100 100 100 100 130 300 62 93 200 60 240 140 121 Apr-11 Refinery Quanzhou Pengzhou Yangzi Rayong Map ta Phut Zhuhai Baota Huabei Jiujiang Hainan Cuddalore Paradip Cilacap Sitra Huizhou Taizhou Zhenhai Shanghai Gaoqiao Kochi Jan-11 Year 2014 2014 2014 2014 2014 2015 2015 2015 2015 2015 2015 2015 2016 2016 2016 2016 2016 2016 . its gradual shift towards being a net exporter removes an important demand sink the region. but are presently aware of only two Asian refinery closures in 2015. given announced capacity expansions and closures.OSP) so that higher Brent prices gives the refiners a small buffer of margins as well. In our view. Simple= Simple refinery GRM 32 Source: Bloomberg.Asia Pacific Equity Research 18 November 2014 Samuel Lee.P.8mbd of Asian capacity closures necessary to balance market. Australia Jan-12 Source: J. some of the new capacities will be used to feed new downstream petrochemical plants (mainly PX) while the rest of the products will be likely be diesel/jet.P. Jul-12 Table 19: Select Asian refiners product exposure Capacity -120 -180 -67 -38 -135 -200 -118 -96 -109 Source: J. Apr-12 Not only are there CDU capacity expansions but there are also 500-600 kbd of new condensate splitting capacities starting up in Asia during 4Q14-1Q15. Philippines Lytton. versus 670 kbd of Asian demand growth. product specifications will improve and more exports will flow to Europe.com As upgrading units come online.com Parsley Rui Hua Ong (852) 2800-8509 parsley.rh. Table 18: New 2014-16 Asian capacity additions (>50 kbd) Table 20: Select Asian capacity closures kbd kbd Source: J. Taiwan Bulwer Island. This will further put pressure on Asian refiners as they are middle distillates-centric given the growth of diesel demand over the past 10 years. Interestingly. We saw a spate of refinery closures in Japan and Australia in 2013 and 2014 (total: 685 kbd). Morgan. further capacity rationalization is necessary to support margins through 2016 and beyond. especially in places like China and Indonesia. compressing utilization rates and margins in Asia-ex China. SIN=JPM benchmark GRM. Additionally. Australia Tobangao. Plans to shutter a further 323 kbd of Asian capacity have been announced. Refinery Tokuyama Muroran.P. Japan Wakayama West Japan Kurnell. Brent pricing has been under more pressure as of late. Australia Kaohsiung. in 2015. Asian refiners normally pay a premium to Dubai crude via the premium that Saudi charges to it customers (called Official Selling Price . Since condensate splitters generally produce middle distillates.lee@jpmorgan. c900 kbd of capacity expansions are expected to come online in Asia (400 kbd from China).sw. Hokkaido Kawasaki. Not only that. Morgan. Jul-14 Oct-14 Apr-14 Jan-14 Others 1% 2% 12% 5% 0% 22% 3% 6% Jul-13 Diesel Fuel Oil 39% 22% 26% 41% 35% 4% 31% 12% 39% 8% 43% 0% 39% 8% 50% 14% Oct-13 JET 4% 13% 9% 29% 17% 7% 19% 9% Apr-13 Mogas 27% 12% 22% 13% 18% 23% 17% 12% $/bbl 9 8 7 6 5 4 3 2 1 0 Oct-12 Petchem 7% 7% 18% 10% 18% 5% 14% 9% Figure 42: Lower Brent-Dubai crude spread is negative for Asian refiners Jan-13 SIN Simple FPCC S-Oil SK Inno RIL TOP PTTGC Owner Idemitsu Kosan Nippon (JX Holdings) TonenGeneral TonenGeneral Caltex CPC BP RD Shell Chevron (Caltex) Brent-Dubai spread narrowing The other key risk for Asian refiners is the recent narrowing of Brent-Dubai spread. As more and more light crude is available globally. 933 PE (x) FY14e FY15e 25.0% 6.2% 14.00 1080 1. Morgan estimates.7 34.1% 1.000 60. and we value investments at book value (telecom at a 50% discount to BV to account for earnings uncertainty).716 2. we currently do not have any OW stocks in our coverage and therefore RIL is preferred on a relatively basis.2 15. We believe RIL will fare better relative to peers in a weak GRM environment due to its scale and complexity.5% 11.6% 4. weak business environment outlook and increasing CAPEX for 2017-18 for expansion/upgrading projects.0% 1. Table 21: RIL will have significant petchem capacity growth in the next 12-18 months '000 tons Current capacity Expansion 823 290 425 648 PSF PTA 742 2.856 2. a product where we are also bearish on.5 0.3% 2.000) Price (LC) 68. Phase 2 in early FY16 Phase 1 in 3Q/4QFY15.7 1.3% 4. Phase 2 end FY15 FY16 Phase 1 in 3QFY15. Priced as of November 14.9 97. 7.9
[email protected] 98.639 50.235 7.sw. Also. Finally we believe significant capacity expansion in their petchems businesses over the next 12-18 months will help RIL offset declines in refining earnings. In the past.000 2.50 969 2.6x 2015 BV as we forecast 2015-16 ROE to only average around 6%. J. petchem and shale/PMT businesses at 6.6% 10.7% 3.0% 5.5% Source: Bloomberg.8% 6.60 6.36 PT (LC) 71.2% 1.0 12. S-Oil is a simpler refinery with large exposure to PX.050 346 4. Taiwan and Singapore will be under increasing margin pressure.Asia Pacific Equity Research 18 November 2014 Samuel Lee.4 22.080) In light of the weaker Y/Y refining outlook in 2015. We value S-Oil on 0. Phase 2 in 1HFY16 End FY16 End FY16 End FY16 End FY16 End FY16 Commissioned End FY15 CY16 N N UW N N N UW N 200 150 100 50 0 (50) (100) (150) (200) (250) (300) 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 Source: Bloomberg.350 PX 1.6% 3.4 14.685 1.2% 11. RIL buys their crude almost from anywhere in the world where it can get an advantageous price. 63% owned by Saudi Aramco.8% 14.P.841 5.2 27. Rating We believe with the emergence of new mega-refineries from the ME.7% 12.7% 14. Table 22: Asian refining valuations FPCC SK Innovation S-Oil PTTGC Thai Oil RIL Shanghai Petchem Sinopec Corp Figure 43: S-Oil refining has been loss making for last 7 quarters 1Q13 Our SOTP based Mar-16 PT of Rs1080 values the refining.9% 3.1 FY13 12.0% 4.7 2.com Preferred: Reliance Industries (N. unlike other Asian refiners where most of the crude is sourced from the ME.7% 11.7 0.0% Yield (%) FY14e FY15e 3.7% FY15e 10.rh.6% 12.0% 5.1 1.5% -0. $/bbl Timeline Source: Company data.3 -119.5% 13.328 ROGC MEG Ethylene Propylene PP HDPE/LLDPE PBR SBR Butyl Rubber 733 1.7 10. S-Oil refining business has been loss-making on an OP basis for last 7 quarters.8% 0.4% ROE (%) FY14e 10. PT Rs1.1 1. Despite fairly robust Asian GRMs for most of 2013-14.000 29.2% 1.000 40.00 Mkt Cap USD mil 21.5 1. S-Oil was seen as a dividend play but we think that is also at risk now given our forecast of FY14 losses. Figure 44: YTD share price performance SPC 17% RIL 10% Sinopec 0% FPCC -16% PTTGC -19% TOP -24% SK Inno -39% S-Oil-45% -50% -40% -30% -20% -10% 0% 10% 20% Source: Bloomberg. Company Least Preferred: S-Oil (UW.4% 4. We use FY16 EBITDA in our SOTP.850 63. 33 .2% 14.8% 4.200 74 - 730 1.3 10.883 3. J.4 11.00 47.7 10.0 87.P.2 1. We value the D6 stake on an NPV basis.9 0.400 150 156 950 40 150 120 Polyester PFY PET Commissioned Phase 1 commissioned.7% 3.182 8.0 0. Morgan estimates. traditional exporting refiners from Korea.231 4.0 24. 2014.6 9.4% 1.8 1.5x. CFA (852) 2800-8536 samuel.5 1.5 PB (x) FY14e FY15e 2.4 11.50 42.5x and 5x EV/EBITDA respectively (in-line with peer group).5 1.ong@jpmorgan. PT W29.com Parsley Rui Hua Ong (852) 2800-8509 parsley.4 86.8 8.2% 3.7% 2.4% 4.4% 5.5 0. Figure 48: Decline in China refining margins 15 150 10 125 5 100 0 75 -5 50 70% Source: Bloomberg.P. Morgan Jan-09 80% 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Fuel Oil Jet and Kerosene Other Products . kero/
[email protected]@jpmorgan.Asia Pacific Equity Research 18 November 2014 Samuel Lee.g. Sinochem Hongrun). diesel. Guanghui Energy). J.g. 60% the yearly average over the last three years. the government has also started to approve crude oil import licenses not only to small state owned enterprises (e. the sharp fall in oil prices saw several oil product cuts with a subsequent fall in refining margins (Figure 48). Morgan estimates. Morgan Securities (Asia Pacific) Limited The moderation in Chinese oil demand growth has impacted refining dynamics in the country.P. naphtha and fuel oil averaged 230 kbd yoy in 9M14. Apparent demand for key products . Morgan Source: BP 2014 Statistical Review of World Energy 2013 2011 2009 2007 2005 2003 2001 1999 1997 1995 1993 1991 1989 1987 1985 65% Jul-14 Jan-14 Jul-13 Jan-13 Jul-12 Jul-11 Jul-10 Jul-09 Jan-12 0 Jan-11 25 -15 Jan-10 -10 China's theoretical GRM (US$/bbl . further exacerbates the overcapacity situation as the ability to import crude oil improves their competitiveness to state refiners. J. offset by weakness in diesel from lackluster industrial activity. Chinese refiners are said to continue to be offering tolling agreements whereby crude oil is supplied in exchange for oil products with a small processing fee. However.l. CFA (852) 2800-8536 samuel.ong@jpmorgan. Chinese state refiners have also raised oil product exports as domestic oil demand growth lags capacity additions. The fuel price mechanism for gasoline and diesel prices was amended in March 2013 and the government is adhering to the revised mechanism. This volume of exports is apparently not counted towards the export quotas.P. kbd (y/y) 1200 700 200 -300 J.sw. Bloomberg.stansfield@jpmorgan. OGP.RHS) 75% 34 Gas/Diesel Oil Naphtha Total Oil Source: NBS. This. CGA. Figure 45: China refining plant utilization 90% 85% Gasoline LPG and Ethane Figure 47: Net oil product imports collapsed 15 10 5 (5) (10) Total import Total Export Net prod import Source: J. Chart shows total oil product imports and exports in m tonnes on a quarterly basis The Chinese government remains in control over oil product prices through the National Development and Reform Commission (NDRC).5m b/d import licenses granted which represents only c5% of the country’s imports).LHS) Crude cost 1-month delay (US$/bbl . (Note: the NDRC adjusts gasoline and diesel prices when a basket of crude oil prices (dated Brent. refinery utilization rates have fallen to 78% so far this year from just over 80% over the last few years (Figure 45). Government quotas for such exports have increased accordingly. with gasoline demand growth around 10% y/y. China became a net diesel exporter since late 2012 and overall net oil product imports have fallen sharply this year (Figure 47).com Parsley Rui Hua Ong (852) 2800-8509 parsley. but also private companies (e.gasoline. With new capacity still coming on-stream after years of over investment by the industry. In an effort to improve competition within the domestic oil market. although the amounts are small relative to total imports (c0.P. Dubai and Cinta) moves by Rmb50/ton (US$1/bl) over a 10 day period).com China – Managing oversupply with slowing demand Scott DarlingA C Michael Stansfield (852) 2800 8578 scott.com Figure 46: Chinese oil product demand outlook.rh. however.com (852) 2800 8563 michael. albeit slight. nationwide rollout started this year with gasoline moving to China IV standards and diesel to follow in 2015. corporate re-structuring is improving the free cash outlook for the business.lee@jpmorgan. Preferred: Sinopec (N. Sinopec has been the first of the China Oil & Gas SOE to reform certain parts of its business and while the macro outlook for refining may remain challenging. Chart shows operating profit by segment for 2013 35 . Sinopec’s refineries are mainly located in China's southeast coastal areas. Morgan estimates.ong@jpmorgan. Morgan estimates Fuel specification reform China continues to rollout fuel specification adjustments. Key Stock Picks Within our Asia Oils coverage. retail. in oil demand in the country next year. Zhejiang Capacity 240 200 160 100 100 100 100 Zhenhai Shanghai Gaoqiao Dushanzi . an increase from c37% in 2011) which still exhibits strong volume growth (gasoline sales rose 11% y/y last year) and margin (Figure 49 . our global refining model suggests plant utilization remains broadly unchanged in the coming years. Figure 49: Sinopec profitability still biased to the upstream Petrochemicals. where through cycle returns are better for upstream rather than refining assets such as PetroChina.0/bl incremental margins (all other things being equal) according to Sinopec.6 mb/d refinery capacity. Guangdong Taizhou. 55% Refining . 1% Marketing. energy infrastructure).5-1. as the consumer is required to pay a higher price at the pump for the tighter specification. we have had a broad preference for more upstream biased companies with less refining exposure. 35% Gasoline 6-Dec-06 31-Dec-09 31-Dec-13 31-Dec-17 E & P. This together with some oil demand growth. Refining profitability has been weak with cuts to oil product pricing and moderation in oil demand growth. While major cities such as Shanghai and Beijing already have implemented the highest fuel specification standards.Xinjiang Kunming. Most major refineries have already invested in upgrading to meet these specifications which add cUS$0.P.rh. home to the majority of China’s inefficient teapot refineries has recently announced a reform and upgrading plan for the refining industry. PT HK$7.3mt per year to 4. middle and lower reaches of the Yangtze River and North China. as the country’s oil demand growth moderates and upgrading existing plants. the largest in Asia and one of the largest in the world. there is a focus for the Chinese government to on improving returns at SOE companies by promoting capital discipline and cost management and efficiency as well as allowing entry by private investors to some segments (e. The initiative closes 20 small plants to remove 12mt capacity by 2017 and increasing plant scale from 2. However. Table 23: China refinery capacity additions 2014-17E Kbd Year 2014 2014 2014 2015 2015 2015 2015 2016 2016 2016 2016 2017 2017 Plant Quanzhou Pengzhou.g.7 mb/d (43% domestic capacity share). Both PetroChina and Sinopec are likely to guide lower capex in 2015 and perhaps beyond and we see some of the capex reduction from downstream (and chemical segments) which may see delays the capacity expansion (Table 23).Figure 51). (Table 24) to address pollution caused by vehicle fuel emissions in major cities and further eliminates inefficient teapot refineries. although the company continues to shift product mix toward gasoline (yield was c46% in 2013.960 Operator Sinochem PetroChina Sinopec Zhuhai Baota CNPC Sinopec Sinopec CNOOC parent CNPC / RD Shell / Qatar Petroleum Sinopec Sinopec PetroChina PetroChina / Saudi Aramco Source: J.com Parsley Rui Hua Ong (852) 2800-8509 parsley.0) Sinopec is China's largest refiner with refining capacity at 5.Asia Pacific Equity Research 18 November 2014 Samuel Lee.5mt by 2017 and 5mt by 2020 and control total provincial capacity to c100mt. Sichuan Yangzi Petrochemical Zhuhai Baota Huabei Petrochemical Jiujiang Petrochemical Hainan refining & Chemical Huizhou. Table 24: National rollout of fuel specifications Stage China I China II China III China IV China V Source: Bloomberg Diesel 1-Jan-02 1-Oct-03 1-Jul-11 31-Dec-14 31-Dec-17 Phase out of teapots Shandong province.com 2015-16 Key Issues/Risks The main challenges facing the refining industry in China remain managing overcapacity. CFA (852) 2800-8536 samuel.P. 9% Source: J. Yunnan Total additions 200 60 240 140 120 200 1. where plants have good access to high growth demand centres. phasing out small and inefficient teapot refineries. which represent c20% of the country’s total 12.sw. unadjusted. SPC shares have outperformed in 2014 reflecting anticipation of the HK-SH connect program (SPC-H currently trades at a c30% discount to SPC-A). are seeing fresh food gross margins at 35% and tobacco products 68%). North East . However.5bn with a transaction value at 1.rh. although will allocate capital in the best interests of shareholders according to management. also is exposed to commodity chemicals has seen a collapse in profitability this year (Figure 52). however.Liaoning.ong@jpmorgan. Morgan estimates. Gansu. Hainan. Heilongjiang. Sinopec guides that non-fuels has delivered 15-20% y/y revenue growth over the last six years and that this could expand to 30% y/y growth in the medium term. Fujian. Chart shows refining operating profit (US$) per bl throughput for PetroChina and Sinopec. we continue to view the shares as overvalued against regional peers. Jiangsu. This reflects lower utilization at its refinery from a moderation in oil product demand and lower refining margins as well as weak chemical margins and a plant scale and limited product grade portfolio/feedstock optimization to partly mitigate the current chemical environment. PT HK$1. Inner Mongolia. Ningxia. Sinopec Group’s Yanbu refinery in Saudi Arabia (400kb/d. likely in cooperation with Reuntex.Samuel Lee. Sichuan. Figure 51: Sinopec’s refining/retail network is well positioned in China Source: Baidu Maps. Figure 52: Single-asset refinery biased to commodity chemicals Synthetic Fibers 3% Trading 11% Others 1% Resins & Plastics 14% Intermediate PetChems 17% Petroleum Products 54% Source: J. Deal is awaiting Ministry of Commerce approval possibly later this year. which will have a Board of Directors made up of three members from these new investors and of which some have already worked closely with Sinopec marketing as well as Sinopec (3 seat) and an independent director.Shandong. Guangxi.sw. but the investment marks the first refining asset entry into the Middle East.5bn. Sinopec is still considering use of cash proceeds with some being used in shale gas.P.5) Sinopec Shanghai Petrochemical (SPC). the company expects margins to improve (Shanghai-based test stores. Note: East .5% interest in its parent.lee@jpmorgan. Xinjiang. with the program’s start date now in question and the company’s fundamentals increasingly challenged.Guizhou. The company also opened up its retail network to private investors with 25 new investors taking a 30% stake in a new entity. Qinghai. Zhejiang.5% stake) for US$0. A potential IPO will be decided by the new board of directors which has yet to meet. CFA (852) 2800-8536 samuel. The refinery is currently in the commissioning phase. Saudi Aramco has a 62. Guangdong (less Guangzhou). The company recently proposed to acquire a 37. its newly created marketing arm. for US$17. Jilin.Hebei. Sinopec Easy Joy Sales. Morgan estimates. Hubei. North West . a premium to book which reflects the fact that Sinopec Group invested in 2011 bearing all construction and related risks.6x P/B. Chart shows net sales by segment for 2013 36 . Management notes that the project meets the company’s internal IRR hurdle rate (guided in the past at 12%) and can help Sinopec enhance supply chain linkage with this asset and with Saudi Aramco. one of the top five largest refineries owned by Sinopec Corp (51% shareholding).P.com Figure 50: Superior refining performance than domestic peers Source: J. a major crude supplier.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. South West . Hunan. Jiangxi. North . Anhui. Tibet Least Preferred: Sinopec Shanghai Petrochemical (UW.Shaanxi. Shanxi.Henan. South Central . while upgraded for high oil product specification largely directed into the Shanghai market. We believe July-September results are likely to be strong. CFA (852) 2800-8536 samuel. Morgan.200 2014 Overview: Profit improving on a reduction in refining capacity Japanese petroleum industry earnings slumped in 2013 but have recovered in 2014 amid improving refining margins. Upgrading cracking facilities is not feasible because of the large investment required. and Showa Shell Sekiyu were down 12%. but it is difficult to see investor sentiment improving given the rapid drop in refining margins caused by crude oil price declines. Cosmo Oil was down 15%.com Parsley Rui Hua Ong (852) 2800-8509 parsley. 140 4.lee@jpmorgan. raising expectations of strong earnings for the first time in a while. J. Trade.900 3.com capacity utilization has slowed. contributing to supply/demand balance normalization. and Idemitsu was down 10%.P. the price of brand gasoline was increased by ¥1-2/l.400 J.rh. while JX Holdings.Ltd CY2014 (81) 3 6736 8617 yuji. TonenGeneral was up 1%. Morgan. Topix was up 2% YTD. JX Holdings closed its Muroran refinery (180 kbd) and Idemistu closed its Tokuyama refinery (120 kbd). J. Japan – Can Japan remain an independent market? Figure 54: Change in refining capacity kbd 4.500 10 Sep-14 Jan-14 May-14 Sep-13 Jan-13 May-13 Sep-12 Jan-12 May-12 Sep-11 Jan-11 May-11 Sep-10 May-10 Jan-10 5 Sep-09 2 23 Kyokuto Taiyo Cosmo Shell Toa Cosmo Tonen Tonen CY2012 15 Jan-09 43 120 Share performance weak despite refining margin correction Although the petroleum industry has embarked on a road to normalization in 2014. This reduced capacity by 10%.ong@jpmorgan. Also. As of October 31. and Industry (METI) has publicly stated that the petroleum industry must reduce capacity and consolidate and refiners are unable to disregard the new laws. the largest refiner.300 4. and as a result refiners are likely to comply by reducing their processing (distillation) capacity. The recovery has been driven by three main factors: 1) supply/demand improvement due to refinery closures.P. At the end of March 2014.100 4. We believe weak results severely damaged investor confidence in the petroleum industry and created doubt as to whether profit levels would increase even if refining margins improved. The Minister of Economy. 2) a change in the way sales prices to wholesales are determined. a sharp divergence between this indicator and actual market conditions in 2013 prompted a change to price setting based on the price of crude oil. 20 May-09 45 Source: Company reports. and 3) the enactment of laws to boost industry competitiveness in January. As a result.. 37 . Pursuant to regulations to enhance the sophistication of energy supply structures. 25 Industry competitiveness laws provide tax breaks and other incentives to promote consolidation in an industry that has too much processing capacity vis-a-vis demand. 2015-16 Key Issues/Risks: A further 10% reduction in capacity We believe investors will focus on industry realignment developments in 2015.600 4.P.000 Figure 53: Gasoline margin Source: Nikkei.sw. 0 67 4. refiners must increase their residue cracking-to-distillation ratios by end-March 2017. the share price performance of refiners has been weak.800 Y/Liter Petroleum product wholesale prices were previously based on prices announced by a market research company. but this was still worse than the overall market performance.com JX Yuji Nishiyama Idemitsu AC We believe this is mainly due to disappointing April-June results announcements. Morgan Securities (Japan) Co.nishiyama@jpmorgan. 38 4.Asia Pacific Equity Research 18 November 2014 Samuel Lee. But scheduled maintenance costs weighed on profits and demand was lackluster because of unfavorable weather. Refining margins bottomed in February and began to rise. However. the flow of surplus products into the market caused by an emphasis on 5 180 3. P. Also. Nuclear power generation was gradually wound down after the March 2011 Great East Japan Earthquake and no reactors have operated since October 2013.P.ong@jpmorgan. we expect domestic supply to be reduced by around 10% moving forward. we believe consolidation measures are likely to be concentrated in two groups: a JX HoldingsIdemitsu alliance and a TonenGeneral-Cosmo Oil-Showa Shell alliance. refiners had consistently reduced Bunker C output since the 1970s. we estimate the following cuts would be needed: JX Holdings (160 kbd). which is another 10% of current processing capacity. As furnace fuel oil demand is no longer a major contributor to refiners’ earnings. and the minimization of related production equipment in refinery configurations meant that imports were needed to meet the demand spike after the March 2011 disaster. The increase in thermal power generation to compensate for the loss of nuclear power led to a significant increase in furnace fuel oil demand.com Figure 55: Capacity reduction required outstrip demand growth and refining margins will slump.rh. Cosmo Oil (52 kbd). Idemitsu JX Taiyo If refiners were to comply with regulations purely by reducing processing capacity. As a result. This equates to an industry-wide reduction of 410 kbd. we forecast nuclear plant restarts will have only a limited earnings impact. We believe the probability of multi-company alliances—that is. J. J. we forecast global supply capacity growth will 38 Nuclear restarts unlikely to have a major impact Finally. Figure 56: Consumption of crude oil and fuel oil for electric generation 100% 80% 60% 40% 20% 0% -20% -40% -60% -80% Oct-14 Fuji Jul-14 Tonen Apr-14 Cosmo Jan-14 Shell Source: Company reports. This is a big point of difference from refining industries in other countries. realignment— is high. . and power companies responded by postponing periodic inspections of coal-fired plants and increasing LNG facility capacity utilization. oil-fired power generation costs are high. CFA (852) 2800-8536 samuel. Morgan estimates. Oil-fired thermal power generation has now almost returned to the pre-disaster level. It would be difficult for JX Holdings to merge with another company because of its high domestic market share and we therefore expect its efforts to center on its existing distribution tie-up with Idemitsu. it has gradually become more difficult for companies to achieve targets on their own.com Parsley Rui Hua Ong (852) 2800-8509 parsley. and we expect it to strengthen cooperation with Showa Shell at the Kawasaki complex. This is because Japanese companies have enough refining capacity to meet domestic demand and importers are required to hold 70-days-worth of inventory. Morgan.sw. Realignment in focus Although the pace of capacity reduction has accelerated since 2010. Jul-13 0 Oct-13 20 Apr-13 40 Jan-13 60 Jul-12 80 However. Oct-12 100 Apr-12 120 Jan-12 140 Jul-11 160 Oct-11 180 Apr-11 kbd Source: FEPC. Can Japan’s market independence be maintained? The Japanese petroleum products market is not integrated with the Asian market and the wider global market. In this report. Showa Shell (37 kbd). As mentioned earlier. However. We do not expect nuclear plant restarts to significantly change Bunker C production volume. but petroleum product demand declined 4% Y/Y in Jan-Aug 2014 and if it continues to contract at this pace we estimate there will again be a processing capacity surplus in three years.Asia Pacific Equity Research 18 November 2014 Samuel Lee. Idemitsu (55 kbd). Japan must bring domestic demand and supply into balance or reduce domestic supply to below demand. Tonen General (81 kbd). where Showa Shell has surplus coker capacity. Tonen General has begun integrating its refining operations at the Chiba complex with those of Cosmo Oil. to remain an independent market. Cosmo Oil’s debt and Showa Shell’s capital relationship with Royal Dutch Shell are potential obstacles to closer ties and we highlight related news flow as a point to watch (please see the Europe section of this report for more on asset sales by Royal Dutch Shell).lee@jpmorgan. but Japanese refiners could still post relatively strong earnings as the Japanese market is largely independent. we would like to discuss the issue of nuclear plant restarts. 14 0.00 0.1 Source: Bloomberg. which include upstream oil operations and copper mine development. Morgan estimates.6 5.195 8.4 6. In addition.809 9.46 0.32 0.0
[email protected] 6. even if petroleum product supply capacity continues to decline. but if the price of crude increases sharply it is unclear whether Idemitsu could pass on the cost to sales prices.7 6. but securing a casting vote is not out of the question if it moves quickly.6 4. PT ¥2.sw.0% -5.51 P/B(x) FY15E 1.30 0.Samuel Lee.com Preferred: JX Holdings (N.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley.7 15.6 4.07 0.28 0.15 0.100) Idemitsu’s position in the domestic market is stable.4 2. In the short term. Solar cell business environment deterioration (Showa Shell) and oil business profitability deterioration (TonenGeneral) are potential risks to dividend sustainability. Cosmo Oil -18% -20.9 7. we believe it is best positioned to benefit from the margin improvement that is likely to accompany consolidation measures by other refiners. and if large increases in crude prices are passed on directly to sales prices it could cause political unrest.149 11.8 5. however.3 9. Other stocks Showa Shell and TonenGeneral are both dividend yield plays.642 10. Operations at Cosmo Oil’s mainstay Chiba refinery have finally returned to normal after the disruption caused by the Great East Japan Earthquake and performance is improving.ong@jpmorgan. PT¥480) JX Holdings already has a dominant market share and can be distanced from concerns about market realignment uncertainty.5 4. Also. Petroleum products are much more of a necessity good in emerging markets than they are in developed economies.rh.9 7.2 216 6.0% -15.064 Nov-14 450 Nov-14 Market Cap P/E(x) ($mn) FY14E FY15E FY16E 3.9 4.48 FY16E 1. CFA (852) 2800-8536 samuel. Vietnam.0% -10. Table 25: Japan refining valuations Company name Showa Shell Sekiyu Cosmo Oil TonenGeneral Sekiyu Fuji Oil Idemitsu Kosan JX Holdings Bloomberg Ticker 5002 JT 5007 JT 5012 JT 5017 JT 5019 JT 5020 JT Currency JPY JPY JPY JPY JPY JPY Price Price date 972 Nov-14 164 Nov-14 990 Nov-14 321 Nov-14 2.14 0. J. JX Holdings is currently struggling to expand copper mine and petrochemical operations and the share price is low.0% FY14E 1.5 9.55 1. which we have identified in this report as a possibility. we believe the likelihood of dividend cuts is small and we expect share prices to remain stable. Figure 57: Stock performance Tonen General 4% Showa Shell Idemitsu Kosan -9% -14% JX Holdings -17% Least Preferred: Idemitsu Kosan (N.0% 0.45 ROE(%) FY14E 10.2 Source: Bloomberg Idemitsu plans to refine Kuwait crude oil in Vietnam and sell petroleum products in the local market. As the smallest of the big five refiners Cosmo Oil is unlikely to be a driver of industry realignment.8 1.4 5.0% 5.49 1.P.42 0.44 0.9 9.52 1. JX Holdings can expand through its non-refining businesses. 39 .839 10.3 7. but we believe this is just a teething stage.3 27. and has the highest exposure to a slump in refining margins in Asia. but it is moving forward with a US$9 billion petroleum refinery/petrochemical plant project in Nghi Son.15 0. private sector Indian refiners will face rising competition.000 15% 4.000 3. India – Overcapacity remains. with the oil marketing firms satisfying a higher proportion of retail sales through their own refinery operations. necessitating the development of new product markets.com our global refining model suggesting a growing supply overhang.Asia Pacific Equity Research 18 November 2014 Samuel Lee. and new refineries being set up – as the state owned oil marketing firms look to bridge the gap between refining throughput and retail sales.com J. and with new refineries potentially competing for share outside their home markets. consumption of which declined into early 2014.lee@jpmorgan. and has averaged ~1.P. However.000 5% 1. Refinery throughput MMT Source: PPAC 240 Figure 59: India diesel consumption growth (3 month rolling average) Oil product consumption Refining throughput 220 20% 200 15% 180 160 10% 140 5% 120 0% 100 FY01 FY03 FY05 FY07 FY09 FY11 FY13 -5% -10% Apr-02 Jan-04 Oct-05 Jul-07 Apr-09 Jan-11 Oct-12 Source: PPAC 2015-16 Key Issues/Risks: India remains an oversupplied market. Note: Refinery throughput includes RIL SEZ refinery – which is an export oriented unit Key Stock Picks: Within the Indian refining space. As such.000 0 Jun-09 Mar-10 Dec-10 Sep-11 0% Jun-12 Mar-13 Dec-13 Sep-14 Source: PPAC -5% Apr-02 Jan-04 Oct-05 Jul-07 Apr-09 Jan-11 Oct-12 Jul-14 Figure 61: Oil product consumption vs. with the potential start up of IOCL’s Paradip refinery (albeit delayed). this masks continuing challenges facing the refining sector.x. prefer marketing Neil GupteA C (91 22) 6157 3592 neil. less complex refineries. we currently. With older.rh.com Parsley Rui Hua Ong (852) 2800-8509 parsley. Morgan India Private Limited 2014 Overview: While the downstream Indian names have performed well through 2014 (ex RIL) due to reforms/oil price weakness leading to lower subsidies. Figure 60: Net product exports (3 month rolling average) ‘000 MT 6. Diesel. . has begun to rebound as well. the state owned refiners continue to face a low margin environment.5% since April. Oil product consumption growth is beginning to recover. with continuing weakness in downstream businesses. and the expansion at BPCL's Kochi refinery. after weakness through 2013/early 2014 and has averaged c.sw. we see HPCL/BPCL better placed due to benefits of fuel price reform/lower oil
[email protected]@jpmorgan. We see the overcapacity in the Indian system remaining. CFA (852) 2800-8536 samuel. exports are likely to continue to trend higher.5% since April.000 Figure 58: India oil consumption growth (3 month rolling average) 5. With 40 Jul-14 Source: PPAC.000 10% 2. we think RIL as well placed as far as refining margins are concerned. with capacities being enhanced at existing refineries. 7 1. 2014.0 PE (x) FY15e FY16e 50.5 2.Asia Pacific Equity Research 18 November 2014 Samuel Lee.1 841 776 712 648 584 Source: J.9 765 701 637 573 508 2.44 11.0% 16.0 895. with a consequent reduction in interest costs as well.68 1.767 13.3 1.sw. Figure 63: YTD share price performance Figure 62: Reduction in HPCL leverage 150% HPCL 130% BPCL 110% IOCL 90% RIL 70% 0% 50% FY14 FY15E FY16E FY17E 20% 40% 60% 80% 100% ROE (%) FY15e 14. We expect the private players to take an 8-10% share as a consequence.32 FY14 1.2% 1. 41
[email protected]% 22.0 405.028 14.7 1. Morgan estimates.6% 1. Table 27: India refining valuations Company RIL BPCL HPCL IOCL Rating N OW OW N Price (LC) N OW OW N PT (LC) 969.lee@jpmorgan. Balance sheet leverage is likely to decline quicker than earlier anticipated.88 17.8 Mkt Cap USD mil 1.1 14.0 690.2 356.2% 1.9 555.9 PB (x) FY15e FY16e 13.com Parsley Rui Hua Ong (852) 2800-8509 parsley. CFA (852) 2800-8536 samuel.044 13.P.1% 9.com With our expectation of a more benign crude price environment.rh.8 8.3% 9. Table 26: Sensitivity to subsidy share and diesel marketing margins INR/sh Downstream subsidy share (Rs bn) Preferred: HPCL (OW. and a gradual expansion in diesel marketing margins.P. Morgan estimates.605 19.33 1.68 2.5% 12.2 734.1% FY16e 14.6% 120% 140% Source: Bloomberg.99 10. J.4% 7.6% Source: Bloomberg.6 3.22 Yield (%) FY15e FY16e 13.P. Priced as of November 14.9% 2. we highlight that the state owned oil marketing firms are likely to see a quicker roll off of subsidy losses.1 1. PT Rs690) Diesel marketing margin (Rs/lt) 1.1% 11.5% 16.080.5 1.7 539 614 690 475 550 626 411 486 561 347 422 497 282 358 433 0 10 20 30 40 1. Source: Company reports and J. Morgan estimates.5% 12. 42 Overall the importance of domestic refining is decreasing with import infrastructure becoming more important as judicious sourcing becomes vital. defend position.com Parsley Rui Hua Ong (852) 2800-8509 parsley. the remaining refinery. with the primary asset the more than 600 Shell Coles Express petrol stations and the Geelong refinery. win new contracts. the rate of premium diesel growth is in its infancy and hence is likely to be a multi-year driver due to vehicle mix and canopy reconfiguration. 2013. Initial outcomes include A$80-100m cost savings. This reduces the proportion of transport fuels sourced from domestic refineries to less than 50%
[email protected]. (3) Kurnell closure of refinery and conversion to an import terminal.9bn. up 55% in 1H14. further refinery closures cannot be ruled out.Asia Pacific Equity Research 18 November 2014 Samuel Lee. labour and maintenance costs. Vitol.cousins@jpmorgan. with dividend payout ratio and return of surplus capital including franking credits possible outcomes. Increasing focus on leveraging the CTX infrastructure network (i.910 6. (2) Premium diesel growth. host competitors. 1) Company wide cost and efficiency review which should support future ROCE expansion.44) CTX is the only publicly listed refinery operator in Australia.300 Source: BREE. Refinery capacity has been reduced and some global oil players have exited from elements of the value chain. ex jet.com (612) 9003 8628 quinn.g. having better product mix and yield and lower operating costs. Global oil players have exited some elements of the industry with specialist retail operators (e. the economics of Australian refineries is somewhat challenged with competing product from attractive sources (i.e. (4) Broader repositioning benefits remain at CTX. with Lytton.sw. Morgan Securities Australia Limited 2014 Overview The transport fuels market in Australia has undergone significant change in recent years with more possible.50/bbl. resulting in a significant number of closures announced and occurred in recent years resulting in imported refined product increasing as a percentage of transport fuels. and the opportunity to participate in the early stage of a business improvement programme.g. A key example is Vitol’s acquisition of the downstream. 7-Eleven) and trading houses (e. working capital reductions of 1mmbl and lower capex guidance.Australian Refinery Details & Capacity Location Kurnell* Bulwer Island** Lytton Altona Geelong Kwinana State NSW QLD QLD VIC VIC WA Operator Caltex BP Caltex Mobil Vitol BP Year commissioned 1956 1965 1965 1949 1954 1955 Capacity (ML/pa) 7. large scale Asian refineries) now more available. value-add acquisitions). As a result.com Australia – domestic refining shifting to product imports Shaun CousinsA C Quinn Pierson (612) 9003 8623 shaun. While the rate of premium petrol growth has moderated. Energy in Australia. with initial progress the early repayment of high cost debt. Table 28: CTX . . Preferred: Caltex (OW. with trading houses and convenience retailers playing a greater role.820 5. and suffer from a lack of scale. In October 2014 Kurnell refinery units were shut.e. There are plans to have only 4 refineries in the middle of this decade following the announced closures and /or conversion to import terminals at Bulwer Island (BP). Trafigura) playing a greater role in the industry.lee@jpmorgan. We suggest there is further upside with 4 key medium term drivers. *Refining shut down October 2014. operations of Shell in Australia in February 2014 for A$2. with plans to increase efficiency to enable break even at US$5. 2015-16 Key Issues/Risks Australian participants will continue to look to secure import infrastructure as importing product is increasingly attractive compared to domestic refining.300 4. **Refining to halt mid 2015.470 8.640 7. driving transport fuels margin and overall marketing EBIT.r. Kurnell (CTX) and Port Stanvac (Mobil). with broad retail network and brand valuable but not fully leveraged.com J.rh. PT A$28. Refineries in Australia have endured rising energy. Capital management review announced. CFA (852) 2800-8536 samuel.P.50/bbl. with a CRM breakeven of US$6. Kurnell production is to be replaced with imported product driving sourcing benefits.pierson@jpmorgan. CTX is undergoing a repositioning and one we believe will increasingly be considered by a broader range of investors including consumer focused investors due to its increasingly stable earnings profile as refining becomes less influential (given recent closure of Kurnell). Clyde (Vitol). As a result. 6172 5.6 mbd of incremental European refining capacity must be removed.0 J. thus driving down utilization rates and margins (Figure 66). USA and Middle East build more competitive refined product export capacity. Our Global Refining Model shows that in order to raise European refining utilization to a more reasonable 72%
[email protected]@jpmorgan. Morgan estimates. Combined with soft demand trends this has.com Figure 65: European refinery utilization vs.com Europe – refiners’ graveyard remain suppressed. suppressed European refinery utilization (Figure 64). European margins show a relatively high historic positive correlation to average utilization.0 1.0 4. So we think it is reasonable that as utilization rates 43 . Figure 66: European refinery utilization outlook 95% 85% 75% 65% 55% 86% 25000 82% 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 45% 84% BASE BEAR BULL 80% Source: J. Figure 64: European refining capacity & utilization 25500 R² = 0.P.P. over 1. so too will European margins (Figure 65). We note that Murphy Oil’s failure to complete the planned sale of its Milford Haven refinery to Klesch Refining Limited may reflect the buyer's concerns on the margin outlook. These flows will continue to displace European refinery runs.com (44-20) 7134 5947 nitin. gross margins 19922014 8. more disadvantaged refineries in Europe e. 7) High costs of plant closure. There have not been any closures in 2014 and none are scheduled post-2015. Morgan estimates.0 70% 72% 74% 76% 78% 80% 82% 84% 86% Source: J.g.0 2014 Overview Aside from their old age and inefficient scale (average capapcity around 135 kbopd compared to new world scale capacity of 300-400 kbopd). France and Italy must be converted to terminals or closed. European refineries suffer numerous operational disadvantages which include: 6.0 2.P.rh. As we have shown. We are only aware of two small refinery closures / conversions in 2015 (Table 29).Asia Pacific Equity Research 18 November 2014 Samuel Lee.0 0.g. 78% In our view.sw.sharma@jpmorgan. this is 24500 76% 24000 74% 23500 72% 2000 2005 2010 Capacity Utilization Source: BP 2014 Statistical Review of World Energy. Fred LucasA C Nitin SharmaA C (44-20) 7155 6131 fred. in turn.ong@jpmorgan. Morgan Securities plc 7.0 3.0 1) High dependency on relatively expensive Atlantic Basin crude oil feedstock 2) Relatively high energy (gas and electricity) costs 3) Relatively high and inflexible labor costs 4) Tough emission standards and refined product specifications which mandate relatively high sustained levels of asset integrity expenditure 5) Relatively mature markets with declining consumption patterns 6) Reduced export opportunities as US refineries reduce US import needs and as ME refineries export more products to Asia. CFA (852) 2800-8536 samuel. 2015-16 Key Issues/Risks Our Global Refining Model suggests that European refiners will remain under extreme margin pressure as other regions e.com Parsley Rui Hua Ong (852) 2800-8509 parsley. In our view. often made more difficult by politics which has inhibited the necessary capacity closure This leaves the European refining system under enduring attack from refined product exports from the Middle East and as far afield as refineries in India. 0 2013 CFFO ($bn) Target ROACE 10-12% 3. The through cycle performance of its IRMVC sub-segment is even more . UK Total closures Capacity -117 -137 -80 -80 -260 -85 -70 -70 -80 -105 -90 -220 -320 -86 -162 -110 -105 -135 -2. merchant refining capital employed was approximately $15bn. returns (target ROACE 10-12% versus 6. Figure 67 highlights the downstream ROACE improvement potential if RD Shell can reduce its exposure to loss-making Merchant Refining (plants with little or no integration e. The first action was to atomize performance in order to enable more accurate capital deployment / rationing. and more value-oriented decision-making. Of $33bn refining capital employed. Pakistan 40% Integrated Refining & Marketing Value Chain 2. CFA (852) 2800-8536 samuel.0)bn with a through cycle ROACE ranging from -5% to +10%. (-) GALP – like Statoil. Preferred: RD Shell (OW. France Odessa. We consider two names: (+) RD Shell – this name retains a relatively heavy exposure to refining (Oil Products 14% 2013 earnings). investors can assume a small refining exposure via Statoil which owns 100% of two refineries (Mongstad. lubricants etc. Excluding any contribution from fuels marketing. Blob size equates to capital employed. France Raffineria di Roma. Key Stock Picks: Within our European coverage universe. Norway – 240 kbd and Kalundborg.0 Chemicals -20% Challenged legacy positions eg Argentina.312 Operator Pluspetrol TOTAL TOTAL Lukoil ConocoPhillips Petroplus ENI OMV Tamoil Lyondell Basell ERG Petroplus TNK-BP ERG-TOTAL Petroplus RD Shell ENI Murphy Oil Source: J. but generated a loss between $(0.0 Advantaged positions eg Canada Fuels Marketing Lubricants 1. France Porto Marghera.0 Source: RD Shell presentation NYC – 5 September 2014. Morgan estimates.P. capital employed.0 -2.downstream portfolio segmentation & performance 4. Country Teesside.sw.500p) One of the reasons for our OW recommendation on RD Shell is the restructuring potential of its North American Upstream and its global Downstream portfolios.5)bn and $(1. no integration eg Deer Park 2013 ROACE 7% 10 20 30 2013 ROACE (%) -1. Figure 67: RD Shell . Denmark – 118 kbd). Ukraine Fiumicino. France Normandy. Austria Cremona. . this name also owns 100% of two refineries both in Portugal (Sines – 220 kbd and Porto – 110 kbd). In our view.ong@jpmorgan. Italy Coryton. RD Shell aims to 44 improve Downstream financial performance. Ukraine Wilhelmshaven. France Harburg. UK Lisichansk. but also some more challenged legacy integrated refinery positions such as those in Argentina and Pakistan). Sicily Milford Haven. Company data. At YE 2013. It also suffers a higher near term earnings dependency on downstream which is likely to remain in loss in 2015. RD Shell’s downstream business has been reorganized in to 72 of 150 group-wide business performance units. but it is undergoing a major restructuring to raise cash flow and returns from this business so it has self-help protection. Germany Reichstett.9% in 2013) and free cash flow (target CFFO > $10bn versus $7.0 -5% 10% Merchant refining Biofuels 0. investors in the large cap integrated space can side-step refining altogether via BG Group which instead provides an above average and differentiated exposure to global LNG. Table 29: European refinery capacity reduction 2009-15E kbd Year 2009 2010 2011 2012 2013 2015 Plant. offshore Mozambique. Venice Arpechim.Samuel Lee. refining capital employed was around $33bn or just under 15% of RD Shell group capital employed. each with its own P&L. offshore Brazil and the Rovuma Basin. Alternatively.lee@jpmorgan. per 2014.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. PT 2. Germany Gela.5bn excluding WC 2013 or 20% of group CFFO).g. Deer Park in the USA) and also raise the performance of its Integrated Refining & Marketing Value Chain (IRMVC which includes integrated refineries e. UK Dunkirk. GALP has rising balance sheet risk given its upstream expenditure commitments (over which it has little control as minority partner) in the pre-salt Santos Basin. having spun-off and then divested its fuels retailing business.0 -10 0 Little. Italy Berre L'Etang.g. the Scotford refinery in Canada. cash flow and performance targets.com extremely unlikely to happen in the foreseeable future given political sensitivities to the unemployment and trade balance consequences. we estimate that refining lost money in 2013 so this remains a real drag on Downstream and group ROACE. A restructuring of RD Shell’s refining business is front and centre to this aspect of the group’s overall positive change story. Under the strong leadership of John Abbott. but unlike Statoil it lacks a large cash generative upstream business.rh. Italy Petit Couronne. Morgan estimates.000 1. In contrast.P.number of refineries & net refinery size 60 120 50 110 40 100 30 90 20 80 10 70 0 60 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014E Number of refineries 2. By exiting small minority positions e.sw. ranging from -20% to +40%.5 0. We await the sale of its Fredericia refinery in Denmark to reduce its total refinery count to 27.000 Table 30: RD Shell refinery divestments since 2007 2. we note that in 2000 BP’s European refining capacity was just 23% of its global refining capacity. Table 31: RD Shell . RD Shell has sold 11 refineries with a total net capacity over 1 million bopd (Table 30). CFA (852) 2800-8536 samuel. Average net refinery size (kbopd) Source: J. Morgan estimates.000 3. underlining the varied quality of RD Shell’s legacy positioning. advantaged (by location.Asia Pacific Equity Research 18 November 2014 Samuel Lee. We note that Oil Products capex in 2014 may be around $3. on the Q3 2014 results conference call. Company data.000 1. the Kralupy and Litvinov refineries in the Czech Republic in 2014. Assuming an exit from Denmark.P.European refining exposure Country Germany Netherlands Plant Miro Schwedt Rheinland Pernis Interest 32% 38% 100% 100% Capacity (kbopd) Gross Net 310 99 220 84 325 325 404 404 Source: J. 462 kobpd) which is an over-supplied fuels market.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014E Post-tax free cash flow ($m) Capex / depreciation (x) Source: J.P. Morgan estimates. its European capacity percentage peaked at 46% of its global system.000) 0. less than half its peak refinery count of 55 in 2002. Morgan estimates. RD Shell has already reduced unplanned plant downtime to less than 2% in H1 2014 (Figure 70). RD Shell continues to shrink its refining footprint via divestments. RD Shell has raised its US refining exposure from 19% to 36% of its total. By concentrating its ownership in fewer.3bn (based on 9M runrate). Company data.P.ong@jpmorgan. * Post tax cash flow calculated as net income plus DD&A less capex so excludes changes to working capital. Since 2007.5 4. RD Shell is also showing good availability of its global refinery portfolio Looking beyond Europe.009 Source: J.rh. We note that in 2005. at 93% 9M 2014.lee@jpmorgan. Company data. The combination of refinery sales and a recent plant closure (Harburg – Germany) in Europe has also reduced its net capacity exposure to this most challenged region. Company data.5 (4.com variable.0 2.0 (2.Oil Products cash flow and capex / depn 8. at YE 2013 BP’s European refinery capacity was 46% of its total capacity. Simon Henry (CFO) indicated that the group is reviewing its global distillation capacity and may close one of three CDUs at its Bukom refinery in Singapore (100%. larger and more efficient. RD Shell has almost doubled its unit net refining capacity since 2000 (Figure 68).0 6. down 21% Y-o-Y and an implied capex to depreciation ratio below 1x (Figure 69). As a result of refinery divestments ex-Europe.000) 0. 45 . thus concentrating its position in what is now the most advantaged region for refining. Figure 68: RD Shell . scale and integration) refineries RD Shell has reduced its working capital and maintenance capital needs. The average gross capacity of its 28 refineries is now a more competitive 193 kbd (198 kbd if Fredericia is sold).000 kbd Year 2007 2008 2010 2011 2013 2014 Country France USA Dominican Rep Germany Sweden UK Norway Czech Republic Australia Plant Berre L'Etang Petit Couronne Wilmington Haina Heide Gothenberg Stanlow Mongstad Kralupy & Litvinov Geelong TOTAL Net capacity 80 154 100 17 83 87 296 43 29 120 1. RD Shell's net European refining capacity will fall to 783 kbopd or 26% of its global capacity comprising interests in four refineries (Table 31). Over the same period. Figure 69: RD Shell . These are all important drivers of RD Shell's growth in group operating and free cash flow.5 3.g.com Parsley Rui Hua Ong (852) 2800-8509 parsley. Australia. Texas: Port Arthur – 600 kbd) with a total capacity of almost 1. In the USA. RD Shell’s total downstream business (Oil Products and Chemicals) held capital employed of $56. Asia.500 85% 4 2.5) H2 '12 H1 '13 Pre-tax earnings H2 '13 H1 '14 Free Cash Flow Source: RD Shell presentation NYC .5 September 2014 All these measures should helpfully reduce the volatility of its Oil Products earnings stream which per Figure 72 (including Merchant refining and Integrated refining + marketing value chain) demonstrates by far the highest through cycle ROACE variability. more recently. improved plant reliability.com Figure 70: Bukom refinery. where RD Shell owns 6 refineries. divestments (on-going). Motiva owns 100% of three Gulf Coast refineries (Louisiana: Convent – 227 kbd. We note that Q3 2014 Oil Product earnings benefitted $140m Q3-o-Q3 from a higher 50% share of Motiva earnings.sw.0 0. Singapore .000 5 2.500 1 0. impairments ($2.000 7 3. Morgan estimates.284bn to global refining – primarily Bukom in Singapore charge taken with Q2 2014 results) and. .lee@jpmorgan. RD Shell’s Downstream restructuring which includes refinery divestments / impairments. Oceania USA Other Americas Worldwide refinery utilisation Source: RD Shell presentation NYC . This has already shrunk from a peak of $69bn in mid-2011 through capex moderation (from a recent peak of $4. Figure 71: Motiva earnings and FCF (100%. Company data. The improved financial performance followed a change to Motiva’s management in 2014.500 8 95% 4. we also note a material improvement in the financial contribution from Motiva.9bn in 2011).unplanned downtime (%) Figure 72: RD Shell's regional refining exposure 4. CFA (852) 2800-8536 samuel.5 0. $bn) 1. At end Q3 2014. a key driver of the stock’s FCF generation and relative valuation.7bn or 25% of group capital employed. This is a key driver of the group’s overall ROACE improvement objective which is.P.300 retail sites. lower cost feedstock selection with enhanced product yields and the successful ramp up of the Port Arthur refinery (now the largest refinery in North America) following some initial commissioning issues.500 3 80% 1.0 (0.Asia Pacific Equity Research 18 November 2014 Samuel Lee.com Parsley Rui Hua Ong (852) 2800-8509 parsley. We expect divestments to further reduce this capital pool and cost efficiency measures with improved plant operating efficiency to amplify the benefit to segment ROACE.rh. 46 Notwithstanding our cautious outlook for refining margins (especially in Europe).500 90% 6 3. Norco – 229 kbopd.000 2 0.5 September 2014 Source: J. so Motiva continues to drive Downstream performance improvement. This will help the group to cover its dividend in a lower oil price environment as we now forecast Brent 2015-16 $82-$88/bbl.000 1.ong@jpmorgan. in turn. downstream product price weakness which has reduced working capital. RD Shell’s 50:50 downstream JV with Saudi Aramco (Figure 71).000 75% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014E 0 2009 2010 2011 2012 2013 H1 2014 Europe Africa. improved cost efficiency and capital discipline should enable some overall ROACE and free cash flow improvement.1 million bopd as well as 35 terminals and 8. P. Morgan.Asia Pacific Equity Research 18 November 2014 Samuel Lee. Weak cash generation despite capital intensity decline Galp's downstream cash generation (excluding changes to working capital) has turned positive over the last 2 years but the segmental cash contribution remains low. returns from investing in complexity are often much lower than expected.6 0.started operations in 1966 (110 kbd) and has a NCI of 10. Figure 73: Galp’s number of refineries and average size $/bbl 2. This ratio has averaged 1.8 0 90 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Number of refineries Source: J. FCF contribution from downstream in 2012/13 is significantly below the 2002-2007 average despite the lighter product slate from the higher complexity. 47 . Galp still retains an above sector average exposure to European downstream – which accounts for 15% of our Galp SOTP of €16.7.8 1% 0.2 0.5 130 1 Limited options Galp has no plans to shrink its refining base. PT €
[email protected]) Galp has evolved from a pure play Portugal-focused refining company (pre-IPO in 2006) into a more integrated play driven by its exploration successes in Brazil (and more recently in Mozambique). We expect the capital intensity of the business to remain low. Morgan.8/share.5x 2000. we note that the utilization of Galp’s refining capacity has averaged only 71% 2008-13 vs. Per Figure 74.com Parsley Rui Hua Ong (852) 2800-8509 parsley. Morgan.13 – this average has dropped to 0.4 Average net refinery size (kbopd) 325 80% 315 75% 305 70% 295 65% 285 275 60% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Europe USA Rest of World 1.rh.5 100 Figure 75: Galp post-tax income/bbl 2. The negative cash flow (in 2008-10) was due to the acquisition of Exxon and Agip's downstream business in 2008 and higher capex spend on refinery upgrades in 2009-2011.com Least Preferred: Galp (UW. We believe that the loss of the US as a product export market and decline in product demand in Portugal means that the Galp would anyway struggle to find a buyer for these assets (no such intention expressed by the company).ong@jpmorgan. We believe that the earnings upside from the increased complexity have been more than offset by the weaker margin environment. This partly shows the impact of declining product demand in Iberia. 2010-13 average ROFA 1% 2% 1.0 2% 0.7 per bbl over the period 2010-13. As is often the case. It invested €1. in our view. 120 110 0. We believe that the outlook for this business remains challenging (downstream reported operating losses in 2 of the 3 quarters in 2014) – an ongoing negative for Galp's equity story. The company owns two refining assets: 1) Sines – started operating in 1978 (220 kbd) and has a NCI of 7. the other name with a big downstream exposure to Iberia.7.4bn upgrading its refineries/ conversion projects (2008-12). Galp’s average post tax 2010-13 ROFA (return on total fixed assets) is only 1% -this is a low return.4 1% 0.sw. well below the comparable average for Repsol. CFA (852) 2800-8536 samuel. Figure 74: Galp refining capacity and utilization kbd 90% 345 85% 335 Refining capacity (kbopd) 3% 1. Worldwide refinery utilisation Source: J. Downstream profitability has been under pressure Galp delivered average earnings per barrel processed of € 0.P.5 170 160 2 150 140 1.2 Refining exposure concentrated in Portugal Galp’s refining business is concentrated in Portugal total refining capacity increased to 330 kbd from 310 kbd in 2010.6 1.0 3% 1. an average of 82% 2000-2007. Galp’s capital expenditure to depreciation ratio spiked in 2008 driven by these asset acquisitions.0 0% 2010 2011 Post tax income per refinery barrel throughput(€/bbl) 2012 2013 Post tax return on Total assets (%) Source: J. 2) Porto .6x 2012-13. 0 2000-13 average 1.0 (200) 4. Galp's strategy of heavy investment in European refining (conversion projects) was in contrast to the ‘step back' from refining theme noted with the other Euro names. Notwithstanding what appears to have been relatively low levels of reinvestment in last couple of years.0 (1000) 0. Morgan.Asia Pacific Equity Research 18 November 2014 Samuel Lee.P.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Post-tax free cash flow (€m) Capex / depreciation (x) Source: J. This has denied any earnings upside from higher complexity.0 (400) 3.reflecting a challenging operating environment in Portugal). Mozambique and the weaker oil price outlook. CFA (852) 2800-8536 samuel.ong@jpmorgan. The performance of Galp's downstream business has been persistently weak in recent years . RHA) .0 6. This deterioration in downstream cash return will certainly increase the stress on Galp’s B/S especially given its relatively high capex commitments to non-operated upstream growth projects in Brazil. the price achieved disappointed the market. We remind that Galp was an enforced seller of part of its presalt portfolio in 2011/12 and.sw. Figure 77: Share price performance 2700 14 2600 13 2500 2400 12 2300 2200 11 2100 10 2000 1900 9 1800 1700 8 RDSB (pence. LHA) Source: Bloomberg.0 0 5. 48 GALP (€.com Parsley Rui Hua Ong (852) 2800-8509 parsley.com Figure 76: Galp downstream cash flow and capital intensity $m 400 8.lee@jpmorgan. Galp’s downstream cash flow (excluding changes to working capital) contribution to the group has reduced from a peak of €337m in 2006 to just €127m in 2012 and €152m in 2013.0 (800) 1.5x (600) 2.rh.0 200 7. judged by the share price reaction to the news of its dilution. The planning tax changes were called the ‘tax maneuver’. the integrated oil companies (the holders of the bulk of the legacy Soviet Union refineries) were encouraged to maximize the existing distillation capacity utilization.0 45% 9.0 3.Samuel Lee. Overall.rh.5 5.0 35% 8.0 55% 10. the government started actively discussing a major ED/MET upstream taxes rebalancing (halving crude oil ED and doubling MET).0 50% 2009 2010 2011 Light product output proxy 2012 2013 2014 Light yield (rhs) Source: InfoTEK. 42% in ‘04).P.9m tons). Rosneft was gradually ramping up the upgraded capacity of Tuapse refinery within the existing infrastructure limitation. This supported the investments into hydrotreaters and hydrogen units. the tax regime changes also included a major review of oil product ED rates.0 5.5 50% 10. Gasoline/naphta rates were set at 90% to effectively ban export. Morgan estimates.5 40% 9.P.5 4. Figure 79: Russian crude oil output and refining coverage mbd 11. Since 2004 light oil product export duties (ED) were at about 70% and heavy oil product EDs at about 38-40% of crude oil EDs (65% above $25/bbl). With growing crude oil prices. providing material discounts to high quality products (Euro4/Euro5)
[email protected] 30% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Crude oil production Refining cover (rhs) Source: InfoTEK. Since the beginning of this year. Morgan estimates. This system was clearly beneficial for simple refining distillation units.0 4. In a parallel process. Given ED level importance for the downstream. There were a number of serious accidents at Rosneft’s refineries throughout this year led by serious blast at the Achinsk refinery.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. 2014 Overview Operationally. the key events in 2014 were launching of two big hydrocrackers by Tatneft (2. companies reports.gromadin@jpmorgan. Figure 80: Integrated oils light product output and yield mbd 2. while Novatek was increasing the capacity utilization of Ust Luga gas condensate processing facility (launched in 2013). CFA (852) 2800-8536 samuel.9 m tons) and by SurgutNG (4. the government introduced 100% ED on heavy oil products from 2015. In the same decree. In practice.sw. 49 . the government decided to support upstream at the expense of downstream and introduced a ‘60/66’ tax rebalancing: crude oil ED cut to 60% and equalizing product EDs at 66% from 4Q11. while there were numerous small independent refinery projects with the key goal to play on export duty differential. The key focus of this year’s developments was clearly on the regulation front. the government was quickly raising gasoline/diesel excises.com Russia – Slow upgrading in changing tax environment Andrey GromadinA C (7-495) 967-1037 andrey. J. J.com J.
[email protected] 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: InfoTEK.P.6 55% 2.9 60% 2.3 2. Morgan estimates. Morgan Bank International LLC Background Russian oil sector taxation historically favored the refining sector. As a result.P. This was the key encouragement for the oils to build cracking units. the refining throughput increased by 40% for last 10 years and refining coverage reached 52% in ‘14 (vs. Figure 78: Russian refining throughput mbd 6. 2014 was in line with the general trend of last few years: the integrated oils continued their refineries upgrading program with the key focus on light product quality improvement (a shorter payback) and worked on selective cracking units building.5 8. The gradual .60% crude oil.9 New regime 2015 2016 2018 9. Old 60/66 Current 290 139 226 246 220 253 101 154 179 207 215 65 65 118 215 -217 -194 -194 -140 76 -186 -200 -297 -243 -50 -155 -158 -269 -215 -155 151 70 81 152 45 106 151 0 151 -24 -294 270 14 -137 151 3 0 3 101 87 94 96 75 106 -141 -65 -55 26 7 45 Source: J. 100% heavy products. the rebalancing is inevitable. significantly raising capital cost requirements. Export duties ($/ton) Crude oil Light products Gasoline Naphta Heavy products ED differentials ($/ton) Crude oil/Light product Crude oil/Heavy product Heavy/Light ED differential basket ($/ton) Simple Complex The implications for the refining business Simple distillation profitability will still suffer (-$55/ton. 66% products.rh. +$15. in our view.9 12.P. 2) Gasoline and distillates EDs are set gradually to decrease to 30% and naphta ED to 55% in 2017. 60/66/90 EDs. 50 2015-16 Key Issues/Risks The numerous changes in the taxation throughout last three years raised the risks for the refining segment. limiting financing ability for sector. crude oil price Source: J. The key driving factors are limited financing. while fuel oil ED is to reach 100%. This happens mainly due to the gasoline ED rate cut to 30% of crude oil rate from 90% (+$111/ton. The government’s main idea of switching from export to production tax revenue collection remains intact.0/bbl).0 7 60 Table 33: New tax regime (after major tax rebalancing) 70 80 90 100 Source: J. 3) potential gas condensate processing facilities.Asia Pacific Equity Research 18 November 2014 Samuel Lee. 55/66/90/100 EDs. ‘Current’ assumption suggest 100% heavy product ED. Given the Custom Union expansion plans. If a new distillation facility is built it means that it will need to be upgraded.5 mn tons run rate).com Parsley Rui Hua Ong (852) 2800-8509 parsley. On the other hand. Complex refining profitability should improve moderately (+$26/ton. while the document proposes RUB3. producing predominantly light products even in simple configuration. heavy product tax increase delay and the regulation uncertainties.55% crude oil. In this situation. The growth in independents distillation capacity stopped given higher taxation of heavy oil products. as heavy product ED differential shrinks by $137/ton ($19/bbl) in 2018.P. The key exemptions from this trend are 1) potential Tatneft’s Taneco capacity raising to 14 mn tons (the existing refinery is overly complex even with 8. New regime vs. diesel and heating oil excises are to be cut. There is no certainty that the planning major tax rebalancing is a final one and the government would not amend the legislation in coming years. CFA (852) 2800-8536 samuel. The draft legislation includes the following: 1) crude oil export duty (ED) marginal rate is to be cut gradually to 30% in 2018 (from 59% in 2014).sw. in our view. 3) Gasoline. 2) Rosneft’s Far East downstream facility (24 mn tons) driven mainly by political reasons. Morgan estimates. 60% diesel.4 13 10. +$4/bbl). the mediumterm outlook consists of three main parts: Figure 81: Product ED differential basket (‘15E) vs.ong@jpmorgan. 90% gasoline. Table 32: Old/current tax regime Export duties ($/ton) Crude oil Light products Gasoline Naphta Heavy products ED differentials ($/ton) Crude oil/Light product Crude oil/Heavy product Heavy/Light ED differential basket ($/ton) Simple Complex Old tax regime ‘04-‘10 60/66/90 2012 55/6066/90 2015 55/60/90/ 100 2015 433 258 258 258 139 402 265 361 361 265 370 222 333 333 245 370 222 333 333 370 174 294 -119 137 137 0 148 126 22 148 0 148 217 171 130 80 128 84 69 61 $/bbl 16 13. The upgrading programs implementation delays with finishing the process is now expected in 2017-2020 vs.55% crude oil. 2015-2016 targeted previously. 90% gasoline.com The government published the first draft of the tax changes in late August for the public discussion.500/ton excise rates on aromatic products and jet
[email protected] 10 8. 90% gasoline. 55/60-66/90 EDs. -$7/bbl). The Duma approved the tax rebalancing in the first reading in late October. Morgan estimates. the sanctions introduced against certain oil and gas companies and remaining uncertainties in Russia/Ukraine situation development effectively closed the access to the debt markets for Russian oil and gas companies. 60-66% products. Morgan estimates. the light yield for the integrated oils (holding about 84% of distillation throughput currently) could reach 78-80% by 2020 from current 59% in 2014. Figure 83: Rosneft refining capex ($ mn) 6. 51 . The company operates Pur gas condensate stabilization plant (upgraded to 11 mn tons) in West Siberia and Ust Luga gas condensate processing facility (6 mn tons) located on Baltic Sea. the economics of remaining relatively simple refining operations could become relatively questionable for some distant regions if ED differential basket falls below $10/bbl given the extra costs on transport and processing. implying slightly more than 1 mmbpd of extra light product output.Samuel Lee. Least Preferred: Rosneft (UW. where it refines gas condensate mainly into naphta and light product mix. the dependent sector accounting for about 16% of total refining throughput (c. According to our rough estimates. According to our estimates. Rosneft still has a huge Far East refining and petchem facility still in the pipeline. the company will not have to upgrade the facility in conditions of higher taxation on heavy products.000 4.000 Preferred: Novatek (OW. In particular. but the process development is extended by at least 3-4 years. The capex requirements for all three stages (1) 12 mn tons refining.000 Figure 82: Ust Luga gas condensate processing facility 0 2010 2011 2012 Total refining capex 2013 Tuapse 9M14 Source: Novatek. the key complexity upgrade projects are yet to start.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. 1. Roughly half of the spending was allocated on building new Tuapse refinery and
[email protected] Novatek has the lowest refining exposure in the Russian oil and gas
[email protected]. PT $130) 2. The simple distillation capacity utilization might be under pressure from the oil prices and the regulation. but the management is still keen to go ahead with its development and even asked the government about financial support from National Wellbeing fund. Source: Novatek. We believe that the company is likely to spend not less than $25 bn on the refining segment (excl Far East greenfield) within next four years and new unit launching delays/capex overruns risks are substantial. The project is unlikely to be economically viable. CFA (852) 2800-8536 samuel. The undergoing tax changes in the sector make the refining profitability even more sensitive to the oil price. 800 kbpd) might be at risk.0) Although Rosneft spent more than $17 bn in refining segment capex for the last five years. 2) 3 mn tons petchem and 3) 12 mn tons refining + 3 mn tons petchem) have been indicated at RUB1.000 3. We suppose that the rest of money was mainly spent on light product quality improvement. PT $5. taking into account changing tax landscape.000 5. Taking into account light own feedstock at Ust Luga.3 trln.sw.com improvement in the light yields is still on agenda for the integrated oils. lee@jpmorgan. Mediterranean refinery margins (complex) reduced to $1.rh. On the refinery margin front.ong@jpmorgan. 16 8% 12 6% 8 4% 4 2% 0 0% 2013 2014e 2015e % Growth Source: J.0 2014 Overview Turkey and Poland import about 25%-35% of fuel required. Poland has an above average autos penetration of 486 cars per thousand people. CFA (852) 2800-8536 samuel. 2015-16 Key Issues/Risks: In our view.com in 9M13. Morgan estimates. which is not hugely supportive of very high fuel demand growth over the long term. Tupras is the sole refiner in Turkey and provides about 65% of fuel demand while PKN provides about 60-65%.P.0 5. PKN recognized impairment charges in 2Q for refining assets (which could process10mt crude) of Orlen Lietuva. Company data.P.0 -1. refinery margins remain challenging for PKN with average refinery margin of $2. we expect Tupras to benefit from its Residuum Upgrade Project (RUP) which would increase the fuel/white product yield and hence higher margins.z.0 3.fuel consumption growth (%) 15. varies crude oil grades differential with Brent. diesel/jet fuel/gasoline consumption increased by 2%/12%/2% over the JanAug14.e.3/bbl 52 4. diesel/ gasoline consumption increased by 0-2% over 9MTD. N. apart from challenging refinery margin environment.0% 0. Tupras’ average net refinery margins slightly increased to $2.0% 2Q10 4Q10 2Q11 GDP (YoY) 4Q11 2Q12 Diesel growth 4Q12 2Q13 4Q13 Gasoline Growth Source: J. Figure 87: PKN.71/bbl in 9M14 from $2.Asia Pacific Equity Research 18 November 2014 Samuel Lee.60-70% in 2015.0 20 2012 6.0% 10.com Parsley Rui Hua Ong (852) 2800-8509 parsley.sw. i.0 0.0 1Q04 1Q05 1Q06 1Q07 1Q08 1Q09 Tupras refinery margins ($/bbl) 1Q10 1Q11 1Q12 1Q13 1Q14 Mediterrean Source: J. currency depreciation.A.0 1.P. in our view. Key Stock Picks: We prefer Tupras over PKN.0% 5. We expect transportation fuel consumption to increase in Turkey due to a low auto penetration rate (120 cars per 1000 person vs more than 400 cars per 1000 person for EU). However.0 3. In Turkey. other key issues/ risks are development in the fuel demand growth.0 1.com Figure 86: Tupras’ refinery margin vs Mediterranean ($/bbl) J.kumar@jpmorgan. We expect refinery assets of Orlen Lietuva to run at relatively low operating rates c.0 Figure 84: Turkey: diesel consumption (mt) 2011 7.59/bbl in 9M13 mainly on a better demand environment and crack spreads. Company data. Morgan estimates. Both TRY and PLN depreciated more than 5% YTD had a negative impact on the earnings.0% -5. In Poland. lower crude oil price is positive for Turkish GDP growth.0% -10. . and any geopolitical risk.0 -1. Figure 85: Poland.13/bbl in 9M13.0 -2. our negative view on the refinery margins.0 2. Poland/Turkey – Fuel importers Neeraj KumarA C (971)4428 1740 neeraj.model refinery margin ($/bbl) 9.P. There was an increase in fuel oil consumption by about 1.4/bbl in 9M14 from $2. France and Germany.6% mainly due to a higher demand from power sector.0 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 10% Diesel Consumption 5. This rate is close to some of the WE countries. Morgan estimates. Morgan Chase Bank.0 PKN model refining model ($/bbl) Source: J. Despite. Dubai Branch 8.0 7. In our view. This should have a positive impact on the fuel demand growth in 2015 but it remains to be seen. Despite the decrease in Mediterranean refinery margins (complex). We have seen an increase in fuel consumption YTD on the back of improving economy and as demand improves from a lower base in both Turkey and Poland.9/bbl in 9M14 vs $4.P. Morgan estimates. Company data. Company data. capital discipline remains key as the energy and upstream businesses get an overproportionate share of development capex (c60%) vs. We believe tough refinery margin to be a drag on downstream business. (Benefit from better product cracks in 3Q but inventory losses/fx could be a drag. In our view. i.ong@jpmorgan. 3) Tupras’s key demand drivers are still intact.com Preferred: Tupras (OW.lee@jpmorgan. Prefer Tupras over PKN) Least Preferred: PKN (UW. low autos penetration (120 cars per 1000 person vs average 450 for EU). Diesel demand consumption grew by 7% in 2013 and > 5% in 1H14. below guidance of $11/bbl over 2014-17. 2) Tupras’s capex cycle is nearing its end. There was increase in gasoline consumption by 1-2% in 2013 and 1H14. CFA (852) 2800-8536 samuel.e. with retail (c27%) in line with company guidance and upstream benefiting from recent acquisitions in Canada.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley.sw.9/bbl. (Tough refinery margin outlook. PT TL57) We are OW on Tupras due to: 1) Potential of margin improvement by more than 150bps due to the Residuum Upgrade Project (RUP).Samuel Lee. ambitious EBITDA guidance. We think downstream margins are likely to remain under pressure and forecast average model downstream margin of $9.rh. We are cautious on shale production in Poland.Initiate with UW) 53 . 4) Increase in fuel demand. Downstream business contributes c70% of 2014-17E EBITDA (LIFO). PT PLN38) We forecast an EBITDA increase over 2014-17 of PLN1. mainly on lower contribution from downstream business. limited contribution (c6%) to 2014-17E EBITDA. so increasing dividend potential.6bn. c20%. We forecast Petrochemical will be the biggest contributor to 2014-17 EBITDA (c42%). below company guidance. Air fin coolers – a radiator-like device used to cool or condense hot hydrocarbons.P. A hydro-treater removes sulfur. Acid treatment – A process in which unfinished petroleum products such as gasoline. In a more complex refinery. kerosene and lubricating oil stocks are treated with sulphuric acid to improve colour.boil off next. odor or other properties.LPG.Samuel Lee.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. Morgan. specifically relating to the refining process. The simplest refineries stop at this point. Middle distillates . The heaviest products (residuum) are recovered at temperatures that may exceed 1. additional processes follow which take the heavy.rh.sw.ong@jpmorgan. The lighter products . naptha and gasoline . diesel and gasoline). A reforming unit produces higher octane components for gasoline from lower octane feedstock recovered during distillation.jet fuel. 54 . Crude oil is heated and put into a distillation column . CFA (852) 2800-8536 samuel. The downstream industry contains no fewer technical terms than the upstream. A coker uses the heaviest output (the residue) to produce lighter feedstock and petroleum coke.com Appendix I: Downstream glossary of terms Refining The core refining process is simple distillation (Table 34).000 1000+ Distillate fuel blending Heavy Gas Oil Fluid catalytic cracking Residuum Coking Source: J. higher-valued output.different products boil off and are recovered at different temperatures. We summarize the most commonly used terms to enable investors to see through more of the 'jargon'. low-valued streams and convert them into lighter.000 degrees F. A catalytic cracker converts gasoil into finished distillates (heating oil.are recovered at the lowest temperatures. Additive – chemicals added to petroleum products in small amounts to improve quality or add special
[email protected] overview Crude oil Distillation column Temp Deg F Product recovered Product sent to <90 Butane & lighter Gas processing 90-200 Light straight naptha Gasoline blending 200-350 Naptha Catalytic reforming 350-450 Kerosene Hydrotreating 450-650 Distillate 650-1. Alicyclic hydrocarbons – ringed hydrocarbons in which the rings are made up only of carbon atoms. distillates (heating oil and diesel) . kerosene. Table 34: Refining process . g.industry term referring to the group of aromatic hydrocarbons benzene.2 degrees. primarily as a fuel for electricity generation. Tank bottoms are the heavy materials that accumulate in the bottom of storage tanks. steam.a substance which alters the rate of a chemical reaction without being used up itself in the reaction. The accumulated coke can be removed from the coking vessels during an off cycle and either sold. Blending – the process of mixing two or more petroleum products with different properties to produce a finished product. It is used for road-building and roofing. or used in gasification units to provide power. Alkylation – a process using sulfuric acid or hydrofluoric acid as a catalyst to combine olefins (usually butylenes) and isobutene to produce a high-octane product known as alkylate. usually comprised of oil and water.rh.ong@jpmorgan. 55 . Caustic wash .a process in which distillate is treated with sodium hydroxide to remove acidic contaminants that contribute to poor odor or stability. API gravity – an arbitrary scale expressing the density of crude oil and petroleum products. Atmospheric tower – a crude distillation unit operated at atmospheric pressure. one barrel is 35 imperial gallons or 159 litres. ethane. Asphaltenes – the asphalt compounds soluble in carbon disulfide but insoluble in paraffin napthas.sw.com Aliphatic hydrocarbons – hydrocarbons characterized by open-chain structures e. toluene and xylene. CFA (852) 2800-8536 samuel. Bottoms – tower bottoms are residue remaining in a distillation unit after the highest boiling point material to be distilled has been removed. and/or hydrogen for the refinery. more viscous fluid and a higher gravity indicates a lower density (lighter. propane. Coke – a high carbon content residue that remains following the destructive distillation of petroleum residue. thinner) fluid. the EIA estimates that the average API of US crude imports has fallen from 32.5 degrees to 30. BTX . Over the last 20 years. butane. Barrel – the American standard unit of measurement for oil. Bitumen – an extremely heavy semi-solid product of oil refining made up of long chain (heavy) hydrocarbons.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley.Samuel Lee. Coking also is the removal of all lighter distillable hydrocarbons that leaves a residue of carbon in the bottom of units or as buildup or deposits on equipment and catalysts. A lower figure (gravity) indicates higher density. Aromatic – organic compound with one or more benzene rings. Coking – a process for thermally converting and upgrading heavy residual into lighter products and by-product petroleum coke.lee@jpmorgan. Catalyst . Fractional distillation – a separation process which uses the difference in boiling points of liquids.Samuel Lee. and butane into olefins (ethylene. primarily gasoline range naptha and diesel range gas oils. Cracking – the process of breaking down larger molecules of hydrocarbons into smaller ones. Debottlenecking – a process that improves the flow and better matches capacity among different refining units by turning more and more to computer control of processing. Distillates – the products obtained by condensation during the fractional distillation process. Fuel gas – refinery gas used for heating. Desulphurization – any process or process step that results in the removal of sulphur from organic molecules. Flash point – lowest temperature at which a petroleum product will give off sufficient vapor so that the vapor-air mixture above the surface of the liquid will propagate a flame away from the source of ignition.com Condenser reflux – condensate that is returned to the original unit to assist in giving increased conversion or recovery. industry and marine boilers.the process in which a heated oil under pressure is suddenly vaporized in a tower by reducing pressure. Flashing . Fraction – one of the portions of fractional distillation having a restricted boiling range.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. heating oil and light fuel oil. propylene and butene). If a catalyst is used. Dehydrogenation .sw. Crude assay – a procedure for determining the general distillation and quality characteristics of crude oil. used to produce diesel fuel and to burn in central heating systems. CFA (852) 2800-8536 samuel. kerosene.A reaction in which hydrogen atoms are eliminated from a molecule. propane.ong@jpmorgan. usually includes diesel fuel. Dehydrogenation is used to convert ethane. it is known as catalytic cracking.rh. Gas oil – a middle distillate petroleum fraction with a boiling range 350-370 deg F. Fuel oil – a heavy residual oil used for power stations. Feedstock – stock from which material is taken to be fed (charged) into a processing unit. Fluid catalytic cracking (FCC) – a process for converting high boiling gas oils to lighter liquids. When this is done by heating the oil it is known as thermal cracking. Gross product worth (GPW) – this is the weighted average value of all refined product components (less an allowance for refinery fuel and loss) of a barrel of the 56 .lee@jpmorgan. lee@jpmorgan. which produces hydrogen sulphide that can be easily removed from the crude stream. For forecasting purposes the J. plus capacity not in operation but under active repair that can be completed within 90 days.A process used to convert heavier feedstock into lower-boiling. Hydrocarbons may exist as solids. This process consumes hydrogen and is used in lieu of acid treating. Hydro-finishing . Hydrogenation – the chemical addition of hydrogen to a material in the presence of a catalyst.0% 50. Hydrocarbon – a compound containing hydrogen and carbon only.0% 50. high temperature. Idle capacity – the component of operating capacity that is not in operation and not under active repair.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. but capable of being placed in operation within 30 days. 57 .7% 50.3% 33. GPW is computed by multiplying the spot price of each product by its percentage share in the yield of the total barrel of crude.0% Gasoil 33. higher-value products. It is also applied to paraffin waxes and microcrystalline waxes for the removal of undesirable components. its yield and the value of its products (and hence its location). Refining margins will thus vary from refinery to refinery and depend on the cost and characteristics of the crude used.A catalytic treating process carried out in the presence of hydrogen to improve the properties of low viscosity-index naphthenic and medium viscosity-index naphthenic oils.rh.0% Source: BP Heavy vacuum gas oil (HVGO) – an intermediate product produced in the vacuum distillation unit which is further processed to produce gas oil or gasoline.com marker crude. CFA (852) 2800-8536 samuel. taking into account the marginal refinery operating costs.sw.3% 33.3% 50.Samuel Lee. Table 35: Regional Refining Marker Margin definitions Region US Gulf Coast US West Coast US Midwest NW Europe Mediteranean Singapore Crude Mars ANS LLS Brent Azeri Light Dubai / Tapis Refinery Coking Coking Coking Cracking Cracking Cracking Gasoline 66.0% 50. liquids or gases.this is the net difference in value between the products produced by a refinery and the CIF value of the crude oil used to produce them.0% 50.7% 66.7% 66. Morgan European Oil & Gas Team uses BP’s Refining Marker Margin (RMM) so that we have a
[email protected] catalytic process in which the principal purpose is to remove sulfur from petroleum fractions in the presence of hydrogen. Hydro-cracking . continuous and comparable data series for regional GRMs. Hydro-desulfurization . a catalyst. The RMM is calculated using the following marker crudes and product yields. The process employs high pressure.P. Gross refining margin (GRM) . BP’s RMM uses regional crack spreads to calculate the margin indicator and does not include estimates of fuel costs and other variable costs. and hydrogen. Nelson in a series of articles in Oil & Gas Journal in 1960-61 to quantify the relative costs of the components that constitute the refinery. Kerosene – a medium light oil use for lighting.2.75. Iso-octane – a hydrocarbon molecule (2. catalytic reforming 5.0.1% benzene and with carbon numbers from C3 through C16. lower smoke emissions and reduce lube oil fouling.0.4-trimethylpentane) with excellent antiknock characteristics on which the octane number of 100 is based. aromatics / polymerization 10. The complexity of each piece of refinery equipment is then calculated by multiplying its complexity factor by its throughput ratio as a percentage of crude distillation capacity. which is assigned a complexity factor of 1. The NCI method uses only the Refinery Processing Units or the "Inside Battery Limits " ( ISBL ) Units. Nelson complexity index (NCI) – the NCI was developed by Wilbur L. determines a refinery’s complexity on the Nelson Complexity Index. reduce piston deposits.0 and lubes 60. and does not account for the costs of Offsites and Utilities or the " Outside Battery Limits " ( OSBL ) Costs. heating and aviation fuel. it is the smallest hydrocarbon molecule with only one carbon atom and four hydrogen atoms. Methane – the main component of natural gas. and xylene. Storage tanks. toluene.0.lee@jpmorgan. The reaction rearranges the carbon skeleton of a molecule without adding or removing anything from the original material.Samuel Lee.0.1%). Marine distillate – or residual fuel oil is used for marine applications.sw. Methyl-t-butyl-ether (MTBE) – an oxygen-containing fuel component used in reformulated gasoline.0. coking 6. utilities required etc. terminals. The Nelson complexity index assigns a complexity factor to each major piece of refinery equipment based on its complexity and cost in comparison to crude distillation.ong@jpmorgan. Adding up the complexity values assigned to each piece of equipment. Thus. Liquefied petroleum gas (LPG) . the greater the cost of the refinery and the higher the value of its products. CFA (852) 2800-8536 samuel. including crude distillation. the higher the index number.A reaction that catalytically converts straight-chain hydrocarbon molecules into branched-chain molecules of substantially higher octane number. used to produce petrol and as a raw material for the petrochemical industry to make plastics.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley.com Isomerization . such as Land. Naphtha – A general term used for low boiling hydrocarbon fractions that are a major component of gasoline. Additives help to stabilize fuel consumption in four stroke engines. Light vacuum gas oil (LVGO) – the lightest fraction from the vacuum column that is blended in to the gas oil mix. A high NCI means that a refinery can (i) process inferior quality crude or heavy sour crudes (ii) produce a superior product 58 . Aliphatic naphtha refers to those naphthas containing less than 0. Aromatic naphthas have carbon numbers from C6 through C16 and contain significant quantities of aromatic hydrocarbons such as benzene (>0.commercial LPG usually contains mixtures of propane and butane. For example – vacuum distillation 2. commonly made from methanol and isobutene. thermal processes 2.rh. The Nelson complexity index indicates not only the investment intensity or cost index of the refinery but also its potential value addition. the product resulting from a solvent extraction process and consisting mainly of those components that are least soluble in the solvents.the thermal conversion of naphtha and gas oils into high-quality gasoline at high temperatures and pressure in the presence of re-circulated hydrocarbon gases. marginal crude freight. Paraffins – a family of saturated aliphatic hydrocarbons (alkanes) with the general formula CnH2n+2 Polyforming . Quench oil . Refinery – a plant where the components of crude oil are separated and converted into useful products. defined to include transport and credit allowance costs Transport costs. insurance and ocean loss (in case of an FOB crude). catalyst and refinery fuels beyond own production Less fixed refinery operating costs. as per Table 36. vary with crude feedstock and refinery configuration.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. naphthenes. 59 .Samuel Lee.oil injected into a product leaving a cracking or reforming heater to lower the temperature and stop the cracking process.ong@jpmorgan. CFA (852) 2800-8536 samuel.com slate comprising a high percentage of LPG. and applicable fees and duties. assuming a single voyage for an appropriately sized tanker chartered on the spot market Less Credit allowance. have a lower specific gravity than the crude oil and feed stocks processed (e. Refinery processing gain . light distillates and middle distillates and a low percentage of heavies and fuel oil. Net refining margin – this is the gross product worth (calculated by multiplying the spot price of each product by its percentage share in the yield of he total barrel of crude) Less variable refinery operating costs. maintenance.sw. additives. Polymerization – the process of combining two or more unsaturated organic molecules to form a single (heavier) molecule with the same elements in the same proportions as in the original molecule.these are used for refinery margin calculations and. in total.g.rh. This difference is due to the processing of crude oil into products. taxes and overhead costs adjusted monthly to take account of escalations based on industry cost indices Less refinery delivered crude cost. Raffinate . which. chemicals. The product recovered from an extraction process is relatively free of aromatics. Recycle gas – high hydrogen content gas returned to a unit for reprocessing. Refinery product yields . defined to include the feed-dependent costs for power. defined to include labor. in conversion processes). crude transit time).lee@jpmorgan. representing the financial effect of the time delay between paying for crude versus when it is received in the refinery (crude credit. and other constituents that adversely affect physical parameters. water.the volumetric amount by which total refinery output is greater than input for a given period of time. sw. bbl) Petroleum Gasoline / gases naptha Distillate Fuel oil 3. Straight-run gasoline . or vacuum tower bottoms (VTB).1 36. to odorless disulfides to improve odor. Regeneration .6 39.4 30. Atmospheric resid. CFA (852) 2800-8536
[email protected] 43. Morgan.8 24.7 5.7 50 22.com Table 36: Refined product yields Region Europe Input crude Brent Urals US Gulf Coast US West Coast Singapore LLS Mars Blend ANS Dubai Tapis Refinery type Catalytic cracking Hydroskimming Catalytic cracking Hydroskimming Catalytic cracking Coking Catalytic cracking Hydroskimming Hydrocracking Hydroskimming Hydrocracking Refinery product yield (%. alkylated.9 10.4 52.1 41. sometimes called long resid or atmospheric tower bottoms (ATB) is the undistilled fraction in an atmospheric pressure of crude oil.7 19.1 42.6 1. is the undistilled fraction in a vacuum distillation.9 2.Samuel Lee.3 3. Stabilization – a process for separating the gaseous and more volatile liquid hydrocarbons from crude petroleum or gasoline and leaving a stable (less-volatile) liquid so that it can be handled or stored with less change in composition. tank car. the general term given to any refinery fraction that is left behind in a distillation. It contains no cracked.Gasoline produced by the primary distillation of crude oil (as opposed to conversion).4 23.7 30. Sweetening
[email protected] 42.0 3.6 2.portion of the distillate returned to the fractionating column to assist in attaining better separation into desired fractions. Switch loading .rh. color.P.4 37. mercaptans.9 3.6 43.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. diesel fuel) into a tank truck. or vis-broken feedstock.7 42.5 Source: J.6 14. and oxidation stability.3 14.9 4. reformed.an upgraded naphtha resulting from catalytic or thermal reforming.0 25.processes that either remove obnoxious sulfur compounds (primarily hydrogen sulfide. polymerized. Scrubbing – purification of a gas or liquid by washing it in a tower. sulfur-bearing compounds such as hydrogen sulfide and mercaptans. 60 .the loading of a high static-charge retaining hydrocarbon (i. Reflux . Reformate .7 2.9 39.e.1 46. Stripping – the removal (by steam-induced vaporization or flash evaporation) of the more volatile components from a cut or fraction.6 13.9 46. as in the case of mercaptans. and thiophens) from petroleum fractions or streams.9 28.in a catalytic process the reactivation of the catalyst. Vacuum resid.6 42. or convert them.0 22.8 29. sometimes done by burning off the coke deposits under carefully controlled conditions of temperature and oxygen content of the regeneration gas stream. Resid .8 41. short resid. Sour gas – natural gas that contains corrosive.an abbreviation for residuum.6 1.3 35.5 8. or other vessel that has previously contained a lowflash hydrocarbon (gasoline) and may contain a flammable mixture of vapor and air.7 7. Upgrading oil – extra heavy oils. and repair operations and to inspect. The most corrosive crudes.the breaking up of heavy oil molecules into lighter fractions by the use of high temperature without the aid of catalysts. Storage tanks also have vapor recovery systems which recover vapors emitted from 61 . high API). This combination of characteristics makes it an ideal crude oil to be refined since it yields a greater proportion of its volumes as lighter products. Utilization – represents the utilization rate of the atmospheric crude oil distillation units. Vacuum distillation – The distillation of petroleum under vacuum which reduces the boiling temperature sufficiently to prevent cracking or decomposition of the feedstock. Premium (heavier) crudes yield c. refiners routinely perform maintenance. a car wash and a convenience store.rh.70% (c. The depth of maintenance is influenced by the margin environment and outlook e.5% content by weight) crude that is produced in the USA. sweet (low sulfur. or of an entire refinery to perform major maintenance. like those from the Orinoco region (Venezuela) and the Alberta tar sands (Canada). US demand for product is lower in the colder months and higher in the warmer months.50%) of their volume as light products. A modern high volume throughput filling station may sell more than 5 million liters per year and cost $3-4m to build (subject to location and real estate value). Tail gas – the lightest hydrocarbon gas released from a refining process. if product inventories are high and demand is slack. with TANs greater than 1. require significant accommodation to be processed. Underground storage tanks and fuel lines are either made from steel set in concrete or special plastic. Tanks are usually double skinned and both tanks and connecting pipes have detectors which warn of the slightest leak before it becomes a problem. As refineries move out of the gasoline (driving) season in early autumn. WTI – West Texas Intermediate crude is a light (low density.sw. Retailing The modern forecourt today may have multi-pump dispensers. Vis-breaking – Viscosity breaking is a low-temperature cracking process used to reduce viscosity or pour point of straight-run residuum. test. it indicates the number of milligrams of potassium hydroxide needed to neutralize the acid in 1 gram of oil. are typically upgraded to produce high quality synthetic crude (syncrude) which is then refined. For example.g. The rate is calculated by dividing the gross input to these units by the operating capacity of the units.com TAN – total acid number is the standard measure for crude corrosiveness. CFA (852) 2800-8536 samuel. Turnaround – a planned complete shutdown of an entire process or section of a refinery. About 60% of this capital is equipment that is not seen but which is essential to the safe and more environmentally friendly operation of a modern site. Thermal cracking . maintenance activities are likely to be longer and deeper. Wet gas .a gas containing a relatively high proportion of hydrocarbons that are recoverable as liquid. and replace process materials and
[email protected]@jpmorgan.Samuel Lee.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. overhaul. <0. 05% weight. Clean diesel is an evolving definition of diesel fuel with lower emission specifications which strictly limit sulfur content to 0. Dealer-Operated (DODO) . Biodiesel . these help fuel economy. 62 . This collects water off the forecourt which may contain fuel or oil and stops it getting into surface drains and watercourses. In the future it may be used as a replacement for diesel.com the tank when it is being filled with petrol from a road tanker. this system is being extended as "Stage 2" to capturing vapors when a vehicle is filled. newspapers & magazines. soft drinks and tobacco. lottery tickets. fruit & vegetables. E85: Ethanol/gasoline mixture containing 85% denatured ethanol and 15% gasoline. frozen food. friction. some also help to clean the engine.The forecourt is owned by an independent business. Convenience stores – these sell a range of non-petroleum products that include alcohol. but the site and store are operated by an independent business.Samuel Lee. baked goods. with the key difference being that a group of stores are run by another independent company rather than an independent dealer. Also underground out of sight is the drainage interceptor system. engine cleanliness. power restoration and compatibility with biodiesel blends. Company-Owned. acting as a distributor for an oil company.sw. milk. as with any other multiple retail business. Fuel additives – for both diesel and gasoline. fast food. Dealer-Operated (CODO) . snacks. health & beauty products. which supplies fuel and usually a branding package.This is a similar model to CODO.these are high octane and high cetane formulations that are designed to burn more efficiently. The ownership and branding of retail forecourt sites is complex. chilled food. confectionary. emissions.lee@jpmorgan. household goods.a light oil fuel used in diesel engines.rh. by volume.a biodegradable transportation fuel for use in diesel engines that is produced through trans-esterification of organically derived oils or fats. E10 (Gasohol): Ethanol/gasoline mixture containing 10% denatured ethanol and 90% gasoline. Advanced performance fuels . but broadly falls into three areas: Dealer-owned.The forecourt is owned by an oil company which also supplies the fuel. by volume.ong@jpmorgan. CFA (852) 2800-8536 samuel. Company-Owned Company-Operated (COCO) – The forecourt is owned by an oil company and operated by its employees according to instructions from Head Office. Often called "Stage 1" recovery. Company-Owned Group-Operated (COGOP) . Diesel .com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. Chemical additives are typically ‘splash-blended’ at the terminal. packaged groceries. Biodiesel is used as a component of diesel fuel. We follow with a brief glossary of terms for fuels retailing. Octane rating – a measure of the performance (antiknock characteristics) of gasoline. Lubricants Synthetic base stocks – synthetic motor oils are made from the following classes of lubricants: polyalphaolefins (PAO).com Gasoline – an alternative term for petrol. Semi-synthetic oils . a high octane rating gives efficient ignition. CFA (852) 2800-8536 samuel. and other petrochemical companies developed a catalytic conversion of feedstocks under pressure in the presence of hydrogen to produce high-quality mineral lubricating oil. They are designed to have many of the benefits of synthetic oil without matching the cost of pure synthetic oil.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. In 2005. the best of which perform much like polyalphaolefin.Samuel Lee. low and high temperatures and chemical resistance.rh.g. synthetic esters and hydro-cracked lubricants.sw. Chevron. production of GTL (gas-to-liquid) Group III base stocks began.also called 'synthetic blends' are blends of mineral oil with no more than 30% synthetic oil. Shell. A blend of napthas and other refinery products with sufficiently high octane and other desirable characteristics to be suitable for use as fuel in internal combustion
[email protected]@jpmorgan. 63 . Such advantages include their ability to perform under extreme conditions e. Synthetic lubricants – these are a combination of synthetic base oil plus thickeners and additives that will give the grease or oil lubricant a number of performance advantages over conventional mineral based lubricants. including dividends (group average 29%). Risks to Rating and Price Target We believe the primary downside risks to our price target and Overweight rating include: growing concern that the crude export ban will be lifted. Price Target: $96. While shares have underperformed recently. CFA (852) 2800-8536 samuel.sw. We see MPC as a solid way to play the most favorable themes in US refining. Midstream EBITDA growth does not meet expectations and/or NGL prices weaken relative to natural gas. which represents 39% total return potential. Price Target: $118. weaker Brent prices cause contraction in olefin chain margins within Chemicals. In our scenario where the crude export ban gets lifted in 2016. given the significant uplift from JVs with minimal related debt.Samuel Lee. we still see many value levers available to pull.rh. making PSX an attractive investment in both our base case and our downside case. we see a strong backlog of MLP drop down opportunities (to PSXP) within Midstream. On this basis. both of which have non-macro levers for growth and significant MLP value creation opportunities. we estimate ~15% EPS downside for PSX (group average 28%).lee@jpmorgan. Risks to Rating and Price Target We believe the primary downside risks to our price target and Overweight rating include: growing concern that crude export ban will be lifted.com Appendix II: Investment Thesis. In a downside case in which the export ban is lifted. as PSX has the most diversified portfolio in the group and the highest potential for more stable growth outside of refining (Midstream and Chemicals). we see 7% upside (group average 9%). group average ~28%). we estimate a December 2015 price target of $118/share (28% upside. Marathon Petroleum (Overweight. Valuation Using our sum-of-the-parts approach. given that all of MPC’s exposure is in the US central corridor. we think riskadjusted return potential is favorable. MPC also has several refining projects under way to drive controllable EBITDA growth. Coupled with PSX’s MLP upside potential. which we expect to remain crude cost advantaged (to varying degrees) relative to the East and West coasts. MPC is diversifying its portfolio into highermultiple logistics and retail businesses (~22% of 2016E EBITDA). Gulf Coast crude spreads narrow versus those of international markets.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. We have valued PSX using a sum-ofthe-parts approach on its adjusted (look-through) EBITDA. As a result of its diversity. We maintain our price target of $96/share. group average 26%). Gulf Coast crude spreads narrow versus international markets. Valuation. Risks Phillips 66 (Overweight. Finally.00) We remain Overweight. weighing on EBITDA growth/multiple. Further. lowest in the group. and Mid-Continent crude spreads tighten versus those of other markets. scaling back of share buybacks while in growth phase.00) Investment Thesis We remain Overweight.ong@jpmorgan. we also see the lowest downside risk at PSX in a scenario where the crude export ban gets lifted (~15% EPS downside. we have a December 2015 price target of $96/share. Mid-Continent crude spreads tighten 64 . and loss of higher-than-expected market share.353 EV (Rs mn) 374. Hindustan Petroleum Corporation (HPCL) (Overweight. Price Target: A$28. we suggest there is further upside with key drivers remaining: (1) Leveraging the infrastructure network.ong@jpmorgan. roll back of reform.118 Debt 252. Our PT is based on 56x EV/EBITDA. While valuation support has moderated (DCF A$26. refining project execution does not live up to expectations. while upside risks are better-than-forecast refining margins and higher margins.173 Net Debt (Rs mn) 140. and also support a gradual expansion in margins.rh.sw. and the prospect of capital management.733 Cash/Inv. Valuation Our DCF valuation is A$26. 112. no improvement in diesel margins.44) Investment Thesis Retain Overweight.lee@jpmorgan. Despite recent share price performance and early progress on business reposition. CFA (852) 2800-8536 samuel. HPCL is most levered to reform/crude and we see HPCL as continuing to remain well placed. 65 .560 Equity value (Rs mn) 233. Caltex Australia Ltd (Overweight.0 62. rising consensus earnings forecasts. Morgan estimates.00) Investment Thesis With lower oil prices likely to lead to a quicker reduction in subsidy losses. Unlocking value from infrastructure assets could provide further upside Valuation We have an OW rating and a Mar-16 PT of Rs690. HPCL Valuation EV/EBITDA multiple EBITDA (Rs mn) 6. Our estimates are based the downstream not bearing any subsidy losses in FY17.54 per share as detailed in the table below. we note the FY15 multiple remains underwhelming for a company with significant earnings growth.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley.558 No. Hess retail acquisition integration synergies miss targets. and MLP valuations take a step backward or rules change around MLPs. Risks to Rating and Price Target Downside risk emanates from higher crude/a weaker rupee. of shares 339 FAIR VALUE (Rs/sh) 690 Source: J.com versus other markets. (2) Leveraging the retail network and brand. Price Target: Rs690. and (3) Improving the financial position.54).P.Samuel Lee. 032 $854 $11 Valuation Per Share (A$/share) $7.Samuel Lee. 4) RD Shell is absent or underexposed in many of the key frontier exploration plays. Risks to Rating and Price Target Our 30 June 2015 share price target has increased to A$28. 66 . Morgan estimates. RD Shell has above-average exposure to high quality LNG assets – we have a very positive view on global LNG in 2014. less the FY14 interim dividend (A20cps) and the FY14E final dividend (A21cps).54 Source: J. Royal Dutch Shell A (Overweight. It continues to reflect our latest long-term Brent oil price of $90/bbl (US natural gas price of $4. Increasing capital investment by some competitors (additional capacity adds competition for volumes which could reduce margins). 3) RD Shell remains over-exposed.rh. Changing product mix within transport fuels (slower growth in higher margin premium fuels a negative for Marketing EBIT).5 per share to reflect recent disclosures and assumptions. 5) However. in our view. Price Target: 2. positive for CRM and Refining & Supply EBIT medium/long term).com Table 37: CTX – DCF Valuation Summary A$ in millions PV of Cash Flows Terminal Value $4.672 Enterprise Value Net Debt Minority interests $8. and Government and regulatory (CTX operates in a highly regulated industry). Caltex Refiner Margin (lower CRM a negative for Refining & Supply EBIT).com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley.3%). This share price target is based on our DCF valuation. CFA (852) 2800-8536 samuel. Currency (lower AUDUSD negative for accounts payable near term.g. to refining where we have a structurally negative view on margins in 2013. we continue to harbor some structural concerns: 1) We believe RD Shell continues to carry too much low-return capital employed e. 2) We are relatively oil price cautious – the breakeven oil price to avoid borrowing to pay its dividend is above $100 per barrel – an oil price around or below this level could undermine its dividend appeal and would send the dividend yield higher.38 per share. its exploration performance continues to
[email protected]. Risks to our share price target include: Lytton refinery (operating and incident risk). rolled forward at the cost of equity (10. Valuation Our SOTP is £
[email protected]) Investment Thesis We remain Neutral on RD Shell given some welcome signs of improved mediumterm capital discipline. refining and Upstream Americas and it will take 1-2 years to raise the productivity of these large units.167 $26. However.75/mmbtu) with 2013 disclosures relating to upstream reserves.44 per share from A$27. e. Major customer risk (WOW comprises ~20% of revenue).361 $3. East Africa and the presalt Santos Basin.g. Upside risks: Portfolio shrinkage – RD Shell could sell more than $15bn of assets 2014-15 and divest more refineries. This would reduce RD Shell’s exposure to a very volatile and low return stream. It implies a 2014E PER of 12x and a dividend yield just below 5% and a price to book multiple of 1. aiming to accommodate rising liquids production at the equity subsidiaries such as SeverEnergia and Nortgas. Novatek should be able to 67 .25 which represents an 18% discount to our SOTP (very close to our prior discount of 19%). we believe that a discount to our SOTP is still appropriate. Sustained oil price strength (much above $100 per barrel) would de-risk RD Shell’s dividend since it would provide the all important cash flow cover. We note a long-run average discount of 21%. CFA (852) 2800-8536 samuel. a prolonged period of LNG market over-capacity could dilute the returns from RD Shell’s LNG projects.lee@jpmorgan. Price Target: $130. Fiscal regimes – Unexpected or adverse changes to the upstream fiscal regimes that apply to any of RD Shell’s key operating areas could reduce its value. operating in West Siberia and on the Yamal peninsula. Provided RD Shell 1) confirms and successfully executes a large divestment program in 2014-15 and 2) demonstrates that organic capex of $35bn pa is a peak. Industrial accidents – Unexpected industrial accidents involving RD Shell assets could expose the company to loss of earnings. Risks to Rating and Price Target Downside risks: Macro factors – As an integrated oil & gas company which does not hedge prices or margins.rh. We note a long-run average discount of 21%.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. Improved capex control is followed by opex efficiency drive – We assume an organic capex spend of $35bn pa.2x – this seems reasonable given a 2014E (2015E) ROACE of 9% (8%).ong@jpmorgan. The company expanded its liquids value chain through addition of the Ust-Luga fractionalization plant and the expansion of condensate processing capacity at the Purovsky plant. RD Shell’s earnings and cash flow are naturally sensitive to oil and natural gas prices and refining margins. asset confiscation and potential litigation risk.com downstream assets and off balance sheet liabilities. It is possible that RD Shell will supplement better capital disciple and announce an operating cost efficiency drive in H2 2014.00) Investment Thesis Novatek is the largest Russian independent gas producer.RD Shell's balance sheet is strengthening fast as larger-thanexpected divestments and a higher-than-expected oil price raise cash flow. The two factors which constrain upside are negative free cash flow in 2014-15 (an uncovered dividend) and a relatively high 2014E EV/DACF multiple of over 7x. Novatek (Overweight. Acquisition risk .sw. LNG pricing risk – As one of the largest IOC producers of LNG. Although we see limited opportunities for the company in the gas segment because of pricing pressure and existing reserve base limitations.Samuel Lee. A large acquisition could dilute returns and perceptions of capital controls. This damage could prove more permanent if LNG's pricing relationship with the oil price is weakened to incorporate more of a regional gas hub connection. We reset our fair value price target to £23. Valuation Our end-’15 price target of $130/GDR is based 50% on our DCF-based end-15 fair value and 50% on our target (normalized) EV/EBITDA (‘15E). Our target EV/EBITDA (15E) for Novatek is 7.lee@jpmorgan. Price Target: TL57.2% and terminal growth rate of 3. and further expansion in US/EU sanctions terms against the company. Our target EV/EBITDA multiple is derived by dividing our DCF-based (target) EV by our estimated normalized EBITDA for ‘17-18E. Nortgas and Yarudeyskoye. Valuation We derive our Dec15 PT of TRY57 using a DCF approach.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley.com demonstrate an 18% CAGR over 2013-2020 in adjusted net income.rh. We calculate our DCF using a WACC of 13.1m tons and Nelson Complexity index of 7. Tupras (Overweight. Lower-than-expected refined products demand growth Crude oil supply disruptions Lower-than-expected product prices and refining margins Decreasing discount between Brent and heavy crude oil benchmarks Meaningful fines from ongoing investigations 68 . based on the projected cash flows and Novatek’s effective ownership percentage. fluctuations in oil prices affecting the liquids side of the company’s business. SeverEnergiya. We perform separate valuation exercises for the company’s equity projects. CFA (852) 2800-8536 samuel. Higher than expected impact from price ceiling from EMRA.0%. Novatek GDR’s valuation offers an attractive risk/reward opportunity at this point. RUP (Residuum Upgrading Project) remains one of the key positive catalysts for the company and is expected to come online later this quarter which could improve gross margins by up to 200bps. Tupras benefits from a low motorization rate in Turkey and domestic demand drivers remain intact.ong@jpmorgan. The company serves about 65% of the energy deficient Turkish refined product demand and generates more than 20% of revenues from exports. in our view. Our key assumptions are a terminal growth rate of 3% and weighted average cost of capital of 12%. Risks to Rating and Price Target We believe the key downside risks that could prevent our rating and price target from being achieved include the following: flat or declining domestic gas prices. in our view.sw.6x.Samuel Lee. and add them to our DCF-based value of the core business. Risks to Rating and Price Target The primary downside risks to our rating and price target include: Execution risk/cost overrun for RUP and other investment projects.00) Investment Thesis Tupras is independent and the sole refiner in Turkey with a throughput of 28.25. assuming no additional discount in terminal value. such as Yamal LNG. CFA (852) 2800-8536 samuel. The implied P/E is 14x based on our FY2014 forecasts. Our price target of ¥480 is based on end-Q2 FY2014 BPS of ¥849 and a P/B of
[email protected] JX Holdings (5020) (Neutral. energy companies such as JX are seeing expanded opportunities for entry. Participation in these new businesses could pose upside risk for our price target. Fluctuation in refining margins: Every ¥1/liter fluctuation in the refining margin impacts annual recurring profit by around ¥40 billion. meaning that profits are highly exposed to fluctuations in resource prices.2%.00) Investment Thesis We rate the four Petrobras stocks that we cover Neutral. Fluctuation in resource prices: JX Holdings develops crude oil. Expansion of power generation and other domestic energy business: With Japan deregulating its electric power and gas industries. We think this has rendered the shares unlikely to advance on expectations alone. The timeframe of our price target is through December 2015. natural gas. A sharper-than-expected rise (decline) in the refining margin could thus pose upside (downside) risk to our price target. Valuation We base our price target on a P/B derived from an RoE-P/B matrix. While we think the shares do look attractive at their current level. 2% higher than 2013 production. We have a Neutral rating on Petrobras shares on the back of: i) uncertainties on short-term production behavior and a miss on the 2014 production guidance—we estimate 2014 production to average 2.6x. ii) FX devaluation impact on fuel import costs and leverage.662kbd.Samuel Lee. Refinery glitches or accidents: Protracted refinery shutdowns owing to technical glitches or accidents could have a major impact on profits and could therefore pose downside risk for our price target. A sharper-than-expected rise (decline) in resource prices could pose upside (downside) risk for our price target. PETROBRAS PN (Neutral. and iii) lack of clarity on fuel price readjustments and 69 . A share buyback announcement would also pose upside risk. Fluctuation in petrochemical prices: A sharper-than-expected improvement (deterioration) in petrochemical prices could pose upside (downside) risk to our price target.rh. derived from our FY2014 ROE forecast of 4. we also see little possibility of a rally until the company starts delivering better results.lee@jpmorgan. Price Target: R$25.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley.sw. Industry realignment: Industry realignment could pose upside risk for our price target even if JX is not a principal. Risks to Rating and Price Target Change in shareholder returns: A larger-than-expected dividend hike (cut) could pose upside (downside) risk for our price target. as it could generate expectations for a better supplydemand balance for petroleum products. Price Target: ¥480) Investment Thesis Investor confidence in the company has been hurt by a series of guidance misses caused by such factors as declining profitability in the petroleum business and delays in copper development. and copper. 26) Gas & Energy 2.335 $0.86 1.30 248.675 $17.305 $17.rh.P. Our YE15 price targets for PETR3 and PETR4 are based on our PBR and PBR/A targets using a year-end 2015 BRL exchange rate of R$2.ong@jpmorgan. We have Dec’15 price targets of $17/ADR for ONs and $18/ADR for PNs. by our estimates.842 $0.688 $2.010 $1. share prices would likely decline.0%.com a specific price readjustment policy that would allow prices to be readjusted according to international parity.062 $4.80/USD.3% Pre-Salt 116.39 89 $0.338 $1.563 $0.14 Unconsolidated Assets .Net Working Capital Changes Equity Value Number of Shares mn FY15 j Cost of Debt US$ debt spread 6.48 920 $10.670 $7.522 Source: J.721 $0.15 3.51 536 144 $0. Should oil prices retreat or fail to meet our 2014 average assumption of $100/bbl (Brent).5% l=b+k Tax Rate 34% g WACC 10.069 $9.89) 2.0% with an equity risk premium of 6.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. Table 38: PETROBRAS ON ADR EM Integrated Oil Valuation .74 3.4 Cost of Unlevered Equity 11.6 Levered beta 1.890 $1.83 26.720) ($0.5 Risk-free rate 4.798 $0.43 (19.46 h 4.5% c Iara 10.810 $0.210 Resource $4.4 Probable 19. We value the E&P portfolio of PBR using a reserve depletion model and value each of the pre-salt projects independently.3% k Cost of Debt 8.359 $1.006 $0.0 Target Lev erage (D/D+E) Iracema (Cernambi) 12.lee@jpmorgan. We also value the downstream projects under a DCF approach that is applied to all of PBR’s refining systems.28 Distribution 4.sw.10 Int'l (non-upstream) 1.7 Equity risk premium 6.1 13.06 3.4 Upstream 246.BAK . Valuation We rate the four Petrobras stocks that we cover Neutral.773 $0. as well as R$24/ON share and R$25/PN share.9 Cost of equity Rights Cession 35.4 LT Country Spreads 2.365) ($2.08 f $0.279 Rsrvs/Rsrc $6.023 $5.75/BBL LT in 2016) and $90/bbl LT EV / NPV per ADS Capacity Unit Firm Value Type per unit WACC CONSOLIDATED ASSETS Prov en Reserves Variables 110.759 $38.Net Debt '15E 2.84 40.0 + Div idends paid 14 .201 $10.4 Cost of Levered Equity 12. We apply a WACC of 10. Morgan estimates.821 $37.577 $16.02 226 Carcara Jupiter Libra Rsrvs 35% e D/E 54% f=e/(1-e) $6.Samuel Lee.594 $10.940 $3. CFA (852) 2800-8536 samuel.28 229 $7.475 $5.89 8. Returns from new investments could be lower than estimated. Risks to Rating and Price Target Downside risks Sensitivity to oil prices: PBR generates incremental EBITDA of ~$29 million for every 1% decrease in reference oil prices.516 $20.2 Unlev ered beta 1.01 14.8% d=b+c Guará (Sapinhoa) 9.136 $1.5 Carioca (Lapa) 1. The company has a capital expenditures plan for 2012-16 of $233 billion.3% i=a*f+d 12.0% a Ex isting Brazil 130.PETROBRAS (USING OIL @ $87.201 $4.938 $0.37 4.53 2.95 10.97) Ex ceeding Rights Cession Refining Corporate Downstream & Other Total 1.628 $1.31 (142.01 110.3% b Tupi (Lula) 27.999 $7.0% 6.1 3.72 Biofuels (1. While we believe the investments devoted to E&P projects are strategic and therefore unlikely to be 70 .3 Long term US bond 2.743) ($21. rh. An increase of 1bn boe in pre-salt resource base should boost PBR’s NAV by $0. petchem and shale/PMT businesses at 6. Demonstrating larger scale of pre-salt fields already in portfolio. but will be offset by weaker petchem margins.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. A $1/boe increase in the NPV per barrel of pre-salt assets should boost PBR’s NAV by $3. we do not see a material change in earnings trajectory near-term. 71 .ong@jpmorgan. investments in segments such as refining could have returns lower than the company’s weighted average cost of capital.sw. Upside risks Addition of new production licenses in large reservoirs such as Libra.5x and 5x EV/EBITDA. We factor in gas price reform. while uncertainty over telecom spends is likely to continue to weigh on the stock. by our estimates. respectively (in line with peer groups).080 values the refining. However.080. Reliance Industries Ltd (Neutral.00) Investment Thesis We remain positive on RIL’s strategy of organic growth in its core businesses and continue to see strong earnings delivery with the commissioning of new capacities – we expect a 17% earnings CAGR over FY14-FY17.8/ADR. Valuation Our SOTP-based Sep-15 PT of Rs1. Faster upturn in oil prices than assumed. CFA (852) 2800-8536 samuel.com modified. We value the D6 stake on an NPV basis and investments at book value (with telecom at a 50% discount to BV). 7. in our opinion.lee@jpmorgan. Price Target: Rs1. Faster production growth than assumed. with earnings driven by capacity growth.5x.0/ADR. but a turnaround in production is likely to be slow.Samuel Lee. We believe GRM are likely to be slightly better. Demonstrating better economics in pre-salt fields already in portfolio. 3
[email protected] 354 354 Petrochemicals Petchem EBITDA EV of petchem business' Value of Petrochem business 155. CFA (852) 2800-8536
[email protected] Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. R&M and chemicals.4 9.8 138 176 314 281.9mn BOPD.004 (103. Price Target: HK$7.503.30mn BOEPD.9 18.9 87 (32) 55 Investments and Net debt Treasury stock Net Cash Value of Investments and Net debt New E&P Assets Rs mn US$ bn 6. 72 .6 -1.in line with peers At 7.in line with peers KG D-6 Gas + Oil Value for Equity holders (Rs m) Comments DCF based on 60 mmscmd of peak production + 60K b/d of oil production from MA fields NEC -25 50% recovery and CBM at 50% recovery at US$ 3.in line with peers SOP of E&P assets without sustainability premium (Cash+Investments-Debt).698 1.Samuel Lee.410 447.542 3.4 16.083 Source: J.052 569.5/boe 1. Morgan estimates Risks to Rating and Price Target Key downside risks include project delays.sw.914 7.4 55 176 57. Our Neutral view is based on the following: Improving refining margins on improved product specs – We expect Sinopec’s refining margins to improve as China moves to tougher gasoline standards.320 569.862 3.574 At 6.rh. It is integrated with E&P.826 19. China IV gasoline may add cUS$1/bl to refining margins in 2014 and almost a similar incremental uplift for diesel in 2015.H (Neutral.0 9.862 1. higher-than-expected gas price rises and an improvement in petrochemical demand/margins.7 2.869) 177.443 1.954 1. adverse E&P regulations and significantly larger-than-expected telecom spend/losses.135 4. ethylene production 10mn tonnes. Sinopec has SEC proven reserves of 4.5x EV/EBITDA .9mn BOPD and natural gas 0.826 1.016. weaker refining/PX margins and a stronger rupee.00) Investment Thesis Sinopec is the second-largest oil company in China. Key upside risks include better-than-expected refining margins.9 At 5x EV/EBITDA .143.698 18. In 2013. Rs/Share 390. Sinopec Corp .143.165.com RIL: SOTP valuation Sep-15 SOTP Refining Existing Refinery Refining EBITDA EV of Refining business Value of Refining businesses Rs m US$ bn Rs/share 175.P. crude production was 0.3 360 Shale/PMT and other assets Shale/PMT EBITDA PMT and shale businesses New E&P Assets Value of total E&P & other assets 89.5 121 NEC-25 + CBM New E&P Valuation 179.5x EV/EBITDA . refining throughout was 4.4bn BOE (70%+ is crude). Post announcing its USD17.000: New valuation is based on 0. a collapse/improvement in chemicals profitability from weaker/higher margins. It is a subsidiary of Sinopec Corp (386 HK). Price Target: HK$1. we see the pace of reform at Sinopec slowing down as the company digests the stake sale (focus on IPO) and previous purchases (international E&P assets. we believe there are further downside risks due to a weaker refining outlook for 2015 and PX likely to stay near trough valuations for the foreseeable future. Sinopec Shanghai Petrochemical (Underweight. Yanbu refinery). Risks to Rating and Price Target Risks to our rating and PT include: lower/higher domestic oil product demand. It produces refined oil products. intermediate. Valuation Our Dec-15 PT of HK$7. synthetic resins and synthetic fibers.rh. refiners’ profitability can be highly volatile due not only to swings in GRMs and PX spreads.6x 2015E BV.Samuel Lee. but also to FX and commodity movements. but negative on PX spreads due to overcapacity. and lower-/higher-than-expected incremental refining margin upside from fuel spec reform. as we now expect 2015-16 ROE to average 6%.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. Risks to Rating and Price Target Upside risks to our rating and price target include a strong rebound in PX spreads due to new capacity delays and a spike in oil prices. additionally. Valuation UW with Dec-15 PT of W29.0 is based on our DCF valuation of the different segments. we have increasingly limited visibility on use of the proceeds of the stake sale in the medium term.ong@jpmorgan. We see the potential for S-Oil to cut its dividend payout for 2014 as another de-rating risk for the stock.000) Investment Thesis S-Oil is an integrated refiner/petrochemical company with downstream in PX.5% and a terminal growth rate of 3%. Swings in the latter two components can wipe out operating profits in some quarters. In Korea. While S-Oil is already trading at trough
[email protected] marketing stake sale.com Demand outlook for refined products remains strong – Earnings are expected to be driven by robust Chinese oil demand growth (4% y/y) from double-digit gasoline demand growth more than offset by diesel demand growth at 1% y/y. CFA (852) 2800-8536 samuel. S-Oil Corp (Underweight.50) Investment Thesis Sinopec Shanghai Petrochemical is one of the largest integrated refining and petrochemical companies in China. Natural gas upside – Strong natural gas production growth as well as further natural gas price hikes should support upstream profitability. using a WACC of 10. The company recently completed the 6th Phase expansion and 73 .sw. We are more positive on refining in 2014. petrochemicals. Lack of positive catalysts in the medium term . Price Target: W29. limiting refining upside – With petrochemicals pricing weak going into 2015 and limited improvements forecasted.0bn capex spending in FY14 to Rmb1. Shanghai Petrochemical is currently capable of producing gasoline meeting Euro V (similar to China standards).5 is based on DCF. and the A-H share through-train program shrinking the discount of SPC’s H-share listing vs A-shares. which contributes c70% of 2014-17E EBITDA (LIFO). CFA (852) 2800-8536 samuel.0bn capex in FY15).com upgrading program which increases its effective refining capacity to 16mn ton/yr from 12 mn ton/yr. Key points to our negative view include: Limited view on capex spending – While the company has cut its Rmb2. Valuation Our Dec-15 PT of HK$1.00) Investment Thesis We have an UW rating and Dec15 PT of PLN38. and diesel of Euro IV and Euro V qualities.2bn. PKN’s valuation looks demanding to us.sw. limited contribution (c6%) to 2014-17E EBITDA. better-thanexpected improvements in GRM’s on the shift to higher spec gasoline/diesel. We see tough refinery margins being a drag on the downstream business. Price Target: zl38.rh. we believe that the commodity chemical segments will remain a drag on SPC’s earnings.2% and perpetual growth rate of 2% in our DCF calculations. Valuation We derive our Dec15 PT of PLN38 from our DCF valuation. High capex spending in chemicals capacity limits free cashflow.ong@jpmorgan. asset injections from Sinopec. PKN ORLEN (Underweight. Risks to Rating and Price Target Risks to our price target include improving petrochemicals pricing. In our view. Weakness in petrochemicals to continue. we remain unclear on if the cut is merely a delay of project spending to be pushed into FY15 (we model Rmb2.8%. We have applied a WACC of 11.Samuel Lee. Our key assumptions are 1) terminal growth rate of 2%. capital discipline remains key as the energy and upstream businesses get an overproportionate share of development capex (c60%) vs. and 2) weighted average cost of capital 8.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley.lee@jpmorgan. refinery and petrochemical margin Higher-than-expected Brent/Ural differential Better-than-expected refined product demand growth Better-than-expected operating rates for plants Higher-than-expected production from TriOil and Birchill in Canada Crude oil supply disruptions due to various potential reasons Changes in the regulatory environment for E&P/shale in Canada/Poland Any lack of capital discipline 74 . Risks to rating and price target Upside risks: Higher-than-expected downstream. Our 2014-17E EBITDA (LIFO) increase is c20% below PKN guidance and our 2015/16E EPS is c5-10% below BBG consensus. After peaking in 2009 with reserves life reaching eight years. 75 .Samuel Lee. However. in our view. Ecopetrol ADR (Neutral.P.00) Investment Thesis With total hydrocarbon output exceeding 5 mmboe/day. We rate EC Neutral and maintain our view that Ecopetrol’s main challenge remains long-term sustainability. while any planning growth in crude oil production is getting more and more challenging. we believe that Rosneft's financial position looks manageable even though net debt/EBITDA exceeds 2x. the ratio has decreased to 6-7 years currently. the E&P assets.00) Investment Thesis Ecopetrol’s biggest challenge remains reserve addition and LT production growth. we use a sum-of-the-parts NAV model. effectively banning the company from access to the global debt markets.1bn boe.4% and cost of debt of 6. potential gas pipeline export access and the existing sanctions removing as the key upside risks. This is our standard valuation approach for Russian oil and gas companies. We highlight Ecopetrol’s initiatives to boost its reserve level on four fronts: exploration.sw. Our target EV/EBITDA (15E) for Rosneft is 4. valuing the largest portion of the portfolio. We assume a production schedule that is lower than the company’s target of 1. efficient maintenance is the key issue: expansion in the gas segment is becoming less attractive.3% and terminal growth rate of 3. Rosneft is the largest global crude oil producer.3mn boed by 2020. Risks to Rating and Price Target We consider additional state financing support. Price Target: $30. Given the size of the company. CFA (852) 2800-8536 samuel. We apply our own assumptions in terms of price realizations for crude and gas.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley.1%. Morgan’s forecast YE15 FX rate of Col$2. and development costs and discount the cash flow schedule using an 8. Out target EV/EBITDA multiple is derived by dividing our DCF-based (target) EV by our estimated normalized EBITDA in 2017-2018. development of unconventional potential and acquisition.lee@jpmorgan. we see no single source as enough to deliver the likely volumes required.com Overpayment for any potential acquisition in upstream/other businesses Unschedule maintenance shutdown Rosneft (Underweight. Taking into account cash on balance sheet and more crude oil prepayments in the future. with a reserve depletion model based on the existing proved reserves and estimates for produced volumes adding up to 5.150/share for ECOPETL CB is derived from the conversion of our YE15 PT of US$31/ADR using J. The company is included in both the US and EU sanctions lists.0%. in our view. improvement of recoverable factor. Our YE15 PT of Col$3. We calculate our DCF using a WACC of 12. Valuation Our end-15 PT for Rosneft of $5.rh.2x.8% discount rate (CAPM with cost of levered equity of 10.0 is based on a 50% weight of DCF-based fair value and 50% weight on target (normalized) EV/EBITDA (’15E). assuming additional 23% discount in terminal value due to discrepancy between expected dividend flow and FCF generation in the LT.ong@jpmorgan. Price Target: $5. improvement in the dividend policy.100. Valuation To arrive at our YE15 PT of US$30/ADR. lifting costs. and a debt-to-capital ratio of 33%). 0% Cost of Debt 6.461 $3.0% $0.1% Tax Rate 33% WACC 8. such as downstream.3% 1. Outperformance in Colombia’s macro figures.3 Cost of equity 3.P.6 10% Transportation 3.3mnboed target by the end of 2020.179 $35.8% Source: J.3% LT Country Spreads 1.rh.4 17% US$ debt spread 2. by our estimates. has greatly reduced the risk of big losses.8% Risk-free rate 4. but cost cutting in the coal business.4% Cost of Debt 2.056 52. Price Target: ¥2.14 Cost of Unlev ered Equity NAV Share Count (Basic) Current Price Upside
[email protected] Lee. Potential sizable discoveries in existing licenses.637) ($7.6 100% Description Consolidated Units Working Capital YE15 + Stakes Div idend YE15 (+) Net Debt (YE15) (+) ST/LT Debt (YE15) (-) Cash (YE15) Balance Sheet 553 Assets CAPM Inputs Adjusted equity risk premium 6. are also valued using a DCF model.185 $0. We think the share price appropriately reflects the situation at the company. Increase in dividend payout and commitments. our price target would likely decline. Upside risks Faster production growth than assumed.100) Investment Thesis We believe not only is profit stable in the oiled business. Please find below a summary of our SOTP for EC.6% 10. Should oil prices retreat or fail to meet our 2014 assumption of $100/bbl (Brent).9 9. 76 .277 $1. Risks to Rating and Price Target Downside risks EC generates incremental EBITDA of $125mn for every $1/bbl rise in oil prices. Morgan estimates. previously a cause for concern.6 4% 73.2) D/E 33. CFA (852) 2800-8536 samuel.4 85% Refining 7.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. so earnings are healthy overall.494 $30.224 $1. Table 39: Ecopetrol NAV ECOPETROL NAV % of total EV per ADR Upstream 62.807) ($5.0% Long term US bond rate 2.372 $29.7) Lev ered beta 1.com The remaining portions of the portfolio. Management potentially meeting or exceeding key performance goals.6 (
[email protected] Unlev ered beta 0. While we believe the investments devoted to E&P projects are strategic and therefore unlikely to be modified.6) Current Capital structure (D/D+E) 25.822) ($8. investments in segments such as refining could be front loaded as work completion moves forward.sw. The company has an aggressive capital expenditures plan in order to meet its 1.93 (11.238 Cost of Levered Equity $25.0% (16. Idemitsu Kosan (5019) (Neutral. We calculate our ¥2.9% and a discount of 15% taking dilution risk into account) to end-Q2 FY2014 BPS of ¥3. For Galp specifically.Samuel Lee.50. Movements in resources prices: Idemitsu Kosan is engaged in crude oil. Refinery problems/accidents: Problems/accidents resulting in prolonged production stoppages are a downside risk to our price target because they have a considerable impact on income.ong@jpmorgan. (Our price target applies through December 2015).com Valuation We set our price target using an ROE-P/B matrix. 77 . Implied FY2014E P/E is 11x. and 3) we see limited potential for resources upgrades emanating from the company’s drilling pipeline in 2014. Risks to Rating and Price Target The main generic risks to our rating and price target come from crude oil or natural gas prices or refining margins significantly above our projections.6/share (in-line with average 12-month discount suffered by the stock). and coal development projects.sw. we think industry realignment could benefit the share price owing to expectations for the supply/demand balance to optimize. a greater increase (decline) in the margin than we forecast is a potential upside (downside) risk to our price target.100 price target by applying a P/B of 0. Capital increase: We see a capital increase as a downside risk to our price target.30% to our SOTP valuation of €16. upside risks include success in the deepwater Brazil exploration programme and delays associated with the Tupi project. Valuation Our end June 2015 PT is €11.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley.rh. Risks to Rating and Price Target Movements in refining margin: We calculate that for each ¥1/liter change in the refining margin has a roughly ¥20 billion impact on operating profit.844. Other upside risks could come from material improvement in downstream.6x derived from our FY2014 forecast ROE of 4. and we see any difficulties that may arise as a downside risk to our price target. natural gas.lee@jpmorgan. CFA (852) 2800-8536 samuel. 2) the stock does not have wither the yield or earnings support – a negative when oil price is weakening . Our PT is set at a discount of c. and thus see it as an upside risk to our price target. Given the substantial earnings impact. Industry realignment: Irrespective of whether Idemitsu Kosan is directly concerned. Galp Energia (Underweight. Difficulties for Vietnam refinery construction project: The company is building a refinery in Vietnam. Price Target: €11.50) Investment Thesis We rate Galp Underweight for the following reasons: 1) we believe that the weaker outlook for oil prices and refining margins will continue to increase the stress on Galp's balance sheet . Greater price rises (declines) for these resources than we forecast are a potential upside (downside) risk to our price target. L/2202p/Overweight). BG Group. Statoil (STL. JX Holdings (5020). Rosneft. (ESRO. Rosneft. Tupras.HK/HK$2. For all Korea-based research analysts listed on the front cover. Royal Dutch Shell A. is. 2010.70/Overweight) Analyst Certification: The research analyst(s) denoted by an “AC” on the cover of this report certifies (or. Novatek.IS/TL49. Client/Non-Securities-Related: J.sw. or had within the past 12 months. Bharat Petroleum Corporation (BPCL). S-Oil Corp. BG Group. BG Group.rh. Statoil. Morgan Securities plc and/or an affiliate is a market maker and/or liquidity provider in Royal Dutch Shell A. Phillips 66. S-Oil Corp (010950. the Brazilian primary analyst signing this report declares: (1) that all the views expressed herein accurately reflect his or her personal views about the securities and issuers. Marathon Petroleum (MPC/$92.T/¥2018[17 November 2014]/Neutral). Royal Dutch Shell B. Showa Shell Sekiyu (5002) (5002. PKN ORLEN (PKN. In compliance with Instruction 483 issued by Comissao de Valores Mobiliarios (the Brazilian securities commission) on July 6. PETROBRAS PN. the following company(ies) as investment banking clients: Ecopetrol ADR. Phillips 66 (PSX/$71. JX Holdings (5020).T/¥437[17 November 2014]/Neutral). BG Group.H (0386. Royal Dutch Shell A.H. Reliance Industries Ltd. Sinopec Corp .85[17 November 2014]/Overweight). Morgan currently has. Sinopec Corp . PETROBRAS PN. Statoil. Idemitsu Kosan (5019) (5019. Lead or Co-manager: J. Novatek (NVTKq. Caltex Australia Ltd. Reliance Industries Ltd. the research analyst denoted by an “AC” on the cover or within the document individually certifies. Marathon Petroleum. Hindustan Petroleum Corporation (HPCL).BO/Rs549. that their analysis was made in good faith and that the views reflect their own opinion. Galp Energia. they also certify. the following company(ies) as clients: Ecopetrol ADR. Royal Dutch Shell B. Royal Dutch Shell A (RDSa. or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report.WA/zl45. and (2) no part of any of the research analyst's compensation was. Royal Dutch Shell B. CFA (852) 2800-8536 samuel.38/Overweight). Marathon Petroleum.OL/Nkr149.H. or had within the past 12 months.BO/Rs726.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. Idemitsu Kosan (5019).45/Underweight). Galp Energia. Essar Oil Ltd. Novatek. BG Group. Galp Energia (GALP. Essar Oil Ltd.20[17 November 2014]/Neutral). Phillips 66. S-Oil Corp. unless otherwise indicated) BG Group (BG. the following company(ies) as clients. Securities-Related: J. securities-related: Ecopetrol ADR. as per article 17. Client: J.T/¥980[17 November 2014]/Overweight). PETROBRAS PN. and the services provided were non-investment-banking..KS/W42500[17 November 2014]/Underweight).L/$98.98/Underweight). Sinopec Corp . Reliance Industries Ltd. JX Holdings (5020) (5020. Client/Investment Banking: J. Marathon Petroleum within the past 12 months. Sinopec Shanghai Petrochemical.P. or had within the past 12 months. as per KOFIA requirements. Tupras.. with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers. Tupras. JX Holdings (5020).LS/€11. Showa Shell Sekiyu (5002). Statoil. including from the entity in which he or she is an employee. and the services provided were non-securities-related: JX Holdings (5020). Marathon Petroleum. Showa Shell Sekiyu (5002).P.HK/HK$6. Tupras (TUPRS. Phillips 66. Phillips 66.P.P. Essar Oil Ltd. Rosneft (ROSNq. Galp Energia.P. without undue influence or intervention. Essar Oil Ltd.. Reliance Industries Ltd.ong@jpmorgan. Rosneft. where multiple research analysts are primarily responsible for this report.H. Statoil.05[17 November 2014]/Overweight).com Companies Discussed in This Report (all prices in this report as of market close on 14 November 2014. Novatek. Caltex Australia Ltd. Morgan currently has.21/Neutral). Ecopetrol ADR (EC/$24. Royal Dutch Shell A. Reliance Industries Ltd (RELI.L/$4. Galp Energia. Statoil. Galp Energia. Essar Oil Ltd. 78 . Statoil.H.Samuel Lee. Sinopec Corp . PKN ORLEN.. and (3) that he or she will set forth any situation or conflict of interest believed to impact the impartiality of the recommendations herein. II of Instruction 483. Sinopec Corp .13/Overweight). TonenGeneral Sekiyu (5012) (5012. Important Disclosures Market Maker/ Liquidity Provider: J.43[17 November 2014]/Underweight). Bharat Petroleum Corporation (BPCL). Royal Dutch Shell B. PETROBRAS PN. the following company(ies) as clients. Royal Dutch Shell A. Royal Dutch Shell B. Tupras. Sinopec Shanghai Petrochemical (0338.H. PETROBRAS PN.SA/R$13. Morgan currently has.L/2295p/Overweight). Morgan acted as lead or co-manager in a public offering of equity and/or debt securities for Ecopetrol ADR.40/Overweight). Sinopec Corp . Idemitsu Kosan (5019). Idemitsu Kosan (5019). Client/Non-Investment Banking.20/Neutral). Caltex Australia Ltd (CTX.81/Neutral). TonenGeneral Sekiyu (5012).AX/A$31. or had within the past 12 months. Galp Energia. Bharat Petroleum Corporation (BPCL) (BPCL. Rosneft. BG Group. PKN ORLEN.P.78/Overweight).L/1046p/Neutral)
[email protected][17 November 2014]/Neutral). (2) that all recommendations issued by him or her were independently produced. Hindustan Petroleum Corporation (HPCL) (HPCL. Marathon Petroleum. Royal Dutch Shell B (RDSb. Morgan currently has.45[17 November 2014]/Overweight).BO/Rs116.15[17 November 2014]/Neutral). PETROBRAS PN (PETR4.T/¥961[17 November 2014]/Overweight).BO/Rs985. An NR designation is not a recommendation or a rating.T). Morgan’s research website. Morgan expects to receive. Marathon Petroleum.P. Phillips
[email protected]). Marathon Petroleum.T). the certifying analyst’s coverage universe can be found on J. Myer Holdings Limited (MYR.T). Chugoku Electric Power (9504) (9504. Phillips 66. PTT Public Company (PTT. Showa Shell Sekiyu (5002) (5002. Showa Shell Sekiyu (5002). SK Innovation Co Ltd (096770. Scott L: Anton Oilfield Services Group (3337. Statoil.T). Tupras. In our Asia (ex-Australia) and U. or intends to seek. Sinopec Corp . Shin-Etsu Chemical (4063) (4063. Oil and Natural Gas Corporation (ONGC.T). Caltex Australia Ltd.T).KS).P. (1623. are available for compendium reports and all J.KS). Novatek.AX). Siam Cement (SCC. compensation for investment banking services in the next three months from Ecopetrol ADR.] Neutral [Over the next six to twelve months. Essar Oil Ltd. JX Holdings (5020). Royal Dutch Shell A. Mitsubishi Chemical Holdings (4188) (4188.and mid-cap equity research.AX). Thai Oil Public Company (TOP.KS).T). Formosa Petrochemical Corp (6505.KL). Royal Dutch Shell B.disclosure. or e-mailing research.K.HK). S-Oil Corp. Hindustan Petroleum Corporation (HPCL) (HPCL. Rosneft.HK). Woolworths Limited (WOW. regulatory or policy reasons. JX Holdings (5020). Royal Dutch Shell A. not to those analysts’ coverage universe.BO). JX Holdings (5020). Osaka Gas (9532) (9532.BK). Idemitsu Kosan (5019). Sinopec Corp . Mitsui Chemicals (4183) (4183.com.sw.BK) Darling. Statoil. the price target.jpmorganmarkets. Super Retail Group Ltd (SUL.T).P. if applicable. Marathon Petroleum.AX). Indian Oil Corporation (IOC. TonenGeneral Sekiyu (5012) (5012. (PLNG.HK) Nishiyama. J-POWER (9513) (9513. Non-Investment Banking Compensation: J.T). if applicable.AX). Coverage Universe: Lee. Sinopec Corp . Essar Oil Ltd.T). PETROBRAS PN. calling 1-800-477-0406.P.AX). Morgan. no longer should be relied upon.HK). PetroChina (0857. Petronet LNG Ltd. Fantastic Holdings (FAN. Bharat Petroleum Corporation (BPCL).disclosure. and Quantitative Research teams may screen companies not covered by J. BG Group. we expect this stock will outperform the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe. S-Oil Corp (010950.com Asia Pacific Equity Research 18 November 2014 Parsley Rui Hua Ong (852) 2800-8509 parsley. Honghua Group (0196.P..BO). Designations and Analyst(s) Coverage Universe: J. including price charts.T).H.Samuel Lee. SPT Energy Group Inc.HK). Idemitsu Kosan (5019) (5019. PTT Global Chemical Pcl (PTTGC.KS). Royal Dutch Shell B.P. CNOOC (0883. Kyushu Electric Power (9508) (9508.T). each stock’s expected total return is compared to the expected total return of a benchmark country market index.AX) 79 . Harvey Norman (HVN.P. Galp Energia. Morgan received in the past 12 months compensation from investment banking Ecopetrol ADR. Hilong Holdings Ltd. Explanation of Equity Research Ratings.com/research/disclosures. The previous rating and. Metcash Ltd (MTS. Company-Specific Disclosures: Important disclosures. Sumitomo Chemical (4005) (4005.. Caltex Australia Ltd (CTX. China Oilfield Services Limited (2883. Cosmo Oil (5007) (5007. Reliance Industries Ltd. Pacific Brands (PBG. JX Holdings (5020) (5020.rh. CFA (852) 2800-8536 samuel.P. Essar Oil Ltd.TW). Technical.T).BK). the price target.T). Morgan’s Strategy. Shaun: Billabong International (BBG. Statoil. Indorama Ventures (IVL. Idemitsu Kosan (5019). J. for this stock because of either a lack of a sufficient fundamental basis or for legal. Phillips 66. Hokkaido Electric Power (9509) (9509. please call 1-800-477-0406 or e-mail research. Tupras. we expect this stock will underperform the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe. If it does not appear in the Important Disclosures section of this report. Essar Oil Ltd. Galp Energia. Morgan– covered companies by visiting https://jpmm. Wesfarmers Limited (WES. Morgan uses the following rating system: Overweight [Over the next six to twelve months.com. PTT Exploration & Production (PTTE.] Not Rated (NR): J.BK).T).T) Gupte.T).com Investment Banking (past 12 months): J.BO). Gas Authority of India Limited (GAIL. Investment Banking (next 3 months): J.BO). Yuji: Asahi Kasei (3407) (3407. (ESRO. Idemitsu Kosan (5019). Morgan has removed the rating
[email protected]). Sinopec Corp H. China BlueChemical Ltd (3983.T).T).TW).HK). For important disclosures for these companies. Galp Energia.AX).BO). Sinopec Shanghai Petrochemical (0338. Petronas Chemicals Group Berhad (PCGB. Samuel See Wai: Formosa Chemicals and Fibre Corp (1326. small.BO) Cousins. LG Chem Ltd (051910. Reliance Industries Ltd (RELI. www.T). Nan Ya Plastics Corp (1303. Tokyo Gas (9531) (9531. Cairn India Limited (CAIL. Tohoku Electric Power (9506) (9506.AX). Broker: J. (1251. Kansai Electric Power (9503) (9503. Formosa Plastics Corp (1301.T).AX).HK).T).H (0386. Hanwha Chemical Corp (009830.TW).. Inpex Corporation (1605) (1605.HK).com with your
[email protected]). BG Group.P. PETROBRAS PN. Toray Industries (3402) (3402. PETROBRAS PN.AX).AX). Hokuriku Electric Power (9505) (9505.] Underweight [Over the next six to twelve months. Neil: Bharat Petroleum Corporation (BPCL) (BPCL.HK). BG Group. Lotte Chemical Corp (011170.BK). Royal Dutch Shell A.T). Royal Dutch Shell B. Shikoku Electric Power (9507) (9507.BO). Morgan Securities plc acts as Corporate Broker to BG Group. we expect this stock will perform in line with the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe. Reliance Industries Ltd.BO). Reliance Industries Ltd. JB Hi-Fi Limited (JBH.TW). Morgan has received compensation in the past 12 months for products or services other than investment banking from Ecopetrol ADR. Chubu Electric Power (9502) (
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