Brian Gaynor

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Brian Gaynor: Barrel of woes sets stage for refinery vote

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Refining NZ's CCR Project will have an important bearing on the profitability performance of the Marsden Pt oil refinery. Photo / APN
Refining NZ's CCR Project will have an important bearing on the profitability performance of the Marsden Pt oil refinery. Photo / APN

Refining NZ's annual meeting at Marsden Pt next Friday should be interesting.

It will be held against the backdrop of a slumping share price, board dissent and a New Zealand Shareholders' Association request to its members to vote against the re-election of two directors.

The most important resolution is Item 3, which requires shareholders' approval for the construction of the Continuous Catalyst Regeneration Platformer (CCR Project) at a cost of $365 million.

This project will have an important bearing on the profitability and share price performance of the refinery in the years ahead.

Refining NZ, previously known as the New Zealand Refining Company, owns and operates the Marsden Pt oil refinery.

The site was chosen by the Government in the late 1950s because of its low earthquake risk, deep-water harbour, its proximity to the main North Island markets and the large land bank next to the site.

Construction began in 1962 and the refinery was officially opened by Prime Minister Keith Holyoake on May 30, 1964.

The refinery was substantially upgraded in the 1980s under Prime Minister Robert Muldoon's "Think Big" programme.

The expansion, which included a 170km pipeline to Auckland, cost a huge $1840 million. This was significantly above the original forecasts as the project was dogged by poor planning and major industrial disputes. It was finally completed in May 1986 - almost two years behind schedule.

In the late 1980s the company's $1200 million Eurodollar loan, which partially funded its "Think Big" expansion, was transferred to the Crown. In addition the Government made an $85 million cash grant to the refinery as part compensation for the deregulation of the petroleum industry.

Accordingly, the 1987 sharemarket crash had no impact on the company's share price as it went from a low of $1 that year to a high of $42.50 seven years later (it subsequently had a 10 for one share split in 2006).

But industry deregulation has had a negative impact on Refining NZ in recent years, with net profit after tax plunging from $135.5 million in the December 2006 year to just $34.5 million in the latest 12-month period .

This has been mainly due to a sharp contraction in revenue from $403.7 million in 2006 to just $291.1 million last year (see table).

The primary reason for this poor performance has been the decline in refining margins and the sharp drop in the US dollar against the NZ dollar.

Refinery NZ, which is effectively a tolling operation for the major oil companies, receives a processing fee for each barrel refined. This is based on Singapore refinery margins and is paid in US dollars.

Singapore refining margins have fallen sharply in recent years because of the global financial crisis, lower economic growth and a huge increase in Asian refining capacity.

This has cut Refining NZ's processing margin from an average of US$8.37 per barrel (bbl) in 2006 to US$6.11/bbl last year.

The refinery margin was just US$4.17/bbl in the January/February 2012 period.

The strength of the kiwi versus the US dollar has exacerbated the situation as far as the Marsden Pt refinery is concerned. When foreign exchange movements are taken into account Refining NZ's margin, in NZ dollar terms, has plunged from $9.13/bbl in January-February 2006 to just $5.04/bbl in January-February 2012.

This is a 45 per cent fall over the six-year period and has had a huge impact on the company's revenue and profitability.

Asian refining margins have improved recently because of maintenance closures, unplanned stoppages and an increase in seasonal demand as the summer season gets under way.

However industry analysts have a mixed view on the outlook for Asian refinery margins.

Some believe that the recent improvements can be maintained because of lower than expected Asian capacity additions and several refineries are being shut down for extended periods because they are no longer viable at current margins.

Examples of this are the proposed closure of Shell's Clyde refinery in Sydney and Caltex Australia, which is listed on the ASX, announced in February that it had written down the value of its two refineries by $1.5 billion because of declining margins and the high Australian dollar.

The company is carrying out a major review of these refineries and is "considering all options to improve shareholder value, ranging from investment to closure".

Meanwhile other analysts believe that refinery margins will ease back when maintenance shutdowns have been completed and refineries are reopened after unplanned stoppages.

Refining NZ has been reluctant to make any substantive forecast but it has released a table showing the level of net profit after tax it expects to make at various refining margins and foreign exchange rates.

If the January/February margin of US$4.17/bbl and the current NZ$/US$ exchange rate are maintained for a full year then the company would record a net loss of about $32 million for the December 2012 year.

But if the margin increases to US$6.00/bbl for the full year, which would be similar to last year, and the exchange rate drops to US77.5c then Refining NZ would report a net profit after tax in the region of $30 million.

At a US$7.00/bbl margin and a US75c exchange rate Refining NZ would report a net profit after tax of about $64 million.

Although these figures are low compared with the 2006 to 2008 period it should be noted that Refining NZ has a much higher operating cash flow because of its large depreciation provision.

In 2011 the company had a positive net cash flow from operating activities of $122.4 million and had only $25.6 million of interest-bearing debt at year end.

The main item at next week's annual meeting is the approval of the CCR Project.

This involves the replacement of the 1960s Platformer, which would require expenditure of about $105 million to extend its operational life beyond 2015.

The CCR Project will enable crude oil to be processed into oil products much more effectively and efficiently.

This should add about US$1.10/bbl to the company's refinery margin once the project is completed. The project is expected to boost annual revenue by about $70 million and ebitda (earnings before interest, tax, depreciation and amortisation) by about $60 million a year.

But the CCR Project does not have the full support of the board of directors, which is dominated by representatives of the major shareholders.

These are BP New Zealand (23.7 per cent), Mobil Oil NZ (19.2 per cent), Z Energy Holdings, which is 50/50 owned by the New Zealand Superannuation Fund and Infratil, (17.1 per cent) and Chevron New Zealand (12.7 per cent).

As a consequence chief executive Ken Rivers has been travelling the country this week to convince non-oil company shareholders to vote in favour of the CCR Project resolution as its approval is not a foregone conclusion.

The problem with Refining NZ from an investor perspective is that the major oil companies are both shareholders and customers.

They appoint their employees to the Refining NZ board but these board representatives are constantly changing.

The Shareholders' Association has asked shareholders to vote against the election of a BP and a Mobil representative because these appointments "change frequently ... on the whim of their employer" and "it seems to us that oil company directors are perceived as representing their own company's interests, rather that the interests of ALL shareholders".

The major oil companies are expected to vote in favour of each other's board representative even if they don't all support the CCR Project.

Disclosure of interest: Brian Gaynor is an executive director of Milford Asset Management, which holds Refining NZ shares on behalf of clients.

- NZ Herald

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