S-Oil Corporation (A010950) Earnings Call Transcript & Summary

[Interpreted] Good afternoon, everyone. This is [ K.T. Gong ], the Treasurer of S-Oil. I'd like to extend my gratitude to investors and analysts for taking your time to call in this investor briefing for Shaheen Project. We prepared for this briefing to give investors more details on Shaheen Project and I would like to ask for your understanding on having to give you a short notice. Today CFO, J.W. Bang, and officers as well as team leaders involved in Shaheen Project joined to share the project in further detail with investors. We have [ J.L. Lee ] from New Business Development division; [ G.M. Lee ] from Polymer Sales division; K.S. Kim from Basic Chemical division; [ P.K. Zhong ], Project Control team leader; and IR team leader, J.W, Gwang and his team members. Then let us start. Please refer to Page 1. S-Oil is implementing green initiatives, which is the company's long-term strategic direction to drive a sustainable future. One pillar of the green initiative is petrochemical expansion, which is a key milestone and to drive this, the company made final investment decision in Shaheen Project on November 16. From 2018, the company has been preparing for the project in prudence with thorough feasibility study and front-end engineering design. Shaheen Project will construct the world's largest refinery integrated steam cracker, which is energy efficient and eco-friendly with forward-looking design. In addition to this, the project will build TC2C facility that upgrades crude into petrochemical products and polymer facility that produces high value petrochemical products. Shaheen Project not only expands the company's business portfolio to petrochemicals, but serve as a turning point in driving innovative growth and successfully delivering green initiatives by achieving industry leading energy efficiency and carbon intensity. The company believes this is the right time to make investment for the future when uncertainties around the global economy have dampened investment in the industry for years. Support from Korean and Saudi government, major shareholder, local community coupled with S-Oil manpower's outstanding capability and passion demonstrated from successful projects since the company's foundation and the company's resources will no doubt bring yet another mega project to success. We'll make a great leap forward in improving long-term value of the company through successful completion of the Shaheen Project in response to global energy transition. We'll also fully commit ourselves to enhancing shareholder value during the project execution period. Team leader, J.W. Gwang, will share more details in the following slides.

[Interpreted] Good afternoon. I'm J.W. Gwang, IR team leader. Before we begin, please be noted that forecast information based on internal analysis and external assumptions are provisional and thus may change according to changes in the future market conditions and execution progress of detailed tasks. Let me explain background, core competitiveness, execution plan and how the company will look like after Shaheen Project. First, let me give you the background of Shaheen Project. Please refer to Page 5. Petrochemical industry is serving as a growth engine with healthy demand structure backed by global economic growth along with population increase, urbanization and industrialization. From demand perspective, bullish factors such as recent pandemic-driven stay-at-home economy and bearish factors like growth in plastic recycling market amid eco-friendly and decarbonization trends are affecting demand of petrochemical products. According to the outlook of major institutions, global demand for petrochemical products will remain high in the long term. As for basic chemicals, for olefin products, 51 million tons of new global ethylene demand will be created from 2022 to 2030 and another 45 million tons thereafter until 2040. Polypropylene is also projected to generate 39 million tons in new demand until 2030 and another 29 million tons over the following 10 years thereafter. In order to meet this global demand growth, continuous investment in new facilities is required. Recently petrochemical especially the cycle of olefin based chemical markets are hitting the downturn due to supply clog on the back of larger scale capacity addition since early 2020s and slowing demand owing to COVID-19 restrictions and tight monetary policy in the world. However, in the mid to long term, oversupply is expected to ease in the mid-2020s as cumulative growth in demand will outpace capacity addition from 2024 or 2025. After this turnaround of the industry, petrochemical market is forecast to show a stable move in 2030. The latest downcycle of the industry and macroeconomic uncertainties are working as barriers to new facilities investment. But the fact that several years are needed to build new facilities and market products out of them means the best investment timing is when business cycle is at its lowest. So in the face of unprecedented uncertainties around the world, we'll maximize chances of successfully undertaking new investments based on the company's core competency and resources. Since its foundation, the company has brought success to all mega projects. We completed the construction of a Bunker-C Cracking center in 1997, #2 Aromatics in 2011 and RUC and ODC project in November 2018. The series of projects are the result of bold investment decisions made by the company during business downcycle, which combined with market leading new technologies applied to past projects, maximized the projects' internal rate of return. We are sure these proven success stories will be a huge asset in executing Shaheen Project. S-Oil has long been accumulating operational excellence with over 40 years of experience in refining and chemical business and established its strong sales network of olefin, monomer and polymer products in domestic and overseas market after the completion of RUC and ODC. There is another distinct competitive edge that we have over others, which is the potential for collaboration and synergy with Saudi Aramco, which is the global supersize energy chemical company. On top of stable crude supply, we can create project synergy in various ways through collaboration for global marketing and technology. Next, the overview and core competitiveness of Shaheen Project. Shaheen Project will construct the world's largest refinery integrated steam cracker and relevant facilities, which is energy efficient and eco-friendly with a forward-looking design. Shaheen Project consists of 3 processes: TC2C, Steam Cracker and Polymer. First, TC2C stands for thermal crude to chemical, a new technology that upgrades crude and low value heavy oil from existing refining facility into steam cracker feed stock with enhanced yield. Second, the world's single largest steam cracker with 1,800 KTA ethylene production capacity, which will bring economies of scale. Third, polymer producing LLDPE and HDPE from ethylene. From Shaheen Project, monomers including 580 KTA of ethylene, 770 KTA of propylene, 200 KTA of butadiene and 280 KTA of benzene; and as for polymer, 880 KTA of LLDPE and 440 KTA of HDPE will be produced. Through Shaheen Project, our goal is to secure the most competitive refining chemical integration in North Asia, which we'll achieve based on key competitiveness in synergy from refining chemical integration, deployment of TC2C technology, industry leading energy efficiency and carbon intensity and superior cost competitiveness and economics. Let me give you more details. First, synergy from refining and chemical integration, which will secure the company competitive feed stock and facilities and operation. The company has low value products such as LPG, naphtha and asphalt that can be upgraded to high value-added chemicals, including ethylene and propylene. Refinery integrated steam cracker is able to enhance the company's competitiveness and profitability by upgrading these low value fuel products to high value chemical products. Online conventional steam crackers that use only naphtha as feed stock, steam cracker in Shaheen Project also treats offgas from existing refining process and LPG as well as naphtha from TC2C as feed stock. This enhances yield and minimizes unnecessary byproducts. In addition, designed to interconnect utilities and storage facilities of existing refinery with the new one will minimize new construction and operation expense as well. Second, deployment of TC2C technology. Trended towards energy transition in the long term will slow down demand growth for refining products while the other petrochemical products will continuously grow based on the forecast. This subsequently pushed for technological advancements in the industry towards minimizing production of refining products in existing refining facilities while maximizing chemical yield. As a technology that leads such industry trend, TC2C maximizes the production of feed stock naphtha and LPG for steam cracker from crude and low value heavy oil from process that is much more simplified than conventional ones. Additionally, it produces VLSFO, which has good economics as byproduct. Whereas conventional process yields based on crude oil is less than 20% petrochemical, chemical yield from TC2C is over 70%. Also it can reduce CapEx and OpEx by 30% to 40% by simplifying the process. Third, industry leading energy efficiency and carbon intensity. Shaheen Project is designed to achieve the world's best energy efficiency and produce major products that meet domestic and international greenhouse gas emission standard aligned with the global decarbonization trends and growing importance on ESG management. TC2C minimizes production of transportation fuel compared to conventional naphtha cracker while raises production field of naphtha, which is the petrochemical feed stock. This makes it possible to produce petrochemicals with lower carbon intensity. Our world-class energy efficient steam cracker process is designed to maximize efficiency through the integration with existing refining facility. Especially gas turbine generator for self-power generation will be installed in order to utilize recovered high temperature with heat for core cracking process thereby reducing full consumption. Shaheen Project optimizes steam and energy network through interconnection with existing refinery and introduce energy and greenhouse gas reduction facilities [ across the board ] including the energy efficient low pressure gas-based reactor in the polymer process. As a result, Shaheen Project is expected to achieve better energy efficiency than global top tier. As for greenhouse gas emission standpoint, ethylene, butadiene and benzene product from the project will qualify for emission standard of EU and K-Taxonomy. With the adoption of a future oriented refining and chemical integration technology, the company is expected to take the lead in cost competitiveness in Northeast Asian region. Analysis shows that Shaheen Project will place the company in the first quartile based on olefin cash cost meaning that our production facility is in the Top 25%. Based on this cost competitiveness, internal rate of return or IRR for Shaheen Project is projected to reach 16.4% with the payback period of 6 years. For your reference, economics were estimated based on the latest IHS forecast on spread between feed stock and product. We did not assume leverage for IRR. Next is execution plan for the project. After Shaheen Project, the company plans to market total 1,800 KTA of monomer and 1,350 KTA of polyethylene. With respect to the monomer sales, discussion is ongoing with chemical customers in Ulsan to replace their import demand with our product out of Shaheen Project reliably supplied via pipeline. This will make S-Oil the most competitive and reliable monomer supplier. Remaining volume will be exported utilizing Aramco's global network. As for polyethylene, the company's set marketing plan based on customer needs that vary based on product application and is discussing sales to key domestic customers in detail. For export of polyethylene, the company established marketing plans based on close cooperation with Aramco chemical affiliates and will continue to engage closely with them going forward. Total investment for Shaheen Project is KRW 9.258 trillion, of which direct investment required for EPC is KRW 7.678 trillion and indirect investment, which includes interest of construction cost and personnel expense is KRW 1.58 trillion. For the project, the company will utilize existing land in Ulsan Industrial Complex, home to the company's Onsan refinery. For direct CapEx reduction, existing utility and storage facility in the existing refinery will be utilized to minimize construction of new facilities. In the design phase, we also save CapEx through value engineering activities. Among direct investment, KRW 166 billion of engineering cost has already been executed. Actual spending on interest costs may reduce if interest rate is adjusted downward as capitalized interest on construction includes capitalized borrowing cost for general debt in addition to interest for project loan according to accounting standards. Next, financing plan. Shaheen Project will be funded with 71% of internal financing and 29% of external financing, which includes major shareholders' loan and corporate bond. For your reference, proportion of external financing is estimated based on conservative business case. As refining industry is projected to enjoy high cycle over the next several years, we expect stable cash flow from business operations. Also we have flexibility in working capital operation, which will limit requirement for external debt financing to less than 30% out of total investment. We are also discussing with Saudi Aramco, our majority shareholder and who is strategically aligned with our project, on possible financial support including shareholder loan. So even assuming conservative business scenario during the project period, we'll be able to keep our financial structure healthy and execute the project in a stable manner. The company selected top tier engineering and construction companies with world-class construction capabilities as preferred bidders through competitive bidding. EPC work for Shaheen Project will begin in January next year. Total project period will take 42 months and the mechanical completion will be at the end of June in 2026. Target commercial operation is Q4 2026 after commissioning. The company's Vision 2030 is the most competitive, creative and clean energy and chemical company and Shaheen Project will play a central role in putting the company closer to the vision. Shaheen Project will enlarge the company's chemical production to 25% of total production, which is one of our strategic objective. Current fuel weight to the business portfolio will be diversified to generate more stable and sustainable income, which will set the foundation for further expansion into polymer downstream. In 2027 when commercial operation starts, we expect company's complex refining margin to increase by more than $4.5 per barrel. We forecast petrochemical business cycle to turn up in 2024 or 2025 and stay on the upward curve until 2030. This suggests that margin improvement will be even greater when we make the estimation based on the price in 2030. The company moved ahead of others when we invested in conversion of refining facilities via RUC and ODC project at the end of 2018, which significantly impacts the company's income generation capability. This has the support from peers with distinct performance by taking advantage of the unprecedently high refining margin in 2021 and 2022. In the face of energy transition, refiners will compete for higher margin through refining petrochemical integration. Through Shaheen Project, S-Oil envisage taking our fundamental competitiveness to a higher level by investing in a different way in terms of timing and method. By doing so, we'll be able to achieve differentiated profitability and performance regardless of business cycle and energy transition, whose course is still highly unpredictable, and do our best to ultimately bring shareholder value to a higher level. With this, I'd like to wrap the investor briefing session for Shaheen Project. Thank you.

[Interpreted] The Q&A session will begin shortly. Please wait for a moment until Korean presentation finishes.

[Interpreted] [Operator Instructions] The first question will be given by [ Kim Jin Woo ] from Eugene Investment Securities.

[Interpreted] I'm asking my question on behalf of my colleague who is absent. This is with regards to the cost associated with the carbon emissions. We believe the construction of a new steam cracker could incur higher cost when it comes to the carbon emissions. Do you have any outlook when it comes to this internally?

[Interpreted] So I'm aware of the trend towards ESG management these days. So in reflection of this, we have been applying the eco-friendly and green design from the front-end engineering design phase. One example of it is the high efficiency cogeneration power utilities, which will allow us to generate low carbon electricity of 150 megawatt. And also since all of the feed stock for Shaheen and the steam cracker will be sourced from our refining facilities, which was adjacent to the new facilities, we'll be able to keep the carbon emissions coming from the transportation to minimum, which is a major comparison from other naphtha crackers. And also in supplying the monomer to our customers in Ulsan Industrial Complex, most of them the petrochemical downstream players, the transportation will be done via the underground pipelines, which will also allow us to keep the cost and the carbon emissions to minimum level. In determining the economics and also arriving at the FID for the Shaheen Project, we also reflected the cost associated with carbon emissions and based on our analysis, the impact of the cost related to carbon emissions on the project economics and the FID is minimal. So the company has aligned our business to the global trend towards decarbonization and we accordingly set our carbon reduction targets for 2030 and 2050. So in alignment with this, we will continue our effort to enhance the energy efficiency and reduce carbon emissions from the new facilities.

[Interpreted] The following question is by Oscar Yee from Citi.

Thank you for the call very detail and informative. First question is regarding your surplus ethylene and propylene output. You mentioned you plan to sell within the Ulsan complex to some of your downstream customers. Can I roughly ask what is the sort of total requirement currently, I mean the sort of in proportion that you think you can substitute? And roughly what external volume do you expect to sell after selling to these sort of downstream customers? Would there still be a need to sell to a third party or export? Second question is could you give us a little bit details about the rough product yield from your TC2C complex, i.e. roughly what percentage will be the naphtha, the LPG and the VLSFO yield from the TC2C unit? And thirdly, you mentioned that your 16% IRR is based on IHS forecast, right? Could I just roughly ask you what sort of PE naphtha spread is incorporated in the 16% IRR? [Foreign Language]

[Interpreted] So to answer part of your first question. In Ulsan there are quite a number of petrochemical companies that rely on outside sources to purchase the ethylene and propylene because they don't produce ethylene and propylene on their own in order to produce their petrochemical downstream products. They source the ethylene and propylene from within Ulsan Industrial Complex from their neighbors, but also they rely on regions outside of Ulsan as well as import. So for these petrochemical downstream players, sourcing on a reliable and stable basis is highly critical, which is why they are very supportive of Shaheen Project and the capability for us to supply our ethylene and propylene products in a long-term basis via the pipeline. So based on this reliable sourcing, they also plan to expand their production capacity. So other than the ethylene volume that we will be consuming in-house to produce polyethylene, about 60% of our production meaning ethylene and propylene will be supplied to our customers in Ulsan Industrial Complex and I'm very pleased to tell you that the financial discussions have been made with regard to the supply. And for the remaining volume, we will take advantage of Saudi Aramco's global marketing network to export. So with regard to your second question on the yield of byproduct from TC2C. The conversion rate for the petrochemicals by using the naphtha and LPG as a feed stock for steam cracker will be 70%, which is far higher than the 10% to 20% that is seen in the conventional way of producing petrochemicals in the refining facilities. So to answer your third question about the PE and naphtha spread in calculating the company's -- the IR for Shaheen Project, again, this is based on the price outlook by IHS based on Q3 2022. And while it varies by the type of polyethylene, we believe and we estimate the spread in 2022 to be in the range of $530 to $550 and the spread to moderately widen from 2028 and onwards. I hope I answered your questions.

[Interpreted] The following question is by [ Ki-Jin Song ] from Hana Securities.

[Interpreted] So I have 4 questions, which is about financing for Shaheen Project. First is about the CapEx schedule, please share with me the CapEx schedule on a rough basis. Second is will this project bring about a change in the company's dividend policy? Third is about the shareholder loan, how will this support the company? Can you elaborate on this? And number 4 is about the business environment, it does not seem that bad at the moment and assuming that the business environment will stay quite favorable, will this affect the company's borrowings?

[Interpreted] So about the CapEx schedule, as we communicated, the EPC for Shaheen Project will commence in January next year. But at the beginning stage, it will mostly be focused on site preparation and ordering for the long lead items, which means the CapEx in 2023 will not be that sizable. And a lot of the CapEx will go into full swing from 2024 with that peaking in 2025. With regard to the dividend policy, our goal is to maximize the shareholder value in the long term and maximize the shareholder return. But when we do so, we look into a number of factors. First, we look into the company's financial performance. We also reflect the company's financial structure and the investment funding for sustainable growth into the future. And this is how -- this is the basis on which we determine our dividend policy. So in reflection of Shaheen Project, as we communicated earlier, we have been maintaining the company's dividend payout ratio at 30% and lower for the past 2 years, which is lower than our previous dividend payout. So given the fact that there will be uncertainties in the business environment, until we complete our financing, we plan to be more prudent and discrete in the way we keep our financial structure. However, we don't expect to see a radical change in the company's dividend policy even though there will be a major investment coming. This is because we have been planning Shaheen Project for a number of years during which period -- during when we have worked hard to improve the company's financial competency and capability. And also we have very big confidence that we'll be able to maintain a strong financial structure throughout the project execution period. So for 2022, as was communicated to the investors earlier, the company's dividend payout will be at 30% of the current net income. And given the fact that we'll hopefully be able to end the year with a record high business performance since the history -- since the foundation of the company, we expect the dividend per share to be higher than the past years. And as for the company's dividend guidance in fiscal year 2023 and onwards, we will share and communicate them with you in 2022. And as for the shareholder loan, the purpose for this is to save the company's financial cost. This is in discussion with Saudi Aramco at the moment. The size of the loan will be USD 600 million or higher, but please forgive me that we're not able to share the exact amount for the interest rate because they are in discussion at the moment. However, I can tell you that the interest rate will be a fair one based on the arm's length transaction, but we believe it will be lower than the domestic financing cost. And also we can flexibly adjust the credit period with Saudi Aramco, who is our majority shareholder, based on the long-term crude supply agreement. But I want to ask for your understanding that we cannot share the details about this credit period extension. But I can certainly tell you that there are many ways for us to get the financial support. So the company's financing plan is based on a conservative scenario. I'm assuming that is 50% of the operating income based on the long-term price forecast and outlook announced by IHS most recently. This means that if the business environment improves more than what we expect, there could be some change in the borrowing -- change in the [ borrowing ] in favor of the company.

[Interpreted] The following question is by [ Eun Ji Won ] from Hanwha Asset Management.

[Interpreted] So I have 2 questions with regard to carbon emissions. You mentioned a number of eco-friendly technologies that will be used to curb carbon emissions from the new facility, but you did not really share with us the actual carbon emissions from producing the naphtha and the steam cracker. I would like to know how much this will contribute to carbon emissions and whether this will affect S-Oil's goal to achieve 35% carbon emission reduction versus BAU in 2030. Second is about the impact of carbon emission cost to the Shaheen Project economics. You said that it does not have a negative impact on Shaheen Project economics. However, there is a very strong commitment by the government to meet their nationally determined contribution target and this means -- and S-Oil's allocation amount is 7.4 million tons. But this is lower than the 9.6 million tons that the company emitted in 2021, which means the company will eventually have to purchase carbon credit to make up for the excess. So that said, I would like to know what is your outlook on the price?

[Interpreted] It is true that the carbon emissions on an absolute basis from the naphtha cracker in Shaheen Project will go up. However, I would like to tell you that we're making a lot of efforts to reduce energy consumption also and reduce the carbon emission. So compared to the industry level, this means our carbon emissions per intensity will be less than the industry level. And as to echo what you said about the 35% carbon emission reduction versus BAU in 2030 although on an absolute basis while the carbon emissions will go up after Shaheen, our efforts to continuously curb and reduce carbon emissions will continue. So about the impact of carbon cost on the project economics, we believe this is a very critical factor in determining the economics of the project. That is why we engaged with outside agencies to do a study to make a forecast on the future of carbon prices based on a number of scenarios. So given the fact that we are estimating very good economics of the project because of the widening of the olefin spread from 2030 and onwards and the favorable petrochemical market, the impact of carbon emission cost to IRR even when assuming that the carbon price will be higher than now is only 0.1% to 0.2% of the IRR. That was my answer.

[Interpreted] The following question is by Hyunryul Cho from Samsung Securities.

[Interpreted] I have 2 questions. First is about the chemical yield of TC2C, is it mostly from the naphtha? And after the Shaheen Project, where will the naphtha will -- where are you selling the naphtha right now, which will change after Shaheen Project? Second is about the TC2C technology, which has been developed by Saudi Aramco. I heard that this will be the first ever commercialization of TC2C technology. That said, will there be some issues in achieving the design yield in the initial stages and do you also expect to see some technological hurdles along the way?

[Interpreted] So the feed stock for the steam cracker that we'll be producing from TC2C will be offgas, LPG and naphtha. And naphtha, which will be the feed stock for high quality petrochemical, will represent about 80% of the production. And as for the naphtha that we're producing at the moment, most of them is supplied to the domestic market and to our Japanese customers. Yes. As you said, the TC2C technology will be the first ever to be commercialized in Shaheen Project based on the source technology owned by Saudi Aramco and also coupled with the outstanding engineering capability of process technology developers from the United States. So to ensure the successful commercialization of TC2C and to reinforce its operational reliability, we plan to tap into the rich experience and capability of operating the company's hydro cracker for more than 40 years. So we have performed the heads-up study to look into the process -- we did the heads-up study and we also invited the experts from our process licensor and the engineering companies to ensure that we can have a reliable operation for successful commercialization of the new technology. Let me correct what I have just said about the portion of naphtha out of total production from TC2C. Its portion out of total production from TC2C is 65%.

[Interpreted] So our allocated time is up for the Shaheen Project briefing. I would like to once again express my deepest gratitude to the analysts and investors for taking part in the Shaheen Project briefing. We will continue to engage in close communication with the market. So if you have any further inquiries about the project, please feel free to contact the company's IR team. So this is the end of our briefing for Shaheen project. Thank you very much.

[Interpreted] This concludes the Shaheen Project Investor Briefing by S-Oil. Thanks for the participation. [Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]