Do export-oriented refineries make sense?
Reliance Industries Ltd plans to set up a completely export-oriented oil refinery in Gujarat. The former petroleum Minister also wanted export-oriented refineries in the public sector. This violates the basic principles of refining that I learned as a young reporter in the 1970s. Should refineries be located near the point of production or point of sale? Many layfolk think refineries should be at the well-head. However, if this made economic sense, the vast majority of refineries would be in the Persian Gulf, not in countries importing crude from the Gulf. Why are refineries generally located near consumption rather than production points? Because moving crude is cheaper than moving refined products. Crude can be shipped cheaply in very large crude carriers (VLCCs) going to refineries with large terminals. But product tankers are much smaller (just 20,000- 30,000 tonnes capacity in the 1970s), largely because product terminals for diesel or petrol are small (they are built to serve a limited distribution area). Besides, crude can be pumped into a tanker without cleaning the hold, whereas a product tanker that has been used for diesel must be cleaned before loading petrol, and this adds to costs. Since scale economies for moving crude are large, it makes sense to move crude to refineries near consumption centres. This is one reason why in the 1950s three MNCs (Burmah-Shell, Esso and Caltex) decided to build refineries in India rather than supply India from refneries in the Gulf. For pipeline supply, pumping crude is cheaper than pumping products. Crude can be pumped without interruption. But products are pumped in consignments. After pumping a consignment of petrol, the pipeline must be cleaned before sending a consignment of kerosene, and cleaned again before sending a consignment of diesel. So, it is cheaper to pump crude than products. Hence, it is economic to pump crude to refineries near consumption points. However, politics often intervenes. When oil was found in Assam in the 1960s, the Assamese wanted this refined within the state. But Assamese consumption of products was tiny: most of the consumption would be in West Bengal and Bihar. So the government decided to pump Assamese crude to a refinery at Barauni, Bihar. However, Assamese students protested, and blockaded oil supply in 1980. A committee was appointed to suggest a new refining location within Assam. The students thought this would be near the oilfields. Instead the committee suggested Bongaigaon, far away from the oilfields and as close as possible to West Bengal, which would consume most of the products. This was a compromise between the politics and economics of refinery location. India depends mainly on imported crude. This could in theory be refined in giant refineries in Bombay, and then distributed all over the country. But India has opted for the cheaper route of several refineries to serve different states. Let us return to our original question: should Reliance and public sector oil companies build export-oriented refineries? No, says the conventional wisdom: if Reliance wishes to supply products to Europe or the US, it should set up refineries in those regions. Instead, Reliance has opted to export to these markets from a refinery in Gujarat. Why? The company gives several reasons. First, it has a comparative advantage in building large projects rapidly and cheaply. It reckons it can build a refinery in India at two-thirds of the cost of building one in Europe or the USA. Second, salaries and operating costs are lower in India. Third, Indian corporates can now get international finance at low interest rates, ending the earlier financial disadvantage of locating in India. Fourth, tough environmental standards impose additional costs on refineries in western countries. The US, for instance, insists that all tankers should be both double-bottomed and double-hulled (to avoid accidental oil leakages), whereas tankers touching India (and much of Asia) have to be double-bottomed but not necessarily double-hulled. Fifth, the Gulf of Kutch is deep enough to permit the berthing of large product carriers of up to 130,000 tonnes capacity. These still have a freight disadvantage compared with VLCCs, but the disadvantage is much less than for old-time product carriers of 30,000 tonnes. Big product tankers can load different products in different compartments, and so can unload say petrol at one location and diesel at another, overcoming the problem of small receiving terminals. Sixth, Reliance has built a complex refinery that can crack low-quality crudes profitably. It can also refine a wide variety of crudes, and this enables Reliance to trawl the market, seeking crude varieties that are cheap in relation to the products they yield. The refinery is flexible enough to switch from one crude variety to another, giving it a profit advantage over conventional refineries designed to process just one or two varieties. This will be even more true of its new export-oriented refinery, which will be designed to be even more complex and flexible. Reliance has long been exporting much of its output from its existing 33-million tonne refinery at Jamnagar, and proved that this is highly profitable. So, it can with confidence build a new export-oriented refinery in an adjacent Special Economic Zone, qualifying for tax breaks. Will a similar export-oriented strategy work for public sector refineries? I doubt it. Unlike Reliance, public sector companies do not build fast and cheap: they often suffer cost and time overruns in building projects. They lack the managerial nimbleness to switch from one crude variety to another, as Reliance does. Large product tankers can be berthed in the Gulf of Kutch, but not at the public sector refineries at Bombay, Mangalore, Haldia or Kochi. So, public sector oil companies would be well-advised to stick with the conventional wisdom on locating refineries near consumption points. They should stick to refineries catering to domestic consumption. A recent EIL study suggests that public sector refineries should set up capacity for cracking low-quality crudes, and this makes sense. But export-oriented refineries make sense only for exceptional companies that can defy the conventional wisdom. Reliance can claim to be one of them. Alas, IOC, BPCL and HPCL cannot.