Mumbai: The gap between the refining margins reported by Reliance Industries Ltd (RIL) and global benchmarks has been narrowing since January 2008, an indication that India’s largest private sector firm could be losing the efficiency-led edge it once had over competitors.
Refining margins measure the difference between the cost of crude oil that goes into a refinery and the price at which the refiner sells fuels such as petrol and diesel to customers. RIL has traditionally benchmarked itself against Singapore gross refining margins, or GRMs.
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A Mint analysis shows that RIL has seen its superior margins gravitate towards the Singapore benchmark in recent quarters: from a huge $8.5 (Rs398) a barrel lead in the January-March quarter of 2008 to $4.4 in the same quarter of 2009 to $2.7 a barrel in the September quarter of this fiscal, the last for which reported numbers are available.
Analysts say this narrowing gap is due to the changing dynamics of the global energy sector, especially the fact that the price of crude oil variants that RIL uses in its two refineries at Jamnagar fell at a slower rate than the inputs used by many other global refiners.
An emailed questionnaire sent to an RIL spokesman on Wednesday did not get an answer till Thursday evening, but in a presentation to its investors in October, the company had pointed to the same set of market factors as being drags on its performance.
“The deltas between light and heavy crude have been coming down for sometime now to the point that they are non-existent now. In fact, heavy crude is commanding a slight premium sometimes,” said Deepak Pareek, sector analyst at Mumbai-based domestic brokerage Angel Broking Ltd, pointing to one of the two major factors that have snipped RIL’s margin lead.
Heavy or dirtier crude goes relatively cheap and is hence more profitable to process into various fuels. Fewer refiners globally demand it, RIL being one of this minority. Light and sweet crude varieties cost more and yield lower profits.
The global recession reduced demand for fuels and walloped Western refiners that used light crude, forcing them to either cut production or completely shut down refineries. Light crude prices tumbled, thus lowering the “profit leverage” of refiners such as RIL which used heavy crude as feedstock for their refineries.
An analyst with the Indian arm of a foreign brokerage, who did not want to be named, said the “profit leverage that was playing out because of higher complexity (of RIL’s Jamnagar refinery) had vanished” since the “light-heavy crude arbitrage was out of the picture”.
Also, the so-called diesel crack spreads—the difference in the selling price of diesel over the crude it was refined out of—have plummeted and RIL’s product portfolio has a fairly large proportion of diesel in it, explained the analyst quoted above. “About a third”, he estimated, adding that the Singapore index had a lower proportion of diesel. This meant that whenever diesel cracks rose, RIL’s gross refining margins, or GRMs, would rise faster than the benchmark and when they fell, RIL’s margins would fall faster.
“In 2007 and 2008, diesel margins were so good, they were touching $35-40 a barrel over Dubai (crude levels). It is now down to $5-5.5 a barrel. So RIL’s leverage has been taken,” said another Mumbai-based sector analyst with a foreign brokerage firm, in addition to the “feedstock advantage they had earlier”.
In a 29 October investor presentation, RIL had stated that its refineries—the older refinery at Jamnagar with a capacity of 660,000 barrels a day and the adjacent new refinery with a capacity of 580,000 a barrels a day—with their “higher complexity”, or ability to use the dirtiest of crudes, had “enabled the premium to benchmark refineries, despite the impact of poor light-heavy differentials”.
“Light-heavy differentials remain narrow at levels significantly lower than 5-year average (and) Opec crude cuts on heavy crudes has further worsened the situation”, it said. RIL also made a reference to “demand for middle distillates (that were) yet to show revival despite economic recovery—inventories are 39% above year-ago levels”. Diesel is one of the mid-distillates.
Analysts were divided on whether the closing gap between RIL’s refining margins and the regional benchmark was because of strategic errors or economic trends beyond the control of the company.
“How can one know that for sure? How does one know what they are doing wrong now when we didn’t know what they were doing right earlier? And even if one guesses, the quantum cannot be determined. It is possible to only analyze the sectoral reasons,” explained a Mumbai-based analyst with a domestic brokerage, who did not want to be quoted on this subject. “Let me put it this way. Heavy crude is in short supply. A smart (RIL) team can’t change that,” said one of the analysts with a foreign brokerage quoted before.
Besides a very efficient pack of refineries, RIL is also one of the smartest buyers of crude and sellers of its refined products globally but much of its trading desk activities, and the mode of operation, is strictly kept under wraps.
Angel’s Pareek pointed to another possible reason: “Their new refinery is still being ramped up and in the process, may be trying several feedstock combinations. That may be part of the teething problems” and could be depressing the combined GRMs being reported by RIL.
Analysts were, however, divided on whether RIL will reclaim the lead over Singapore GRMs that it once had or whether it is likely to languish or even veer closer to the industry averages. While one said the small premium was likely to stay, another said it was part of a cycle, that light-heavy differentials will jump again as Opec increases output. The third was ambivalent saying it was dependent on how fast the demand came back up and how fast and what kind of refinery capacity was added in the future.
RIL, on the other hand, is understandably sanguine. Its October presentation predicted that “as production grows, light-heavy differentials (will) improve and benefit complex refineries” and “improvement in middle distillates (was) imminent as growth in demand (was) being led by non-OECD countries and emerging markets”.
Graphics by Sandeep Bhatnagar/Mint