Caltex refines its plans

Background, by Eureka Report editor James Kirby: Caltex, the only Australian-listed oil refining and marketing company, is enjoying strong profits as supply continues to struggle to meet demand in the oil sector. As Caltex chief executive Des King tells Robert Gottliebsen* in today’s video, the tight supply of refining capacity around the world is expected to benefit Caltex for years to come.

Reflecting the underlying surge in oil prices and wider margins in refining, Caltex recently upgraded its half-year profit guidance from $150 million to $170 million, which would represent a 13% increase on the corresponding period a year earlier.

As the Howard Government prepared to announce plans to entice motorists into using alternative fuels, Caltex is also developing its alternatives business, especially ethanol.

Caltex operates about 2000 petrol outlets in Australia under the Caltex and Ampol brands. As King explains, the move towards cleaner fuels is occurring across the Caltex business.

The interview

Robert Gottliebsen: Approximately what percentage of your profit comes from refining and what percentage comes from retail?

Des King: As a rough number, about half our profit comes from refining and about half from our marketing side, which is more than retail '” it’s our whole supply terminals, our retail, our wholesale prices, wholesale parts of the business. So overall, refining is about half and our marketing is about half.

Is that likely to change in the next two or three years?

As we move forward, certainly with some of the opportunities to grow the business that we have, the anticipation is we’ll be able to grow both marketing and refining, but more of the growth is likely to come in refining. So I would say the refining portion of the overall profit may be more than 50% as we move forward.

Caltex is short of refining capacity. How much will you increase your capacity in the next two or three years?

We have plans to increase our refiner utilisation, increase our output by about 20%. Currently we make about 10 billion litres of transportation fuel and our current plans are to increase that to 12 billion litres.

Will the rest of Australia follow?

It’s unsure whether the rest of Australia will invest to increase their refining capacity. We can’t speak for our major competitors. What I can say is, though, Caltex makes its decisions about investment locally in Australia. We’re the only Australian listed refining and marketing company and we certainly believe that with our strong balance sheet we have the capacity to invest in these growth projects.

Are similar percentage increases likely in Singapore and Asia over the same time period?

Refining capacity is likely to increase around the world and in the region. Our estimates are, though, that as refining capacity increases it will just keep up with the demand increases, so overall refining capacity will be tight for many years to come and refining margins should be good for many years to come.

What’s happening in the Middle East and India? Are they bridging the gap?

In terms of refining in the Middle East: a number of refineries have been planned and talked about, and India is expanding as well and they all feed into the mix. But what we’ve looked at is, overall, the increase in refining capacity worldwide will just keep up with the demand increase.

Your refinery margins have increased over the past two or three years. Are they likely to increase further in the period to 2010.

Refining margins certainly have gone up, but so have the costs. We have just invested over $500 million to make clean fuels for clean air for Australia, but margins certainly have been strong and the anticipation is '¦ can’t forecast exactly where they will go but they will certainly remain strong moving forward.

Longer term, what about a new refinery in Australia? Is that possible?

It’s highly unlikely that a new major refinery will be built in Australia. The new world-scale refinery is typically 2½ to 6 times what an Australian refinery is because we need those large refineries for the economies of scale '¦ very expensive to build a new refinery, so it’s highly unlikely that such a large refinery will be built in Australia.

Where will they be built?

It’s most likely that the large refineries will be built in areas of large consumption, such as Singapore supplying Asia, China, India '¦ potentially China '¦ and also in large oil-producing countries such as Saudi Arabia.

When you buy overseas refined product, you must buy high quality inputs. Does that come at a cost?

Certainly the clean fuels that we have in Australia mean it is more expensive to make that fuel and that’s reflected in higher cost. We estimate that an extra 2.5 cents per litre is additional cost of the clean fuels, but certainly that’s a low price to pay compared to the improvement in air quality in our cities.

But then does that boost your refinery margins?

Certainly it does improve our local refining margins but of course it also increases the cost. But overall, certainly clean fuel is the right thing to do for Australia.

What effect will ethanol and bio fuels have on your business?

Today the industry imports one out of every four litres of product sold in Australia. What we anticipate will happen is, with bio fuels that will back out some of those imports. So actually for us it’s good that we can source some of our product more locally.

Without oil prices, your annual rate of profit is around $500 million a year. Is that likely to increase in the coming years?

The current forecasts and the current '¦ that you talked about is based on current refiner margins and it’s difficult to predict what’s going forward for refiner margins, but it certainly looks very strong. Overall we anticipate there’s lots of growth opportunities in this business. In the short-term '” two to three years '” we have a number of projects we’re developing to improve our refining capability, to increase our output from 10 billion litres to 12 billion litres of product. So that backs out imports, which is good for security of supply. So anticipate growth in our refining profitability.

What about retail? Can you grow that?

There’s also a chance just to go retail, although we’re doing very well in retail now '” we probably have one of the best retail outfits in the world in terms of profitability due to excellent execution; so there’s some opportunity to grow retail, a lot of opportunity to grow marketing, when you look at our terminals and our supply system in addition to the refining growth.

* Robert Gottliebsen is a national business commentator with The Australian.