Zia Mian | Petrojam review: doing the maths!
“The PRC’s purpose, objectives, and functions included a review of the following:
“1.The current plans for upgrade of the refinery and assessing them in relation to possible alternatives and against realistic options in respect of the future strategic path for the petroleum sector in the national interest, including considerations in relation to energy security … .”
– Petrojam Review Committee (PRC) Report, Page 4
The quote above from the PRC’s terms of reference (TOR) is the very first task that the Cabinet Office asked the PRC to respond to. The key words in this task are (emphasis added): “ future strategic path for the petroleum sector in the national interest, including considerations in relation to energy security”.
The question that needs answering is: Have the PRC’s recommendations to the Cabinet Office responded to the spirit of this directive fully?
I already addressed the energy-security issue in an earlier article. Let us now conclude what is in the national interest or what is the least-economic-cost petroleum supply option for Jamaica. To accomplish this, we need to do a little math and review the analysis that Gaffney Cline and Associates (GCA) included in the PRC report (though not all the tables are legible).
The consultants reviewed a number of refining scenarios. Considering the introduction of LNG for the power generation (that would reduce the demand for 2.5 per cent heavy fuel oil - HFO), GCA narrowed its focus to three options:
a) Business as usual with Petrojam switching to sweet crude oil (such as Espoir and Lula) and improving the refinery utilisation factor to 78 per cent. A short-term and temporary fix.
b) Processing extra-light crude oil (such as Eagleford 40+ APIO gravity) by investing about US$70 million-US$250 million (depending on the refinery processing size) in plant and equipment and improving its utilisation factor to 78 per cent.
c) Shutting down the refinery and operating the terminal as a stand-alone enterprise.
Right from the outset, the consultants rejected the proposed Refinery Upgrade Project (RUP - to cost US$1.2 billion); or the installation of a vacuum distillation unit (VDU to cost about US$120 million). They found that these options would yield negative return on investment.
For option A and B to be financially viable, the following preconditions are necessary:
i) Notwithstanding the ownership structure, the Government must grant the refinery a permanent tax incentive.
ii) The refinery must improve its plant-utilisation factor from the current 60 per cent to at least 78 per cent. During the past 35 years, it has failed to achieve this level.
iii) Long-term crude oil supply and surplus product export contracts must be secured.
The consultants performed a comparative analysis of net present value (NPV – calculated using a 10 per cent discount rate) over a 20-year period. The analysis essentially compares four scenarios:
1. If the refinery continues business as usual, processing a sour crude oil, NPV will be negative at US$567 million, without custom administration fee (CAF) and US$380 million negative with CAF benefit. Under this option, government revenue is estimated at US$2,435 million. For the past four years, the refinery’s net margins over the CIF import parity have averaged at minus US$8.33 per barrel (bbl) – (PRC, Page 21). This option is not sustainable.
2. If the refinery switches to sweet crude oils (to reduce sulphur level), the NPV would be negative at US$208 million without CAF, and US$24 million positive with CAF. Under this option, government revenue is estimated at US$2,406 million (a stopgap option).
3. If the refinery switches to extra-light crude oil and makes an investment of about US$70 million, the NPV would be negative at US$159 million without CAF and US$78 million positive with CAF. Under this option, government revenue is estimated at US$2,423 million. The Planning Institute of Jamaica (PIOJ) favours this option, but we have no underlying analysis. The PRC recommends this option to the Cabinet Office!
4. If the refinery is shut down and the terminal is operated in perpetuity, the NPV will be US$161 million positive. Under this option, government revenue is estimated at US$2,513 million.
The analysis clearly demonstrates that the terminal-alone scenario is the most ‘financially attractive’ option for the Government as well as the country.
Jamaica is required to improve on its refining environmental standards to international benchmarks. The consultants estimate that this would increase capital cost by about US$236 million. The analysis shows that the environmental investments would reduce the net cash flow of all cases. The reduction in the NPV for the selected extra-light 70 scenario is an additional US$82 million (comparison of PRC’s Tables on pages 28 and 29).
In presenting the terminal-alone option, the consultants performed only financial and not rigorous opportunity/social cost analysis.
The maths reveals that without a permanent tax incentive, the refinery will continue to incur losses.
Over the years, recommendations by international agencies or consultants have made successive administrations aware of the uneconomic nature of the Kingston refinery. The approach, however, has been: “My mind is made up. don’t confuse me with facts!”
Every time there is a crisis (financial loss or a scandal), the Government appoints enquiry commissions or committees and launches studies – and then it is business as usual. There is a long list of such studies that are gathering dust.
Why have we failed to take action?
Once the Government acquired the refinery, it was allowed to establish a creative pricing mechanism that generated high operating margins. The refinery not only became a cash cow, but was also elevated to the status of an untouchable sacred cow.
The cash generated at the expense of motorists and the productive sectors, funnelled through the PCJ, financed off-budget projects favoured by politicians, provided funds for ministers to travel, and created lucrative jobs both at the PCJ and the refinery. Notwithstanding many scandals, authorities have failed to institute an accountability framework or oversight mechanism.
Generally, committees avoid ruffling feathers by not recommending the closure of the refinery or criticising its management.
The recommendations of the PRC do not follow through to its conclusion that the continued operation of the refinery will not serve the national interest.
The PRC observes that the terminal operations and price adjustments are the positive contributors to the “consolidated profitability” of the company, but the refinery operations have a negative contribution to Petrojam’s margins. On page 34, in its recommendations, the PRC Report states:
“The committee’s analysis demonstrates that for the Petrojam refinery to become commercially viable, its operating efficiencies must improve, the CAF fiscal regime must be maintained, and an investment (extra-light scenario) of approximately US$78-million must be made. The committee makes the following recommendations:
“1. The PRC is of the view that transfer of active management of the refinery and terminal to the private sector provides the only credible opportunity to improve the operating performance of both entities while also mitigating the operating and project execution risks to GOJ. Irrespective of GOJ’s policy decision to maintain the CAF margin or otherwise, the PRC, therefore, recommends that the GOJ exit active management of both the terminal and the refinery through a lease of Petrojam’s underlying assets.” (PRC page 34)
The report should have stated in no uncertain terms that no matter who owns or operates the refinery (public or private sector), it will never be financially viable and it is not in the national interest of Jamaica. Why recommend an uneconomic option? Obviously, Petrojam remains untouchable!
Here is my take on the PRC Report:
a. The Kingston refinery is not a financially viable option. For years, the productive sector and motorists were charged high margins to keep the refinery going. If it is shut down, the cost of petroleum fuels in Jamaica will drop, the foreign exchange outflow will decline, and the Government’s revenue will increase.
b. With the introduction of LNG, it is only a matter of time that the bauxite sector will fully switch to natural gas, thus eliminating the use of HFO.
c. The transport sector is expected to switch to the compressed natural gas (CNG) in the medium term and to electric vehicles in the longer term, thus reducing the demand for transport fuels.
d. A common carrier petroleum terminal to serve the marketers is the best option for Jamaica. The terminal can be owned by the Government or be leased or privatised to a third party.
e. It is time that the Government articulate petroleum product pricing principles and establish regulatory oversight for the petroleum sector.
f. It is not a good idea to increase the number of marketers in a small market like Jamaica, which will continue to shrink.
g. We do not need new feasibility studies (though Petrojam loves them) to establish the financial viability of a non-viable refinery. We already have a room full of them.
The powers that be should take a note of the PRC analysis in its entirety and not get fixated on the extra-light 70 crude oil scenario that I consider to be uneconomic.
For a change, let us stop wasting time, money, and take positive action.
- Zia Mian, a retired senior World Bank official and former director general of the OUR, is an international consultant on energy and information technology. Email feedback to firstname.lastname@example.org and email@example.com.