The art of refining a crude

Nov 26, 2001 01:00 AM

by Anna Raff

Little of Russia's vast oil wealth ends up in the nation's gas tanks. But, with crude prices increasingly unstable, the oil industry is no longer ignoring opportunities lurking downstream, and competition for refineries and gas stations is heating up. Simon Kukes, president of Tyumen Oil, calls it his weakness. An eight-story column trimmed with a maze of tubing and red railing towered above a group of dignitaries and TNK's Ryazan refinery employees on a cold and wet morning earlier this month.
Everyone had gathered to celebrate the completion of this new catalytic cracking unit, whose purpose -- as Kukes so wryly explained it -- was to "break big molecules into little ones." This step in the refinery's upgrade is a crest in what looks to be a wave building up in Russia's downstream sector, which is the refining and distribution of crude oil.

Even during Soviet times, Russia's strength was in the upstream -- exploration and extraction -- segment. Because personal automobile use took a backseat to the country's military and industrial demands, government officials didn't make deep refining a priority. Crude exports supplied the Soviet Union with hard currency, and most of the complex refining took place in Europe.
Russia's refining and distribution capabilities were neglected as overall industrial output fell in the 1990s. billions of dollars in investment are needed to make Russia's refining competitive, a disadvantage illustrated by a long-standing industry adage: It's cheaper to export crude and import refined oil products than to do the refining at home. This is what experts call "negative value." Over the past 10 years, there has been a change in the refining slate, or the % different kinds of crude products make up of total output, said Valery Nesterov, an analyst with the Troika Dialog brokerage.
"In the mid-1990s, the government tried to engage the industry," Nesterov said. "And then realized that refining should be a private sector affair. But the government is still pro-active." For example, the Finance Ministry provides guarantees to Russian companies that use foreign firms and banks to modernize refineries.

The high oil prices of the past two years have deepened oil majors' pockets, and with narrowing profit margins in crude production, companies are looking downstream to diversify and offset the risks of a crude oil price plunge. Multimillion dollar refinery upgrades and plans to build new plants may soon make this "negative value" positive.
TNK's refinery upgrade has attracted the most attention because much of its financing comes from a $ 500 mm credit line granted by the US Export-Import Bank. In 1999, then-Secretary of State Madeleine Albright blocked the loan package from going ahead after oil major BP and TNK had a falling out over the Chernogorneft production unit. The nine-year loan was eventually approved in April 2000.
"American taxpayers can sleep well knowing that their loan is safe with us," Kukes said. Refinery renovation is estimated tocost $ 394 mm, $ 241 mm of which will come from ExImBank loans. Refineries are graded on their conversion rate. Before the new cracking unit, the Ryazan refinery had a crude oil conversion of 59 %. This means that for every 100 barrels of crude oil that goes in, 59 barrels comes out. The conversion rate will increase to 68 % with the new unit and to 82 % by 2003 after addition construction.

While the addition of the catalytic cracker will transform the Ryazan refinery from an average Russian refinery to an average European refinery, it still trails behind Sibneft's flagship Omsk refinery, which analysts consider to be Russia's most modern. The race to modernize is on, and at stake are Russia's fledgling consumer market and -- perhaps -- Europe's. In October, LUKoil strengthened its grip on the Volga region when it acquired 86 % of the Norsi Oil holding, including the 35,000 bpd Norsi refinery, in a privatisation auction.
LUKoil won Norsi for $ 26 mm, a price industry analysts called cheap despite Norsi's debts of 6 bn roubles (about $ 200 mm). Sibneft was the only other contender, and soon after the envelopes were opened, some assumed that LUKoil had cut a deal with its rival.
The details of that deal became clear, when Sibneft said it was close to completing an acquisition of LUKoil's downstream operations in the Moscow region. According to the investment bank United Financial Group, this includes a 40 % stake in the Moscow refinery as well as a 45 % stake in Mosnefteproduct, the successor to the Soviet oil marketing monopoly.
"The Moscow refinery -- although not very sophisticated -- is favourably located in the most lucrative domestic market," UFG said in a research note. "Even though the plant does not deliver as high netbacks as Sibneft's Omsk refinery, it is the best refinery Sibneft could buy." LUKoil has yet to confirm this information. In turning its attention to Central Russia, LUKoil announced that it would invest "substantial sums" in the Norsi refinery.
As well as being Russia's largest producer of crude, LUKoil is also the largest refiner with a throughput of 32 mm tons in 2000.

As both independent and oil company-owned refineries rush to upgrade their facilities, foreign companies are offering technology and advice. Shell Global Solutions and Germany's Sued-Chemie won a tender last month for the reconstruction of the Far East Khabarovsk refinery, estimated at less than $ 10 mm.
In this case, the foreign firms offered the best "quality for the price," said Renat Khuramshin, the refining director at the Alyans group, which owns 52 % of the Khabarovsk refinery. "The market dictates its own conditions," Khuramish said. The project -- which aims to increase the refinery's output of high-octane gasoline is expected to financially justify itself in five years.
Alyans concedes that its hand was forced by Rosneft, whose competing refinery in the Khabarovsk territory added a catalytic reforming unit in April. Catalytic reforming is a process used to produce high-octane gasoline. Built in 1942, the Komsomolsk plant is gunning to become the biggest and most efficient refinery in the Far East with Rosneft's planned $ 678 mm overhaul to be completed in 2004. The refinery's current conversion rate is 60 %, and the company says that is set to reach almost 100 % once the expansion is completed.
Rosneft has plans to bring all phases of refining up to Western standards. This includes hydroprocessing, which further breaks down hard-to-get-to heavy oil components under high pressure and temperatures of about 350 degrees Celsius. "By the time this refinery is done, it will be the most modern in Russia, unless, of course, Surgutneftegaz doesn't beat us at Kirishi," said Rosneft president Sergei Bogdanchikov.

Russia needs billions of dollars to make its oil refining industry competitive and is increasingly looking to foreign companies for their technology and advice. With $ 4 bn in cash sitting on its balance sheet, Surgutneftegaz has been criticized for not using its resources toexpand the company. After losing a string of government tenders for oil field development, Russia's third-largest oil producer has turned to refining. But the benefits will be mixed at best.
The Kirishi refinery is located only 320 km from the Estonian border, making crude or fuel oil shipments to European refineries cheap because of low transport costs and leading some analysts to believe that the modernization of Kirishi will add little value to the company.
Last December, Surgutneftegaz awarded the modernization contract to ABB Lummus Global, which also was general contractor for TNK at Ryazan and for the Nizhnekamsk refinery in Tatarstan. The plans call for a $ 800 mm hydrocracking unit that, once built, will be the first of its kind in Russia. During this first stage, scheduled for completion by 2004, Kirishi's conversion rate will reach 75 %, and it will produce 60,000 bpd of light oil products. Light oil products will increase from 46 % to 62 % of the refinery's output.
Surgutneftegaz president Vladimir Bogdanov says Kirishi "will be the biggest refinery in Europe," no small claim for a company whose strengths lie in the upstream. In addition to the hydrocracking unit, Surgutneftegaz plans to construct a $ 500 mm catalytic cracker.

Refinery modernizations are sweeping the country because oil companies have realized that their product mix -- favouring heavier products such as fuel oil -- doesn't correspond to the needs of the markets and consumers.
Foreign oil companies such as BP, which has 33 gas stations in Moscow, have successfully made inroads to Russia's consumer market. "This network has more throughput per site than any other BP network in the world," said BP spokesman Peter Henshaw.
In August, the American oil giant Texaco announced that it wanted 20 % to 30 % of Moscow's gas station market in two to three years. Texaco, which has about 40,000 Star Marts, created a joint venture with TNK to produce motor oil as well as develop Texaco's distribution market in Moscow. "Investment will be comparable with BP's capital expenditure on gas stations -- between $ 1 mm to $ 4 mm each," Alexei Pavlyk, general director of the Texaco-TNK joint venture, said at the time.
Since then, however, Texaco has merged with Chevron to become ChevronTexaco, and all plans have put on hold while the new company evaluates its interest in Russia, Kukes said. Shell East Europe, a division of Shell, plans to open its sixth gas station in St Petersburg by year's end. Another 25 stations could be opened after a "careful analysis of all existing stations," said Steve Devon, head of Shell East Europe's representative office.

Russian companies have expanded abroad as well. No. 1 retailer LUKoil made waves last year when it bought 72 % of the US Getty Petroleum Marketing, which operates 1,300 gas stations along America's East Coast. LUKoil expects a profit of $ 26 mm from its US operations, which include 17 oil terminals as well as the Getty chain. Ralif Safin, head of LUKoil's Evropa Holding, said that this year LUKoil sold 4 mm tons of oil product in the United States, equivalent to 9 % of the US market.
And domestically, oil companies are expanding their distribution chain just as aggressively as their refining capacity. LUKoil wants to add 1,400 new stations to its existing chain of 1,100 already operating across Russia. Yukos this year allocated 5 bn roubles for marketing, some of which will be used to modernize a portion of the 1,200 gas stations it owns throughout Russia. In addition, Rosneft wants to establish a distribution chain in the Far East. During a $ 30 mm first stage, the company would build 35 to 40 stations in the Khabarovsk territory and would later extend its reach to the Sakhalin Island, Primorsk territory, the Amur region and the Chitin region.

Industry officials say there is still excess demand for quality gasoline that comes from a reliable brand. "Customers want to know that they can drive their car out of the station," said Vladimir Kapustin, TNK's vice president for refining.
After conducting an investigation titled "Alchemists," the Tax Police discovered that up to 25 % of Moscow's gasoline is of bootleg quality. Producers mix low-octane gasoline with chemicals to avoid excise taxes, and then sell it as high-octane gasoline at some stations. And some companies have had problems with foul play. In August, drivers who filled up at Slavneft's St Petersburg gas stations found later that the gasoline damaged their engines.
Slavneft paid for any damage done, and the company's security service later discovered that someone had tampered with gasoline as it was making its way from the Yaroslavl refinery to St Petersburg by rail. To have any hope of exporting oil products -- and not just oil -- to Europe, these and a myriad of other problems must be resolved. In a directive, the European Union has settled on tougher standards for gasoline and diesel, most notably in its reduction of the acceptable sulphur content.

Diesel and gasoline exported to the European Union musthave a sulphur level of not more than 50 ppm, and regulators are now considering lowering that figure to zero. Gosstandart -- one of Russia's regulatory bodies -- set the sulphur limit of Russian diesel meant for cars at 2,000 ppm, and if producers want their sulphur to be labelled "ecologically friendly," they must have no more than 50 ppm.
While Europe's standards might be just a little more stringent, the difference is in the execution. Many European countries have stopped selling leaded fuels. In Russia, only a handful of refineries have the capabilities to produce unleaded gasoline. Diesel, like gasoline, is sold bootleg.
TNK's Ryazan refinery will be able to produce European-standard fuels by the time its modernization is completed. But this petrol and diesel won't make it to the local market any time soon. Recently, a Moscow law that penalized buyers of low-octane gasoline through taxes was repealed, making gasoline cheaper overall with the expected effects on air quality.
This is typical, said Sergei Borisov, president of the Russian Fuel Association. The government levies excise taxes on quality refined products but doesn't stop the influx of bootleg gasoline. "This homemade gasoline first and foremost affects the environment," Borisov said earlier this year. "It's a plague. They throw out emissions that our chemists and ecologists can only guess and lead to mutations that they can hardly comprehend."

Source: Anna Raff
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