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Incentives for Development

Anatoly Cherner

Interview with Anatoly Cherner, Deputy General Director of Logistics, Processing and Marketing, Gazprom Neft

29 June 2011; “Gazprom” Magazine.

— Mr Cherner, what effect did the aftermath of the global financial crisis have on the politics of Gazprom Neft Group in terms of processing and marketing?

— The events of 2008-09 showed that the lowest losses in periods of financial instability are experienced by companies whose results are determined largely by internal factors rather than the prices of oil and petroleum products. The main things to consider are operating costs and efficiency in production and sales.

We were already paying a considerable amount of attention to these factors before the crisis, so the policy of Gazprom Neft hasn’t changed fundamentally. At the same time, negative trends in the global and domestic markets have become an additional incentive for more active implementation of our plans. This is why new complex medium-term programmes of operational improvements were approved for all directions of processing and marketing in 2009-10. In particular, for the oil refineries in 2011-13, they envision a quantitative leap in the dynamics of key performance indicators as expressed in the Solomon Associates indices. These indicators include total operating cost, efficiency, availability, staffing and so on. Such benchmarking has been adopted by refineries all over the world as a reference to compare data on the efficiency of oil processing. We plan to reach the European average for most of these indicators. Working groups have been set up at each refinery to develop and implement measures aimed at improving the efficiency of existing facilities. As for the sales divisions, they face the annual task of reducing operating costs despite the negative influences provided by external factors, most notably the rise in prices and tariffs.

The crisis has also convinced us of the need to accelerate the pace of modernisation and development of our processing assets, primarily to increase the volume of products with high added value and expand the premium distribution channels through which these products are sold, including end users. This will significantly increase sales in the Russian market, which is not severely impacted by global trends and developments.

— What is included in the Gazprom Neft domestic refinery development plans, taking recent changes into account?

— The strategy adopted by the company presents three main objectives. First, we need to ensure that all of our factories are producing Environmental Class 5 fuel — identical to the Euro-5 standard — by 2015. This is the aim of the “Quality” programme. Second, in the period leading to 2020, we will need to raise refinery indicators in processing depth and product yield to 90-95% and 77% respectively, while simultaneously increasing the volume of oil refining in Russia to 38-40 million tonnes per year.

Third, we have drawn up a programme to improve productivity and lower costs associated with processing raw materials, energy production, reducing fuel consumption and losses, as well as increasing the operational readiness of our processing plants.

The first stage of development is linked to the need to bring the company into compliance with Russian technology regulations regarding the quality of fuel. Thanks to government regulations on the differentiation of excise duties on petroleum products (depending on environmental class), we have an economic incentive, not only to make the transition to the new standards, but to do so as quickly as possible. To do this we need to renovate existing facilities as well as establish new processing plants. According to our estimates the cost of implementing this phase will reach more than 70 billion roubles.

Work on this stage is already in full swing. In particular, last year at the Omsk refinery we opened Europe’s largest installation for the isomeration of the light benzene fraction “Isomalk-2”, with a capacity of 800 thousand tonnes per year. Its launch has allowed us to increase the production of Environmental Class 4 gasoline to 30% and the total volume of gasoline production by 650 thousand tonnes. Two new installations are currently under construction at the Omsk refinery: a catalytic cracking unit for hydrotreating gasoline, with a capacity of 1.2 million tonnes per year, and a diesel hydrotreatment unit with a capacity of 3 million tonnes. These installations are scheduled for completion in 2011, after which all petrol and diesel produced at the location will achieve Environmental Class 4 and 5 respectively.

At the Moscow refinery, which has manufactured Class 4 diesel fuel since January, the reconstruction of the existing DT-LCh-24/2000 hydrotreatment unit will be completed in 2012. As a result of this modernisation the regeneration period of the work will increase and 80% of all diesel fuel produced at the facility will meet the requirements for Class 4. After the installation, due in 2014, of a new DT hydroforming unit with a capacity of 2 million tonnes per year, the Moscow refinery will fully switch to the production of Class 5 diesel fuel. In addition, the following new installations are under construction: light naphtha isomerisation and catalytic cracking for hydroforming benzene. The capacity of the latter is 1.2 million tonnes per year, and it is expected that construction will be completed in 2012. With the commissioning of these two installations 100% of the petrol produced at the facility will meet the requirements for Class 5.

Yaroslavnefteorgsintez plans to finish construction of two new production facilities this year, which will enable them to produce Class 5 gasoline: a naphtha isomerisation unit and a catalytic cracking unit for hydrotreatment of gasoline. At the beginning of 2013 it is expected that a new DT hydrotreatment unit will be commissioned, following which the facility will fully switch to the production of Class 5 diesel fuel.

In the second stage of refinery reconstruction special attention will be paid to deep oil processing projects, as well as increasing efficiency and productivity of primary processing facilities through the replacement of obsolete and worn-out installations with new ones. According to preliminary estimates, the total capital investment in the renovation of existing installations and the building of new ones to increase the processing depth in three of Gazprom Neft’s Russian oil refineries will amount to approximately 171 billion roubles.

Along with renovation and construction the company pays a lot of attention to projects aimed at improving the operational efficiency of existing assets. Every year, factories implement measures that have a large economic impact and significantly improve the performance of the company, according to the methodology of Solomon Associates.

— What impact will the implementation of new mining projects and the associated change in the quality of raw materials have on the processing sector of Gazprom Neft Group?

— Today our Russian enterprises are practically fully loaded with their own oil. The quality of this material is really deteriorating, due primarily to a decline in the proportion of light fractions and, in some cases, an increase in sulphur content. This is taken into account when drawing up projects aimed at modernisation and development of the refineries, and we are working to counteract this negative trend. In addition, we are considering the idea of refining oil together with gas concentrate.

— How will you develop the company’s processing capacity outside of Russia? Are there any plans to expand, and is the possibility of acquiring new assets under consideration?

— A complex dedicated to hydrocracking of vacuum gas oil and hydropurification of diesel fuel is currently under construction at the refinery at Pancevo, a division of the Serbian Naftna Industrija Srbije (NIS), of which our company is the major shareholder. Commissioning this facility will convert the plant to the production of motor fuels in accordance with Euro-5 standards. The complex should be completed in 2012. Thus we will fulfil the investment conditions which facilitated the purchase of our shares in NIS. Our total investment into developing the Serbian company comes to over €540 million.

However, the high level of competition in the European oil product market raises the issue of further increasing the efficiency of oil refining at the Serbian refineries. Because of this, NIS is carrying out preparations for further technical development of these enterprises. The main aim here is an increase in the production of motor fuels from fuel oil resources. Under the given conditions, increasing productivity becomes even more important.

With regard to the acquisition of new assets, I will remind you that Gazprom Neft’s long term strategy includes increasing the refining capacity in Europe to 25-30 million tonnes per year. Therefore we are analysing existing assets in the European markets, and exploring the prospects and conditions for their acquisition. Most of our attention is focused on large and highly complex refineries with the capability of processing our oil and establishing synergies with our current overseas assets. However, it is important to note that over the next two years the acquisition of refineries outside Russia will not be a priority for us. We aren’t ruling anything out, but we will take decisive action only when the opportunity presents itself to purchase effective and modern facilities at a reasonable price.

— What are Gazprom Neft’s plans in the fields of logistics, marketing and sales?

— We continue to improve our system of selling crude oil and petroleum products. In particular we are continuously working to optimise the supply lines for our products overseas. One important area here is the reorientation of export flows into Russian ports. For example, in April we began shipping fuel oil produced at the Moscow oil refinery to the new Rosneftbunker terminal at the port of Ust-Luga. These quantities were previously exported through the Baltic States. By the end of the year we will increase the transhipment in this sector using oil from Yaroslavnefteorgsintez.

In December of last year a new subsidiary of our company began operations: Gazprom Neft Logistics. It serves as the single shipment centre at the Moscow and Omsk facilities. Its main task is to improve efficiency and cost control in this business segment. Thanks to its activities we can now identify the proportion of the company’s total costs accounted for by logistics, which will allow us to significantly reduce costs without affecting production.

Particular attention will be paid to premium distribution channels, which involve the sale of petroleum products to the end user. I will remind you that, in accordance with the company’s strategy, we need to reach a total sales volume of 40 million tonnes of our products domestically and overseas by the year 2020. This includes some 18 million tonnes from aviation fuel, bunkering vessels, lubricants and petrochemicals, 10 million tonnes from small wholesale retail to large-scale end users and 12 million tonnes from sales through the company’s retail network.

Work is already underway in these areas. Thus, the allocation of distribution channels to independent business units, including aviation fuel (OOO Gazprom Neft Aero) and bunkering (OOO Gazprom Neft Marine Bunker), as well as production and sales of motor oils (OOO Gazprom Neft Lubricating Materials), are already yielding positive results. In particular, the retail sales of jet fuel rose last year by 19%, sales of bunker fuel rose by 17%, and sales of lubricating oils rose by 29%. We were the first in Russia to begin organising industrial-scale production of polymer-bitumen binders and asphalt emulsion at the Omsk oil refinery, which in the future will enable us to take a leading position in this niche market. By 2020 we plan to at least double the sales of these premium lines.

Optimising the system of small-scale wholesale trade also gives results. The sales of petroleum products through this channel grew by 22% last year. Moreover, I stress that this was achieved not by increasing production capacity, but through good management of the available assets. However, in the future we will certainly need to expand our oil storage facilities, something which our new subsidiary, Gazprom Neft Terminal, has already started working on.

The growth of sales through our retail network last year was 21%, due mainly to the active work of individuals and legal entities, as well as the rebranding of filling stations, which we plan to complete this year. We continue with the renovation of existing stations and the construction of new ones; in 2010 42 stations were upgraded and 27 new ones were built. In addition, we acquired 60 fully operational filling stations. Today we have almost 1600 filling stations at our disposal, in Russia and overseas, including those belonging to NIS in Serbia, as well as our own stations in Kazakhstan, Tajikistan, Kyrgyzstan and Belarus. In our own country we plan to develop our retail network in the Nizhny Novgorod, Irkutsk and Krasnoyarsk regions. The South Federal District is also of great interest to us, and to facilitate the implementation of our plans in the region we have established a new marketing subsidiary, Gazprom Neft South. Through the purchase of SibirEnergy our company has become a major player in the Moscow motor fuel retail market, although of course we plan to modernise and possibly expand our own network of filling stations in the region. In the CIS our main efforts will be focused on developing our retail network in Kazakhstan and Ukraine. We are planning to expand our sales operations overseas, particularly into the Balkans. For example, we are currently exploring the possibility of entering the retail market in Romania, Bulgaria, Montenegro, Croatia, and Bosnia and Herzegovina. We are also interested in the Hungarian market. We expect that in the medium term, that is, by 2015, we will increase our retail network in Russia and abroad to 1700 filling stations, and in the long term, by 2020, we plan to have 2100 stations at our disposal.

— And do you have any plans to develop your retail network in St Petersburg?

— In the northern capital our primary focus is the construction of modern service stations on our existing sites. Alongside this, together with OAO Gazprom and the St Petersburg authorities, we will implement, through our subsidiary Gazprom Neft Northwest, a pilot project dedicated to the conversion of road transportation to compressed natural gas (CNG). We will start with municipal transportation, but we also plan to work on commercial passenger and small-capacity freight transport. Through this project we will be able to determine the true size of the market, which is currently estimated at around 2 billion m3 per year, as well as the technological capabilities and economic impact of converting transportation to CNG. After this a decision will be made regarding the prospects of this trend, including expansion to other regions.