Zia Mian | Petrojam: The yarn we spin!
“Do you see over yonder, friend Sancho, thirty or forty hulking giants? I intend to do battle with them and slay them…”
“What you see over there aren’t giants, but windmills ...”
– Don Quixote, Miguel de Cervantes
In August 2006, the Petroleum Corporation of Jamaica (PCJ), Petrojam, and PDV Caribe signed a joint venture (JV) agreement, whereby PDV Caribe bought 49 per cent of PCJ’s shares in Petrojam.
As there were ‘curious considerations’ to introduce coal into Jamaica’s energy-supply mix, the upgrade and expansion of the refinery were deemed necessary.
The sale proceeds were to be reinvested as part of Jamaica’s contribution to the upgrade.
PCJ/Petrojam retained Purvin & Gertz Inc. (PGI), a United States consulting firm, to value the refinery assets for this transaction.
The engagement of PGI did not follow the Government’s procurement rules. The rules required that PCJ/Petrojam invite competitive international bids and obtain prior approval of the National Contracts Commission (NCC) to retain the best-evaluated bidder. None of it was done as PGI was hired on a ‘sole source’ basis.
PGI used three methodologies, namely:
a). Depreciated replacement value,
b). Market value; and
c). Income stream.
The depreciated replacement valued the assets at US$67 million. The market approach valued the assets at US$52 million. The income stream approach valued the assets at US$128 million. All valuations included the Montego Bay terminal.
The parties agreed to a transactional value of US$130 million. PDV Caribe paid to PCJ US$63 million to acquire 49 per cent the Petrojam shares.
The agreement stipulated
- increasing the refinery’s capacity from 36,000 barrels per day (b/d) to 50,000 b/d.
- installing a new catalytic reforming unit.
- installing a de-sulphurisation facility to reduce the sulphur content in diesel oil.
- installing a new vacuum tower.
- installing a Delayed Coker Unit (to eliminate fuel oil production).
The transactional value used on-going business’ methodology. The option to close down the refinery was not considered, which would have required using opportunity cost methodology. For the income stream methodology, the management had provided the ‘assumptions and projections’ to the consultants.
GIANTS OR WINDMILLS
Let me narrate two anecdotes that explain how the formulation of ‘assumptions’ can adversely impact policy decisions.
One day in the late 1970s, the then energy minister (Dudley Thompson) gave me a three-volume feasibility study. A US consulting firm had done this study for the Luana Development Company (LDC). The study contained detailed engineering and financial analysis. It projected the DCF and economic rate of return (ERR) that supported the financial viability of the proposed export refinery project.
Minister Thompson asked me to review the study and give him my comments, which he needed for the following Monday Cabinet meeting, where a final policy decision was to be considered. After reviewing the feasibility, I decided to look at the ‘disclaimer’ by the consultants.
I suggested to the energy minister that we must brief the prime minister prior to the Cabinet meeting. Minister Thompson and I met with Prime Minster Manley at the Jamaica House (JH) breakfast room at eight on that Monday morning. Our meeting was short.
I drew the prime minister’s attention to a ‘footnote’ on the inner cover page, where the consultants had a disclaimer, saying that the study was based on ‘assumptions’ furnished to the consultants by the LDC. Meaning, that the economic/financial analysis was neither independent nor objective.
The study, which cost millions (financed from the bauxite levy), was not worth the piece of paper it was written on.
That day the Cabinet shelved the idea for an export refinery in Jamaica indefinitely.
In the early 1980s, I led energy strategy missions to Zambia. During these missions, we discovered that IFC, an affiliate of the World Bank, was ready to lend to Zambia for the erection of an ethanol plant with an 11.5-million liter/annum capacity. The ethanol was to be used to enhance the octane rating of gasoline that the local Indeni refinery produced. A consultant from South Africa had done the feasibility study. The consultant estimated an attractive ERR of 13.1 per cent. The recommendations were based on assumptions furnished by the IFC.
My team considered those assumptions unrealistic and doubted that the project was economic. At the end of the mission, President Kenneth Kaunda invited me, and key members of my team, to a lunch at the President’s Palace. During the lunch, I was to brief the president about my mission’s findings.
The president pointedly asked me about our assessment of the ethanol project. I suggested to him that Zambia needed an independent analysis to confirm the economics of the proposed project.
While on my way to Washington, I received a fax in London inquiring: “what did you tell the President regarding the IFC project?”
Once in Washington, the senior vice-president wished to know why I had raised doubts about the ethanol project economics. I was directed not to question the economics of the IFC project in my report.
To comply, I qualified my conclusions by adding: “based on IFC’s ‘assumptions’, the project shows an ERR of 13.1 per cent.”
The World Bank/IFC executive board approved a loan of US$15 million to finance the proposed project.
A Zambian team visited Washington to negotiate the loan. One member came to me and asked how confident I was about our findings.
My response: “ the answer lies in an independent economic analysis”.
Six months later, the same official called and said to me, “ it is mid-night in Lusaka, and I am calling you from the presidential palace. We have just finished a meeting. I wish to inform you that an independent study has confirmed your findings. Tomorrow, we will cancel the IFC loan.”
In 1982, the Government bought the refinery for US$13.6 million. During the 1990s privatisation, the assets were valued at US$68 million.
The Jamaica Public Bodies Report of March 2018 (the Ministry of Finance and Public Service) includes the draft-audited accounts for the refinery. For the FY2016-17, the book value of the fixed assets in the balance sheet is stated at US$145.9 million.
In 2018, Petrojam retained Muse Stancil, a US consulting firm, to provide fair market value of its assets. The consultants relied on the assumptions and data that were provided to them by the refinery.
One basic assumption was that if the refinery were not upgraded, it would have to be shut down by January 1, 2020. The valuation assumed that the terminal would operate ‘as business as usual’ (in perpetuity).
By using income approach, the consultants valued the terminal assets as follows:
“The income approach yields a value of US$34 million, at a real discount rate of 10 per cent, US$27 to 45 million for a +/- 2 per cent change in the discount rate; US$73 to US$102 million at forecast EBITDA multiples of five to seven times, consistent with market transactions.
“US$152 million based only on storage capacity at a market value of US$53 per shell barrel of tankage higher value range as total terminal tankage is underutilised at the forecast throughput for product imports.”
- Zia Mian, a retired senior World Bank official and former director general of the OUR, is an international consultant on energy and information technology. He writes on issues of national, regional, and international interest. Send your comments to firstname.lastname@example.org or email@example.com.