Upstream & Midstream
Weak oil prices have caused China’s domestic crude oil production to fall, settling at 16.76 million tons in May, as the major producers cut back on output. Most of Chinese’s production comes from mature oilfields in the north that were already declining, and with oil prices weak, there has been little appetite to invest in expanding production.
With domestic output dwindling, China has always looked abroad to secure crude supplies in the form of bilateral investment deals. The latest is with Nigeria, beset by saboteurs, which signed US$80 billion worth of oil and gas infrastructure deals with Chinese companies that will see China pouring money into beefing up the country’s entire energy grid, including pipelines, refineries and power facilities.
Saudi Arabia has cut its official selling price for crude in Asia, as well as the US, as it moves to compete with a growing supply of crude destined for Asia, particularly from Iran.
Indonesia and Iran will collaborate on the development of Iranian oil and gas fields, with two identified blocks as top priority, as Iran looks to stimulate foreign investment and Pertamina keen to secure more overseas upstream assets as part of its goal to expand its upstream output.
India has a mammoth new refinery planned on its west coast, a joint venture between the country’s big four state-run fuel companies – IOC, BPCL, HPCL and EIL. The US$30 billion project will include a massive petrochemical complex and unfold over several phases, aimed at easing the refining and distribution bottlenecks for the state companies in the populous west and south, where demand is strong.
The Balochistan refinery project in Pakistan appears to be back on track, as Pak-Arab Oil Refinery (PARCO) moves ahead with the US$5 billion, 250 kb/d project. a joint venture between Pakistan and the UAE governments.
Vietnam’s ambition to expand its domestic refining base from the sole Dung Quat site took another setback last week, as Thailand PTT indefinitely postponed its plans to build a US$20 billion, 400 kb/d refinery and petrochemical complex in central Vietnam, citing a need for ‘prudence in these challenging times.’
Middle East tensions are threatening to derail a planned US$4 billion merger of Japanese oil giants. Idemitsu and Showa Shell have been in talks to tie the knot, but their allegiances with crude suppliers may be too ‘inappropriate’ for the merger to go ahead; Idemitsu has close ties with Iran dating back to the 1950s, while Showa Shell is 15% owned by Saudi Aramco. The merger is planned to be completed by 2017, but could be derailed by the geopolitical tensions.
Trafigura is reportedly in talks to acquire a minority stake in Essar Oil, the second-largest private refiner in India. The deal is looking at a 15% stake in the Indian company, which would give the trader a foothold in India’s growing downstream market.
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Supply chains are currently in crisis. They have been for a long time now, ever since the start of the Covid-19 pandemic reshaped the way the world works. Stressed shipping networks and operational blockages – coupled with China’s insistence on a Covid-zero policy – means that cargo tanker rates are at an all-time high and that there just aren’t enough of them. McDonalds and KFCs in Asia are running out of French fries to sell, not because there aren’t enough potatoes in Idaho, but because there aren’t enough ships to deliver them to Japan or to Singapore from Los Angeles. The war in Ukraine has placed a particular emphasis on food supply chains by disrupting global wheat and sunflower oil supply chains and kicking off distressingly high levels of food price inflation across North Africa, the Middle East and Asia. It was against this backdrop that Indonesia announced a complete ban on palm oil exports. That nuclear option shocked the markets, set off a potential new supply chain crisis and has particular implications on future of crude oil pricing and biofuels in Asia.
A brief recap. Like most of Asia, Indonesia has been grappling with food price inflation as consequence of Covid-19. Like most of Asia, Indonesia has been attempting to control this through a combination of shielding its most vulnerable citizens through continued subsidies while attempting to optimise supply chains. Like most of Asia, Indonesia hasn’t been to control the market at all, because uncoordinated attempts across a wide spectrum of countries to achieve a similar level of individual protectionism is self-defeating.
Cooking oil is a major product of sensitive importance in Indonesia, and one that it is self-sufficient in as a result of its status as the world’s largest palm oil producer. So large is Indonesia in that regard that its excess palm oil production has been directed to increasingly higher biodiesel mandates, with a B40 mandate – diesel containing 40% of palm material – originally schedule for full implementation this year. But as palm oil prices started rising to all-time highs at the beginning of January, cooking oil started becoming scarcer in Indonesia. The government blamed hoarding and – wary of the Ramadan period and domestic unrest – implemented a Domestic Market Obligation on palm oil refineries, directing them to devote 20% of projected exports for domestic use. Increasingly stricter terms for the DMO continued over February and March, only for an abrupt U-turn in mid-March that removed the DMO completely. But as the war in Ukraine drove prices even further, Indonesia shocked the market by announcing an total ban on palm oil exports in late April. Chaotically, the ban was first clarified to be palm olein only (straight refining cooking oil), but then flip-flopped into a total ban of crude palm oil as well. Markets went haywire, prices jumped to historical highs and Indonesia’s trading partners reacted with alarm.
Joko Widodo has said that the ban will be indefinite until domestic cooking oil prices ‘moderate’. With the global situation as it is, ‘moderate’ is unlikely to be achieved until the end of 2022 at least, if ‘moderate’ is taken to be the previous level of palm oil prices – roughly half of current pricing. Logistically, Indonesia cannot hold out on the ban for more than two months. Only a third of Indonesia’s monthly palm oil production is consumed domestically; the rest is exported. An indefinite ban means that not only fill storage tanks up beyond capacity and estates forced to let fruit rot, but Indonesia will be missing out on crucial revenue from its crude palm oil export tax. Which is used to fund its biodiesel subsidies.
And that’s where the implications on oil come in. Indonesia’s ham-fisted attempt at protectionism has dire implications on biofuels policies in Asia. Palm oil prices within Indonesia might sink as long as surplus volumes can’t make it beyond the borders, but international palm oil prices will remain high as consuming countries pivot to producers like Malaysia, Thailand, Papua New Guinea, West Africa and Latin America. That in turn, threatens the biodiesel mandates in Thailand and Malaysia. The Thai government has already expressed concern over palm-led food price inflation and associated pressure on its (subsidised) biodiesel programme, launching efforts to mitigate the worst effects. Malaysia – which has a more direct approach to subsidised fuels – is also feeling the pinch. Thailand’s move to B10 and Malaysia’s move to B20 is now in jeopardy; in fact, Thailand has regressed its national mandate from B7 to B5. And the reason is that the differential between the bio- and the diesel portion of the biodiesel is now so disparate that subsidy regimes break down. It would be far cheaper – for the government, the tax-payers and consumers – to use straight diesel instead of biodiesel, as evidenced by Thailand’s reversal in mandates.
That, in turn, has implications on crude pricing. While OPEC+ is stubbornly sticking to its gentle approach to managing global crude supply, the stunning rebound in Asian demand has already kept the consumption side tight to match that supply. Crude prices above US$100/b are a recipe for demand destruction, and Asian economies have been preparing for this by looking at alternatives; biofuels for example. In the past four years, Indonesia has converted some of its oil refineries into biodiesel plants; in China, stricter crude import quotas are paving the way for China to clamp down on its status of a fuels exporter in favour of self-sustainability. But what happens when crude prices are high, but the prices of alternatives are higher? That is the case for palm oil now, where the gasoil-palm spread is now triple the previous average.
Part of this situation is due to market dynamics. Part of it is due to geopolitical effects. But part of it is also due to Indonesia’s knee-jerk reaction. Supply disruption at the level of a blanket ban is always seismic and kicks off a chain of unintended consequences; see the OPEC oil shocks of the 70s. Indonesia’s palm oil export ban is almost at that level. ‘Indefinite’ is a vague term and offers no consolation to markets looking for direction. Damage will be done, even if the ban lasts a month. But the longer it lasts – Indonesian general elections are due in February 2024 – the more serious the consequences could be. And the more the oil and refining industry in Asia will have to think about their preconceived notions of the future of oil in the region.
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