Platts: Russia's refining sector bounces back in H1 but future uncertain

Jul 7, 2017

FEATURE: Russia's refining sector bounces back in H1 but future uncertain
Moscow (Platts)--7Jul2017/1237 pm EDT/1637 GMT

     * Energy ministry expects refining throughput flat, analysts see a rise
     * Average 2017 refining margin estimated at $3/b-$4/b
     * Domestic refining netbacks above export netbacks
     * But export duty 'subsidy' looks vulnerable

Russia's refining sector has seen a pick-up in the first half of the year compared with the dire state it was in a year ago, and expectations are that the rest of the year will continue to show stronger economics, although estimates of processing volume dynamics and margins diverge.

The first half of the year saw a rise in processing but Russia's energy ministry expects primary refining for the full year to be flat at 280 million mt (5.62 million b/d), because it sees refining margins holding at comparatively low to historical values.

"Refining volume is higher than last year but the margin raises questions," Russia's deputy energy minister Kirill Molodtsov said last month. "The margin has improved on the year, but it isn't what it used to be two and a half years ago."

So far this year margins have been well above the negative figures of the second quarter last year, and in the first six months of the year the country's primary refining throughput rose by 1.2% year on year to 137.4 million mt, with a notable jump of 2.3% on the year in June, according to energy ministry data.

In contrast to the ministry, and despite an expected 0.2% year-on-year cut in Russia's crude output -- which is expected to stabilize at 10.947 million b/d this year as a result of the OPEC/non-OPEC deal -- some analysts are forecasting a slight increase in refining throughput, driven by higher netbacks for domestic processing.
    
MODERNIZATION MOMENTUM

The energy ministry said in June it expects exports to grow by 0.9% on the year -- a slowdown from the pace of the first six months, when exports outside the Commonwealth of Independent States rose by 4% on the year.

But with Russia's secondary refining capabilities on the rise due to the ongoing country-wide modernization program, exports may give way to domestic refining this year, Grigory Vygon, head of independent Vygon Consulting, told S&P Global Platts.

"The modernization rides the momentum, capacity is increasing and has to be loaded. Despite the fact no new primary refining capacity has been introduced since 2015, growth continues on the back of secondary refining," he said, adding that he expects a rise in Russian refining throughput this year.

"There is the principle of domestic market priority. If refining netback exceeds crude export netback, refining takes priority. So those 300,000 b/d are taken out of export," he said, referring to the volume of Russia's crude output cut from October levels under the OPEC/non-OPEC deal.

The domestic refining netback was 15% higher than the crude export netback in the first quarter of this year, at $38/b, according to Lukoil, one of Russia's leaders in terms of refining complexity.

"So far, refining at our own plants and the sale of oil products in Russia has been a more attractive crude outlet than exports. This year, most likely, our plants will be fully loaded," Lukoil's director of capital markets, mergers and acquisitions, Pavel Zhdanov, said in June.

The expected refining boost comes despite a forecast decline in the company's crude production this year, and is driven by the company's refining margin being above Russia's average, he said.
        
SUBSIDIZED MARGINS

Russia's taxation system ties refining margins in tandem with the oil price, so if oil prices were to rise in the second half of this year, it may trigger further refining growth due to higher subsidy.

This year, Russia's average refining margin of $3/b-$4/b based on various estimates is higher compared with sometimes negative margins last year, but it is largely the government subsidy -- in the form of export duty -- that keeps processing economics propped up, analysts said.

Any further refinery sector expansion is doubtful at this point with the finance ministry advocating for the removal of subsidy, which would make refining largely uneconomic at current prices, said Vygon's chief economist Sergei Yezhov, adding that it is only the matter of time until this move is implemented.  

"The finance ministry wants to remove it every year. So far, they are just threatening, but everyone understands that in some foreseeable future, this will change," he said.

The consultancy estimates the average refining margin at $3.4/b and the subsidy at $4/b-$5/b depending on the plant complexity, which makes the average plant loss-making without the subsidy, he said.

"So average refining is loss-making, except for the best plants. Building new plants in this situation requires the understanding that this subsidy will remain in place, which the state, however, doesn't want to pay." he said.

Downstream subsidies account for 11%-24% of the oil sector's EBITDA at an oil price of $50/b, according to VTB Capital calculations.

Although the situation has improved for refining compared with last year, the sector remains far from the prosperous days in the years before the oil price collapse and the introduction of the "tax maneuver."

"The combination of the tax maneuver and the drastically reduced oil prices has resulted in a macro environment in which the once highly profitable and cash generative downstream has become less and less lucrative," VTB Capital analysts said. "We see refining throughput recovering a slight 0.6% year on year," they said.
    
PETROCHEMICAL OPTIONS

Given the situation, companies are looking at alternatives. For instance Rosneft, Russia's top producer and refiner, is reorienting its efforts to petrochemicals in a bid to improve downstream economics, its CFO Pavel Fyodorov told analysts last week, according to a note by Aton.

"The company will focus on maximizing margins that will be accomplished via expanding the petrochemical business (up to 20% of refining capacity), optimizing its refining operations by cutting losses, reducing maintenance time and service intervals, and increasing the share of premium sales channels along with the creation of regional hubs," Aton said following the meeting.

The company's Q1 Russian processing volumes dropped 5% on the quarter to 23.7 million mt, while rising by more than a third due to the acquisition of control in Bashneft last autumn.

Gazprom Neft, which has some of the most advanced plants, will also pull down the country's overall throughput, as it expects a 14% drop in processing volumes to 36.1 million mt this year after the lengthy maintenance at the Moscow refinery between January and mid-April, which took its refining margin below Russia's average to $2/b at the start of the year, the company said.

Surgutneftegaz also plans to cut processing volumes by 1.6% on the year to 18.2 million mt this year at its only refinery, a volume its general director Vladimir Bogdanov last week called "optimal" in the current environment.

Nastassia Astrasheuskaya, nastia.astrasheuska@spglobal.com
Alisdair Bowles, alisdair.bowles@spglobal.com