SAUDI ARABIA - Saudi Arabia's Oil Refining Sector Is Upgraded, But Expansions Face Rising Costs.

Most of state-owned Saudi Aramco's seven oil refineries in the kingdom have been upgraded to produce premium fuels. Some of them are being upgraded further and expanded through integrated mega-projects involving massive petrochemical plants in JV with international oil companies (IOCs) or major producers of plastics such as Dow Chemical of the US. Their refining capacity at present is 2.2m b/d. But plans to build new refineries to raise the total capacity to 3.8m b/d by 2012 are being questioned in view of rapidly rising project costs since 2002. IOCs brought in or being approached as partners in new projects are hesitating.

Saudi Aramco has been looking for IOCs to build heavy conversion refineries, to turn heavy/sour crudes into light fuels to be on stream by 2011/12. World refiners reject offers of Arab Heavy (AH) crude because it is difficult to turn into light products such as high-quality gasoline, gasoil/diesel and jet fuel.

Project costs have risen more than three-fold since 2002 and the Arab Gulf Co-operation Council (GCC) region, of which Saudi Arabia is the leader, has been affected by a global financial crisis (see news14-GCC-FinanceProjectCostsOct1-07).

Moved by a lack of global refining capacity and soaring domestic demand, Saudi Aramco is in a hurry to prove it can deliver its bold plan to raise the output of premium fuels and petrochemicals in the next five years (see survey of the Saudi petro-chemicals sector in DT 15 for projects involving SABIC and Saudi Aramco and in DT 16 for projects involving the Saudi private sector). Now the kingdom has five new refining projects, including one integrated mega-project to cost up to $26 bn, but there are question marks over three of them in view of the rising costs and resultant risks of low returns on investment.

MEED on June 29, 2007, quoted Alan Gelder, vice-president for downstream oil at energy consultant Wood Mackenzie, as warning: "Refinery capacity expansion consistent with demand growth will lead to reasonable refining margins, but a binge of over-expansion may drive margins down to modest levels of the past". It quoted Abdul Aziz al-Khayyal, Saudi Aramco's senior VP of refining, marketing and international as acknowledging the future of the refining business could unfold in three different ways, and each will have a huge impact on his company's plans. The first is that margins may vary from year to year, but will generally follow a downward trend and return to their historically low levels, plunging the business case for the new refining capacity into uncertainty. Proponents of this view argue the industry is over-investing, having forgotten the over-capacity lessons of the past and being cast under the spell of today's attractive margins. The second holds that fuel demand growth worldwide will remain strong, that investors have learned their lessons and will act prudently and that the days of perennial over-capacity are over.

In the third - less risky scenario - consuming nations with high demand growth or private firms operating in those countries will continue to invest aggressively in refining as margins remain relatively high. Saudi Aramco is hedging its bets on this. Khayyal was mindful that, to take advantage of growing demand, the industry will have to expand tanker tonnage to export more crude oil and refined products from the Gulf region. He pointed to a range of hurdles which had made it difficult for new ship deliveries to keep pace with demand, including soaring new ship prices and freight rates peaking over the past two years as shipyards around the world operate at full capacity. He added that the shipping industry must enhance its capabilities if new refineries were not to be economically disadvantaged by the traditionally higher cost of transporting refined products, saying: "This means we are likely to see the emergence of a significant trade using very large product carriers - perhaps as large as two million barrels a ship - to export refined products out of the Middle East to an energy-hungry global economy".

From 1989 to 2004, no new major refineries were announced in Saudi Arabia, mainly due to a lack of international demand and unfavourable market conditions (see background in down14SaudiRefOct3-05). But it is not alone. In the US, the situation is even more stagnant, with new grassroots refinery built there since 1976 - despite being the world's largest energy consumer, while its gasoline consumption is soaring.

With unlimited appetite for global expansion, Saudi Aramco has come to realise it is in an enviable position with ample feedstock and swelling coffers, thanks to record oil income. And there is no shortage of international investment opportunities. According to the IEA, about 9m b/d of additional refining capacity over current levels will be required globally by 2010, rising to 223m b/d of incremental capacity by 2030.

As a result, Saudi Aramco executives estimate the company is now engaged in about 25% of all of the announced plans for world refining capacity increases. In May 2006, Saudi Aramco signed a JV agreement with Total to build a 400,000 b/d heavy conversion refinery in Jubail, on the Gulf coast, at a then estimated cost of about $6 bn, to start up in 2011. In the same month it signed a JV deal with ConocoPhillips for a similar 400,000 b/d plant at Yanbu' on the Red Sea coast. Under both deals, Saudi Aramco and Total will hold 35% stakes in the Jubail JV, with a similar shareholding between it and ConocoPhillips. The remaining 30% in each of the two JV are to be offered to local investors through IPOs. Since then the Petroleum and Mineral Resources Ministry has launched a 250,000-400,000 b/d refining JV to be built at Jizan, on Saudi Arabia's south-western coast. Although Saudi Aramco has not joined this JV, with the ministry having short-listed five IOCs to negotiate the partnership terms, major IOCs like ExxonMobil and Chevron refused to join the project.

All three projects, however, have since become problematic. Each of the Jubail and Yanbu' JVs now is said likely to cost over $13 bn, more than double the May 2006 estimate. The Jizan JV is estimated to cost between $7-12 bn. So the IOCs involved in the three JVs have delayed making a final investment decision and, as a result, project costs are likely to rise further in the coming months.

After a recent submission of developer's prices to build Saudi Arabia's first private refinery at Jizan, the ministry expects the venture to have a 250,000 b/d capacity. It has received five bids for the concession to build and operate the plant. 'Abed al-Sa'doun, an adviser to the ministry, was on Sept. 28 quoted as saying the decision over the capacity will be taken by the IOC which will win the licence. But he said the plant was likely to have a 250,000 b/d capacity.

The ministry in July took the unusual step of listing pre-qualified firms before being sure potential interest from the firms themselves. The five bidders are Reliance Industries of India, China National Offshore Oil Corp. (CNOOC), Petrobras of Brazil, Petronas of Malaysia, and Formosa Petrochemical Corp. of Taiwan. Sa'doun said Saudi Aramco was still a potential bidder after being pre-qualified for the project. The refinery is to be part of an "economic city" in the Jizan region.

After completing half the engineering on Yanbu', ConocoPhillips in September decided to pause and reflect, as the cost now was put at over $13 bn. The engineering is being done by Kellogg Brown & Root (KBR) which is to finish its work in the spring of 2008. At the new price, the JV's rate of return is too low for it to be commercially viable. Even Saudi Aramco, which depends on this project as well as its twin at Jubail to justify development of a field to produce 900,000 b/d of heavy crude by 2011/12, is hesitating; it has delayed work on the field (see gmt14SaudiFieldsOct1-07).

The 400,000 b/d JV with Total as reached the tendering phase for it five main process packages as front-end engineering and design (FEED), done by Technip, nears completion. Michel Benezit, Total's president of refining and marketing, in September was quoted as saying: "we are on schedule, either at the end of the year or at the beginning of 2008, to take the final investment decision". Technip's FEED will determine costs, configuration and other details, as well as the investment decision.

MEED on Sept. 21 quoted "industry observers" as saying that, with the Jubail refinery being so similar to its Yanbu' counterpart, "it is inevitable...the same questions will be asked about its commercial feasibility". MEED added: "While nobody wants the two...projects to be abandoned, the potential is there for that to happen. If one or both of the schemes are stalled, it will naturally be a huge blow for Riyadh..."

Tender documents are done for the Jubail JV's two crude oil storage tank packages. More than 12 local and international firms have submitted expressions of interest in the two lump-sum engineering, procurement and construction (LSEPC) contracts. Together they are to total about $800m. Invitation to bid documents are to be issued by end-2007, with an award expected by end-March 2008. The work covers construction of 88 storage tanks, with a total capacity of more than 2.6 MCM. A tender is to be issued by end-October for the refinery's marine works package, which calls for the dredging of a 60-hectare area - reduced from the originally envisaged 120-hectare area - to increase storage capacity for oil products. Five international groups have been prequalified for the $300m job. Prequalification applications were due on Sept. 20 for the five main process packages, with tenders for each to be issued by end-2007. The packages cover an aromatics unit, a conversion unit, a distillate and hydrotreater package, a coker unit, and a plant, utility and main pipe rack package. An award is expected in the second quarter of 2008, with production due to start in the first half of 2012.

Saudi Aramco has been able to produce large amounts of light crude oil, the most attractive grade for refiners on both sides of Suez. But with many of its fields ageing, the kingdom has had to start producing large amounts of heavier grades as it looks to increase production and stem declines of up to 500,000 b/d. To do this, Saudi Aramco wants to increase production capacity to 12.5m b/d by 2009 and 15m b/d by 2015 as part of a $130-150 bn programme. A lot of this additional crude will come from expansion of Arab Light (AL) producing fields. Beyond that however, the potential of more AL output from known deposits is exhausted (see omt14SaudiFieldsOct1-07).

Key to this plan, as well as to the two 400,000 b/d refineries, is the offshore Manifa field. Located south-east of Safaniya, the field was first brought into production in 1964 by drilling eight wells. Saudi Aramco hopes to produce 900,000 b/d of AH from the field by 2011. AH could also be produced from the Zuluf and Marjan fields (see gmt14SaudiFieldsOct1-07). But with only limited existing refining capacity capable of processing AH, Saudi Aramco has been banking on the four new refineries. Should the crucial extra refining capacity fail to materialise, Saudi Aramco and its overseas units will find it difficult to market the additional AH (see omt15SaudiExprtOct8-07).

At the same time since 2006, Saudi Aramco has signed deals for overseas refining JVs in South Korea through S-Oil Corp, in the Philippines with Petron; in the US via its Motiva JV with Shell, and in China and elsewhere with Sinopec and ExxonMobil - in the latter case the JV is to be an integrated mega-refining/petrochemicals project. Oil Minister Ali al-Na'imi on April 6, 2005, said American investors had refused a Saudi offer to have two 500,000 b/d refineries built in the US at a meeting in Dallas a year earlier. He said US investors had rejected the offer because they would have to pay $100m for paperwork and other expenses to get a permit for the plants. No refinery has been built in the US since 1976 (see survey of Saudi overseas investments in OMT 16).

Khayyal said: "Given Saudi Arabia's geographic location, the US can be an appropriate market for our gasoline, Europe and China could be attractive markets for diesel, while the Far East in general may offer other attractive export opportunities, depending on market circumstances and future patterns of demand". The Saudi Arabian General Investment Authority (Sagia) says the planned expansion in the kingdom's local refining capacity is justified even as the costs have risen sharply since 2002.

Khayyal said crude oil quality was diverging regionally, turning especially heavy in the Americas and in the Middle East. He said: "It is our hope that an optimum level of conversion and hydro-desulfurisation capacity will be built in the coming years, which would certainly go a long way in helping the industry better match product demand with the crude supply mix".

MEED quoted Khaled al-Bu'ainain, Saudi Aramco VP of refining, said investing in refining for low-cost AH will give the company a competitive advantage, adding: "Regardless of their location, refineries with the ability to utilise low-cost...heavy crude could come out ahead, despite their need for higher capital investment". As part of the equation, Saudi Aramco adopted the strategy to embrace downstream integration into petrochemicals with some of its projects, including a new 400,000 b/d Ras Tanura "East Coast" plant. Khayyal said: "Such integrated facilities will form the cores of new economic clusters to include appropriate downstream, value-adding industries and necessary service industries. This strategy will...help maximise the kingdom's competitive advantages of low energy costs, vast mining potential, a central geographic location, and existing industrial and transportation infrastructure". Other advantages of such integration would include upgrading low-value fuels to higher-value chemicals, sharing common infrastructure such as utilities, an efficient management of joint energy costs and spreading support and administrative service costs.

Although cautious about the market, Wood Mackenzie's Gelder said Saudi Aramco had wisely deployed the integrated refinery model, noting: "The first time they did it was for PetroRabigh [refinery] and it has proved to be a complementary model".

Saudi Aramco realises there is more to the equation than simply building capacity and recognises the cyclical nature of the business. Bu'ainain said: "Past experience with refining capacity expansion announcements have proven that not all the capacities...will be built. The fate of projects beyond 2011 will be determined to a great extent by the performance of the industry in the coming few years".