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CONFERENCE 2006
The Third Annual Conference
REFINING AND OIL TRANSIT IN THE CIS AND BALTIC STATES

15-16 June 2006
Odessa Hotel, Odessa, Ukraine

Sponsored by
OilMarket magazine and VNIPIneft engineering company



Official support from
Russia's State Oil and Gas Gubkin University



Session sponsors




BONDED BY CRUDE FLOWS

Without giving any thought to political battles being waged in Ukraine, OilMarket magazine organized and hosted the Third international oil conference on Oil Refining and Transit in the CIS and Baltic States. The forum brought together specialists from Azerbaijan, Belarus, Bulgaria, Kazakhstan, Russia, Poland, the United States, Ukraine and the Czech Republic and covered a wide range of topics on developments in the Ukrainian market and generally post-soviet downstream.

The presence and active participation of representatives from the Russian Association of Oil Refineries and Petrochemical plants operators and the VNIPIneft Research Institute was indicative of the level of the conference. Speaking at the venue, VNIPIneft director Vladimir Kapustin noted that if just a few years ago one could speak of a systemic crisis and hopeless state of Russian refining, a noticeable step forwards has been made today.

Much has changed as a result of steps taken by the Russia's central government - this includes shifting the burden of export duties from oil product exporters to crude exports and the adoption in March this year of tax breaks for those importing modern oil refining equipment. Consistent efforts of Russia's state owned oil products transporting monopoly Transnefteprodukt to stimulate diesel exports was also a very important factor. It's important that all above mentioned changes happened in the country where couple years ago oil barons never worried about economics of oil refining and exports and remained sitting pretty on huge revenues from crude exports.

While one of those gentlemen ended up behind the bars and serves prison sentence, the rest have been convinced by arguments based rather on economic leverages.

Impressive results
Board member of Russian refiners association Vladislav Bazhenov had all reason to say in his presentation that in 2005 refining in Russia was steady developing, having grown by 12mn t y.o.y. The refineries capacity load grew to 70%, with growth pace being almost triple of production growth. Refining depth approaches 70% though Bazhenov believes 64-65% is more realistic assessment for now. While 2005 oil production growth lingered at 2.4%, refining segment grew by 6%. Investment in Russia's refining last year totalled some $1.26bn.

The number of new refining facilities reached record highs - this includes the hydro cracking unit in Yaroslavl and a 850,000 tpa catalytic cracker in Tatarstan (with a gasoline hydro treatment unit and the hydrogen production unit).

Besides, a new VGO hydro treatment unit was launched in Ryazan (the refinery has also started hydrogen production), while Komsomolsk refinery installed light fractions hydro treatment unit. The latter example is especially indicative of the trend. For far too long, state owned Rosneft has been seen in Russia as largely focused on oil production, with little done in terms of refining. Now the situation has changed dramatically. As company chief Sergey Bogdanchikov recently stated in London, Rosneft intends to triple the capacity of its 80,000 b/d Tuapse refinery. This trend is in line with Russia's new state strategy of developing refining facilities in the Baltic, Black Sea and Pacific ports.

Amazingly enough for Russia, the situation in Ukraine's refining fits well into this strategy - Ukraine's 80,000b/d Odessa and 150,000 b/d Kherson refineries are sitting still, with little effort applied by shareholders to retain their share of the Black Sea and Mediterranean products markets. Given the political goings-on in Ukraine, referred to by simple folks a "a mess", certain politicians there are likely to see "Moscow's hand" behind the barrenness of the domestic refining sector, rather than the ineptitude of Ukraine's own state administration.

Meanwhile a number of facts highlighted by Kapustin and Bazhenov should be worrying for all FSU refiners. The fact is, billions of dollars are being invested today in Saudi Arabia, Qatar, Kuwait and other countries in the Middle East into the construction of huge and super-modern oil&gas refining capacities. Regional Director of ExxonMobil Anna Gorstein noted that a super-modern gas-to-liquid (GTL) plant with the US major's technology employed is being built in the Middle East. It's clear that decision makers in the Gulf realised already that investment into oil&gas refining today is highly advantageous and they are building modern capacities with an eye on virtually facing gasoline shortages markets in the United States, where no new refineries have been built for 30 years and very big question mark remains on whether any new will be built any time soon.

Transatlantic supplies have long been an important element of export portfolios for Mazeikiu Nafta, Belneftekhim, Yaroslavl, Ryazan, Burgas, Kirishi, Gdansk and a number of other refineries in the FSU and Eastern Europe. The prospective loss of their niche on this market would mean multi-billion losses for the budgets of the countries concerned.

A cold shower
On the Ukrainian side, the best grounded presentation was delivered a representative of Kyiv Oil&Gas Industry Scientific Research (KOGISR). The institution appears to be probably the only institution in Ukraine with complex and balanced vision of industry development and understanding that having single oil pipeline for crude supplies - the Russian one - does not immediately mean having ground to talk about Russian monopoly on crude supplies. Ukraine's heavy dependence is rather rooted in Ukraine's outdated refining facilities and technological stagnation. The experience of neighbouring Belarus and Lithuania shows that with consistent investment into refining modernisation, regardless of political system in the country, refineries can be efficient even if they process exclusively Russian crude.

Meanwhile, KOGISR representatives hailed oil supplies diversification. Unfortunately for Ukraine, this single issue of nation's energy supplies diversification and independence remained the most favourite slogan of the Ukrainian political beau monde.

KOGISR representatives' theoretical proposition of filling 320,000 b/d Kremenchuk refinery with Caspian low sulphur crude volumes provoked chorus of protesting voices from the Kremenchuk operator Russian-Ukrainian JV UkrTatNafta representatives attending the conference. UkrTatNafta reaction is easy to understand - after all, for the 11 years that they have existed, they have been considered the most reliable and stable supplier of motor fuels for many regional markets in Ukraine. And this despite the fact that the JV has been dogged by equity share disputes and an effective management was carried out only thanks to experience and reasonable attitude of the Tatar partners and their huge experience in refinery management.

The stormy UkrTatNafta reaction also shows how much Ukraine needs an objective and highly-qualified arbitration body, something similar to the refiners Association founded in Russia. The authority of such names as Viktor Ryabov, Vladislav Bazhanov and Vladimir Kapustin compel even the central authorities in Russia to pay heed. The question remained open whether such a balance of interests between the needs of the state authorities and the objective needs of the country is possible in Ukraine.

In Ukraine government's influence on refining first of all - which many experts at the conference agreed with - should be stimulating large-scale, or at least medium upgrading of the refineries in order to get plants at least to quality levels resembling Russian indicators, let alone sky-high indicators seen in the promised land of the EU and in politically blockaded Belarus.

The path is well known - tax breaks for those importing modernisation equipment and cutting of the super profits made by Belarusian refiners (who operate with Russian crude imports free of duty currently depriving Ukraine of some $199.8/tonne) at the Ukrainian border - all this is possible within the WTO framework.

The price of crude and the economics of oil supplies are the main headache of the Ukrainian authorities today. But it is the backward technology at refineries which makes this problem so painful. Ukrainian refineries' processing depth is barely 50% of Russian oil they buy - strikingly familiar to the old joke about buying a bus-pass and then not going to piss off the conductor. The old myth about Caspian oil as a desirable alternative to Urals should be forgotten like a bad dream. And oil will not be cheaper simply because Kazakh or Azeri supplies do not involve exporters paying the huge duties that come with Russian volumes - there is a market price and that's that. To buy an even more expensive bus-pass and then not go is pretty much what those who have been beating the drum of diversifying oil supplies to Ukraine are offering, because in most cases they are overlooking the need to modernise Ukraine's own refineries.

The result of this "consistent ignorance" will be that Russia, which is always apt to develop alternative export routes, will ship its volumes to places where the owners of more effective refineries can pay higher prices.

The 2Q 2006 has already been notable for two Western Ukrainian refineries in Nadvirna and Drohobych being ditched from the Russian schedule (not to mention the Odessa and Kherson refineries which simply closed not being able to withstand the pressure on the crude market. At the same time it is true they did so under excuse of modernisation).

The opposite is also true -consistent modernisation efforts will make it possible for Ukrainian plants to buy oil other than Urals, delivered both by wheel and via pipeline, as more effective refining enables companies to compensate losses on transport component, something Mazeikiu Nafta has already proved.

One of the most educational episodes at the conference was the fact that Ukraine's gas companies seemed more concerned about increasing processing depth than the oil companies. The output of light oil products at Ukraine's gas monopoly UkrGazVydobuvannya is over 90%. As Vladimir Kapustin justly noted, it's probably not quite fair to talk about 90% depth of refining in this case: the content of light fractions in the natural gas liquids is significantly higher that in the lightest of Caspian crude blends. But the very fact that UkrGazVydobuvannya gas experts work on further increase of light oil products output at the company's three refineries is quite telling. The company's gas processing department chief Mykhaylo Brynza said the company intends to boost the volume of gas condensate refining to 20,000 b/d.

The inherent advantage
Vladimir Kapustin noted in his presentation that the growing importance of bio-fuels production presents Ukraine with an extra chance to enter highly lucrative niche in the complex international market of motor fuels.

Ethanol production and purification of the end-product to the condition required by internal combustion engines essentially gives a carte-blanche to Ukraine, a country with huge agricultural potential. This is particularly significant now, when motor fuel prices at Ukraine's market approaching European levels, while in Russia production of ethanol for motor fuels market has collapsed, largely under pressure from the domestic oil companies.

On this stage, Ukraine must gear up to approve a coherent government programme on support of bio-fuels production and construction of required facilities. From crude market viewpoint, Ukraine is importer of oil and quite inefficient refiner; but the situation is even more grotesque from the viewpoint of bio-fuels market - here, Ukraine, being dominantly agricultural country, expands feedstock production, being practically net exporter. Bio-fuels production units are already mushrooming along the new EU border in Czech Republic, Poland, even in Estonia.

If Ukraine succeeds in matching its bio-fuel feedstock abilities with production infrastructure, there is no doubt that EU agricultural lobby would ease its aversion to Ukraine's EU ascendance.

A big question mark remains just on what the EU-oriented Ukrainian government is thinking about.
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