World's biggest refinery to test oil bulls

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On India's West coast, the world's biggest refining complex is nearly ready to begin pumping a wave of diesel fuel into the world oil market, removing one of the last near-term fundamentals supporting $100-plus crude.

But unfortunately for oil consumers and for a fragile world economy, Reliance Industries Ltd's new plant is likely to have a much greater impact on global refinery profits and price spreads than it will on New York Mercantile Exchange (NYMEX) crude futures or prices at the petrol pump.

Although a severe refining bottleneck was one of the initial catalysts for oil's six-year rally, it has been eclipsed by the growing importance of financial investors, attacks by Nigerian militants and lacklustre upstream oil output growth.

"The notion that new refineries will bring significantly lower crude prices doesn't look likely," says Kevin Norrish of Barclays Capital, which has been a consistent bull on prices.

"We may see some narrowing in spreads between heavy and lighter grades...but we don't see any major changes in crude price dynamics, since there are other more important factors at work."

Reliance is expected within weeks to begin test running a new 580,000 barrel per day (bpd) refinery in Jamnagar, with full-fledged operation likely by early next year, industry sources say. Together with its existing 660,000 bpd, built less than a decade ago, the site will be world's biggest.

More remarkable is the fact that the new plant -- the most sophisticated in the world for its size -- will produce an estimated 40 percent diesel, helping meet demand that has surged due to power shortages and growing use in passenger cars.

At the same time, demand for most other fuels -- from jet to gasoline to fuel oil -- is clearly in decline, one of the factors that has sliced 16 percent off oil prices since they hit a high of nearly $150 a barrel on July 11.

Whether easing the remaining strain on distillate markets with new supplies will deepen crude oil's losses remains an open question. Many analysts have reason to doubt it.

"The market does appear less concerned about downstream capacity constraints than previously," says Mike Wittner, global head of oil research at Societe Generale.

"I believe that the impact will be more on easing the gasoil cracks than on easing the crude flat price."

This is probably not the market that Reliance chief Mukesh Ambani anticipated when he unveiled plans to build the $6 billion plant exactly three years ago, a time when the global shortage of refining capacity was the main issue for oil markets.

Amid an unexpectedly steep surge in prices and an unforeseen economic slow-down, falling demand in developed economies has resolved those constraints, threatening to push the industry into yet another down-cycle of overcapacity and weak profits.

"Structurally upstream still looks tight, but downstream cycles are alive and well," says Jeff Brown, chief economist for FACTS Global Energy, which often advises on refinery projects.

It's not only Reliance. Some 500,000 bpd of capacity at three Chinese refineries is due to come onstream by early next year, likely halting months of heavy diesel and some gasoline imports by the world's second-biggest oil consumer.

Reliance has not said exactly when the refinery will process its first barrel, but said last week that the plant was 94 percent complete, pre-commissioning work was underway and that it remained on track for start-up ahead of its December target.

The new plant, run as a subsidiary called Reliance Petroleum Ltd is 5 per cent owned by Chevron Corp.

Not all agree that the oil market is ready to set aside weakening near-term fundamentals in favour of a longer view that crude supplies will fail to match demand in the decades ahead.

Some analysts say that bringing down diesel cracks -- which hit a record $45 a barrel in Asia in May before falling to $28 on Thursday -- should be enough to shift traders' focus.

"We've been watching these trends for some time, and combined with the weakness in gasoline and fuel oil demand, led us to conclude early in the spring that the bull market had a weak heart," says David E. Kirsch of PFC Energy.

Analysts at Credit Suisse say the new refinery may add pressure to flat prices not necessarily because of increased fuel supplies, but because it will buy underutilised heavy grades.

"Under-investment in complex refining has stranded some heavier grades of crude, reduced effective spare capacity upstream and kept WTI prices high," Credit Suisse analysts wrote in a report this month titled "Global Refining: The Dark Ages".

"The downstream additions may help heavy crude move through the system," they wrote.