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

Good morning. This is Katie Kong, Treasurer of S-Oil. I'd like to extend my gratitude to our investors and analysts in and out of Korea for joining S-Oil's Conference Call for Q2 2026 earnings results. For today's conference call, we have CFO, J.W. Bang; IR team leader, Mr. H.D. Jeong and team members. First, I will take you through the highlights of Q2 results. In Q2 of 2026, global refining margins remained strong as the impact of the Middle East conflict continued. Despite lower crude prices toward the end of Q2, as the blockade of the Strait of Hormuz was temporarily lifted, operating income reached KRW 965 billion, supported by strong global refining margins and record high lube base oil spreads. In particular, the lube business contributed significantly to Q2 earnings, posting a record quarterly operating profit of KRW 477.4 billion. Next is the market outlook. Due to the Middle East conflict, crude oil and product supply disruptions continued in the first half, leaving global inventories at significantly low levels. With tight supply-demand conditions expected to persist in the second half, we expect firm market conditions to continue. Next is the progress of Shaheen project. The Shaheen project is progressing towards commercial operation in early 2027. The company is currently conducting field inspections, equipment performance checks and document verification to confirm mechanical completion. Pre-commissioning and commissioning activities are also in progress across the process units. The company will make every effort to ensure a smooth start-up in the second half and achieve commercial operation in early 2027. Now IR team leader, Mr. H.D. Jeong will get into more details for Q2 performance and market outlook.

Good morning. This is S-Oil IR team leader, H.D. Jeong. Before we begin, please note that Q2 2026 financial results are provisional and therefore, subject to change according to outside independent external auditors' audit results. First, please refer to Page 5 for Q2 2026 financial results. In Q2 the company posted sales revenue of KRW 11.3 trillion, up 26.8% Q-on-Q driven by higher crude prices. Operating income was KRW 965 billion, down 21.6% Q-on-Q, as the one-off impact of higher crude prices recognized in Q1 largely subsided. If you look at each business segment, operating income from the refining segment declined 49% Q-on-Q to KRW 532.4 billion. Although global refining margins remained strong, particularly for diesel and gasoil amid the Middle East conflict. Operating income decreased Q-on-Q due to the reverse base effect from the one-off crude price benefit recognized in the first quarter. Although margins in the Petrochemical segment improved slightly Q-on-Q, the segment turned into a loss due to inventory-related impact. Operating income from the Lube segment rose 187% Q-on-Q to KRW 477.4 billion, driven by record high product spreads amid tight supply-demand conditions. As mentioned earlier, this represents the highest quarterly operating profit on record. For reference, the company recorded KRW 113.7 billion in inventory-related gains in Q2, most of which were generated by the Lube segment. This was significantly lower than KRW 643.4 billion recorded in the previous quarter. In financial and other gains and losses, the company recorded net interest loss of KRW 66.6 billion and net foreign exchange loss of KRW 155.6 billion due to foreign exchange increase. Q2 income before tax and net income come in at KRW 705.5 billion and KRW 514.6 billion, respectively. Moving on to financial status. As of the end of Q2 2026, the company held KRW 1.5 trillion in cash, while net debt to equity ratio was 78.1%. Despite external market volatilities, the company continues to maintain sufficient liquidity and stable financial structure through competitive and timely financing at low interest rate to support smooth execution of Shaheen project [indiscernible] for the first half came in at KRW 2.1 trillion. Now I will go through market environment and outlook by each business segment. First, turning to the Refining segment on Page 7. As mentioned earlier, despite strong regional refining margins driven by the Middle East conflict second quarter operating income from the refining segment declined Q-on-Q to KRW 532.4 billion as the substantial inventory-related gains recognized in the first quarter did not recur in the second quarter. Turning to Dubai crude prices in the second quarter. Prices remained above $100 per barrel throughout April and May, as the Middle East conflict continued and the Strait of Hormuz remained closed. However, following the temporary easing of the blockade in June, crude prices declined rapidly with Dubai crude averaging $79.5 per barrel for the month. Since then, crude prices have continued to fluctuate sharply in line with developments in the conflict, and they are expected to remain highly sensitive to geopolitical developments going forward. Asian refining margins strengthened significantly in Q2 as tighter refined product supply relative to crude drove product spreads sharply higher. The market was supported by the start of the driving season continued Ukrainian drone attacks on Russian refineries and supply disruptions from the Middle East. Accordingly, the average kerosene and diesel spreads widened further Q-on-Q to around USD 62 per barrel, which also increased Q-on-Q with the onset of the driving season, reaching USD 25.6 per barrel in Q2. Tight market environment is expected to persist in Q3 amid ongoing crude and product supply disruptions. The driving season remains underway, while Europe is expected to increase demand for diesel used in power generation due to heat waves. Also, as continued Ukrainian drone attacks on Russian refineries, Russia's export restrictions on products such as jet fuel and diesel are expected to keep major product markets tight. However, geopolitical developments are expected to influence the strength of product spreads in the second half of the year. A more detailed outlook for the second half will be provided in the key business update section with supporting data. Next is Petrochemical business segment. In Q2, Petrochemical segment posted an operating loss of KRW 44.8 billion, although margins improved somewhat, supported by higher PO spreads. Inventory-related gains turned into losses from the previous quarter Let me now discuss the market environment in Q2. In April and May, PX spreads narrowed to around USD 200 per ton on average, as feedstock naphtha prices surged following the Middle East conflict, while PX prices failed to keep pace with the increase in naphtha prices. However, in June, naphtha prices stabilized following the easing of the Strait of Hormuz blockade, allowing PX spreads to recover to the USD 350 per ton range. As a result, the average PX spreads for Q2 came in at USD 251 per ton. Operating rates at major facilities due to naphtha supply disruptions, together with the resumption of Korean benzene exports to the U.S. helped improve the regional supply-demand balance. As a result, the average benzene spreads for Q2 increased by USD 20 Q-on-Q to USD 139 per ton. For olefin downstream improved to USD 229 per ton in Q2. For PO, the market remains strong as lower operating rates caused by feedstock supply disruptions following the Middle East conflict together with pre-bought customers concerned about supply shortages supported the prices. As a result, the average PO spreads over propylene widen to USD 351 per ton in Q2. Let me discuss the outlook for the Petrochemical segment in Q3. For Aromatics, supply is expected to decline as planned maintenance shutdowns at Chinese facilities originally scheduled for Q2 have been postponed to Q3, resulting in lower operating rates, being volatile depending on the timing of plant restarts and the pace of downstream demand recovery. If geopolitical volatility in feedstock supply and prices, including naphtha and propylene is also expected to continue. For olefin downstream products, PP is expected to remain weak amid continued regional supply growth from new capacity additions. Meanwhile, for PO, spreads are expected to moderate as supply recovers from the previous quarter and seasonal demand weakens. Next is Lube business segment. Operating income from the Lube segment reached a record high KRW 477.4 billion in Q2. LBO market remained strong across all grades due to supply disruptions in the Middle East with particularly tight market conditions for Group III base oil. Direct product disruptions at Middle East facilities, together with logistics constraints caused by the closure of the Strait of Hormuz drove a sharp increase in LBO prices. As a result, LBO spreads increased by approximately USD 90 per barrel Q-on-Q to a record high USD 139.7 per barrel. Tight supply-demand conditions are expected to persist in Q3 as supply disruptions continue. A more detailed explanation will be provided in the key business update section. Next is key business update. First, let me walk you through the supply and demand outlook. The Middle East conflict continues to affect global crude oil and refined product markets. Geopolitical tensions in the Strait of Hormuz and the Red Sea have disrupted crude oil transportation, leaving global crude inventories at historically low levels. Refined product inventories have also remained at historically low levels due to the blockade of the Strait of Hormuz and operational disruptions at refineries in the Middle East and continue to persist. Despite U.S. refineries operating at exceptionally high utilization rates in the mid-90% range during Q2, U.S. gasoline inventories have fallen to historical low levels due to reduced imports amid tight market conditions. In addition, as demand for diesel for power generation has increased amid the European heat wave. Russia has expanded its export restrictions to include gasoline, jet fuel and diesel following damage to its refining facilities. Meanwhile, refinery operations and exports in Middle East continue to be disrupted due to blockade of the Strait of Hormuz following the Middle East conflict. As a result, tight supply-demand conditions are expected to continue affecting market conditions through at least the end of this year and into next year. Accordingly, global refining margins are expected to remain firm for the foreseeable future. LBO market is also being significantly affected, particularly for Group III as tight supply in the Middle East continues to intensify. The Middle East accounts for approximately 30% of global Group III base oil supply capacity. And as a result, Group III spreads have reached record high levels. Given the disruptions, the current supply tightness is expected to persist for an extended period even after the Strait of Hormuz reopens. More than 35% of the company's LBO production capacity consists of Group III products. Accordingly, the current strength in the LBO market is having a meaningful impact on our earnings. Based on current inventory levels and supply-demand conditions, the company expects market conditions for the refining and lube businesses to remain firm throughout the second half of the year. Last is the progress of Shaheen project. The company is currently verifying mechanical completion through site inspections, equipment performance checks and reviews of submitted documents to verify whether the requirements for mechanical completion have been met. At the same time, pre-commissioning and commissioning activities are underway with a start-up scheduled to follow and commercial operation targeted for earlier next year. On the marketing side, annual supply agreements for olefin monomers have been secured with customers, while additional contracts are being pursued to expand the customer base. Customer pipelines have also been completed and commissioning is planned in line with Shaheen start-up. For PE, quality evaluations are being conducted through pre-marketing, while marketing efforts are underway for early securing key domestic customers. We will keep you updated on the progress of Shaheen project. This concludes our presentation. Thank you.

[Foreign Language] [Operator Instructions] The first question will be given by Jung-il Oh from Shinyoung Securities.

[Foreign Language] I have 3 questions and thank you for the opportunity to chose my question. First is your outlook on the refining business in the second half of the year? And how will the company respond to the escalating geopolitical risks in the Middle East, namely a possible closure of the shipping route in the Red Sea and how we are going to counter to these risks in terms of sourcing crude? My second question has to deal with the global -- your understanding and market intel on the global refining facilities disruptions caused by the war in Iran and Ukraine's drone attacks against refining facilities in Russia? And how do you expect the overall market supply and demand conditions to evolve after the end of the war? My third question is your CapEx plan for this year and 2027.

[Foreign Language] So to answer your first question on the refining market conditions in the second half of the year. As was also explained by the IR team leader, the overall margin is very strong for a number of reasons. First of all, we are seeing exports from the Middle East being contracted because of the war and the Russian's refining facilities are also disrupted because of the drone attacks from Ukraine, and this subsequently moved the Russian government to impose restrictions on jet fuel and diesel exports, and China is also restricting its exports of refined products.

[Foreign Language]

So we don't expect the situation to clear itself in the short term. So even if the war comes to an end, we believe the strong refining margin trend will continue at least until the end of the year and even in 2027.

[Foreign Language]

And in response to the company's crude sourcing due to disrupted by the war in Iran, we are actually coming up with various response measures to this. We have been securing feed through a different ports, and we've also taken -- utilized the non-Saharan Blend crude as an alternative, and we're also securing crude oil from Saudi Arabia. Saudi crude oil is stored in Ulsan, and we also sought leased the government stockpile oil. So these are all the measures that we are working on in response to the crude sourcing.

[Foreign Language]

So again, we are using the Detour shipping routes since the war broke out, and we're also looking into various supply scenarios and countermeasures under the assumption that there will be some disruptions in the shipping routes from the Red Sea. And if we opt for the Detour shipping routes through the Suez Canal, this could delay the crude arrival to South Korea by about 30 days. So we'll come up with various phased countermeasures such as leasing the stockpile crude oil from the government and tapping into spot crude oil on a contingency basis.

[Foreign Language]

Doing so, we'll be able to minimize the impact of the disruptions in the shipping routes even if there are, again, disruptions in the shipping routes from the Red Sea.

[Foreign Language]

So to answer your second question, we understand that there have been quite sizable disruptions in the operation of refining facilities in Russia because of Ukraine's continued drone attacks on Russia's refining facilities. As of July this month, about 40% of Russia's refining capacity has been hit by the drone attacks. And in terms of the utilization rate, it is equivalent to about 36%.

[Foreign Language]

And subsequently, the Russian government made announcement on banning the exports of refined products. In June, they announced banning the exports of jet fuel, which will continue until November this year. And they also recently made announcement that export ban of gasoline and diesel will be extended until January next year.

[Foreign Language]

And in relation to the war in Iran, we cannot have a clear information on how much the facilities were damaged because there is direct attack on the refining facilities in the Middle East and also the supply disruptions of crude oil from the Middle East had an indirect impact on the global utilization rate of the refineries.

[Foreign Language]

So based on the outlook from the institutions, the damage and the disruptions done to the refining facilities in the Middle East was very heavy right after the start of the war. However, they are expecting the facilities to gradually come back to the normal track. As for the size of disruption, it was roughly 2.3 million BD in July, but they believe that it will clearly -- it will slowly clear down to 1 million BD in October this year. However, this is all subject to change depending on the situation in the Strait of Hormuz and the Red Sea.

[Foreign Language]

So to sum up, the global refining facilities are disrupted, but they vary to some degree from one region to another. And subsequently, the inventory level is also up on normal level compared to the past. And therefore, it will take time before the market comes back to the pre-war supply conditions.

[Foreign Language].

So to answer your third question on the CapEx outlook, this year, as you know, the Shaheen project is progressing well. And as was shared with you earlier, other CapEx for this year is KRW 2.1 trillion.

[Foreign Language]

So this year, we are going to wrap up Shaheen project. And in 2027, most of the CapEx will be the ordinary CapEx around maintenance and repair, and we don't have any major investment plan for 2027 so far.

[Foreign Language]

And we are at the moment of setting the budget for 2027. And once the final numbers are out, we will share them with you.

[Foreign Language]

This concludes my answering your third question.

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

[Foreign Language] So I have 3 questions. What is the background behind the bullish kerosene and diesel margin since June? And what is your outlook on the sustainability of this margin situation? My second question has to deal with Shaheen project. You explained about Shaheen project in earlier when we began the earnings release. But could you just walk us through in more detail about Shaheen project and when it will go into commercial operation? And also explain to us about the government's petrochemical restructuring policy in Ulsan and how this could affect the Shaheen project. My third question has to deal with the dividends. The company's performance has recently improved significantly. How much do you think this will reduce the company's borrowing? And do you think this will also raise the company's dividend? If so, when and by how much?

[Foreign Language] So to answer your first question, I believe there are a number of factors that are being reflected in the supply side and also affecting the diesel and kerosene margin. The kerosene and diesel exports from the Middle East have been contracted because of the war and the refineries in Asia are sourcing lighter crude oil, which is affecting the overall utilization rate and the yield and the overall supply of kerosene and diesel.

[Foreign Language]

And we are seeing quite sizable disruptions in Russia's refining facilities because of Ukraine drone attacks, and this is affecting their overall exports of kerosene and diesel. And so is China, which is also restricting its exports as well. As a result, the kerosene and diesel spread, which was in the upper 30 level in Q1 had shot up to $60 level in Q2. And as the geopolitical issues renewed from the middle of July, the spread further widened to over $70 at the moment.

[Foreign Language]

So we do not think this disruptive situation will clear itself in the short term. It is likely to continue in the midterm. And therefore, we're expecting this bullish trend to continue towards the second half of the year.

[Foreign Language]

[Foreign Language] To answer your question on the Shaheen project, as was presented to you earlier, Shaheen projects target commercial operation is early 2027.

[Foreign Language]

So to walk you through our preparations on June 30, the EPC contractors have submitted to the company the documents related to the mechanical completion, and we are now in the process of checking the process of build inspection and verifying the performance of the equipment and also verifying the documents submitted by the EPC contractors to check whether the contractual requirements needed for mechanical completion have been met or not.

[Foreign Language]

Given the fact that this is a mega project, we are doing the verification work unit by unit and step by step. And in parallel with this, we are also in the process of pre-commissioning and commissioning work. Our plan is to complete the commissioning and the start-up in the fourth quarter of this year. And as I said earlier, we are going to go into commercial operation from early 2027.

[Foreign Language]

And speaking of the petrochemical restructuring in Ulsan, the company is fully aligned with the government's policies to make the petrochemical industry more competitive, and we are closely cooperating with the government's restructuring policy. However, we are seeing some delays in coming up with the restructuring solution.

[Foreign Language]

Well, as you know well, Shaheen project is very cost competitive, which means it will be a very competitive -- it will have very competitive facilities. But at the moment, the companies involved have different interests. So it is taking some time before the companies involved are coming up with an appropriate solution.

[Foreign Language]

Going forward, the company will continue to avail all the company-wide resources and capabilities to ensure safe completion. And at the same time, we will fully align ourselves with the government policies.

[Foreign Language] To downsize the borrowings and any outlook on any plans to raise dividends, based on the strong performance that the company has been recording recently?