Cover story: Asia driving our fuels destiny

"With oil demand of 6.7 million barrels per day, China is the second largest oil consumer behind the US"

Everyone who uses vehicles and machinery laments the rising cost of fuel. Many blame the oil companies or the government, the most visible identities of their hip-pocket pain.

The real source of the escalation in prices lies to our north, where Asia is playing a lead role in driving our fuels destiny.

China’s and India’s explosion in economic activity over the past five years is having a major impact on what happens to fuels refining and pricing in Australia, for a very simple reason, says Managing Director Des King.

These countries have a voracious appetite for petroleum products, and in our regional marketplace that means prices are going up – and up.

The Asian development boom is affecting everything from the price and availability of crude oil and shipping costs to the supply/demand situation for petrol, diesel and jet fuel, and ultimately prices at the bowser.

As regional refineries struggle to feed the demand driven by the expansion of industry, urbanisation and vehicle ownership in Asia’s two giants, the price of fuel has rocketed.

This has a direct impact on Australians because fuel from Australian refineries is priced in competition with imports. Australia relied on imports from the region to provide around 24% of our transport fuels in 2007, mostly from Singapore.

Demand for fuel has also pushed up the cost of crude oil to make it, with China importing crude from all around the world. World prices for crude oil and fuels are set in US dollars – if it wasn’t for the strong Australian dollar our pump prices would be even higher.

While crude oil prices soar past the US$130 a barrel mark and fuel prices follow the same trajectory, it does not translate into higher profits at the bowser. As a refiner and marketer Caltex makes, on average, a profit of about two cents per litre of fuel sold. The Government makes around 50 cents per litre on petrol through excise and GST so there is very little chance that prices can be lowered unless the federal government reduces the amount of tax it takes from fuel sales.

However, there is an active debate in Australia on whether we would be better off adapting to higher fuel prices despite the pain so we are all better prepared to help fight climate change and a carbon-constrained future when prices could be much higher. Such adaptation would have to provide more public transport options and consider disadvantaged consumers.

Rise of the dragon

China’s economy has grown at about 10 per cent per year for the past 20 years and with a population of 1.3 billion is drawing in mineral resources and other raw materials from all around the globe. China is now the world’s top consumer of aluminium, copper, lead, nickel, tin, zinc, iron ore, coal, wheat, rice, palm oil, cotton and rubber. Its consumption of metals as a share of world usage has jumped in the past decade from 10 to 25 per cent to feed its massive industrial expansion and construction boom.

China’s population is greater than all of the developed countries of the OECD combined, and increased personal incomes are driving consumer demand. China’s vehicle fleet is growing at an average rate of 25 per cent a year. The car fleet totals 43 million, almost four times that of Australia, and there are 80 million motorcycles. To service these vehicles there are 94,000 service stations compared with about 6,000 in Australia.

China has 3.3 cars per 100 head of population compared with 55 in Australia, which is one measure of China’s enormous unlocked demand for vehicles and fuels.

With oil demand of 6.7 million barrels per day, China is the world’s second largest oil consumer behind the US and the largest in the Asia-Pacific, importing about 4 million barrels per day of crude oil to supplement its own production. In comparison, Australia consumes about 0.9 million barrels per day. Of total Chinese petroleum product demand, 2.3 million barrels per day is diesel, with road transport having the largest share and the remainder split evenly between the rail/shipping, residential/commercial, industry and agriculture sectors. China imports diesel to make up the shortfall in refinery production.

The Indian tiger

Though India’s need for commodities is not as big as China’s many analysts predict the gap will narrow quickly as the middle class in this nation of 1.1 billion continues to develop. India’s economic growth has averaged about 6 per cent per year since 1990 and over 8 per cent last year. India has been contributing largely to soaring Asian demand for hard commodities such as crude oil and metals.

At 2.6 million barrels per day, India’s oil demand is triple that of Australia. Diesel is over a third of demand and is used mainly for road transport and industry. Of India’s 88 million vehicles, there are 11 million cars, reflecting the low level of car ownership at only 1 per 100 head of population.

But demand for cars is growing fast with affordable Indian-built small cars supplying the market at one end and Indian-owned Jaguar at the other. India also has 64 million motor cycles compared to 500,000 in Australia. These vehicles are supplied by 35,000 service stations.

To meet the soaring demand for fuels, refinery capacity in Asia is growing strongly. This is well illustrated by what’s happening at the city of Jamnagar in the north-west province of Gujarat. A giant new Reliance Petroleum export refinery there will come on stream later this year making petrol, diesel and jet fuel for the export market. It will process 580,000 barrels of crude oil a day.

I n India, financial incentives encourage refiners to manufacture fuel for export so m any of its new refineries are seeking to sell to Australia. India is a major exporter of both petrol and diesel.

Changing regional competition

New regional state-of-the-art refineries will add competitive pressure on the Australian refining industry. A key question is whether the landed cost of crude oil in Australia plus refining costs will eventually be less than the landed cost of imported petroleum products. “That means Australian refineries’ viability and very existence could be at stake,” explains Des King. “And that is why at Caltex we are constantly looking at ways to keep our refineries competitive. As the only Australian-listed refining and marketing company, we are committed to maintaining a viable refining industry for Australia.”

“The cost of permits for refinery emissions under the Australian Emission Trading Scheme from 2010 could be the tipping point for many Australian refineries. This makes it essential for Australian refineries to receive a free allocation of permits as an import-competing, trade-exposed industry under the Scheme until competitor refineries in Asia bear the same carbon costs.”

While it seeks neither tariff protection nor preferential treatment, Caltex believes oil refining should not be viewed by governments as another manufacturing industry that could exit the country in the face of global change. Australia’s refineries have too much strategic importance.

“Relying entirely on overseas refineries for our petroleum products would expose all industries and private consumers to unnecessary risk,” Des says. “Policies and attitudes need to recognise the industry’s vital strategic role in the Australian economy.”

Asia up, US down

Though demand for oil can’t keep growing indefinitely at the current rate it will almost certainly remain high for the medium term as China’s and India’s growth continues fuelling demand for raw materials.

This may be good news for Caltex because it could continue to translate into demand in Australia for fuels, especially diesel, to feed the mining boom. Demand growth will assist the marketing component of the Caltex business, which in 2007 accounted for around 50 per cent of the company’s earnings.

This doesn’t mean the refining part of the Caltex business will enjoy ever increasing margins. The current slowdown being experienced by the US economy, for example, will likely have a moderating impact on refining margins as global demand softens, says Des. And the large new Asian refineries will boost regional supply.

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