Gen­eral re­fin­ery eco­nom­ics re­veals no over­all eco­nomic jus­ti­fi­ca­tion for a state-owned oil re­fin­ery

Stabroek News Sunday - - LETTERS -

In­tro­duc­tion

Last week’s col­umn fo­cused on re­view­ing the re­sults of Pe­dro Haas’ fea­si­bil­ity study for a state-owned oil re­fin­ery, spon­sored by the Min­istry Nat­u­ral Re­sources (MoNR). Its re­sults drove me to pro­nounce on De­ci­sion Rule 2, which states: the fea­si­bil­ity study makes clear that there is no over­all eco­nomic jus­ti­fi­ca­tion for pro­ceed­ing with a state owned, con­trolled and op­er­ated oil re­fin­ery. And, specif­i­cally one based on a re­quired pro­duc­tion of 100,000 bar­rels/day, in order to be “com­pet­i­tive”. In this cir­cum­stance around 80 per­cent of the crude in­put would be pro­duc­ing re­fined prod­ucts for ex­port.

Rule 2 com­ple­ments Rule 1, which had ear­lier posited: there can be no se­ri­ous eco­nomic ob­jec­tion to ei­ther pri­vate in­vestors (lo­cal and/or abroad) or ex­ter­nal Na­tional Oil Com­pa­nies (NOCs) build­ing a lo­cal re­fin­ery, which they wholly own, con­trol and op­er­ate, pro­vided this does not re­quire any out-of-the or­di­nary state sup­port, in­clud­ing do­mes­tic mar­ket pro­tec­tion, price ac­com­mo­da­tion, or tax ex­pen­di­tures.

Re­sults

I am aware the Haas Study has still not been made public. I have not seen it. Like the gen­eral public, I have only ac­cessed the Power Point pre­sen­ta­tion on the MoNR’s Web­site. Last week I did in­di­cate how­ever, that if or when the Study is made public and it can ob­tain a min­i­mum rat­ing of 4, on a scale of 1─10 (with 10 be­ing the high­est qual­ity), my po­si­tion would still hold. This is be­cause the re­sults are damn­ing and its mar­gin for er­ror is there­fore, huge. A sim­i­lar con­clu­sion would ap­ply to those call­ing for con­struct­ing a state oil-re­fin­ery, as the lead­ing edge of down­stream lo­cal val­ueadded.

To­day’s col­umn briefly re­states the key eco­nomic con­cerns that make a sta­te­owned/con­trolled/ op­er­ated oil re­fin­ery, an un­wise use of scarce Guyana’s re­sources.

Re­fin­ery eco­nom­ics

First, Guyana’s GDP in 2016 was only US$ 3.45 bil­lion USD; equal to 0.01 per­cent of global GDP. The Study strate­gizes for a 100,000 bar­rels/day re­fin­ery for which con­struc­tion costs are US$5 bil­lion. This is about 1.6 times the cur­rent GDP. Gross na­tional sav­ing is about one­fifth of cur­rent GDP, which ne­ces­si­tates for­eign bor­row­ing to build the re­fin­ery. How­ever, with a neg­a­tive rate of in­ter­nal re­turn, along with the re­fin­ery los­ing half or more of the in­vest­ment dur­ing the project life, this would make it highly un­prof­itable that in­vestors would ac­quire debt in such a project, or risk equity.

The cap­i­tal ra­tio is also too high for a state whose cur­rent bud­get ex­pen­di­tures are ap­prox­i­mately US$1 bil­lion and rev­enues US$0.9 bil­lion. Even with large an­tic­i­pated oil rev­enues af­ter 2020, Guyana with its cur­rent needs, can­not af­ford a ques­tion­able ven­ture, re­quir­ing such rel­a­tively large cap­i­tal ex­pen­di­ture.

Sec­ond, as noted in my ear­lier re­view of re­fin­ery eco­nom­ics, re­fin­ery profit is a func­tion of 1) the range/qual­ity of re­fined prod­ucts sales 2) the amount of out­put ex­ported 3) the amount do­mes­ti­cally con­sumed at world prices. (Re­call the be­hav­iour of world prices is a func­tion of global de­mand and sup­ply) and 4) the crude oil fed into the re­fin­ery. The last, has a cost which should be taken into ac­count at world mar­ket prices, af­ter al­low­ing for spec­i­fi­ca­tion, lo­ca­tion, and move­ment costs.

His­tor­i­cally, these prices have been quite volatile. Ex­pos­ing a small econ­omy to large asym­met­ric mar­ket risks pose tremen­dous haz­ards to sus­tain­able de­vel­op­ment and job cre­ation. His­tor­i­cally also, re­finer­ies op­er­at­ing in the “small” economies of Asia, Africa, and Latin Amer­ica have faced enor­mous chal­lenges, which for the most part they have never truly con­quered. Such ex­pe­ri­ences in­clude neigh­bour­ing coun­tries like Venezuela, Suri­name and Trinidad and Tobago, with their sub­stan­tial re­source finds, as well as sev­eral Caribbean coun­tries with no do­mes­tic crude out­put!

Third, while the Haas Study claims that con­struc­tion costs for a Guyana re­fin­ery have been pro­vided by ex­perts, and these specif­i­cally in­clude off-site lo­ca­tion and other re­lated fa­cil­i­ties, as well as en­ergy, hy­dro­gen sup­ply, wa­ter, and dock­ing costs, world­wide ex­pe­ri­ences sug­gest that fi­nal prices and costs of­ten sur­prise in­vestors, largely be­cause of the re­cent em­pha­sis on reg­u­la­tory re­quire­ments and changes in na­tional en­vi­ron­men­tal pro­vi­sions. There­fore, the con­struc­tion costs and the tim­ing of re­fin­ery com­ple­tion as sug­gested by Haas, should make pro­vi­sion for large, un­fore­seen up­ward in­creases!

Fourth, most, if not all re­finer­ies, op­er­ate as price-tak­ers. They have to adapt to changes in the price of their crude feed­stock as well as to the mar­ket prices for re­fined prod­ucts. Guyana’s state re­fin­ery is pro­jected to have a ca­pac­ity of 100,000 bar­rels per day and there­fore will clearly have to adapt to global mar­ket cir­cum­stances, rather than find­ing it­self in a po­si­tion of ser­vic­ing mar­kets over which it has enough mar­ket power to af­fect price for­ma­tion. This price-taker con­di­tion will have two no­table ef­fects.

One of these is paving the way for ex­change rate be­hav­iour to in­flu­ence sig­nif­i­cantly real re­fin­ery earn­ings. In a small, open econ­omy like Guyana, this be­comes an added com­pli­ca­tion, be­cause the terms of trade ef­fect of changes in crude in­put prices and re­fined prod­ucts sales will be­come a ma­jor pre-oc­cu­pa­tion for man­ag­ing the macroe­con­omy.

The sec­ond price-taker ef­fect is that, with “given” prices for in­puts and out­puts, op­er­a­tional ef­fi­ciency be­comes cen­tral to re­fin­ery com­pet­i­tive­ness and prof­itabil­ity. In­deed, the ra­tio of in­puts to out­puts can ba­si­cally im­prove only through in­no­va­tion; con­stant qual­ity up­grad­ing; op­ti­miza­tion; and, ef­fi­cient uti­liza­tion rates. These fea­tures are hard to imag­ine would be com­monly avail­able for a first time Guyana oil re­fin­ery!

Fifth, ev­ery oil re­fin­ery is con­fronted with risks, un­cer­tain­ties, and there­fore a range of choices. Over the short-term, as the in­dus­try say­ing goes: “re­finer­ies try to jug­gle the choices in their crude diet and its prod­uct slate”.

But in the long run each must de­cide whether to in­vest in chang­ing its con­fig­u­ra­tion or shut­ting down! In mak­ing this cru­cial de­ci­sion re­fin­ery size (and hence ca­pac­ity to reap economies of scale) and re­fin­ery com­plex­ity (as dis­cussed ear­lier) de­ter­mine the po­ten­tial prof­itabil­ity of the re­fin­ery.

Glob­ally, the lo­ca­tion of Guyana’s crude (if this is used as the chief in­put to the re­fin­ery) be­cause of its off­shore lo­ca­tion, be­low sea-level depth, and global scarcity of rel­e­vant skills (to con­tend with these fac­tors), put pres­sure on de­liv­ered costs to the re­fin­ery.

Con­clu­sion

Next week I shall wrap up this dis­cus­sion be­fore briefly ad­dress­ing ar­gu­ments con­cern­ing the con­struc­tion of a sta­te­owned re­fin­ery as Govern­ment’s con­tri­bu­tion to up­stream value added.

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