Sat | Mar 23, 2019

Zia Mian | Petrojam, a dilemma!

Published:Sunday | January 27, 2019 | 12:00 AM

DURING THE past few months, Jamaicans have heard a lot of news about the ‘partly’ state owned oil refinery, ‘Petrojam’.

On January 8, 2019, the Minister of Foreign Affairs and Foreign Trade announced that, “Jamaica is seeking to take ownership of the 49 per cent shares in Petrojam held by Venezuelan state-owned oil and natural gas company PDV Caribe, a subsidiary of Petroleos de Venezuela S.A.”

Before proceeding with such a decision, the government must take a holistic look at the petroleum sector in Jamaica. This would, at least, enable the political directorate to make an informed decision rather than shoot arrows in the dark.

Having been involved with Jamaica’s energy sector since 1972, I have some historic perspective on this refinery. Successive administrations have maintained positions that were not based on economics but policy stances to mainly serve the vested ‘interests’.

In next four columns, I shall inform the readers of this paper about the Kingston refinery and what role, if any, it plays in providing security of petroleum products supply to Jamaican consumers or cost benefits.

Again, at the end of the day it is the government in power that makes a ‘policy’ decision. But hopefully it would be an informed decision and not that “had I known!” scenario.

KINGSTON REFINERY

The Kingston refinery is located on a mainly reclaimed 76-acre lot at Hunts Bay. Pursuant to a 20-year ‘Heads of Agreement’ (HOA) between the Government of Jamaica and Esso Standard Oil, Esso completed the refinery construction in 1964. The refinery received a 20-year tax concession that commenced retroactively from 1962 (the date the original memorandum of understanding (MOU) was signed to build the refinery).

Its original design capacity was 26,394 barrels per day (b/d). Since the construction, the refinery has gone through a number of de-bottle-necking and its present nameplate capacity stands at 36,000 b/d. However, it still remains a small refinery, which all struggle to remain financially viable in a highly competitive oil refining market.

THE RATIONALE FOR A KINGSTON REFINERY

The financial viability of the refinery was based on then prevailing environment, where seven sisters controlled 86 per cent of oil produced by the OPEC.

In those days, the oil companies mainly made money by selling crude oil. Through a refinery in Jamaica, Esso could ensure that the entire down stream petroleum market (served by Caltex, Esso, and Shell) was supplied from crude oil that its affiliate Lagoven produced in Venezuela.

By having a local refinery, Esso also aimed to take advantage of a wide shipping cost differential between the clean (white products such as gasoline and kerosene) and dirty product (crude oil and heavy fuel oil) carrying oil tankers.

This was achieved by designing a hydro-skimming refinery that would process spiked crude oil (a mélange of crude oil and semi-refined products). Thus, the clean products could be transported in a dirty tanker and then separated at the Kingston refinery through a simple hydro-skimming process.

Esso purchased crude oil from its affiliate Lagoven in Venezuela and added to it semi-refined products from a large export refinery that it owned in Aruba.

The profitability on refinery feed stock was achieved through inter-company transfer-pricing mechanisms that were widely used by vertically integrated multinational oil companies.

Until the nationalization of oil industry in Venezuela, Esso continued to enjoy reasonable consolidated return on its Jamaican operations, mainly owing to an up-stream profitability of crude oil and the products it supplied to a captive Jamaican market.

With the ‘Oil Crises of 1973’, the price of crude oil jumped from an average of US$3 per barrel to an average of US$13 per barrel.

On January 1, 1976, Venezuela nationalized its oil industry and established Petroleos de Venezuela S.A. (PDVSA) that took over the assets of, among others, Lagoven (Esso) and Maraven (Shell).

Following these developments, the profitability of crude-back up completely disappeared and Kingston refinery was no more a financially attractive unit under the agreed ‘import parity’ pricing mechanism.

Hence the Kingston refinery became financially marginal and Esso requested that the government of Jamaica grant it a ‘small refinery differential’ so that it can remain viable.

The differential request was based on an argument that the ex-refinery pricing of products from the Kingston refinery, on the basis of ‘import parity principle’ that was originally embedded in the 1964 HOA, was no more financially viable.

The cost of refining at larger export refineries in the Caribbean Basin was much lower than the cost of separating products at the Kingston refinery.

The government agreed to a small refinery differential and also introduced a ‘Price Stabilization’ fund to deal with unpredictable and frequent volatility in the crude oil prices.

THE GOVERNMENT TAKEOVER

At the expiry of 20-year tax holiday, in 1982 Esso indicated its inability to keep the Kingston refinery financially viable without continued government support in the form of an increased “small refinery differential” and/or an extended tax holiday.

Rather than allow the Kingston refinery to close down or extend financial incentives to Esso, the government decided to purchase the refinery on October 1, 1982 by paying US$13.6 million for assets plus inventories at its current market value (estimated at US$ 43.9 million).

The assets of the Kingston refinery were transferred to the government on October 20, 1982. As a sole owner, the government established Petrojam Limited (a subsidiary of Petroleum Corporation of Jamaica - PCJ) to operate the plant.

Petrojam’s main activities were to: purchase and import crude oil and refined products; refine the spiked crude oil; operate the terminal; and sell the imported and locally refined petroleum products to local marketing companies.

Subsequently, PCJ also established a number of wholly owned subsidiaries, which, among others, included: Petcom, Petrojam Ethanol, Petrojam Belize, Petrojam UK, bunkering and shipping operations. Most of these ventures were either financially marginal or non-viable.

 

Since ownership by the government, the refinery unit has hardly ever operated beyond 60 per cent of its plant capacity.

The refinery’s financial viability has been maintained by the virtue of margins embedded in terminal operations, tax waivers and protective tariffs granted to it on substantial direct imports of refined petroleum products.

The issue of import of un-leaded gasoline and ensuing protests by the owner/operators of the refinery on tax waivers granted to the importer on the grounds of violation of protection to the refinery in the early 1990s was one such manifestation of the non-market privileges that the refinery had been enjoying under government protection.

In the next column, I will address the partial liberalization of the petroleum sector and government’s efforts in the 1990s to privatize the Kingston refinery.

 

- Zia Mian, a retired senior World Bank official and former Director General of the OUR, is an international consultant on energy and information technology. He writes on issues of national, regional and international interest. Send your comments to mian_zia@hotmail.com or columns@gleanerjm.com.