Presentation on theme: "0 Mr. S.V.Narasimhan Director(Finance) Indian Oil Corporation Ltd Refining Outlook and Risk Management."— Presentation transcript:
0 Mr. S.V.Narasimhan Director(Finance) Indian Oil Corporation Ltd Refining Outlook and Risk Management
1 Presentation Covers…. Refining Outlook Features of oil refining Refining capacity utilization Capacity addition vs demand Risk Management Need for Risk Management Hedging tools and markets Practical considerations
2 Oil Refining – Defining features Capital and Technology intensive Long gestation period Large investment needs: To meet rising demand for oil Spec changes for modern engines & environment issues Transport fuel the drivers – need for upgrading bottom of the barrel Low margin – occasional cycles of boom Investment - a risky proposition
3 Singapore: Gross Refining Margin (Dubai) Prolonged periods of low, even negative margins Considerable volatility in the margins from month to month Occasional boom serves to tide over long periods of poor margins Domestic pricing policies restrict oil companies much needed margins to fund future expansions,quality upgradation projects, etc Source- IEA Occasional boom
4 Global refinery utilization rate Source:BP In last 5 years, despite refining capacity additions, utilization rates soared to new highs. Effective utilization rates exceeded 95% at times considering planned and unplanned shutdowns.
5 Planned refinery additions( mid 2008-end 2009) CompanyLocationAdditional capacity (kbd) Expected completion SinopecQingdao, China 201Jun’08(commissioned) PetroChinaDushanzi, China 104Q3’08 PetroChinaDalian, China 150Q4’08 CNOOCHuizhou, China 240Q4’08 OthersGlobal 3892008 2008 Total1084 Reliance PetroleumJamnagar, India 580Q109 SinopecFujian, China 161Q109 Dung Quat RefineryVietnam 130Q209 SinopecTianjin, China 150Q409 OthersGlobal 4092009 2009 total1430 Grand Total (2008-09)2514 Source: Goldman Sachs
6 Refining additions Vs. Demand- 2001-12 Source: BP,Goldman Sachs and PEL During 2002-07, Refinery capacity additions lagged demand, leading to high margins/prices. Refining capacity additions to exceed incremental demand over 2008-2012, pointing towards softening margins (million barrels per day) Trend reversal Substantial refining capacity additions - 2008 onwards
7 Refineries’ Dilemma : To build or not? Build capacity Risk of unsustainable margins Delay capacity additions Loss of opportunity Risks to Refining investments: Demand growth uncertainty, particularly transport fuels Light/Heavy differentials and sweet/sour differentials NOC structure of Asia– not geared purely to economics – can lead to overcapacity Derivatives available to mitigate risk of poor economics.
8 Indian Refiners:Need for Risk Management Existing refineries Extreme volatility in refining margins Under-recoveries from domestic products sale Customers seeking fixed prices Fluctuation in inventory valuation New Refinery Projects Over capacity- weak margins High investment – poor returns Competition in international market for export oriented refineries RBI regulations: Permits hedging of risks to existing refineries like margins, inventory, domestic product sales, etc. Hedging of new refinery projects not permitted
9 Smoothens/reduces revenue volatility for existing refiners Facilitates remaining within budget Enables judicious deployment of funds, thereby ensuring timely project implementation Protect against price spikes Flexibility to hedge limited volumes allowing to tap market opportunities for remaining volume Exit possible under unfavourable circumstances Risk Management - Advantages
10 Markets for hedging MARKETS PETROLEUM EXCHANGES 1. NYMEX, NEW YORK 2. IPE,LONDON 3. TOCOM, TOKYO 4. DME,DUBAI 5. MCX/NCDEX, INDIA OTC MARKETS 1. SINGAPORE 2. LONDON 3. NEW YORK
11 Dubai Forward price volatility:Q308 Final settlement price for Q308:$113.48/bbl Source: Morgan Stanley, Platt’s
12 GO vs Dubai Forward price volatility:Q308 Final settlement price for Q308:$25.7/bbl Source: Morgan Stanley, Platt’s
13 Hedging tools available for Refiners Refining margins hedging Options and swaps Individual Crack spreads Composite refining margins Inventory hedging Options and swaps Crude oil Products
14 Refiners hedging (illustration) Hedging assures fixed margin Mechanism of hedging margin: Margins go up: Higher revenue on physical sales offsets outgo on derivative contract. Margins go down: Lower revenues on physical sales offset by inflow on derivative contracts Domestic price controls: Higher margins not realised on physical sales but cash outgo on derivatives occurs. This poses additional risk. Hence, need for a consistent and transparent policy. Naphtha: 15% (Sell 150 bbls) Kerosene: 15% ( Sell 150 bbls) HSFO 20% (Sell 200 bbls) Crude 100% Buy 1000 bbls Refinery Margin hedging- Illustration Crack ratio is based on product pattern of the refineries Gasoil: 50% (Sell 500 bbls)
16 Put Option- Gasoil vs Dubai (illustration) Premium-$3/bbl Strike Price: $25/bbl, Premium : $3/bbl Strike-$25/bbl
17 Hedging practice – Oil companies S.NoCompanyPractice (As per trading sources) 1Shell20%(appx) 2Nippon Oil(Japan)Only export volumes are hedged 3Suncor(Canada)40% hedged. (Opportunity loss - USD 100 million, decided not to renew hedges) 4ValeroNot significant volumes 5Kerr McgeeOil production: 80% Hedged 6Cosmo Oil50% max (Actual volumes hedged are lower) 7Idemitsu50% max (Actual volumes hedged are lower) 8Amerada HessOil production: 70% Hedged (Reported opportunity loss of USD 1.05 billion in 2004) 9BPNot significant volumes 10ExxonExxon does not hedge. Oil companies follow diverse hedging strategies, but volume is typically limited unlike end users who hedge large volumes.
18 Hedging activity – Refiners in SE Asia S.NoCountryRefineryRisk Management activity 1KoreaSK Corp, KNOC, Hyundai OilActive 2ThailandPTT (NOC)Active 3MalaysiaPetronas (NOC)Not so active. 4IndonesiaPertamina (NOC)Not so active. 5TaiwanCPC (NOC), FormosaActive 6JapanIdemitsu, Nippon Oil, CosmoActive 7ChinaSinochemActive As per trading sources
19 Practical considerations- Steep backwardation When Gasoil/Dubai spot cracks were at record high of $42.67, Q-4-08 and Q-1-09 were available at $6.6/bbl and $7.7/bbl respectively higher than the spot level. Such Backwardation present a serious dilemma for the hedgers! Source: Platt's, Morgan Stanley
20 Practical considerations -Steep contango When Brent spot price was at $86.69/bbl on 16 th Sep 08, Q-1-09 and Q-2-09 were at $94.81/bbl and $96.26/bbl respectively viz. almost $8.1/bbl and $9.6/bbl higher than spot price. Such sharp contango present a serious dilemma for the hedgers! Source: Platt's, Morgan Stanley
21 Practical considerations: When to hedge Source:Morgan Stanley 31/7/08 15/9/08 15/7/08 15/8/08 Forward prices changed dramatically in a span of few days. Timing of entry is crucial – Yet no scientific way to time the market
22 Practical Consideration: Options premium Premium Level for WTI call options (as of 3 rd Oct 08) Strike ($/bbl)Premium ($/bbl) Dec’08 93.07.37 95.06.39 98.05.22 Jun’09 94.013.65 96.012.81 99.011.63 Dec’09 96.016.13 98.015.32 101.014.17 Buying Call Options ‘At the Money(ATM)’ or ‘Out of the Money’(OTM) involve significant premium payout. Source: NYMEX
23 Risk Management Policy – Key issues Volume limits Corporates should have clearly defined volume limits, based on the risk appetite. Tools Swaps: To ensure a pre-determined price. Options: Call: Caps maximum price(Buyer of crude/products) Put:Ensures minimum price(Producer/Refiner for margin) Collar:Combination of call & put to limit premium Tenor Based on the risk appetite. Prompt positions prone to significant volatility. Hence, positions at back end of curve preferable. Hedging/ Speculation Short term entry and exit are speculative in nature. Need for clear policies on holding position till maturity.
24 Risk Management Policy – Key issues Counter- Parties Criteria: Sound financial standing, experience, trade/bank references, credit rating, etc. Market OTC: Based on exposure of crude oil/products Singapore market relevant for Asian crude oil/products Overseas Exchanges: Brent and WTI crude oil Products like Gasoline, Heating Oil, Gasoil, etc. Approving Authority Need for clearly defined authority for approving deals Trading procedure Competitive basis through bid/offers from 3-5 parties or more is desired. Controls Daily Mark to Market report, segregation of duties between Trading and Settlement functions, audit, etc essential
25 Risk Management - Adequate Controls Prudent Risk Management strategy is essential. Systematic reconciliation of internal transaction/positions Periodic reporting to Board, Management and regulatory agencies Euro 5 billion(approx) loss. Failure of internal controls and faulty reporting systems. Societe Generale (2008) $81 million loss. Inappropriate trading and reporting Mitsui (2006) $ 550 million loss. Resulted from selling Options & faulty M2M reports $ 6 billion loss. One of the biggest collapses in Hedge fund history China Aviation Oil (2004) Amaranth (2006) Derivative Disasters
27 US Gulf Coast(USGC) -Gross Refining Margin (Brent crude) Source- IEA Prolonged periods of low, even negative margins Considerable volatility in the margins from month to month Occasional boom time serve to tide over long periods of poor margins Source- IEA
28 North West Europe - Gross Refining Margin (Brent crude) Source- IEA Considerable volatility in the margins from month to month Occasional boom time serve to tide over long periods of poor margins Source- IEA
29 High volatility in prices: WTI (2007-2008) YearDaily Change ($/bbl) AvgMax 20060.9 4.4 20071.1 4.4 20082.3 16.4 Source: Platt's
30 Dubai Forward price volatility:Q408 Source: Morgan Stanley $/bbl
31 Trading on Exchanges – Some issues NYMEX and ICE are the major energy international exchanges. Use of exchanges involves huge basis risk During the period Jan’07 to Sep’08, Brent dated and ICE Brent showed a strong positive correlation of 0.93. Actual ICE Brent vs Brent (Dated) differential showed substantial variation viz high basis risk Source: Platt’s
32 Risk Management – To summarise India Specific Exposure of Indian companies essentially to Asian oil and petro-products NYMEX and IPE are major petroleum exchanges but do not have liquid Asia specific commodity contracts. No AG related derivative contracts – Singapore market used as proxy. Universal Does not ensure best margin – Only predetermined margin can be hedged. Options hedging involves substantial costs Backwardated markets – can lock into lower margins than currently prevailing Timing of entry – crucial in margin that can be locked into