Sri Lanka develops its potential as refining and storage centre for petroleum products

With its oil and gas resources as yet commercially unviable, Sri Lanka currently imports hydrocarbons to meet the growing needs of its people and industries. However, given the island’s location, industry players are now eyeing the country’s potential as an international centre for refining, storage and bunkering of petroleum products. In the interim, the domestic market continues to present challenges, with pricing and the role of the state among the key issues prompting debate.

A rapidly developing economy is also driving up demand for a wider range of products, including high-performance lubricants, jet fuels and diesel, which is now firing many of the country’s power plants.

Market Players

The state-owned Ceylon Petroleum Corporation (CPC) and the privately owned Lanka IOC are the two main players in the petroleum industry. The latter is the Sri Lankan subsidiary of IOC, which has the largest network of fuel stations on the subcontinent and is India’s largest company by turnover.

The CPC was established in 1961 and given the role of sole importer, exporter, seller, supplier and distributor of Sri Lanka’s petroleum products. Operating today under the Ministry of Petroleum Resources Development (MPRD), the corporation is also responsible for exploration, production and refining. The liberalisation of products and services in key segments, such as lubricants, synthetics, the importation of liquefied petroleum gas (LPG) and others in the bunkering segment in the 1990s led to the CPC gradually losing its monopoly. In 2003 Lanka IOC was awarded a licence to import and distribute a range of petroleum products.

Storage for these imports was also reorganised at the same time. A new entity, Ceylon Petroleum Storage Terminals Limited (CPSTL), was set up under the MPRD to oversee the country’s main storage units at Kolonnawa and Muturajawela. Both the CPC and Lanka IOC were given the right to use these facilities.

Sri Lanka had only imported refined products until 1969. However, a government initiative led to the construction of the Sapugaskanda refinery in the same year which allowed the country to begin importing cheaper crude oil and bring added value to the sector.

Refinery

With a crude distillation capacity of 6900 tonnes per day, the facility is still run by the CPC today, although it requires an upgrade, reliant on just one pipeline which suffers occasional ruptures. The pipeline connects the refinery to Colombo Port, where the crude oil is landed. The refinery itself was designed to process light, Iranian oil, which was in abundant supply in the 1960s. However, in the wake of the Iranian revolution and the imposition of international sanctions, the oil was difficult and expensive to replace. Imports of light grade oil from Abu Dhabi and Malaysia proved to be inefficient at the plant, which lacks a hydrocracker.

The return of Iran into key international markets has allowed for the resumption of some imports, although question marks hang over future developments, following the US elections. Prior to the sanctions, Iran was the source for some 93% of Sri Lanka’s crude oil.

New Initiatives

Plans to upgrade the Sapugaskanda refinery so that it can process an additional 50,000 barrels per day (bpd) – doubling the current capacity to 100,000 bpd – were aired by the MPRD in summer 2016. The project to refurbish and modernise the refinery, which includes the addition of a hydrocracker that would expand production of kerosene, jet fuel and diesel oil, is expected to draw in $2bn in foreign investment. The refinery was producing approximately 42,000 bpd as of October 2016, according to the CPC, or 27% of total domestic requirements.

Two additional refineries are also planned. One of these, a 100,000-bpd facility, has been proposed for Hambantota, the new port and airport complex built in the south of the country in 2013. The investment is expected to be part of a string of new projects earmarked for the port, including a projected liquefied natural gas terminal, an industrial and commercial free zone, petrochemicals plants and other facilities. The refinery would also supply an expected surge in bunkering activities at the port, as Hambantota’s development gains pace. A debt-for-equity swap designed to attract Chinese firms to the port looks likely to provide the basis for future investments.

New Facilities

A further refinery has also been proposed for China Bay, near Trincomalee in the northeast. Press reports in November 2016 said the facility would have a 200,000-bpd capacity, with construction to be supported by assistance from India. Maintaining a balance between input from the two Asian giants has long been a key part of Sri Lanka’s energy strategy.

The proposed China Bay refinery would be entirely export aimed, forming part of a bid to establish Sri Lanka as a centre for hydrocarbons activities. In a boost for the country, Narendra Modi, India’s prime minister, pledged his support for the plans during a March 2016 visit to Trincomalee. Crude oil could be brought in, refined and then exported in a variety of new forms, with the Asian and Indian Ocean markets in mind.

However, since India currently has excess refining capacity, the Trincomalee project looks likely to be more of a medium-to-long-term venture.

Bunkering

Another facility in is also being planned to extend services at Trincomalee: the China Bay tank farm. Built by the British to supply their Indian Ocean and Pacific fleets during the Second World War, this collection of 101 large, 12,000-tonne-capacity storage tanks has stood largely idle for decades.

Lanka IOC is in charge of 14 of the 99 tanks that are still functional and plans to develop the others jointly with the CPC. Legal and technical issues have prevented the initiative from moving forward, although in late 2016 both Lanka IOC and the CPC were confident that the project would soon progress.

Having full use of the farm would enable Trincomalee to establish itself as a major bunkering centre. The tanks would also be able to link up to the new refinery, enabling the area to tap into the storage segment, which is fast emerging as a major business in its own right in the current climate of low international oil prices, ahead of anticipated increases.

Project Pipeline

The CPC is also looking to re-enter the long-liberalised bitumen market, which is widely expected to surge in the coming years on the back of major infrastructure construction projects. Its plans include the construction of a production plant, which is expected to be located near Galle in the south of the country. Key players currently include Bitumix, which makes products for road construction and industrial use at its Kalagedihena and Homagama plants, while Lanka IOC is also a major operator in the segment.

The state-owned corporation is also eyeing a return to the LPG market in the near term. At present the industry remains dominated by LAUGFS Gas, which recently signed an agreement with China Huanqiu to build an $80m LPG terminal at Hambantota, and Litro Gas Lanka, which has a larger market share and operates the country’s only existing LPG import terminal, at Kerawalapitiya. The CPC produces limited volumes of LPG at its Sapugaskanda refinery, and is currently seeking expressions of interest for a partner that will enable it to re-enter this important local market.

Lubricants have also proved to be an attractive segment for both the CPC and Lanka IOC, which has entered into an agreement with a Malaysian firm to construct a lubricants plant in Sri Lanka within one year.

Elsewhere, a proposed new $50m underground pipeline to carry jet fuel to Colombo’s Bandaranaike International Airport is taking shape. At present the fuel is transported by rail from the CPSTL’s storage facility at Kolonnawa. The facility is also undergoing a major upgrade to its existing pipelines, which carry oil from the landing stage at Dolphin Pier in Colombo. A tender worth some LKR8.7bn ($59.3m) has been issued for four, 6-km lines to replace the existing 69-year old tubes.

Pricing Change

The issue of tariffs remains one of the most contentious in the petroleum sector. At present the government sets base prices nationwide for the CPC’s petrol, diesel and kerosene. Lanka IOC is in theory free to set its own price. However, given that the CPC controls around two-thirds of the market, the price set by the government effectively acts as a baseline for the entire market. Political pressures mean that the government is usually keen to set a lower than market price, especially during times of high international oil and gas prices. However, its strategy risks exposing both the CPC and Lanka IOC to losses and has also necessitated the implementation of major government subsidies. These have, at times, been financed by Treasury issues, adding to the country’s debts.

The CPC and Lanka IOC are calling for a new mechanism for pricing. In autumn 2016 a proposal for an automatic mechanism was accepted in principle by the government. The Ministry of Finance also made a commitment to the IMF to introduce a system that takes account of the need for cost recovery by the end of 2017. The discussion is likely to continue, with the CPC and Lanka IOC keen to see an equitable automatic pricing mechanism brought into play in the near term.