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Home > Business > Special


Why Reliance needs Chevron

Prasad Sangameshwaran & Meghana Biwalkar | July 11, 2006

In his address to shareholders at their annual general meeting last month (June 27, 2006), Mukesh Ambani, chairman, Reliance Industries laid out his grand plans in the petroleum sector.

"Jamnagar will become the world's largest hub for petroleum refining," he declared. Ambani is talking about the scenario in end-2008, when Reliance Industries' refinery at Jamnagar, Gujarat, will nearly double its capacity from the current 0.66 million barrels of crude oil a day to process 1.24 million BPD.

Ambani then proceeded to provide a status report on Reliance's oil and gas, exploration and production in India. Reliance's exploration activities for oil and gas in India cover one-third of the country's prospective areas.

The announcements: crude oil discovery in the deep water D6 block in the Krishna Godavari basin and in two wells in the KG-III-6 shallow water block. The full potential of these discoveries is still being evaluated. But according to Ambani, the current discovery is about a lot more than mere size.

"More than size this discovery signifies a large geological play that could result in future discoveries," he said, referring to the deep water D6 block.

It's not just Indian soil, or even deep waters. The company's international plans are taking shape too. "Reliance is building a global portfolio of exploration assets through organic growth and strategic acquisitions," the chairman said.

For instance, production at Yemen is at 2,000 BPD at present, and is expected to peak to 20,000 BPD in 2007; and exploration in Oman is progressing ahead of schedule.

Reliance was also involved in a seismic survey in the Pacific Ocean off the coast of Columbia and has interests in an exploration block in hydrocarbon-rich East Timor. As the petroleum business of Reliance increases its global footprint, how does its American strategic investor, Chevron Corporation, add value?

Big deal

A couple of months ago, Chevron forked out Rs 1,320 crore (RS 13.2 billion) for a 5 per cent share in Reliance's petroleum business, with an option to hike the stake to 29 per cent. The deal happened against the backdrop of the mega-expansion plans for the Jamnagar refinery.

It's not as if Reliance cannot do it alone. The success of the existing Rs 27,000-crore (Rs 270 billion) Jamnagar refinery, which was commissioned in 1999-2000, is ample proof. So why does Reliance need a partner?

Ask the analysts and they will tell you it's not for the money. That's a significant statement. Reliance will invest $6 billion in doubling the refinery's capacity, and another $10 billion over the next five years on international oil exploration activities and to develop recent discoveries like the KG basin.

It further needs $1.5 billion to expand its petroleum retail outlet network from the current 1,200 to the 5,800 for which Reliance has already received government approval.

"Bandwidth to invest is not a question for Reliance," says Partha Bardhan, head, energy and natural resources, KPMG, without a second thought. So what does Chevron bring to the table? In a word: expertise.

"This tie-up will help them bring in global best practices into the business," says a consultant. Adds Bardhan, "It is more to do with the ability to tap into the technical know-how for both the existing business and areas where Reliance may not yet have a presence."

There are others who feel that Reliance has attracted a partner to create access to global markets. Arvind Mahajan, partner at consulting major IBM, is one of them.

"The tie-up with Chevron will not only help Reliance create a large refining capacity, it will also help develop an easy access into the global markets from a product marketing as well as facilitate optimisation of refinery crude supplies," he points out, adding, "From the long-term perspective, this partnership could evolve beyond a strong vendor-buyer relationship to cover other opportunities in the energy value chain, as Chevron has an option to increase it equity stake in the refinery to 29 per cent."

Does Ambani agree? To some extent, yes. As he remarked at the AGM, "the relationship with Chevron is being developed around two objectives. One is to optimise crude supply, product offtake and marketing from the refinery. The second is to collaborate in other areas of the energy value chain." That's the essence of the Reliance partnership strategy. But how will it unfold?

Crudely put

When the Jamnagar expansion plan is completed in 2008, Reliance will obviously need to tap more sources of crude, to ensure that its refinery runs at optimum capacity and gets the cost advantage.

With global refinery capacity utilisation estimated to be in the range of 87-94 per cent from 2008-2015, after taking into account new capacity creation, operating at full steam should not bother Reliance.

But as the expanded facility in Jamnagar will be operational in that period, Reliance needs to be on par, or above industry standards in capacity utilisation, to get the edge in refining margins.

At present, Reliance Petroleum claims it will have an advantage over Singapore (which has among the highest gross refining margins in the world) of about $5.5 per barrel in gross refining margins, based on crude cost advantages and superior product slate and quality.

But to maintain that edge, the company needs to secure its supply of crude, that too at a pre-determined price.

That's where a partner like Chevron could step in. After all, Chevron's refining interests span seven countries in the Asia-Pacific region, including a 650,000-BPD GS Caltex refinery in South Korea. That means the company has a significant supply chain of crude already in place in Asia.

Also, Chevron is the largest oil producer in Indonesia and Thailand, and has a presence in 11 Arab countries in oil-rich West Asia, including the partitioned neutral zone between Saudi Arabia and Kuwait. According to experts, the Asia-Pacific region accounts for more than a third of Chevron's international oil production.

So, does Chevron fit in with Ambani's objective of optimising crude supply? It's anybody's guess.

Time to market

Then, Chevron has a global marketing and distribution set-up through its Caltex-branded service stations, Star Mart convenience stores and Xpress lube outlets, through which the company markets automobile fuel, lubricants and vehicle additives.

The finished products coming out of Jamnagar could find a ready ride on this network. True, Reliance already has an export network in place, but Chevron is far better as it has been an international player in Asia for over 70 years.

The American company started operations in Indonesia in 1924 and had established a presence in West Asia by 1930. Reliance cannot ignore this advantage as West Asia and Asia-Pacific put together are expected to account for more than 50 per cent of the global oil demand till 2015. (Source: EIA International Energy Outlook, 2005).

Points out IBM's Mahajan, "Chevron is a well-known brand in the global markets, while Reliance is yet to become a widely recognised brand internationally."

Analysts point out that Chevron, which is known to adopt superior marketing techniques, will help Reliance gain expertise in this area. In fact, consultants feel that Reliance can even gain from Chevron's expertise, as its fuel retail initiatives in India are expanding.

On the other hand, if Reliance had decided to walk all alone, what would it have done? "To capture the diverse reach in terms of products, markets and knowledge expertise would be difficult through organic expansion," says Bardhan.

Tech specs

It's not just about securing crude and marketing. Experts feel that access to superior technology is another crucial reason for the Reliance-Chevron partnership.

"Chevron has its competency in exploration and production technology. Its global experience will contribute a great deal," says Bardhan.

That means if Reliance were to have bought this service from Chevron as an outsider, it might not have gained complete access or gotten the full advantage. "Technology owners will not pass on, but they will participate," points out Bardhan.

Technology access becomes even more critical as Reliance explores unfamiliar territory in the value chain. Like gas, for instance. Remember: Ambani's objective is also "collaboration in other areas of the energy value chain".

With Reliance working towards monetisation of its world-scale discovery of gas in 2002 in the D6 block of the KG Basin, Chevron can help in bringing Reliance's gas faster to market.

After all, as Chevron corporation Chairman and CEO David J O'Reilly claimed in a keynote address at the World Gas Conference in Netherlands last month, "Chevron has the technology and operating expertise to go into such areas as the Arctic, the Rocky Mountains or offshore and have demonstrated that we can develop energy with minimal environmental impacts." (see Quickbite: High on gas).

What's in it for me?

If you were Chevron, you could well ask this question.

According to Jeet Bindra, president, Chevron Global Refining, who was quoted in the company press release when Chevron bought the Reliance stake, "It is our strategy to continue to increase our refining flexibility and scale to meet growing global demand."

Chevron needs flexibility and spread across geographies because OECD markets of Europe and the US have environmental restrictions for Greenfield refining projects.

Besides, setting up Greenfield refineries can be an expensive proposition. According to Reliance estimates, setting up Greenfield refineries can cost as much as $15,000 a barrel, primarily because of high construction costs.

It's also worth noting that more than 40 per cent of the world's existing crude distillation capacity is over 25 years old, leading to operating and efficiency constraints. And Chevron needs scale.

Nearly 60 per cent of the world's 661 refineries have sub-economic capacities (less than 150,000 BPD). With an expansion plan of adding a capacity of 580,000 BPD, Reliance is four times bigger.

Also, Chevron is adding to its portfolio by actively exploring in Bangladesh. The refining destination of a probable oil find could be Jamnagar. Reliance must be hoping that Chevron hits a pot of black gold.

Quickbite high on gas

Excerpts from a keynote address made by David J O'Reilly, chairman and CEO, Chevron Corporation, at the World Gas Conference, Amsterdam, the Netherlands on June 7, 2006:

"Oil has dominated the world's energy portfolio for the past century, natural gas has become an important contributor to the global energy industry. While overall global energy demand is expected to increase by 50 per cent over the next 20 years - demand for natural gas is projected to increase nearly 70 per cent�.

"The emerging global gas business is moving steadily toward open markets. We see this in the LNG (liquefied natural gas) industry, which is expanding rapidly and evolving from several long-established markets, such as Japan and Europe, to a truly global marketplace, much like the one that currently exists for oil�.

"Chevron's contribution to the growth of global LNG markets is our Gorgon project in Western Australia. Gorgon - our joint venture with ExxonMobil and Shell - is undergoing environmental review at the moment, and we are confident that the outcome will balance economic benefits and environmental impact to allow full development of this key resource.

"And our confidence is based on Chevron's involvement in operating the Barrow Island for over 40 years and the high quality work we have done in preparing Gorgon's Environmental Review and Management Program.

"We have also signed three Heads of Agreements with Japanese utility companies for LNG from Gorgon, which will move Chevron and our partners closer to commercialising Gorgon's gas resources.

"Last year, we acquired Unocal, which propelled Chevron into the top tier of natural gas producers in the Asia-Pacific region.

"I mention these achievements because they demonstrate Chevron's commitment to natural gas.

"It is our firm belief that natural gas will play a major role in supplying the energy the world needs for economic and human progress."


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