Mergers & acquisitions: PARCO to join PSO bid for Pakistan Refinery

Analysts question the wisdom of buying what is described as ‘a piece of junk’.

ISLAMABAD/KARACHI:

Pak Arab Refinery Company (Parco), a firm jointly owned by government of Pakistan and the Emirate of Abu Dhabi, has decided to join Pakistan State Oil (PSO) in a joint bid to acquire Shell Pakistan’s share in Pakistan Refinery Ltd (PRL), even as analysts question the value of buying the troubled refinery.

PSO announced in May last year that it planned to buy Shell’s 30% stake PRL, a company in which PSO also has an 18% share. When it was announced, PSO’s management characterised the acquisition bid as part of the company’s effort to become a vertically integrated oil company. It remains to be seen how this joint bid will now play into PSO’s strategic plans.

“Now, Parco’s board of directors has approved acquiring shares of PRL in a joint venture with PSO,” sources told The Express Tribune, adding that Parco has started process of conducting due diligence in a bid to strike a deal.

PSO has hired BMA Capital, a Karachi-based investment bank, to serve as its financial advisor and propose a deal structure that might work for the cash-strapped company. Grant Thornton, the international accountancy firm, is conducting the due diligence on the deal. PRL has not yet appointed a financial advisor and it is unclear whether Parco has done so yet.

PRL’s refinery facility is located on the coastal belt of Karachi and is a hydro skimming refinery designed to process imported and local crude oil. The refinery can process up to 47,000 barrels of crude oil per day. While PRL produces several types of oil products, it primarily converts the crude oil into furnace oil.

According to sources familiar with the matter, about 40% of the total crude oil refined by PRL is turned into furnace oil, which then sells as below the price of crude oil, resulting in losses on a significant chunk of the company’s sales. The rest of the company’s sales have higher margins and include products such as high speed diesel, kerosene oil, jet fuel and motor gasoline.

Shell Pakistan is selling its stake in the refinery as part of a process of realigning its strategic position in the energy sector based on decisions made by their Netherlands-based parent company, Royal Dutch Shell to concentrate on upstream, high-margin businesses. To this end, they have already sold off Shell Gas, a liquefied petroleum gas distributor to OPI Gas, a subsidiary of the Hashoo Group, for $8 million, in 2010.

Sources say that PSO and Parco plan to upgrade PRL’s production capacity to 100,000 barrels per day, though doing so may require investing substantial sums of cash into the company’s existing infrastructure.

“PRL is an antiquated piece of junk,” said one financial analyst who wished to remain anonymous. “Everyone in the market knows that.”

Yet the strategic logic for the deal may still make sense. “Due to the circular debt issue, PSO has had a lot of problems in maintaining a steady fuel supply. Owning more shares of PRL would help them stabilise those supplies,” said a source.

PRL currently supplies between 30% and 40% of PSO’s fuel supplies. PSO, as an oil marketing company, does not have its own refining capacity though it has been seeking a more integrated supply chain in recent months.

It is unclear how Parco’s participation in the venture will change the dynamics of the deal. Parco’s experience in running refineries may add synergies to PSO’s management of PRL, but it may also introduce another player with whom PSO management will have to contend.

Yet the fact that PSO has been analysing the deal for over a year now and has yet to close suggests that PSO management may not be comfortable going it alone on the transaction.

Published in The Express Tribune, August 1^st, 2011.