No Drop in Gasoline Prices is Forthcoming

As expected, direct involvement of the state in activities of Russian oil companies which made them invest in large-scale modernization of oil refining capacities entailed growth in the sector of engineering and transport services. This led to higher demand for heavy cranes, barge fleet and specialized machinery for the cargoes weighing over 100 tons. Therefore, overview of oil refineries rehabilitation progress in Russia and CIS countries will be even more interesting to our readers.

According to the Ministry of Energy, Russian oil companies put into service 15 re-refinery units in 2012. It is reported that in 2012 the oil companies invested about RUB 190 billion in upgrade of refineries; in 2013, these investments can be doubled – up to RUB 350 billion.

The Ministry of Energy confirmed that all the activities to rehabilitate and construct refinery units, start-up of which is scheduled at the second stage of modernization in 2013-2015, are ongoing as per the plan. Meanwhile, construction of rerun units to become operational from 2016 till 2020 is still at planning or FEED stage.

According to estimates of the Ministry of Energy, average level of equipment deterioration at the Russian refineries came up to 80% prior to rehabilitation, and service life of certain process units far exceeded all admissible levels. Out of 27 refineries located on the territory of Russia, six had been put into operation before the war, the same number – built until 1950 and eight became operational by 1960.

Very few now remember that at the dawn of the new Russian economy, one of the main purposes of establishing vertically integrated oil companies (VIOC) such as LUKoil, Sibneft and TNK was attraction of investments in upgrade of refineries. But the whole decade had passed before modernization of at least one Russian refinery started (the first one was Ryazan Refinery owned by TNK-BP). Ten more years required for this process to cover the entire sector. The first results are: finally, our country produces as much of high-octane gasoline as approximately needed by our market.

In total, about RUB 1 trillion has been invested in oil refining since 2005. At this, oil companies managed to reach only the lowest mark of the worldwide average level with their refineries to various levels of success, and only some of them achieved the sound European average level. Therefore, further major investments in this field will be required – to increase Nelson refinery complexity, yield of light petroleum products and refining level, resolve the misbalance issues of producing certain types of products, and encourage growth of competition in this sector.
The Russian refining industry is one of the world’s largest even now. In overall refining output, Russia is among the top five global countries, trailing only USA and China. This place was directly inherited by Russia from the former USSR – all the largest oil refineries had been built before 1991. Currently, Russian crude refining industry combines more than 30 big plants (ref. Table) and several dozens of minor refineries.
If Russia is among the leaders in volumes of refined oil, it still lags behind the Western countries in terms of petroleum products derivation and technical resources. According to Alliance-Analytics company, output of fuel oil in the Russian refining industry in 2012 reached 29% of refining output, motor gasoline – 14.3%, diesel fuel – 27.8%. For reference: yield of gasoline in USA is over 46%, diesel fuel – 27%, fuel oil – only 4%. As for EU countries, gasoline yield is around 25%, diesel fuel – 44%, fuel oil – 14%.

The fact that the Russian refining industry is above all focusing on production of fuel oil and diesel fuel given comparatively low yield of gasoline fractions, is mainly explained by the Soviet legacy: own cheap oil allowed to build multiple and most primitive refineries, without secondary and tertiary processes which were not really required, as truck transport was the main consumer of motor fuels in USSR. Geography of investments in oil refining in the last decades of the Soviet government also played its part: almost all new refineries, except for Achinsk plant in Krasnoyarsk Krai, were built outside today’s Russia – in Lithuania, Belarus, Kazakhstan.

Following collapse of the Soviet Union and establishment of first VIOC, almost nobody has ever taken to modernization of refineries. In the 1990s, in particular, under completion were the projects started in the 1980s. At that time, modernization covered Kirishi Refinery controlled by SurgutNeftegaz, as well as the group of Ufa and Moscow Refineries controlled by regional authorities.

And only in the early 2000s, the Russian oil industry had at least two big causes for investment in oil refining – altered domestic demand pattern and state-implemented graduated duties for oil and products export.

Uncontrolled modernization

Booming automobilization of the country in combination with regularly rising number of foreign cars brought about rapid growth of demand for high-octane gasoline of better quality. For quite a long time, the only company that took this market challenge had been TNK-BP. From 2000 till 2003, it invested approximately a billion dollars in rehabilitation and modernization of owned Ryazan Refinery. It became the first oil refinery producing full-value high-octane fuel, not by dissipating straight-run gasoline with additives, but on the basis of cracked gasoline with added alkylated fractions.

The majority of other companies focused on other issues. Oil production was becoming the most important revenue source for the budget which led to imposition of graduated duties for oil and products export in 1999. The lowest duties were charged for fuel oil, and this product turned rather interesting for the oil workers as an alternative export commodity. Further on, the ratio of duties for oil and petroleum products changed, but the benefit of fuel oil export remained the same. After 2005, the volumes of pre-processing began to grow quicker than those of oil production which resulted in decrease of oil export. And this “major fuel oil export” period is still underway.

However, despite the fact that “subsidy” was ensuring rather high level of operational income from oil processing, it hasn’t led to investment boom in this field.

Diesel fuel also became a profitable export commodity. As fuel oil, it started to be used at European refineries as a raw material for further processing stages. But in order to export Russian diesel fuel using oil product pipelines, it had to be first cleaned from harmful impurities – first of all, from sulphur. For this very reason, the oil workers had to massively invest in relatively simple and cheap hydrotreatment units. As for gasoline, investments were limited to relatively low-capacity units producing additives to make the octane number of straight-run gasoline higher. These types of units have taken a confident lead in the number of implemented investment projects. Most of oil refining companies were involved in construction of these units. All this allowed production of better types of gasoline and diesel fuel to be started rather quick, but still failed to improve the oil refining efficiency.

Deficiency of investments in full-scale modernization has led to a paradox situation: the industry was ramping up production volumes, the refineries were approaching 100% of productive capacity loading, but the domestic market was more and more sensitive to gasoline deficit.
The main impetus that entailed qualitative growth of investment in the Russian oil refining was adoption of new technical regulations in 2008, in accordance with which European ecological standards for motor fuel production were to be introduced in Russia. In particular, within several years, production of Euro-2 fuels shall cease on the territory of the country with conversion to Euro-4 and Euro-5 standards to be started. In 2011, in order to follow the refinery upgrade schedule more closely, authorities and oil companies concluded the so-called four-party agreements regulating scopes and timeframes of oil refinery units start-up. The main focus in the agreements was on fuel class, but oil conversion depth and yield of light petroleum products at refineries had to be determined by each oil company for itself. In spite of some delays in introduction of standards, the flow of investment in oil refining multiplied within several years. By 2012, almost 20% of the total volume of investment in Russia’s processing industry fell into oil refining.

Consolidation of oil refining in the industry completed at the same time. Oil refineries of Ufa and Moscow Refinery which in fact had previously had several shareholders and bought oil from independent suppliers, merged with Bashneft (after its acquisition by AFK Sistema) and Gazprom Neft respectively. The latest major event in the market was acquisition of TNK-BP by Rosneft, due to which the company went on top in volumes of oil refining in Russia and secured several large and already modernized refineries in European part of Russia.

All the basic companies – market players – announced rather ambitious refinery modernization programs. In the event of their execution, the volume of pre-processing will increase to 294 million tons by 2020, yield of light petroleum products will rise from 55 to 72%, and conversion depth – from 72 to 85%. However, yield of diesel fuel will rise significantly from 27.8 to 38.1%, and gasoline – from 14.3 to just 19.0%. As a result of altered yield and increase in refining volumes, production of fuel oil will be reduced by half, gasoline production will rise by 50%, and diesel fuel – by 57%.

In addition, most of the projects under implementation by Russian oil processing companies are still targeted at upgrading of fuels. Putting into service of catalyst cracking and hydrocracking units designed for increase of yield of high-quality diesel and gasoline fractions will commence only in 2015.

Strange as it may seem, despite increased share of presence of the largest oil companies in the refinery market, opportunities for competition are not diminished. Small local producers of petroleum products from the South of Russia and Siberia started to enter the refining market. As a rule, they started to do business in the middle of 1990s as producers of fuel oil for export (the groundbreaker here was Mariysky Refinery, owners of which managed to get access to Transneft pipeline system). By the beginning of 2000s, Ilsky, Novoshakhtinsky and Antipinsky Refineries could process more than 1 million tons of oil. The first oil refinery in Kemerovo Oblast was started in 2013. To be honest, owing to established specialization in production of fuel oil, straight-run gasoline and diesel fuel, these enterprises still have no significant influence on the market even locally. Tatneft plant (previously, it hadn’t had its own refining capacities) – Taneco in Nizhnekamsk – became the only new large refinery built by an oil-producing company. But as of today, only pre-processing of oil is carried out there, and construction of the deep oil conversion plant is only beginning to take shape. The majority of small refineries also announced plans to produce motor gasoline, but not a single project has been implemented so far. Therefore, influence of VIOC in the motor fuel market is yet total and unfailing.

As for VIO companies, their actions are now more versatile. Part of the plants located close to the seaside and having outlet to export directions, as a rule, increase the refining output and investment in modernization specializing in diesel fuel of corresponding Euro standards (hydrotreatment and hydrocracking). And this is logical, as it is unreasonably expensive to build an export gasoline plant here: according to Skolkovo Energy Center, an average Russian oil refinery concedes income of about USD 83 per ton of refined produce to an average cracking (gasoline) European refinery because of worse potential access to export outlets and products of inferior quality. That is why, upgrade of Russian refineries for gasoline needs, i.e. construction of catalytic crackers, alkylation and delayed coker units, will take place only hinterland targeted at the domestic market. This kind of modernization is already completed by LUKoil at Nizhny Novgorod refinery, it is planned at Kuibyshev and Syzran Refineries (Rosneft), Omsk Refinery (Gazprom Neft), Perm and Volgograd Refineries (LUKoil).

Prior to merger with TNK-BP, Rosneft owned rather obsolete refineries and commenced their modernization later than other major oil companies. Currently, the company is executing two large projects. Based on Tuapse Refinery, a large state-of-the-art plant is under construction almost from scratch. This is the biggest oil refining project in Russia with almost 1/4 of all sector investments involved. Given the selection of main production units (hydrocracking, catalytic reforming, hydrotreatment of fuel and isomerization), this is going to be a typical project aimed at diesel fuel export. Another project targeted at diesel export is under implementation by Rosneft at Komsomolsk Refinery in the Far East. In 2015, as soon as large catalyst crackers in Novokuibyshev and Syzran become operational, the company will take the absolute lead in the country in terms of high-octane gasoline production.

Modernization of Russian refineries, unfinished as it is, is already paying off. Production of AI-95 and higher graded gasoline is rapidly growing, actually forcing petroleum of lower grades from legal fuel trading. Finally, domestic market is saturated with gasoline of Euro-3 standard and higher. Interestingly, in case of execution of one and all projects to construct committed capacities, the gasoline in the country will be in excess, however, unlike diesel fuel, it doesn’t have any export potential, except for Kazakhstan. Even if this does happen, then only after 2020 – therefore, no drastic drop in gasoline prices is expected.

As for diesel fuel, programs of refineries modernization improve its quality, but in many cases it can no longer exported directly to its consumers, i.e. without pre-treatment at local refineries. In particular, according to Kortes analytical center, a share of diesel fuel with 0.035% of sulphur content and lower hiked from 35.5% in 2011 to 50.2% in 2012. It means that all excessive quantities of diesel fuel will be imminently exported with no pressure on domestic prices.

Furthermore, as Kortes analysts put it, oil companies need a higher margin to balance the expenses. For this reason, investment expenses will probably present a showstopper for reducing prices on petroleum products. Considering rise in excise duties for Euro-4 and Euro-5 motor gasoline and diesel fuel starting from July 1 this year, the prices will be kept at a rather high level until global oil prices change the direction.
This situation will possibly last until 2015, when the government is planning to set the export duties for fuel oil at the same level with crude oil duties. Only following this, refineries with oil pre-processing activities which do not produce high-quality motor gas and diesel fuel will no longer be so attractive. Not until then, front investments in oil refining by all market players, including Gazprom Neft, Bashneft, SurgutNeftegaz and Tatneft will drastically reduce yield of fuel oil and increase that of motor fuels.

But while Russian refineries are trying to pursue the existing standards of Europe, preparations are ongoing there to introduce Euro-6 in 2015, which means that lowering of upgrade paces may not be possible. Which is just handy for domestic contractors…

INSERT: The Ministry of Energy revised the timeframe forecast for rehabilitation of facilities at Russian refineries. Construction of four facilities is ongoing behind the set schedule: methyl tert-butyl ether production units at Afipsky, Mariysky and Syzran Refineries, as well as unit for hydrotreatment of catalytic cracking gasoline at Ryazan Refinery. Activities at other facilities are underway as planned.

INSERT: It is planned to start up 13 units at the Russian refineries this year. One of them – diesel fuel hydrotreatment unit structure at Ukhta Refinery (OAO LUKOIL-Ukhta neftepererabotka) – is already operational. Total scope of investments in rehabilitation and construction of refinery facilities by oil companies in 2013 will amount to RUB 262.158 billion, according to Minenergo.

Adapted from Expert magazine.

Table: The biggest ongoing investment projects in Russian oil refining industry