More on formulating Decision Rule 2: The Haas Guyana Refinery Study
Today’s column aims at walking readers through the Guyana Refinery Study, presented in a talk by Pedro Haas of Hartree Partners, in May this year. This study was conducted on behalf of the Ministry of Natural Resources (MoNR). The talk centred on four items, with a period left open for public discussion. Those items were 1) the strategic question, which the study sought to address; 2) a broad delineation of local and international oil market dynamics; 3) presentations on Guyana’s refinery economics; and 4) other oil related commercial options open for consideration.
The first item expressed the idea, the viability of which, is typically at the heart of every feasibility study: to proceed or not. That query in this context is: “given Guyana’s demand for fuels, and its oil and gas production prospects, what are the economics of investing in domestic refinery assets?” Presumably, this question is framed for a state investment; whether fully or partially state-owned is not specified.
The main petroleum products identified for Guyana in the study are: mogas, gasoil, kerosene, jet fuel, fuel oil, liquefied petroleum gases (LPG), and aviation gasoline. Current annual demand for these is about 13-14 million barrels (MB), all of which is imported. The growth in this demand has been rapid between 2010 and 2012, rising from 11.6 to 13.3 MB.
Two major international developments have been identified. One is the impact of surging US shale oil production. This has led to a structural shift in the Atlantic Basin, from its being a net importing region of refined products to a net exporting region. Presently, refineries in the US Gulf Coast are now major exporters of refined products to the Caribbean and Latin America.
The second international oil market development highlighted is the ongoing effort by OPEC (and other leading oil and gas producers) to cut their output in order to reduce global supply (inventories) thereby permitting global demand pressures to induce a revival in prices. As it has turned out, however, the former effect has largely counterbalanced the latter.
Guyana refinery economics
The study refers to both a “brownfield” and “grassroots” refinery, but operationally focuses on the latter. This type of refinery with its planned capacity is built from scratch, and therefore, includes the refinery infrastructure; and is expected to be constructed at one go. The methodology employed in the study follows the lines of refinery economics, which these columns have already reviewed.
Given expected prices, experts provide capital estimates, (construction costs and their timelines); operating costs and revenues have been proxied from existing refinery margins, bearing in mind the estimated refinery configuration and what this predicts for capacity, capability and complexity, which determine the refined products produced. Several technical terms are used in this discussion, some of which readers may not be familiar with and these are explained below.
One of these terms is the operating netback per barrel of oil. This is a technique for valuing oil from both upstream and downstream perspectives. From the downstream perspective, it is the value of the refined product’s gross product worth, less costs of transporting and refining the oil. And, from the upstream perspective it is the sales price at the wellhead less transport and processing (refining) costs. In other words, the average realized price of a barrel of oil less all the costs of production (including transportation, marketing, production and royalty fees). In other words also, the net profit per barrel of oil. Such prices are used to indicate (compare) variations in profitability, although they do not explain why these variations exist.
Another technical term used is the acronym PADD. This stands for the Petroleum Administration for Defense Districts of the USA. These are geographic aggregations where PADD1 stands for the East Coast; and PADD2 for the Midwest; PADD3 the Gulf Coast; PADD4 the Rocky Mountains; and, PADD5 the West Coast.
In the study, P1 represents the price of Brent oil in the North Sea; and T1 the transport costs of this oil taken to PADD1, or the US East Coast. The price of Brent oil is then equalized to the technical specifications of Guyana’s crude oil. These latter as given as: API = 32.1 and sulphur content = 0.51 per cent. Derived from this, the Netback for Guyana refined oil is its equalized crude oil price at the US East Coast less transport costs to Guyana. This latter is proxied as the transport costs to Venezuela. Guyana’s Netback per barrel of oil at 2016 prices, averages US$46.54
In contrast to the Netback methodology, Netforward pricing is typically used by buyers in order to determine whether to purchase the oil at its supply source and pay for its transportation and other related costs, or to purchase at the destination region. At the US Gulf Coast (PADD3) that price plus transport to the Guyana destination has been estimated in the study for regular gasoline, premium gasoline, and ultra-low sulphur diesel, as US$59.73; US$65.30 and US$59.88 respectively.
Guyana refinery assumptions
There are several assumptions used for estimating the viability of the Guyana refinery. These include: first, the refinery, as configured for the study, will be refining 100,000 barrels of oil per day at the complexity level of fluid catalytic cracking.
This is the type of state-owned refinery which the study deems as needed to be competitive. Second, the 10-year average margin of a 50/50 mix of a Louisiana heavy and light low sulphur oil in a typical US Gulf Coast refinery is US$5.84. This is applied to the Guyana refinery. Third, the overall cost for constructing the refinery is estimated at US$5.2 billion.
Fourth, the cost of debt used in the economic modelling of the refinery is given as 2.88 per cent. This is equivalent to the Bank of Guyana’s 364-day Treasury, plus a 0.5 per cent premium. Fifth, the cost of equity is put at 10 per cent.
This is based on median total shareholder return in the chemical industry for the period 2011 to 2015. Sixth, the exchange rate used is G$206.5 to US$1. Seventh, operating costs for the refinery are proxied by the IEA’s refinery margin estimates and given as US$3.30 per barrel of oil. And, finally, the timeline for construction of the refinery is 60 months, with the project life that normally applied in such studies ─ 30 years. Given the refinery capacity, on completion, it exports the refined products, which are not consumed locally.
Next week I shall present the key results of the analysis pertaining to the “viability of the state refinery idea”, which is the desired outcome of every feasibility study. Then I would be in a position to state Decision Rule 2.