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Saudi Aramco looks east for new downstream oil opportunities

Saudi Arabia has positioned itself as the crude supplier of choice for Asia-Pacific and is quietly cornering the region's refining market as well, writes Digby Lidstone

SAUDI ARABIA sent its first tanker of crude oil to a refinery in China's southern province of Fujian in spring 2008. In terms of the global ebb and flow of crude, the cargo was insignificant. But for state-owned Saudi Aramco, it was symbolic of a shift in focus from western to eastern markets.

It also marks a shift in downstream strategy. Bound from Ras Tanura, the 0.9m barrels of oil were transported to Fujian Refining and Petrochemical, a $5bn joint venture between Aramco, ExxonMobil and China's state-owned Sinopec. The plant exemplifies Saudi Arabia's new approach to its downstream businesses – taking stakes in foreign facilities and building downstream assets close to home. Of the new refining capacity planned in the Middle East, more than a third is due to be built in the kingdom.

The outstanding projects of the Saudi programme are two export refineries, planned for the industrial cities of Jubail and Yanbu. On the Mideast Gulf and Red Sea coasts respectively, they will give Saudi Arabia greater flexibility as an exporter and the potential to take a significantly larger share of the market: the refineries' combined capacity is 0.8m barrels a day (b/d).

It might seem to be a peculiar time to be investing downstream. As an industry with high investment costs and narrow profit margins, refining has always tended to lurch from feast to famine. Bouts of investment tend to be followed by fallow periods.

Five years ago, global refining capacity was so tight that the merest outage of refineries in the US Gulf of Mexico was enough to make crude prices rise sharply. By 2004, with world economic growth reaching about 4% a year, refiners began to relax. Margins for refining US crude rose to $11.50 a barrel – more than three times the typical level at the beginning of the decade.

Inevitably, the prospect of such high returns encouraged investment in the sector. Oil companies drew up plans for some 250 projects worldwide, of which 72 were grassroots refineries and 178 were capacity expansions. In total, some 30m b/d of additional refining capacity was planned by 2015 (PE 9/09 p22).

But the world economy proved as cyclical as the refining industry. Work on much of the planned capacity was starting just as the global economy was collapsing. Refining projects worldwide were stopped, tenders were cancelled and contracts revoked, as oil companies waited to see what the outcome of slower growth would be on their industry.

At first, it seemed Aramco was following the general trend. Both the Yanbu and Jubail projects were put on hold in November 2008, while bidding on the Ras Tanura and Jizan refinery schemes was delayed. Unlike its competitors, however, Aramco had no plans to scale back its long-term plans, despite changing the ventures' timetables. On the contrary, as its dealings with China show, Aramco has the luxury of planning decades ahead – and has no shareholders to please. The delays and renegotiations appear to have been ploys to save money.

By putting pressure on its contractors to lower their fees, Aramco and its foreign partners estimate they have managed to lower costs by as much as 20% on certain schemes. Cost estimates for the Yanbu refinery, being built with the US' ConocoPhillips, and the Jubail plant, being built with France's Total, each doubled to more than $12bn as oil prices rose to their July 2008 peak. But following the rethink, the Jubail refinery is now expected to come on stream in 2013, at an estimated cost of $9.6bn. Yanbu will begin operations the following year, after ConocoPhilips and Aramco decided to re-tender the project. Seven packages have been tendered on the 400,000 b/d refinery.

Yanbu has considerable strategic importance for Aramco. It is intended to fill a hole left by the US and European refining industries. The refinery will probably supply the US east coast market with high-quality gasoline, while low-sulphur diesel will be exported to Europe and naphtha to east Asia. Increasingly stringent environmental laws, which have hampered the US and European refining industry in recent years, have provided a perfect commercial opportunity for Aramco. Besides Yanbu and Jubail, they are also the primary motivation behind a $1.3bn upgrade at the 0.55m b/d Ras Tanura refinery.

Geographical diversity is also a priority. Aramco's energies have been increasingly directed outside the kingdom in recent years, with more than a third of its refining capacity now based in other countries. As well as the Chinese joint venture, the company is involved in four other refining and marketing ventures outside the kingdom: Motiva in the US; SsangYong Oil Refining in South Korea; Petron in the Philippines; and Motor Oil (Hellas) in Greece.

Aramco's primary target is Asia. The International Energy Agency forecasts that the Asia-Pacific region will be consuming some 2m b/d of fuel oil in 2013, compared with 0.82m b/d last year. It also predicts that at least $1 trillion is needed for refinery upgrades by 2030.

China is the lynchpin of Aramco's strategy and it has put considerable effort into building the strategic relationship. Since the beginning of the decade, it has operated an exchange programme for students through its Beijing affiliate Saudi Petroleum. Through careful planning, Saudi Arabia has positioned itself not only as the crude supplier of choice to Asia, but it is quietly cornering the refining market as well.

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