Caltex caves to refinery realities

Like Shell before it, the high dollar, massive Asian competitors, and looming oversupply meant Caltex was always likely to scrap its Kurnell refinery. The spotlight now turns to Australia's final five.

There was probably never any realistic prospect that Caltex’s review of its Kurnell refinery in Sydney would come to a different conclusion to the one Shell reached a year ago after a similar review of its Clyde refinery in NSW.

Despite the apparent surprise of some union leaders, the inexorable logic that ended in the closure of Clyde was inevitably going to lead to a similar outcome for Kurnell, whose closure Caltex announced today.

If there is a surprise it is that the Australian refineries have survived for as long as they have and, in the context of Caltex, that it decided to retain its Lytton refinery in Brisbane and, indeed, invest in it. Caltex revealed Lytton had been spared at its annual meeting in May.

Part of the explanation for why the refineries have kept operating long after it became clear they were sub-scale and uncompetitive with the giant new facilities that have been built, and are still being built, in Asia and the Middle East showed up in the Caltex announcement.

It is going to cost Caltex $430 million to dismantle Kurnell and remediate the site – refineries are "dirty" facilities – and another $250 million to convert the site to an import terminal. The value of the refineries had already been written down by $1.5 billion in February. The cost of exiting the sector prolonged the lives of Clyde and Kurnell for quite some years.

The new refineries in the region, apart from the fact that several of them have as much capacity as the entire Australian industry used to have, produce petrol as a by-product to their primary product, diesel. Despite the transport costs, they can supply this market on very competitive terms.

The position of the local refiners has, like much of our trade-exposed industry, also been exacerbated by the strength of the Australian dollar. If the assumption is that the strength of the dollar is likely to persist for some time, that will add to the lack of competitiveness of the local sector. Certainly Kurnell has been losing significant amounts.

Caltex’s Julian Segal said earlier this year that he expects Asia Pacific refining capacity to grow roughly in line with demand in 2012 and 2013 before new capacity coming on stream created significant over-capacity in the region.

That would exacerbate the position of the domestic refiners – but would also create an opportunity to import product even more cheaply, particularly if the dollar does hold up.

For Caltex, unlike Shell – which as an integrated oil major has refineries within the region but outside Australia that it owns and operates – there was another complicating factor in determining the fate of the refinery.

Caltex is 50 per cent owned by Chevron of the US but isn’t an integrated part of its operations and therefore couldn’t take it for granted that it would have secure access to a competitive source of supply. It has, however, now negotiated a commercial agreement with Chevron to ensure long-term supply of petrol, diesel and jet fuel at market-based prices.

Today Caltex sources about 55 per cent of its transport fuels from its own refineries. After Kurnell closes, Lytton will supply only about a quarter of Caltex’s requirements.

Caltex supplies about 30 per cent of all transport fuels in this market so the withdrawal of refining capacity will make clearer the nature of the modern Caltex, which is fundamentally an attractive and high-margin fuel marketing and distribution business.

There will, unfortunately, be significant job losses associated with the closure of the refinery and its conversion to an import terminal, with the Kurnell workforce likely to be reduced from 430 employees to less than 100 and the prospective eventual loss of a further 300 contractors.

While Caltex expects that the cash outflows related to the redundancies, the closure and dismantling of the refinery, the remediation of the site and its conversion to an import terminal will broadly match the cash inflows from expected tax benefits and working capital releases, it isn’t taking any chance of a liquidity mismatch.

It said today that in the short term it would change its dividend policy, reducing the range of its payout ratio from the current 40 per cent to 60 per cent to between 20 per cent and 40 per cent but intending to revert to the existing policy once the refinery has been closed in the second half of 2014.

As further insurance and protection for its investment grade credit rating and its ability to continue to support and invest in its core operations, the group is also considering capital management options, including an issue of hybrid securities.

Before the Clyde closure there were seven refineries in this country. Once Kurnell closes there will be five. At least for a while.

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