JP Morgan - Global Downstream - Global Refining - A Long and Painful Sunset For Many

Global Equity Research
08 September 2011
Global downstream
Global refining - a long and painful sunset for many
European Oil & Gas Fred Lucas

AC
(44-20) 7155 6131 fred.lucas@jpmorgan.com J.P. Morgan Securities Ltd.
Nitin Sharma
(44-20) 7155 6133 nitin.sharma@jpmorgan.com J.P. Morgan Securities Ltd.
Asian Oil & Gas Brynjar Eirik Bustnes, CFA

(852) 2800-8578 brynjar.e.bustnes@jpmorgan.com J.P. Morgan Securities (Asia Pacific) Limited
Indian Oil & Gas Pradeep Mirchandani, CFA

(91-22) 6157-3591 pradeep.a.mirchandani@jpmorgan.com J.P. Morgan India Private Limited
LatAm Oil & Gas Caio M Carvalhal

(55-11) 4950-3946 caio.m.carvalhal@jpmorgan.com Banco J.P. Morgan S.A.
South African Oil & Gas Alex Comer

(44-20) 7325-1964 alex.r.comer@jpmorgan.com J.P. Morgan Securities Ltd.
For Specialist Sales advice, please contact Hamish W Clegg

(44-20) 7325-0878 hamish.w.clegg@jpmorgan.com
See page 198 for analyst certification and important disclosures, including non-US analyst disclosures.
J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. www.morganmarkets.com
Fred Lucas (44-20) 7155 6131 fred.lucas@jpmorgan.com
Global Equity Research 08 September 2011
Equity Ratings and Price Targets Company BP Royal Dutch Shell B ENI Essar Energy Galp Energia OMV Repsol YPF Statoil TOTAL PETROBRAS ON PETROBRAS ON ADR PetroChina Sinopec Corp - H Indian Oil Corporation Reliance Industries Ltd Sasol Symbol BP.L RDSb.L ENI.MI ESSR.L GALP.LS OMVV.VI REP.MC STL.OL TOTF.PA PETR3.SA PBR 0857.HK 0386.HK IOC.BO RELI.BO SOLJ.J Mkt Cap ($ mn) 112,353 196,675 66,011 5,061 15,191 10,751 31,546 71,247 99,585 177,193 178,805 344,831 107,050 16,697 59,191 29,017 Price CCY GBp GBp EUR GBp EUR EUR EUR NOK EUR BRL USD HKD HKD INR INR ZAc Rating Price 372 1,993 13.02 241 13.00 25.80 18.46 121.00 31.69 22.51 27.42 9.69 7.73 317.10 833.50 31,115 Cur OW N OW OW OW N N UW N N N UW OW N OW OW Prev n/c n/c n/c n/c n/c n/c n/c n/c n/c n/c n/c n/c n/c n/c n/c n/c Price Target Cur Prev 575 n/c 2,400 n/c 22.50 n/c 570 n/c 20.00 n/c 29.00 n/c 25.00 n/c 145.00 n/c 47.00 n/c 35.00 n/c 41.00 n/c 9.00 n/c 9.40 n/c 420.00 n/c 1,200.00 n/c 39,800 n/c
Source: Company data, Bloomberg, J.P.Morgan estimates. n/c = no change. All prices as of 06 Sep 11 except for 0857.HK [07 Sep 11] 0386.HK [07 Sep 11] IOC.BO [07 Sep 11] RELI.BO [07 Sep 11].
Table of Contents
Stock specific summary ................................................................ 4 Global theme refining capacity surplus ................................. 12 Alternative investment strategies to play the theme ............... 17 Why we might be wrong .............................................................. 21 Origin of downstream competitive advantages........................ 24 Refining capacity growth outlook .............................................. 31 Future imperfect ........................................................................... 38 The science and art of separation.............................................. 42 Downstream performance assessment..................................... 48 BP ................................................................................................... 54 Royal Dutch Shell B ..................................................................... 61 ENI .................................................................................................. 67 Essar Energy................................................................................. 71 Galp Energia.................................................................................. 76 OMV ................................................................................................ 80 Repsol YPF.................................................................................... 84 Statoil ............................................................................................. 88 TOTAL ............................................................................................ 93 Petrobras ....................................................................................... 98 China: Refining and Marketing structure ................................ 106 PetroChina................................................................................... 108 Sinopec Corp H........................................................................ 114 India: Refining and Marketing structure.................................. 121 Indian Oil Corporation................................................................ 123 Reliance Industries Ltd.............................................................. 127 Sasol............................................................................................. 133
Appendices
Appendix I: Downstream performance analysis .................... 146 Appendix II: Refinery transactions........................................... 156 Appendix III: Refinery projects data......................................... 159 Appendix IV: Global Integrated Valuation Update ................. 163 Appendix V: Downstream glossary of terms .......................... 164 Appendix VI: Valuation Methodology and Risks .................... 174
Stock specific summary

Refining industry may be about to press the self-destruct buttonas it did in the 1970s
We have analyzed the global refining capacity growth outlook 2011 to 2016 and conclude that any potential for a meaningful cyclical recovery in gross refining margins will be suppressed by excessive spare capacity that looks set to build as National Oil Companies aggressively add new capacity and incumbent International Oil Companies refuse to retire marginal capacity. Of the aggregate new capacity identified 2011-16 (up to+ 27.4 million bopd), we estimate that NOCs are sponsoring 67% (c.18.5 million bopd). We see a risk that a significant refining glut will materialize that will flatten regional refining margins on a 'bath-tub' bottom for some years to come. The outlook is ominously similar to the late 1970s when surplus refining capacity destroyed refining economics for several years 40 years on, history may be about to repeat itself. With this as backdrop, we have also reviewed the downstream performance and strategies of 14 of the worlds largest oil & gas companies over the last 11 year period 2000 to 2010 in order to show which companies are best positioned for what could be a long and painful sunset for many, albeit not all refiners.
OECD 9 focus names

BPs downstream business scores and performs very well on most metrics and ranks second overall
See Table 7: Downstream corporate scores and peer group ranking to see how each company rates
We estimate BP Downstream is worth $59bn, 2012E EV/EBITDA 6.5x
Value of BPs downstream has been lost completely from the share price given 50% discount to 800p SOTP
BP is a prime candidate to spinoff its downstream business
BP - OVERWEIGHT - BPs downstream business scores very well on a number of key efficiency parameters. BP has a well above-average refinery size (2010 167 kbopd), a below-average refinery throughput to equity oil output ratio (2010 102%) and its downstream business generates a consistently high return on downstream net fixed assets (2010 14%, 2000-10 average 15%). This measure of capital productivity is enhanced by a capital lite fuels retailing model, a very strong lubricants franchise (Castrol) and a very efficient trading function. BP has delivered an average rate of network shrinkage (2000-10 -2.7%). BPs historical refinery utilization has improved following the Texas City accident (2007 low of 77% has risen to a 2010 utilization rate of 91%). BPs downstream free cash flow generation is also improving as capital expenditure normalizes and operating performance remains very robust (2010 $0.9 per barrel refining throughput). Consistent with BP's high scores and overall peer ranking (it ranks second of nine companies, see Table 7), BPs downstream business continues to perform well, unlike its share price, which has generated a YTD 2011 return of -15% (7 September), following a 2010 return of -21%. We now measure an extreme 50%+ discount to our SOTP of around 800 pence (unchanged). Of this, we estimate that an ungeared BP Downstream has an EV of around $59bn (189 pence, 24% of our SOTP) this implies a 2012E EV/EBITDA multiple of 6.5x, which compares to a global downstream median multiple of 5.6x (based on 27 companies).This multiple seems to us very reasonable given BPs distinctive downstream scale and reach. We also note that the full year cash flow (EBITDA) benefits of the Whiting Coker will not be seen until 2013. We are convinced that the quality and value of BPs downstream business has been completely overwhelmed by Macondo-related issues. Whilst the disposal of the Texas City and Carson refineries will help to demonstrate this value, we continue to believe that BP is one of the few companies that is best suited to pursue a more radical upstream-downstream dis-integration strategy and, importantly, in our view this would be a welcomed remedy to recover some of the substantial intrinsic value that is missing from BP's share price. BPs CEO said after Q2 2011 results that all strategic options are under consideration. We hope that further consideration by BPs board will lead to more radical corporate restructuring.
RD Shell downstream performance ranks it third equal alongside TOTAL
We would like to see more refinery and network divestments
We estimate RD Shell Downstream is worth $68bn, 2012E EV/EBITDA 7.7x
More of RD Shells downstream value is in the share price given 20% discount to 2600p SOTP
RD SHELL - NEUTRAL RD Shells downstream business scores well on some, but not all of the same efficiency parameters. At just 100 kbopd, RD Shells average refinery size is below the peer groups average of 128 kbopd. RD Shell has been slow to sell disadvantaged plants and also slow to shrink its global retailing network (2000-10 CAGR -1.3%) as management has only recently turned its restructuring eye to RS Shells country retailing empires. On capital productivity, RD Shell also scores well below average (2010 6%, 2000-10 13%). RD Shells refinery utilization was average in 2010 at 82% (2000-10 average 88%) and its refining throughput to equity oil ratio too high, in our view (2010 172%). The one parameter where RD Shell scores well is downstream free cash flow generation when measured across the period 2000-2010, but we note that its performance on this metric in 2010 was mediocre (2010 $0.7 per barrel refining throughput). Similarly, RD Shells profit per barrel of refining throughput was slightly better than average when measured across the 11-year period, but it deteriorated notably in the more challenging period end 2009-10, highlighting its embedded high refining costs. On this basis, RD Shell ranks 3rd equal, alongside TOTAL. We acknowledge, however, that refinery sales in 2011 and further cost reductions will improve RD Shell's competitive positioning going forward. We would encourage management to go another step and reduce its refining capacity much further. Compared to BPs 50% discount, RD Shell suffers a less extreme 20% discount to our SOTP of around 2600 pence. Our downstream EV for RD Shell is approximately $68bn or 685 pence per share (22% of our total SOTP). So, our estimated value of RD Shells downstream portfolio is 15% larger than our value of BPs downstream portfolio ($59bn). We note that our RD Shell value of $68bn equates to a 2010 EV/EBITDA multiple of almost 10x assuming a 35% downstream tax rate. This seems fair enough, if not generous. Even if we assume that more recent refinery and retailing divestments add $1bn to downstream EBITDA, add $1bn of downstream cost reductions by 2012 and assume that both are fully retained, the implied 2012E EV/EBITDA multiple is 7.7x. This is higher than our implied multiple for BPs downstream business of 6.5x. ENI - OVERWEIGHT - ENI ranks 'middle of the pack' (5th) despite weak downstream operational performance - mainly due to the good progress made by the company in shrinking its retail network (-7% CAGR 2000-10) and its high refinery throughput to equity oil ratio, which improved from 104% in 2000 to 70% in 2010. On the operational front, ENIs refinery utilization declined to a weak 75% in 2010 and the business reported an operating loss in both 2009 and 2010. ENIs downstream business has also failed to generate free cash flow in last two years. We believe that given its national status, ENI is unlikely to aggresively divest its lossmaking refining business but carrying these loss-making assets does not help managements credibility, in our view. However, given the very small size (as a % of company EV) of this business, its performance has limited bearing on the overall valuation of ENI. We estimate that ENI's Downstream has an EV of around 1.9bn (2% of our SOTP EV of 111bn) this implies a 2012E EV/EBITDA multiple of 3.8x, which compares to a global downstream median multiple of 5.6x. This seems reasonable given the very challenging outlook for this business. In our view, ENI's weak downstream performance is a fact that is well known by investors and most likely already factored in to the markets views on the name. The ENI investment case continues to look compelling the stock trades at a discount of 50%+ to our SOTP of c.27 and it offers a safe and secure dividend yield of more than 7.5% - the highest in our European coverage universe. We maintain our bullish view on this name.
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ENI downstream performance ranks 5th weak operational performace
Small downstream exposure is positive
Agressive divestment of downstream assets is not on managements agenda
We estimate ENI Downstream is worth 1.9bn, 2012E EV/EBITDA 3.8x
Essar Energy refining asset in India has numerous and sustainable competitive advantages
Refining capacity will grow 25%+ CAGR 2010-13
We estimate Essar Downstream is worth $5.3bn, 2013E EV/EBITDA 3.8x
ESSAR ENERGY - OVERWEIGHT Essar Energy's downstream business is defined by the companys world-scale Vadinar refinery this plant has delivered very high utilisation rates (2009-10 average of 127%) relative to its nameplate capacity. Vadinar has numerous and sustainable competitive advantages a coastal location that can accommodate very large crude carriers (for large-scale oil imports) and product vessels (exports), below peer plant operating costs, a secure domestic market for its product output, the ability to reach overseas demand centres profitably and valuable local tax incentives. Essar Energys profit per barrel of refining throughput was healthy through the down cycle at $2.4/bbl (average 2009 and 2010) and it generated a 2009-2010 post tax average return of 9% on its net fixed assets. The ongoing expansion programme will double the refinery's complexity (NCI from 6.1 to 11.8) and increase its nameplate capacity from 230 kbopd to a world class 405 kbopd in a two-staged process (expansion and optimisation) by end March 2013. Essar Energy has recently expanded its international refining footprint by acquiring Stanlow refinery in the UK (296 kbopd) this asset will provide Essar Energy with storage/terminal facilities for product export from the Vadinar refinery. Our downstream EV (as included in our Essar Energy's sum-of-the-parts) is approximately $5.3bn. Given the aforementioned ramp up in the refining capacity and complexity by end March 2013, we see downstream EBIT potential in 2013E of approximately $1.2bn. Adding downstream depreciation of around $0.2bn, this implies a 2013E EBITDA of $1.4bn and an EV/EBITDA multiple of only 3.8x which is conservative. The stock trades at a discount of c.50%+ to our SOTP. Essar Energy has declined more than 58% from its peak at the end of last year and now trades 41% below its listing price this is despite significant progress by the company on its growth agenda. We believe that the market is now pricing in excessively high 'execution risk' in all its businesses and much of the value of its high quality refining business has been lost from the share price. GALP - OVERWEIGHT Galp ranks at the bottom of the peer group. In our view, its poor performance is largely due to its low complexity refining base, exposure to a challenging operating environment in Iberia (particularly Portugal) and aggressive investment in low margin marketing assets in the up-cycle. Galps refinery utilization was significantly below average in 2010 at 75% (2000-10 average 80% vs peer group average of 87%). Also, given Galp's very low production base, its refining throughput to equity oil ratio is amongst the highest in peer group (2010 - 21x). Galp's retail network has grown by 1% CAGR 2000-10 (so no shrinkage) mostly reflecting the company's acquisition of the Iberian marketing assets from ENI and ExxonMobil. Galps downstream business has also failed to generate free cash flow in the last three years, primarily due to heavy capex on upgrade projects. Similarly, Galps profit per barrel of refining throughput is significantly below the average when measured across the 11-year period. However, we do not believe that the performance of the downstream business has been or will be a primary stock price driver. We continue to believe that the weaknesses in the companys downstream business are more than offset by the upside from its world class pre-salt assets in Brazil. We flag again the near-term potential trigger for this name - the capital increase in Brazil via a third-party buyer which is still expected by end Q3. We estimate that Galp's Downstream has an EV of around 3.2bn (15% of corporate EV of 20.9bn) this implies a 2012E EV/EBITDA multiple of 5.1x, which compares to a global downstream median multiple of 5.6x and seems fair.
Galp ranked at the bottom performance ought to improve
Investment in refining complexity should be a plus for the margins
We estimate Galp's Downstream is worth 3.2bn, 2012E EV/EBITDA 5.1x
OMV ranks low challenging outlook
Downstream exposure has grown, backed by acquisitions
We estimate OMV Downstream is worth 4bn, 2012E EV/EBITDA 4.9x
OMV - NEUTRAL OMV ranks 7th or second last in the peer group. OMVs downstream business scores low on a number of key metrics. At just 88 kbopd, OMVs average refinery size (own account) is significantly below the peer groups average of 128 kbopd. OMV's refinery throughput to equity oil output ratio (2010 193%) is unattractively high, in our view. OMV's downstream business also generated a very low return on total downstream assets (2010 3%, average 2000-10 5%). Given the high capex spend (partially to fund acquisitions), OMVs downstream business failed to generate free cash flow in 2009 and 2010. OMV's retail network has grown by 5% CAGR 2000-10 (so no shrinkage as per GALP). We believe that the outlook for OMVs downstream business remains challenging the return on recent downstream investments (Petrol Ofisi) has already been shown to be very weak. We estimate that OMV's Downstream has an EV of around 4bn (26% of corporate SOTP of 16.2bn) this implies a 2012E EV/EBITDA multiple of 4.9x, which compares to a global downstream median multiple of 5.6x. This is fair enough, if not generous, given the margin pressure that OMV's marketing business is facing in Turkey. It is clear that OMV has allocated a significant percentage of capital to the downstream business so the challenging outlook for this business does not augur well for OMV's valuation. We also do not believe that management is looking to downsize the company's exposure to its downstream business. We retain our cautious stance on this name. REPSOL YPF - NEUTRAL Repsol YPF's performance is weak on a number of key downstream efficiency benchmarks. Given declining production in Argentina, Repsol YPF's 2010 refinery throughput to equity oil ratio was 236% - amongst the highest in its peer group. Repsol YPFs refinery utilization has declined significantly in recent years and has averaged c.80% in 2009-10. Repsol YPF's downstream business has generated a below-average return which has declined significantly in 2009 and 2010 (2010 6% versus 2000-10 average 11%). Consistent with Repsol YPF's low scores, it ranks sixth of the nine companies in our peer group. Whilst we concede that the investment in refinery upgrade projects will be a positive for the margins of the company's Spanish refining system, we also believe that given Repsol YPF's much improved credentials in its upstream business, the company avoid any other major downstream projects. As a reminder, Repsol YPF's earnings are more sensitive to refining margins than the oil price, especially given the upstream price regulations in Argentina a fact that is unlikely to change in the near to medium term. We estimate that Repsol YPF's Downstream has an EV of around 11.5bn (31% of corporate SOTP of 36.5bn) this implies a 2012E EV/EBITDA multiple of 4.2x which compares to a global downstream median multiple of 5.6x. This is fair enough, if not a shade conservative.
Repsol ranks sixth big downstream footprint
Earnings exposure to European refining will remain high
We estimate Repsol Downstream is worth 11.5bn, 2012E EV/EBITDA 4.2x
Statoil downstream ranks first very good operational performance
Limited investor focus on the company's downstream business
We estimate Statoil's Downstream is worth Nkr24bn, 2012E EV/EBITDA 3.7x
STATOIL - UNDERWEIGHT Statoil ranks first, scoring very well on a number of key downstream efficiency metrics. Statoils historical refinery utilisation rate is the highest amongst its peers its niche refining base has clearly been well operated (2000-10 average utilisation of 92%). The company also scores very well (top) on the 2010 refining throughput to equity production ratio given its small refining capacity is backed by such a sizeable upstream production base (2010 23%). Statoil has also delivered an above-average rate of network shrinkage the divestment of a 46% stake in its marketing/fuel & retail business was a key step forward (2000-10 CAGR -5%). Statoils downstream financial performance is very robust (2010 Nkr35.6 or $5.9 per barrel refining throughput). Statoils downstream free cash flow generation is also very strong. We estimate that Statoil Downstream has an EV of around Nkr24bn (4% of our corporate SOTP of Nkr683bn) this implies a 2012E EV/EBITDA multiple of 3.7x, which compares to a global downstream median multiple of 5.6x.This is fair, if not slightly conservative, in our view. Investor focus on this segment has been understandably limited given the companys lack of meaningful exposure to the downstream business we do not believe this is likely to change. We continue to believe that upstream operational performance needs to improve this is key for a positive re-rating of this name and was addressed in our global upstream note last year (Global Integrateds, Upstream the shape of things to come). We maintain our relatively bearish stance on Statoil given the lack of nearterm catalysts and the risks of further disappointments on the operational front (e.g field outages). TOTAL - NEUTRAL TOTAL scores well on a number of key parameters and ranks 3rd alongside RD Shell. TOTAL's downstream business has consistently delivered a high return on capital (average 2000-10 ROFA 22%) and high refinery utilization (average 2000-10 89%). TOTAL scores well on downstream free cash flow generation when measured across the period 2000-2010, with only one year of negative cash flow. However, TOTAL's profit per barrel of refining throughput is below average when measured across the 11-year period, with a notable deterioration in 2009-2010 like RD Shell, TOTALs downstream performance deteriorated notably into the downturn. TOTAL's refining throughput to equity oil ratio is also too high, in our view (2010 155%). Further, at just 98 kbopd, TOTALs average refinery size (own account) is significantly below the peer groups average of 128 kbopd . We believe that the overall quality of TOTALs downstream business may be underappreciated - the business has more often than not delivered good results.We expect further momentum from TOTAL in shrinking its downstream business in Europe we note that the company has already announced a number of divestments YTD 2011 (CEPSA stake, divestment of UK marketing business etc). We estimate that TOTAL's downstream has an EV of around 18.6bn (14% of corporate SOTP of 129bn) this implies a 2012E EV/EBITDA multiple of 5.9x, which compares to a global downstream median multiple of 5.6x. This is fair enough in our view, given the consistently strong performance of TOTAL's downstream business.
TOTAL downstream performance ranks 3th delivered healthy return on capital
Ongoing divestment will be a plus for overall performance
We estimate TOTAL's Downstream is worth 18.6bn, 2012E EV/EBITDA 5.9x
Table 1: Downstream earnings exposure of OECD names

Downstream earnings as % of group earnings BP ENI Essar Energy GALP OMV Repsol YPF RD Shell Statoil TOTAL Group average % 2003 25 8 46 41 24 19 23 2004 30 10 50 47 40 37 26 28 2005 21 10 62 33 57 33 25 25 2006 20 6 65 16 45 28 11 22 22 2007 17 3 41 13 54 26 10 21 21 2008 10 5 131 29 68 19 11 18 16 2009 20 -4 71 19 -16 53 14 6 12 11 2010 19 -1 67 38 15 62 12 7 11 13 2011E 23 0 69 31 5 41 16 5 10 12 2012E 24 1 55 52 14 44 20 4 13 15
Source: J.P. Morgan. * We have estimated post-tax downstream earnings as a percentage of clean group earnings.
Non-OECD 5 focus names

Price controls in China main reason for weak ranking for Sinopec, with recent price decontrol changing the environment
SINOPEC - OVERWEIGHT - Given price controls during most of the last decade (period under study), refining in China scores very badly in this study. Sinopec ranks mostly 4th among the five emerging market companies, with a couple of third place ranks (not surprisingly in average refinery size and capex/DD&A ratio). With the change in pricing policy in early 2009, 2009-10 showed improvements on returns (Sinopec showing strongest returns in entire space in 2009-10) and profitability, and this is the environment we expect for the future (as long as crude doesnt increase too fast, or even better, levels off or goes down). Sinopec has strong leverage to this environment and relatively high quality assets that should ensure good financial performance (its high reinvestment ratio has improved complexity in the system, allowing more heavy/sour crude intake). On the marketing side, Sinopec already has prime locations in the major consuming regions, and is adding non-fuel revenues to further improve overall R&M profitability. Our R&M EV (as included in our Sinopecs PT) is approximately $50 billion or HK$3.5 per share. This represents 40% of our total sum-of-the-parts value of around HK$9.40 per share. Under normalized circumstances (ie GRM of around $5.5-6.5/bbl), we see downstream EBIT potential in 2012E of approximately $8 billion assuming stable profitability in marketing. Adding annual downstream depreciation of around $3bn, this implies a 2012E EBITDA of $11bn and an implied downstream EV/EBITDA multiple of 4.5x. PETROCHINA - UNDERWEIGHT Given price controls throughout most of the past decade (period under study), PetroChinas downstream in China scores very badly in this study. PetroChina ranks 5th among the five emerging market companies across all parameters. With the change in pricing policy in early 2009, 2009-10 showed improvements on returns (PetroChina also showing stronger returns than non-EM refiners in this period) and profitability, and this is the environment that we expect for the future (as long as crude doesnt increase too fast, or even better, levels off or goes down). PetroChina has less leverage to this environment than Sinopec (PetroChina is more integrated) and somewhat lower quality assets will require further investments to bring up quality (capex ratio has been low for PetroChina, with more focus upstream historically). On the marketing side, PetroChina is however ramping up to take market share versus Sinopec, although this requires expanding refining capacity in regions where it has no presence (higher consuming areas South/South-East). Our R&M EV (as included in our PetroChina DCF value) is approximately $40 billion or HK$1.40 per share. This represents 19% of our total sum-of-the-parts value of around HK$7.50 per share. Under normalized circumstances (ie gross refining margin of around $5-6/bbl), we see downstream EBIT potential in 2012E of approximately $3.5bn assuming stable profitability in
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PetroChina needs to invest to improve asset quality downstream after underinvesting last decade
marketing. Adding annual downstream depreciation of around $3bn, this implies a 2012E EBITDA of $6.5bn and an EV/EBITDA multiple of 6.2x.
RILs scale, complexity and location allow it to maintain higher than normal margins, and service major Asian demand centres
RELIANCE INDUSTRIES - OVERWEIGHT - RIL's downstream segment is amongst the strongest globally, ranking 1st among emerging market players. Worldleading refinery scale (1.24 million bopd, at a single location) and high complexity (14 NCI for its new refinery; 11.3 NCI for old), allow for lower than peer operating costs, and consistently enable RIL to deliver refining margins higher than Singapore benchmarks, and ensure high capacity utilization. Its location in Jamnagar, with easy access to port facilities that can handle VLCCs and large product carriers, conveniently places it to serve major Asian demand centres. A skew towards diesel in the product slate allows RIL to cater to a high-EM demand product. Labour costs in India are low, and coupled with high GRMs, have allowed RIL to deliver higher than normal returns on assets, and superior free cash flows. The refinery is ideally integrated with RILs petrochemicals business (naphtha, PX and propylene), with an off-gas cracker now planned as well. We estimate an EV of $30.6bn for RILs refining business, and an EV of $21.5bn for the petrochemicals business, for a per share value of Rs717 ($16/share) which represents ~60% of our SOTP of Rs1200. INDIAN OIL CORP - NEUTRAL IOC is a large state-owned refiner in India that ranks second in the emerging market list. IOC has a total refining capacity of ~1.1 million bopd, across 8 refineries, and also has a controlling stake in Chennai Petroleum. Its spread gives it ideal proximity to key product demand centres across India, and the company also has an extensive network of pipelines. Low capital and labour costs help to make returns competitive. The marketing business operates in a challenging environment, with prices of key auto (diesel) and cooking (LPG/Kerosene) fuels subsidized by the government. A portion of the subsidy loss is borne by the state-owned retailers, impacting profitability. An element of uncertainty on the extent of losses to be shared, coupled with high crude prices is particularly difficult, impacting the ability of these R&M companies to make significant investment plans. Our EV for IOC is $19.6bn ($8.1/share) which includes value for the R&M, petrochemical and pipeline businesses. IOC also has a net cash/investments position of $1.2/share, for a fair value of Rs420 ($9.3/share). The uncertainty over timing/direction of fuel reform initiatives and lack of clarity on subsidy loss-sharing are key issues facing the company. However, with stable refining, pipeline and petrochemical income, IOC is relatively less impacted by these issues than its SOE peers. PETROBRAS - NEUTRAL Petrobras downstream segment is sometimes considered the ugly duckling of its business units, as the company does not automatically pass through international oil price variations to its domestic market. Given the historical dependence on diesel imports, and recent requirements to import gasoline (driven by high ethanol prices and increased demand), the segment now faces the undesirable contingency of domestically selling those fuels at prices cheaper than their acquisition costs. However, when expanding the horizon of analysis to the last ten years, we notice that Petrobras scores second among the National Oil Companies on net income per refinery throughput barrel (an average of $3.7/bbl), and would end up in the first half if we also included the OECD names. Its performance has been helped by Petrobrass long-term policy this has been not to pass through international oil price variations until the price reaches (and stabilizes) at what could be considered a new standard this applies both for oil prices hikes and drops. In 2008, when international prices dropped from $140/bbl in June to
While IOCs refining, pipeline and petrochemical businesses have performed well, uncertainty over sharing of subsidy losses, coupled with high crude levels, has impacted the marketing business, and stock sentiment
We value Petrobras downstream segment in our SOTP valuation at an EV of $24 bn, about 9% of our total NAV
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$40/bbl in December, Petrobras kept selling its gasoline and diesel at stable prices. Looking forward, the short-term future does not look too bright for Petrobras downstream segment in our view. Petrobras last new plant was completed in the early 1980s, and in the past few years, average growth per year in refining capacity was no more than 1%. With the company running today at more than 90% utilization rate, if international prices do not fall and/or there is no increase in dometic exrefinery prices for gasoline and diesel, we can expect the segments profitability to keep declining. There are two ways to overcome this issue: increase refining capacity or increase domestic prices. The first is already addressed, although we see no significant new capacity onstream until 2013. However, we see no room for domestic price adjustments until mid-2012, at the earliest. Nevertheless, we expect returns from the segment to improve, particularly after the new capacity is commissioned. We value Petrobras downstream segment in our SOTP valuation at an EV of $24 bn, about 9% of our total NAV.
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Global theme refining capacity surplus

Capacity binge is set to continue, led by Asian and Middle East
Global structural refining capacity excess may be sustained for many years Our analysis confirms that the global refining industry is only entering the middle (not the end) of another period of very significant capacity growth 2010-16, led by regional additions in Asia (notably India and China), the Middle East (notably Saudi Arabia and the UAE) and Latin America (primarily Brazil). The risk of a growing capacity glut is very real given the following six factors. The net effect of this surplus will be reduced utilization rates a primary driver of refining margins. Ergo, we expect refining margins to remain weak for some years to come. 1. National Oil Companies (NOCs) are less return sensitive - NOCs have government-sponsored mandates to build domestic refining capacity regardless of near-term commercial returns. They are motivated to create employment and inward investment, whilst controlling and capturing more of the barrels value and, in certain instances e.g. Brazil, to avoid exporting new domestic sources of crude only to then import more refined products. Refineries never die, but they are often where capital goes to die We detect International Oil Company (IOC) reluctance to retire capacity given a preference to sit it out and find maverick buyers for marginal plants. The oil field depletion phenomenon which challenges global oil supply growth (Figure 1) simply does not exist in the refining sector indeed, many refineries are like super giant oil fieldswith adequate asset maintenance, they simply never die. New owners have strategies that sustain marginal plant operations - Some of these new owners reset the depreciation base for the refineries and often have different strategic objectives and time horizons either way, they sustain plant operations. We categorize such new owners as: a. Private equity buyers this class of buyer is now featuring much more prominently. They are not subject to short-term capital market performance imperatives and may see other option value in a refinery (terminal capacity, deep water port access, real estate conversion options etc). Example companies which have already bought refineries include Hyesta Energy and PBF Investments LLC. New market entrants these are not new players, they are existing refiners looking to access new markets, either to secure processing capacity for their crude or to secure market access for domestic product exports. An example is Essar Energy that has recently entered the UK market via its Stanlow refinery purchase from RD Shell.
2.
3.
b.
4.
Mega-refineries are the new greenfield facility scale of choice We expect larger unit size additions, to create so-called mega-refineries, as the industry continues to up-scale green field sizes. This mirrors the trend to megaliquefaction trains that have appeared in the LNG market in order to maximize scale economies. These much larger unit additions will more easily upset the capacity / demand equilibrium in any given year.
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5.
Sluggish global demand growth looking more likely than not For now, more sluggish global growth as fiscal austerity measures in OECD continue to bite deeper is looking more likely than not. J.P. Morgans US economist now sees a 30-40% probability of a second US recession. The IEA (August 2011 Monthly Report) has also warned that any reduction in the growth outlook for 2012 could have a big impact on expected oil consumption it currently assumes 4.4% global GDP growth and forecasts demand growth of 1.61 million bopd (+1.8%), but if GDP growth softens to 3%, it estimates that demand growth will more than halve to 0.63 million bopd (+0.7%). Fuel substitution and conventional refinery by-passes Many governments are actively encouraging the development of bio-fuels, to promote local agriculture and domestic fuel supply security. Certain governments (e.g. US) are also looking to promote the expansion of gas-fuelled vehicles. A couple of industry players (Sasol and RD Shell) are also developing gas-to-liquids (GTL). The overall effect of these factors is to reduce the requirement for conventional refining and to reduce demand for refined product therefrom.
6.
NOCs are driving capacity growth, not IOCs
NOCs are driving refining capacity growth for reasons other than direct commercial returns - NOCs are the primary sponsors of this wave of capacity growth in order to maximize national energy security (minimize imports) and the total returns from domestic oil output (own the entire barrel strategy). Of the aggregate new capacity identified 2011-16 (c.27.4 million bopd), we estimate that NOCs are sponsoring around 67% (c.18.5 million bopd). NOCs are also being used by governments to extend foreign policy reach e.g. by using Chinese labor and financial capital to build refineries in Africa, China is extending its overseas positioning and influence. Low refining margins are therefore not necessarily an effective deterrent to new capacity formation, which may thus continue regardless of sub-optimal return expectations. Furthermore, we expect that continued investment in upgrading capacity will boost the supply of light, clean products and thus pressure upgrading margins.
Figure 1: 24 countries past oil output peak (kbopd) 43% of 2010 global oil output
40000 Russia (2007) 35000 Chad (2005) Mexico (2004) Denmark (2004) 30000 Yemen (2001) Norway (2001) Oman (2001) 25000 Australia (2000) Uzbekistan (1999) UK (1999) 20000 Ecuador (1999) Colombia (1999) Venezuela (1998) 15000 Argentina (1998) Malaysia (1997) Gabon (1997) 10000 Syria (1995) India (1995) Egypt (1993) 5000 Tunisia (1980) Trinidad (1978) Indonesia (1977) 0 Romania (1976)
Source: J.P. Morgan, BP 2011 Statistical Review of World Energy.
1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
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Figure 2: Refining capacity net additions by region (kbopd)

800 600 1500 1000 500 0 10 11 12 13 14 15 16
NORTH AMERICA EUROPE
400 200 0 10 11E 12E 13E 14E 15E 16E 3000 MIDDLE EAST 2000 1000 0 10 11E12E13E14E15E16E 3000
AFRICA
3000 2000 1000 0
ASIA PACIFIC
2000 1500 1000 500 0
SOUTH AMERICA
10 11E12E13E14E15E16E
10 11E12E13E14E 15E 16E
2000 1000 0 10 11E12E13E14E15E16E
Source: J.P. Morgan
Capacity growth will guarantee low utilization rates
Capacity growth data points to prolonged cycle bottom - Our global capacity model indicates that, under a BEAR case scenario (net capacity growth as identified coupled to 0% throughput growth in Europe and USA and 3% throughput growth in Asia and the Middle East), crude distillation capacity could rise from 91.8 milllion bopd at end 2010 to almost 109 million bopd by end 2015, 17% growth or almost 16 million bopd (up to 3.2 million bopd per annum on average). Combined with sluggish product demand growth (more likely given the recent directional risk to regional GDP growth estimates), this will cause capacity utilization rates in the US and Europe to continue to decline and could cause the utilization rates in Asia + Middle East to collapse 2014-15. Low capacity utilization rates are synonymous with low margins, so under this scenario or an environment close to it, we believe that regional refining margins will remain depressed for some years to come.
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Figure 3: Regional utilization - BEAR case

95% BEAR CASE Net capacity growth as forecast Europe & USA throughputgrowth 0% pa Asia & Middle East throughput growth 3% pa
Figure 4: Regional utilization - BULL case

100% BULL CASE Delay net capacity growth by 1 year Europe & USA throughputgrowth 2% pa Asia & Middle East throughput growth 6% pa
90%
95%
85%
90%
80%
85%
75%
80%
70%
75%
65% 98 99 00 01 02 03 04 05 06 US 07 08 09 10 11E 12E 13E 14E 15E Europe Asia + Middle East
70% 98 99 00 01 02 03 04 Europe 05 06 US 07 08 09 10 11E 12E 13E 14E 15E Asia + Middle East
Source: J.P. Morgan.
Ominous similarities to capacity growth in 1970s.
Capacity growth options are a real threat, the situation has an ominous similarity with the 1970s During the 1970s, NOCs reasserted their industry positioning via upstream asset expropriation, most notably in the Middle East. We now see some of the same NOCs and some new NOCs pushing for greater downstream influence and oil value chain control via the build-out of their domestic refinery systems and beyond. Given government backing and above-average investment time horizons, there is a good chance that numerous projects scheduled for start dates in 2015+ that have yet to be sanctioned or fully defined will progress. The potential scale of growth looks ominously similar to the situation in the 1970s which cratered refining profitability and enforced substantial capacity retirement. So, 40 years on (a time that is perhaps beyond corporate memories and is certainly longer than the career span of most oil company executives), history may be about to repeat itself. The situation also has one ominous difference to the 1970s - Refining capacity growth during the 1970s created massive over-capacity which was followed by substantial capacity closures in the 1980s. Unfortunately, we see little desire amongst IOCs and NOCs to close capacity this decade. NOCs are less sensitive to low financial returns and are used by many governments that control them to protect the end consumer from free-market product prices. In addition, some IOCs are playing a risky game of brinkmanship, hoping for NOCs and other new entrants to buy and continue to operate their marginal facilities. These aspects of the current refining binge will only extend the cycle bottom for many years, in our view. The situation reminds us of the marginalization of OECD vehicle manufacturing In 1980 PR China produced 0.4% of total worldwide new vehicles. In 2010, PR China produced 24% of all new vehicles. In 1950, the US and Western Europe produced 98% of all new vehicles; by 2010 this had fallen to just 31%. We suspect that without changes to government policy to encourage domestic refining, OECD refining will follow the marginalization trajectory of US and European vehicle manufacturing, as it is gradually displaced by lower cost, lower taxed refining centers in Asia and the Middle East. Indeed, our capacity growth forecasts show that OECD refining may fall from 49% of worldwide capacity at end 2010 (54% in 2000) to 39% by end 2016. We see a future where Asia and the Middle East could become major product export hubs that supply the West. Under this scenario, less efficient coastal refineries in Europe and OECD may become attractive
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.and some equally ominous differences
OECD refining could follow OECD vehicle manufacturing
infrastructure gateways for non-OECD refiners to access this import sink. So their strategic value will not be lost altogether, but it may change.
New refineries will follow demand
Refining capacity will sensibly co-locate close to new demand centers i.e. the vehicle parks - Refineries are best located closest to product demand centers i.e. closest to the car park. In 1986, PR China had 3.6 million passenger vehicles and trucks. By end 2010, that figure had increased to 80.0 million, a CAGR of 14%. If this rate of fleet expansion is sustained and the US vehicle park sustains its comparable rate of historical growth of just 1% per annum, PR China's vehicle park will be larger than the park in the US by 2021. Unattractive domestic pricing regimes and aggressive, government-mandated NOC growth strategies have deterred IOC participation in China's refining boom. IOC refinery growth options are thus paralyzed whilst prospective returns face mounting pressure as NOCs shift their strategies to a refined product export orientation. Some IOC refiners have responded to this threat by retrenching from refining, but many have yet to respond adequately to this threat. Consequences for players that fail to act may be severe IOCs can still mitigate the direct threat by divesting or joint venturing more disadvantaged capacity it is not too late to act. In our view, some companies can and should consider replicating the disintegration strategies of Marathon Oil (enacted) and ConocoPhillips (proposed). From those companies that fail to respond, we see a risk of asset impairments, a higher frequency of negative earnings surprises and greater earnings volatility. As integrated entities, such companies carry the additional risk that persistently weak downstream performance contaminates the rating of the whole entity. Industry participants are often commended for taking a 'long-term view' of price and margin cycles. Our note presents a risk that we believe will play out over the long term it is not too late to act.
IOCs should divest more capacity
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Alternative investment strategies to play the theme

Seven ways to play the negative refining theme
Given our secular negative outlook on refining margins in all regions, perhaps the most obvious investment strategy is to avoid equities that are directly exposed to this specific activity in the industry value chain. However, we present investors with another six distinct investment strategies, as below, with particular listed names highlighted in Figure 8. 1) AVOID DOWNSTREAM ALTOGETHER - Focus on downstream lite, if not pure upstream players. One of the easiest ways to play a negative trend is to avoid it altogether. In this instance, this may be done by investing in names with a zero exposure to refining, such as certain E&P names. In the integrated space, BG Group has zero exposure to refining and Statoil has a very small, high quality exposure. 2) INVEST IN REFINING CAPACITY GROWTH FACILITATORS Focus on Engineering, Procurement & Construction (EPC) providers. As is so often the answer, one of the best ways to play capacity formation in the oil & gas industry is not via its owners or its sponsors, but rather by the contractors that help to put the capital on the ground. In this instance, certain oilfield service names provide EPC services to the refining industry e.g. Tecnicas Reunidas and Technip. Given aggregate new refining capacity 2011-16 of 27.4 million bopd and assuming an average construction cost of $23,000 per bopd (Figure 5), the potential capital investment over this period could reach a staggering $630bn.
Figure 5: Refining capital costs

60000
50000
Capex ($/bopd)
40000
30000
20000
World average $23k/bopd
10000
0 0 100 200 300 400 500 600 700 Capacity (kbopd)
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3) INVEST IN REFINERY SOFTWARE PROVIDERS Focus on software & consultancy providers. There are a few specialist technology providers that provide software, automation and management consultancy services to the refining community. These services can help to debottleneck refineries and enhance profitability. Examples include Aspen Technology and Honeywell International. 4) ANTICIPATE CORPORATE RESPONSE Look for consolidation options. We believe that a prolonged cycle bottom will necessitate consolidation amongst a large population of smaller, disadvantaged players - this may encourage opportunistic bids from better capitalized, more advantaged players. In the US, we note the recently completed merger between Holly Corp and Frontier Oil, to create the enlarged HollyFrontier Corp. Similarly, we suspect that certain crude producers may look to anchor processing rights in parts of the OECD by purchasing refineries e.g. Rosnefts recent purchase of PDVSAs 50% stake in Ruhr Oel - the owner of stakes in four refineries in Germany. Furthermore, certain refined product exporters may look to use refineries as terminal gateways to enable their product exports to reach new demand centers e.g. Essar Energy's recent acquisition of RD Shell's UK Stanlow refinery. 5) ANTICIPATE CORPORATE RESPONSE Look for vertical disintegration candidates. Following the well received and successful upstream-downstream split by Marathon and the intended split by ConocoPhillips, we see few other potential candidates who might be prepared to follow this radical corporate restructuring option. However, one name that could logically follow this break-up option with strong shareholder support is BP. We note that the CEO commented following its Q2 2011 results that all strategic options are under consideration. 6) TRADE THE MARGIN VOLATILITY, EXPLOIT EXCESSIVE MARKET OPTIMISM Focus on pure play trading options. Notwithstanding our negative outlook for refining margins, we do not doubt that there will be periods when refining margins in certain regions will spike due to one or more of the following factors. These factors will inevitably trigger margin spikes accompanied by bouts of optimism that the cycle is turning. There are a number of listed pure play refiners that may be traded for short-term benefits. unexpected plant outages e.g. Asian margins are currently benefitting from the closure of Taiwans 540 kbopd Mailiao refinery, one of the worlds largest refineries, following the seventh fire in 12-months. Formosa Petrochemical Corp. declared force majeure on its product exports for August. JPMs analyst (Brynjar Bustnes) notes that FPCC will essentially have all its units up and running by October. It is in the process of starting up its #2 and #3 CDU while #3 Olefins will re-start by end September. The company expects average Q3 refining utilization rate to be 52% (vs. 74% in QQ) and Olefins utilization rate to be 65% (vs. 85% in Q2). The conflict in Libya has also led to much reduced throughput at the Tobruk and Zawiya refineries. crude evacuation bottlenecks e.g. PADD 2 refineries in the USA continue to benefit from depressed WTI feedstock costs due to rising oil shale output and
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limited pipeline evacuation capacity Which have elevated PADD 2 oil inventories (Figures 6-7). This has been cited as a key benefit by HollyFrontier (created with effect 1 July 2011) that could endure until the Keystone Pipeline (which will transport crude oil from Cushing to the Gulf Coast) opens in mid-to-late 2013. As such, this is a durable and investable theme. We note that of the European names featured in this note, BP has the highest exposure to WTI costed oil feedstock (c.485 kbopd or 20% of 2010 global refining throughput via 50% owned Toledo refinery and 100% owned Whiting refinery). price distortion effects e.g. in PR China, government pricing controls have pushed mainland refineries into losses (the Ministry of Industry and Information Technology released a report in August stating that the Chinese refining industry recorded a loss in May, its first since 2009). This has encouraged reduced throughput and inventory consumption. tax distortion effects e.g. changes to Russias complex export duties can encourage upstream producers to export more refined products rather than crude; this flow of products can impact European refining margins both positively and negatively. seasonal effects e.g. if certain US refineries do not return from maintenance as expected ahead of the US summer driving season. weather effects - e.g. hurricane damage to refineries on the Gulf Coast or an interruption to refinery crude supplies and related demand destruction due to curtailment of industrial activity and reduced transportation requirements.
Figure 6: PADD II oil inventories - million barrels
110 0 100 -5 90 -10 80
Figure 7: Brent less WTI oil price differential ($/bbl)

5
-15 70
-20 60
-25 50 J F M A M J J A S O N D -30 2010
Keystone XL pipeline (1,700 miles) will take crude from Alberta via Montana through Cushing, Oklahoma (PADD 2) to Gulf Coast refineries, but not operational until mid-to-late 2013
2011
Q2
Q3
Q4
Q2
2011
2010
5-year Avg
Source: US DoE
7) PICK SOME REGIONAL WINNERS Look for sustainable competitive advantage. Notwithstanding our bearish view on global refining margins, there are a few advantaged regional refiners that ought to survive a prolonged downturn very well. Such players must be located in structurally high growth, product deficit markets. They must have very large coastal facilities, ideally with high plant complexity and integration synergies with adjacent petrochemical facilities that were built at low cost, often with the additional benefit of special tax incentives. We identify two such advantaged names with refining operations in India - Reliance India and Essar Energy.
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Q3
Figure 8: Seven possible investment strategies to play refining capacity surplus theme
CONSOLIDATION OPTIONS Europe ERG SPA [ERG IM] Petroplus Holding AG [PPHN SW] Saras SPA [SRS IM] DISINTEGRATION POTENTIAL Europe BP [BP/ LN] USA ConocoPhillips [COP US]
(4-5) CORPORATE RESPONSE Strategies
SOFTWARE PROVIDERS Europe KBC Advanced Technologies [KBC LN] USA Aspen Technology [AZPN US] Honeywell International [HON US]
(2-3) INDIRECT PLAY Strategies

PURE PLAY TRADING OPTIONS Europe Neste Oil [NES1V FH] USA Alon USA Energy [ALJ US] Delek US Holdings [DK US] Marathon Petroleum Corp [MPC US] Tesoro Corp [TSO US] Valero Energy Corp [VLO US] Western Refining [WNR US] Asia Bangchak Petroleum [BCP TB] Caltex Australia Ltd [CTX AU] S-OIL Corp [010950 KS] SK Innovation Co. Ltd [096770 KS]
GLOBAL INVESTMENT THEME Refining capacity growth (6) TRADING Strategy (7) REGIONAL WINNERS Strategy
ADVANTAGED PLAYERS USA HollyFrontier Corp [HFS US] Asia Reliance Industries [RIL IB] Essar Energy [ESSR LN]
(1) AVOID Strategy
EPC PROVIDERS Europe & North America Fluor Corp [FLR US] SNC-Lavalin Group Inc [SNC CN] Technip SA [TEC FP] Tecnicas Reunidas SA [TRE SM] Asia Chiyoda Corp [6366 JP] Daelim Industrial Co. Ltd [000210 KS] Samsung C&T Corp [000830 KS] Worley Parsons Ltd [WOR AU]
DOWNSTREAM LITE Europe BG Group [BG/ LN] ENI [ENI IM] Statoil [STL NO]
Source: J.P. Morgan - not all of these names are covered by J.P. Morgan.
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Why we might be wrong

The foundation of our cautious refining margin outlook rests upon an analysis of the outlook for the global refining capacity balance. This analysis hinges on an assessment of over 200 greenfield and brownfield refinery projects for 2011-16 spread around the world, involving numerous sponsors (IOCs, NOCs, governments and smaller independents and investment consortia), many of which have poor track records delivering major facility construction on time and on budget. Furthermore, the oil & gas industry has numerous economic feedback loops (prices, margins and costs) that can constrain the pace of investment, both upstream and downstream. So, we are the first to acknowledge that the rate of refining capacity growth could be lower than we forecast. We cite five specific factors that could reduce the rate of net capacity additions. 1. Delays to government approval, construction and commissioning Most new refining projects require government approval of one sort or another. In the current sovereign debt crisis, we have been reminded of how weak coalition governments can be slow, if not fail outright, to take appropriate, albeit tough decisions. The same problem can apply to the approval process for major energy projects, especially if they are seen to be controversially expensive. An example of this can be seen in Kuwait its 615 kbopd new refinery near Az-Zour was first conceived in 2005, yet the countrys Supreme Petroleum Council still has yet to approve it. Costs for this project, originally estimated at $7bn, have since risen to $15bn ($24,400 per bopd). Every new refinery in China must be approved by the central government, which is increasingly aware of environmental impact and the risks of local labour inflation. In India, the early stage state approval for land allotment (as per the coal mining sector) can also take much longer than expected. Furthermore, refining projects are no different to upstream projects they tend to take longer than scheduled to build and commission. Political uncertainty Many new refinery builds require foreign participation with local players, either via direct equity co-ownership or via the provision of loans. Such foreign-sourced capital may withdraw if countries exhibit excessive political instability. Three examples of countries with tenuous refinery projects that are exposed to political uncertainties include: (i) Egypt - a 200 kbopd greenfield project has been proposed by a group of Saudi and UAE investors (Citadel Capital) (ii) Libya Tamoil (100% government-owned) had proposed a 200 kbopd greenfield project at Zuwara; this is an unlikely priority for the National Transitional Council (iii) Nigeria NNPC is looking to build two new refineries, one in Lagos (300 kbopd) and one in Central Kogi State (150 kbopd). Unexpected changes to government policy We believe that energy security will remain a top strategic priority for all countries, OECD and non-OECD, for decades to come. This is a key factor that is encouraging countries to in-source oil processing they want to develop a captive refining system to reduce, if not extinguish refined product import needs. We cannot see any reason for this core policy driver to change, but that does not mean that such a reason may not exist. No one anticipated the
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2.
3.
catastrophic Fukushima earthquake / tsunami and its impact (negative) on government desires to build energy dependency on nuclear power and its second order impact (positive) on global LNG demand. 4. Sovereign liquidity constraints Many of the greenfield refinery projects rely on direct (via wholly owned NOCs) or indirect (via partially owned NOCs) sovereign funding. Although it looks unlikely, given the current buoyant oil price, certain petrodollar wealthy governments may face budgetary pressures, especially if social budgets escalate post-the Arab Spring. Potential examples in the Middle East may be Iran (where access to capital is further constrained by economic sanctions) and the UAE. Iran has aspirations to build at least 6 new refineries to add a total capacity of 1.2 million bopd and ADNOC (via Abu Dhabi Oil Refining Co.) is also adding a 400 kbopd refinery at Ruwais. In Latin America, PDVSA (Venezuela), Ecuador (Petroecuador) and Cuba (Cupet) are all effectively financially isolated and all three countries face similar budgetary challenges. Mexico is not financially isolated, but the ability of its dominant NOC (Pemex) to deliver the countrys first new refinery in over 30 years (200 kbopd project in Tula, Hindalgo) must be questioned given the governments high dependency on dividends from the nations only substantial cash cow. Persistently weak refining margins could trigger more capacity closures As we have highlighted, refinery capacity closure can often prove all too temporary as plants are mothballed rather than dismantled, leaving their owners (current or future) the tactical option to re-start should margins ever improve. However, a very prolonged period of very weak margins (as we expect will occur) could encourage more commercially driven owners of marginal plants to consider closure, either temporary or permanent. We note, however, that we require a very substantial increase to the current closure schedule (Table 2), to really make a difference to the global capacity balance, especially in Europe. Excluding plants that have been closed and then re-opened (Delaware City and Wilhelmshaven), we estimate a total potential capacity closure of less than 2.3 million bopd 2009-2016. To avoid a capacity glut, this amount of capacity would have to be closed almost every year from 2011 to 2016 to negate capacity growth. At present, there is just no evidence that this is at all likely to occur as participants hold out for better times ahead or maverick buyers and hope to avoid politically controversial plant closures.
5.
These upside risks to the global capacity balance are real enough - we therefore address them in our BULL case scenario analysis. However, we note that a common feature to all these factors is that they can only really influence the picture in 2014 and beyond i.e. they are unlikely to make a material difference to the capacity excess that will persist in 2011-13 not least because we start with a significant capacity excess in 2011.
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Table 2: Refinery capacity retirement

Plant Eagle Point, USA Teesside, UK Bakersfield, California Delaware City, Delaware Dunkirk, France Normandy, France Yorktown, Virginia Wilhelmshaven, Germany Montreal, Quebec Toa Keihin Ohgimachi Mizushima, Negeshi, Oita, Kashima Texas City, Texas Reichstett, France Honolulu, Hawaii Kurnell, Australlia Arpechim, Austria Cremona, Italy Harburg, Germany Clyde, Australia Various Berre L'Etang Cartagena, Colombia Toyama Others Shuaiba, Kuwait CAPACITY RETIREMENT Capacity kbopd -145 -117 -60 -210 -137 -80 -128 -260 -130 -120 -225 -76 -78 0 0 -70 -80 -108 -80 -100 -105 -40 -60 -115 -200 -2,724 Owner Sunoco Pluspetrol Flying J Valero TOTAL TOTAL Western Refining ConocoPhillips Shell Showa Shell JX Holdings Marathon Petroplus Chevron Caltex OMV Tamoil RD Shell RD Shell Idemitsu LyondellBasell Ecopetrol JX Holdings JX Holdings KNPC Comment Closed October 2009 Closed March 2009 Closed February 2009 Closed November 2009, but re-opened by PBF in Q2 2011 Closed September 2009 Closed August 2009 Closure completed Q4 2010 - converted to a storage terminal Closed after fire in May 2010, but recently sold to Hyesta Energy that intends to open it Operated as terminal since November 2010 To close Sept 2011 when next turnaround is scheduled Mizushima closed July 2009 Closed April 2011 - to be converted to terminal Still running as a refinery following renegotiated contract Plant under review (announced 22 Aug 2011) Romanian government is now supportive of closure Final closure in H2 2011 - conversion in to storage site Failed to find a buyer - to stop processing crude Q1 2012 Converting it to a fuel import terminal to avoid $106m maintenance mid-2013 Under review Mothballed to support new refinery To continue to use infrastructure and loading jetties
2009
2010 2011
2012 2013
2014 2016
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Origin of downstream competitive advantages

Downstream competitive advantage is hard to retain
As per Table 3, we believe that it is possible for the best in class players to derive acceptable returns from the downstream suite of businesses across multiple cycles provided they possess and sustain all the key competitive advantages that we cite for each of the three key streams (refining, retailing and lubricants see Appendix IV for glossary of terms).
Table 3: Origin of downstream competitive advantage
KEY VALUE DRIVERS ------> GLOBAL OR NICHE <------REFINING Plant scale - > 150 k bopd Plant complexity - crude diet flexibility Location - coastal for VLCC imports Location - low cost labour, tax concessions Location - close to demand centres Market dynamic - product deficit Construction timing - in to cycle bottom Asset integrity / reliability - maximize availability Integration to petrochemicals - feedstock & facilities planning Storage / terminal capacity - maximise arbitrage RETAILING Respected brand - customer loyalty Incumbency - ideally top 3 market share Location - high throughput zones Location - real estate option value Market dynamic - growing car park / fuels demand Differentiated fuels - premium pricing Non-petroleum merchandise - higher margin, lower tax Ownership - dealer not company owned Regulation - no pricing controls Planning controls - restrict new entrants LUBRICANTS Established power brand - customer loyalty Brand support - effective advertising Streamlined product suite - capture trading up Synthetic lube offering - premium priced market Global reach - scale economies R & D program - sustained product development OEM relationships - first fill, OEM endorsement Blending capacity - less vital to produce base oil
Trading function Biofuels capability - feedstock routing / product placement - future growth option Energy Intensity - on site cogeneration capacity Emissions - minimise carbon footprint <--------------------------------------------------------- Best people --------------------------------------------------------> - correctly incentivised for operational & HSE excellence <------------------------------------------------------ Best contractors -----------------------------------------------------> - incentivised for operational excellence, adequately supervised w clear policies & procedures ith <-------------------------------------------------------- Ass control -------------------------------------------------------> et - exercised efficiently <-------------------------------------------------- Corporate planning --------------------------------------------------> - long term horizon, staying power <-------------------------------------------------- Ownership flexbility --------------------------------------------------> - optimise capital redeployment across cycle
------> ACCEPTABLE RETURN BUSINESS <------Source: J.P. Morgan.
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Refining is capital intensive with very volatile returns
As per Figure 9 and Figure 10, the industrys conventional suite of downstream businesses bears a range of capital intensity and return variability across the cycle. We prefer the specific businesses which consume low levels of capital and which generate the least volatile returns e.g. fuels retailing (especially if through dealerowned as opposed to company-owned sites) and lubricants (especially if exposure is limited to lubricant blending and marketing as opposed to base oil refining and chemical additive production). The capital requirements of other businesses e.g. shipping, may be reduced by chartering as opposed to owning vessels and e.g. Trading may be reduced by disciplined risk management. Unfortunately, the only practical way to reduce capital exposure to refining is by selling assets no oil company dare outsource the operations of a refinery to a third party.
Figure 9: Downstream businesses - capital intensity versus return variability
REFINING
Charter
High
SHIPPING Least desirable exposure
Risk Mgt
TRADING
VOLATILITY OF RETURNS
Medium
SPECIALITY CHEMICALS COMMERCIAL, MARINE, AVIATION RETAILING Most desirable exposure

Low Medium High
LUBRICANTS
Blend only
Dealer owned
Low
CAPITAL INTENSITY
Figure 10 further categorizes these downstream businesses according to market entry barriers and the potential for large, unexpected (low probability) losses (a risk that the equity capital market tends not to price efficiently). Again, refining is located in the least favorable place with low entry barriers (typically limited to capital access which is an easily surmountable obstacle for NOCs) and the high impact potential for large unexpected losses due to plant outages, if not facility damage due to industrial accidents.
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Refining has low entry barriers and bears the risk of large losses
In our view, the return profile from refining is thus asymmetrical we see zero prospects of very high returns, a high probability of prolonged low returns and a sustained small probability of large losses a very unattractive risk-reward mix, in our view. In contrast, businesses such as fuels retailing and lubricants are protected by more substantial entry barriers related to corporate branding, protected / concealed product formulation and market positioning. Although these businesses have limited real pricing power, they benefit from superior cost pass-through capabilities.
Figure 10: Downstream businesses potential for large losses versus segment entry barriers
Risk of major industrial accident
REFINING
High
Risk of major oil spill
SHIPPING Least desirable exposure
Risk of rogue trader
TRADING POTENTIAL FOR LARGE LOSSES
Risk of major industrial accident
Medium
SPECIALITY CHEMICALS
COMMERCIAL, MARINE, AVIATION Branding,

positioning
Low
RETAILING
LUBRICANTS Most desirable exposure
Low
Medium
High
ENTRY BARRIERS
Refining is the least attractive link in the downstream chain
So, on all key dimensions, we consider refining to be the least attractive component of the downstream value chain. In contrast, we see fuels retailing and lubricants as superior businesses. As this note goes on to show, we believe that refining returns will continue to deteriorate, leaving certain incumbents with some tough strategic options. However, we must also highlight that certain regional refiners bear many of the competitive advantages that we have highlighted in Table 3. We give two specific examples in Table 4 - Reliance Industries and Essar Energy.
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Table 4: Competitive positioning of two advantaged niche refiners

Plant scale Reliance Industries World leading Jamnagar I - 660 kbopd Jamnagar 2 - 580 kbopd Jamnagar I NCI - 11.3 Jamnagar II NCI - 14.0 Coastal - adjacent to Jamnagar port (Sikka) which can handle VLCCs and large product carriers Advantaged by low cost labour in India Special tax consessions in Gujarat Close to domestic &Middle East crude supply sources and well located for certain key export markets India is a product deficit market for LPG and is experiencing high growth in diesel demand Built ahead of inflationary up-cycle with low unit capex Consistently runs above 100% of nameplate capacity Integrated to petrochemicals facilities which are being expanded to take more refinery gas Rights to various storage sites, particularly East Africa via GAPCO Well developed in-house trading capabilities Low energy costs On-site power generation Looking to use more refinery gases for petrochemicals and to reduce carbon footprint further VERY STRONGLY POSITIONED Essar Energy Vadinar refinery Post phase 1- 375kbopd (Mar'12) Post optimisation - 405kbopd (Mar'13) Vadinar post phase 1 NCI - 11.8 Also located on west coast of India - in the refining hub of Jamnagar Also benefits from low labour costs and sales tax concessions in Gujarat Close to domestic crude supply sources and well located for certain key export markets High growth in diesel demand in India augurs well for Essar Energy - higher middle distillate yield post expansion Vadinar construction experienced significant delays and cost overruns Average utilisation for 2009-2010 was an impressive 127% No petrochemicals facilities Recent acquisition of Stanlow refinery (UK) - flexibility following acquisition of storage/terminal faciltities in Europe Competent in-house trading capabilities Low energy costs On-site power generation (Vadinar power plant - under construction) Going through a carbon emissions accounting process - plans to come up with a carbon management action plan STRONGLY POSITIONED
Plant complexity Location Location Location Market dynamic Construction timing Asset integrity / reliability Integration to petrochemicals Storage / terminal capacity Trading function Energy intensity
Emissions
Overall competitive positioning

27
Sources of refining return erosion

Refining has all the hallmarks of a bad industry
Unfortunately, very few companies possess all the aforementioned competitive advantages and too many companies kid themselves that they do, which sustains an inefficient downstream presence. Too much optimism and insufficient realism has long dogged this industry, in our view - the downstream is a challenged business, especially refining. We continue to believe that it faces a number of very tough years ahead given growing excess refining capacity and ever more onerous operating and environmental conditions. In the schematic below, we highlight some of the key factors that will erode downstream returns (in addition to capacity growth), most specifically from refining, which is the most capital intensive downstream activity. From a supplier perspective, we see three key risks to the outlook for asset returns: Very slow IOC capacity retirement IOCs have been reluctant to retire marginally profitable / loss-making refining capacity, preferring instead to try and sell it to another player who will sustain operations. Sunk costs are forgotten, the capital base is reset and such plants are run to be cash flow positive, if not for strategic reasons e.g. to help to develop a presence in new markets. NOC-sponsored capacity growth The entry barriers to refining are very low e.g. the technology has been commoditized. NOCs are the primary participants that are sponsoring capacity growth they have easy access to abundant and relatively cheap capital. They have several motives national product supply security, local employment, inward investment but commercial returns do not typically feature that prominently. Rising cost of asset maintenance - The costs of asset maintenance continue to rise given underlying inflation in labor, software systems and hardware (steel pipes and units) and ever tighter regulatory scrutiny following some high profile accidents e.g. Texas City.
Figure 11: Factors eroding downstream returns
Actions of suppliers Slow IOC capacity retirement NOC sponsored capacity growth Rising cost of asset maintenance Actions of government Tighter product specifications Costing of carbon emissions Implicit-explicit retail price control Actions of consumers OECD fuel efficiencies Biofuel substitution Product price sensitivity
Pressure from suppliers
STRUCTURAL & SUSTAINED PRESSURES ON DOWNSTREAM RETURNS

Pressure from governments
OECD and non-OECD governments also play an important role in accelerating the decline in refinery returns: Tighter product specifications Governments push for lower sulfur content fuels. This increases the burden on refiners to add de-sulfurization units, thus
28
increasing their costs of staying in the game' without providing any incremental pricing advantage. As product specifications are raised around the world, they also tend to converge. This will remove an element of protection that has hitherto protected some markets from product dumping. Mandates for improved vehicle energy efficiency - As per Figure 14, the US (the country with the world's largest number of vehicles), has set a federal fuel standard (Corporate Average Fuel Economy CAFE sales-weighted combined city/highway miles per gallon, for new car sales) which requires a very substantial improvement in the engine efficiency of new cars by the beginning of the next decade. By 2025, major automakers have agreed to reach an average of 55 miles per gallon - to be achieved by raising car fuel efficiency by 5% per annum and light truck fuel efficiency by 3.5% per annum from 2017-2021 and then by 5% per annum from 2022. This will be achieved by greater conventional engine efficiency and a higer penetration by hybrids and electric cars. Automakers may also look to develop more efficient natural gas-fueled combustion engines. As per Figure 12, the transportation sector is the largest consumer of (refined) oil so changes to its fuel diet can have a potentially material impact on the demand for gasoline and diesel (refined products).
Figure 12: Composition of global oil demand
120 Average growth 2000-30 1.4% 100
Figure 13: Composition of uses within transportation market
Light Duty Vehicles 28%

80 TRANSPORTATION 1.8% 60 53 % 58%
Heavy Duty Vehicles 45%
40 INDUSTRIAL 1.3% 20 RESIDENTIAL / COMMERCIAL 0.2% 2000 2005 2010 2015 2020 2025 2030
Rail 4%
Marine 11% Aviation 12%
0 1980
POWER GENERATION -0.2% 1985 1990 1995
Source: Exxon Mobil The Outlook for Energy - A view to 2030 (December 2006)
Source: Exxon Mobil The Outlook for Energy - A view to 2030 (December 2006).
Initiatives to encourage lower carbon fuel substitution A recent example of this in the US is the New Alternative Transportation to Give Americans Solutions Act (NAT GAS Act) this is to be heard by the US House of Representatives subcommittee in September. This Act will provide federal incentives for the use of natural gas as a vehicle fuel, the purchase of natural gas-fueled vehicles and the installation of natural gas vehicles fueling properties. We note that the Natural Gas Vehicles for America (NGVA) group estimates that in 2009 c.18% of all transit buses ran on natural gas. Costing of carbon emissions This is a fast evolving trend whereby governments are taxing either the oil producers or the fuel manufacturers for the carbon emission consequences of refined product combustion. Refineries typically lose the legislative battles. Assuming a $25 per ton CO2 price, a 100 kbopd refiner would have to spend almost $320 million annually on CO2 credits to cover both direct and indirect emissions. It will be very difficult for refiners to pass these costs on to consumers refiners are both cost and price takers.
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Implicit-explicit retail price controls This applies to a number of emerging markets. Essentially, in order to protect the end consumer from volatile and high fuel prices, governments require refiners to suppress factory gate (wholesale) / pump (retail) prices. Refiners are subsequently compensated for their losses, but often incompletely and some time after the losses are incurred. This occurs in a number of emerging markets e.g. India.
Figure 14: New car U.S. Corporate Average Fuel Economy (CAF)
55 50 45 40 Confirmed 35 30 25 20 15 10
74 76 78 79 80 82 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 15E20E
Subject to lobbying
Federal Standard
Total Fleet
Source: U.S. Department of Transportation (sales weighted combined city / highway miles per gallon), J.P. Morgan.
These are the key reasons why investors tend, quite rightly, to place a lower valuation on the downstream than the upstream. Not only is it an inherently low growth business, but its returns are structurally challenged by a number of powerful forces from suppliers, government and consumers. Unfortunately, this investor tendency is further encouraged by much poorer levels of disclosure downstream versus upstream. Companies continue to excuse the need for increased downstream disclosure due to competitive sensitivity. This makes it very difficult to predict performance, an issue made worse by very volatile refining margins. Our experience is that poor disclosure in the oil & gas sector either obscures a very good or a very bad business.....we'll let our readers decide which one of these refining is. Specific incremental downstream disclosures that we would like companies to make, at least annually, include: EBIT split we would like refining EBIT to be separately disclosed. Capital employed we would like all companies to give a standard measure of post-tax downstream capital employed. Refining costs and capex we would like refining operating costs and capital investment / depreciation to be disclosed. Retailing we would like the number of company-owned versus dealer-owned sites to be disclosed, as well as regional site throughput volumes and nonpetroleum turnover.
30
Refining capacity growth outlook

Net capacity growth potential of 28 million bopd or 28% 2010-16E
We use our global database that tracks all refinery expansions, green field construction and plant closures (details of new projects in Appendix III). We exclude potential (likely) capacity creep as a result of existing plant debottlenecking which may be as much as 0.5%+ per annum. We also exclude bio-fuel production capacity growth, but include a few of the most likely GTL projects. We include identified capacity retirement either as a result of plant closure or conversion to terminal status although this is a very modest amount of existing capacity. We also include capacity that has been shut, but that is due to re-open. Our analysis shows a sustained increase in primary distillation capacity 2010-16 (Figure 15). Given global operable refining capacity at year-end 2010 of approximately 91.2 million bopd, we estimate aggregate net capacity additions (additions less closures) of 27.8million bopd, 28% or a capacity CAGR of 4.2%. This is 4x the global refining capacity CAGR 2000-10 of just 1.1%.
Figure 15: Outlook for global refining capacity additions by region (kbopd)
11000 +9.4%
Largest capacity growth aspirations 2014-16 located in Asia and Middle East - NOC sponsored.....
9000 +8.0%
7000
5000
+3.4% 3000 +0.8% net increase
+2.2%
+2.1%
+1.8%
1000
10 -1000
11E
12E
13E
14E
15E
16E
North America
Latin America
Europe
Eastern Europe
Africa
Middle East
Asia
Retirements
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We acknowledge that much of the capacity data for 2015 and 2016 necessarily includes projects that have not yet been sanctioned and which therefore may yet be delayed or indeed may be cancelled. Specific to PR China, which shows the largest amount of potential capacity additions, some projects compete head-on for government approval - not all will be approved in the timeframe shown. However, we note three specific threats:
NOC sponsorship is a risk
As per Figure 15, much of the potential capacity growth in 2014-16 is presently being sponsored by NOCs in Asia and the Middle East who are least sensitive to the risk of poor commercial returns given weak margins and who are often driven to reduce sovereign import product import requirements. This, in turn, enables governments to impose more direct control over domestic product prices. So, we believe that there is a heightened risk that low margins 2011-12 do not inhibit project sanction and consequent capacity growth as might occur if the key sponsors were more sensitive to expected returns. The supply / demand balance may be further upset by two more risks. IOCs continue to operate marginal plants in the hope that maverick NOC buyers will step forward, as they have done recently (e.g. Essar Energy / RD Shell's Stanlow facility). The block size of new plants is now much larger, with green field plants typically scaled 200 kbopd or larger. Two examples of mega-refinery projects are in Saudi Arabia (Jubail, 400 kbopd) and the UAE (Ruwais, 415 kbopd). These units are 34x the global average refinery size of around 130 kbopd (Figure 16).
IOCs refuse to bite the bullet
Greenfield unit sizes are getting much larger
Figure 16: Average refinery size in each country (bopd)
500000
400000
New mega refineries typically scaled up to 200-500 kbopd
300000
200000
115 countries have c.655 refineries Average refinery size 132 kbopd
100000
0 1
Source: J.P. Morgan. 32
11 16 21 26 31 36 41 46 51 56 61 66 71 76 81 86 91 96 101 106 111
So, we are concerned that a rational industry response to sustained weak refining margins may be slow to manifest capacity growth may thus continue, unabated by weak margins. The situation therefore looks as bad, if not worse, than it did in the late 1970s / early 1980s (Figure 17). The implications for regional refining margins are negative.
Figure 17: Global capacity growth / reduction 1970-2010, 2011-16E
12000 12%
10000
10%
8000
Scale of potential capacity growth this decade marks a return to the 1970s build out....which destroyed industry profitability and necessitated years of net capacity retirements
8%
6000
6%
4000
4%
2000
2%
0 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11E 12E 13E 14E 15E 16E -2000
0%
-2%
-4000
Global capacity growth (kbopd) % change (RHA)
-4%
Source: J.P. Morgan, BP 2011 Statistical Review of World Energy
What determines refining margins

In our view, the primary drivers of capacity utilization are product demand (that pulls crude through the processing system) and net capacity changes (that determine the levels of available / idle capacity). Product demand is naturally sensitive to economic growth. However, Figure 18 shows a limited positive correlation (+0.10) between US Gulf Coast refining margins and US GDP growth other than at cycle turning points e.g. most notably in to an economic slowdown when utilization rates collapse. Interestingly (Figure 19), measured quarterly, we see a much stronger correlation (+0.75) between the oil price (WTI) and gross refining margins (US Gulf Coast).
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Figure 18: GDP growth as a driver of refining margins

30.0 10.0%
Figure 19: Oil price as a driver of refining margins

30.0 140
US RECESSIONS
8.0% 25.0 6.0% 25.0
US RECESSIONS
120
20.0
JPM GDP forecasts H2 2011-2012
4.0% 20.0 2.0%
100
80 15.0 60
15.0
0.0%
-2.0% 10.0 -4.0% 10.0
40
-6.0% 5.0 -8.0% 5.0 20
0.0 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11E 12E US Gulf Coast GRM ($/bbl) US GDP growth (real, %)
-10.0%
0.0 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11E US Gulf Coast GRM ($/bbl) WTI ($/bbl)
Regional system utilization is a key driver of gross margins
In Figure 20 and Figure 21, we demonstrate the strongly positive correlation between regional capacity utilization and annual regional average gross refining margins. Regional capacity utilization has shown a strongly positive historical correlation with refining margins. We focus on this parameter as a primary margin driver.
Figure 21: Asian refinery utilization versus gross refining margins 1998-2010
20
2008 2007 2005 2006 2004 2009 2010
Figure 20: NW European refinery utilization versus gross refining margins 1998-2010
20 18 GROSS REFINING MARGIN ($/BBL) 16 14 12 10 8 6 4 2 0 73% 74% 75% 76% 77% 78% 79% 80% 81% 82% 83% 84% 1999 2000 2001 1998 2002 R = 0.8112
R = 0.6935 2008 2007 2006 2004 2010 2009 2003 2000 1998 1999 78% 80% 82% 84% 86% 88% 90% 2002 2001 2005
18 16 14 12 10 8
2003
6 4 2 0
EUROPEAN REFINERY UTILISATION
34
Bull and Bear scenarios

We examine two quite extreme potential demand growth scenarios 2011-15 as defined below in order to set the most likely book ends for regional capacity utilization rates (Figure 22).
Figure 22: Regional refinery throughput growth rates
8.0%
6.0%
BULL CASE +6%

4.0%
BEAR CASE +3%
2.0%
BULL CASE +2% BEAR CASE 0%
0.0%
-2.0%
-4.0%
-6.0%
-8.0%
1990-2000 CAGR USA +1.2% NW Europe -0.6% Asia +4.9%
2000-10 CAGR USA -0.2% NW Europe +0.2% Asia +2.8%
-10.0% 1990 1995 2000 USA NW Europe 2005 Asia 2010 2015E
BEAR CASE portends weak margins for years to come
BEAR CASE We incorporate all net capacity additions that we have identified and assume 0% throughput growth 2011-15 in Europe and the USA and only 3% per annum for the Middle East + Asia. Under this set of assumptions (Figure 23), we see European and US refinery utilization rates continuing to decline from 2011 to 2015. Under this scenario, we therefore expect that refining margins in the US and Europe will continue to soften. Asian capacity utilization rates may improve slightly 2011 to 2013, but will then slide. At this point we expect surplus product to flood in to Europe. In our view, this will destroy margins globally in 2014 and 2015 and for some years thereafter.
BULL case portends a continued margin recovery
BULL CASE We delay all net capacity additions in 2012 and beyond by 1 year and we assume refinery throughput growth of 2% per annum for Europe and the US and 6% per annum for the Middle East + Asia.
35
Under this scenario (Figure 24), capacity utilization rates will continue to rise from the 2009-2010 lows in all regions. Specifically, utilization rates in the Middle East and Asia will rise to above 90% in 2013, peaking in 2014 above 95%.
Figure 23: Regional utilization - BEAR CASE
95%
Figure 24: Regional utilization - BULL CASE

100%
90%
95%
85%
90%
80%
85%
75%
80%
70%
75%
65% 98 99 00 01 02 03 04 05 06 US 07 08 09 10 11E 12E 13E 14E 15E Europe Asia + Middle East
70% 98 99 00 01 02 03 04 Europe 05 06 US 07 08 09 10 11E 12E 13E 14E 15E Asia + Middle East
Reality likely to be closer to our BEAR CASE
In practice, we fear that the outcome will be closer to our BEAR case than to our BULL case given continued capacity creep and the likelihood that more refined product will be sourced from outside the conventional refinery gate e.g. via GTL and bio-fuels. If anything, we also feel that our BEAR CASE is likely too optimistic since we exclude capacity creep and bio-fuels encroachment. Furthermore, we suspect that our throughput growth assumptions over the period may be too high, especially in 2011 and 2012 given recent economic data. Furthermore, as we have argued, we do not believe that NOC sponsors to large green field projects will pull back from investment given deteriorating margins. We therefore believe that any optimism that the refining margin recovery experienced in 2010-11 will continue in 2012-13 is dangerously misplaced. To be more bullish, investors have to believe that NOC-sponsored capacity growth will fall well short of our projections and that demand growth will exhibit a prolonged up-cycle. We cannot see any compelling reasons for either to occur, especially given the latest GDP growth signals in Europe and the USA.
We thus forecast continued weak margins
Our regional refining margin forecasts (Figures 25 to 28) are aligned to our BEAR case and therefore continue to assume a year-on-year de-gradation in the period 2011-15. Although we cannot rule out seasonal spikes, perhaps exaggerated by unexpected capacity losses, we expect such spikes to be short-lived.
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Figure 25: US Gulf Coast gross refining margins ($/bbl)

30.0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 5.6 4.7 8.9 9.5 6.0 8.4 13.1 18.2 20.1 20.8 17.0 9.2 10.2 13 year average $11.7/bbl 2011E 2012E 2013E 2014E 2015E 14.2 13.5 12.8 12.2 11.6
Figure 26: US West Coast gross refining margins ($/bbl)

35.0 30.0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 8.8 10.4 14.5 14.8 9.0 12.2 18.7 21.2 23.4 24.0 16.4 13.4 13.1 13 year average $15.4/bbl 2011E 2012E 2013E 2014E 2015E 12.9 12.2 11.6 11.1 10.5
25.0
25.0
20.0
20.0
15.0
15.0
10.0
10.0
5.0
5.0
0.0 98 99 00 01 02 03 04 05 06 07 08 09 10 11E 12E 13E 14E 15E
0.0 98 99 00 01 02 03 04 05 06 07 08 09 10 11E 12E 13E 14E 15E
Figure 27: NW Europe gross refining margins ($/bbl)

25.0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 4.2 3.6 7.2 6.4 4.3 6.6 11.0 13.2 12.1 14.4 17.2 9.0 10.4
Figure 28: Singapore gross refining margins ($/bbl)

30.0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 3.8 2.5 5.7 4.3 3.8 6.4 11.7 13.9 14.0 15.0 17.0 8.5 10.7
20.0
25.0
20.0
15.0
15.0
10.0 13 year average $9.2/bbl 5.0 10.0 2011E 2012E 2013E 2014E 2015E 10 12.1 11.5 10.9 10.4 9.9 13 year average $9.0/bbl 5.0 2011E 2012E 2013E 2014E 2015E 15.2 14.4 13.7 13.0 12.4
0.0 98 99 00 01 02 03 04 05 06 07 08 09 11E 12E 13E 14E 15E
0.0 98 99 00 01 02 03 04 05 06 07 08 09 10 11E 12E 13E 14E 15E
Our declining margin forecasts are aligned with our declining oil price forecast (Figure 29). Given the aforementioned positive correlation between the oil price and refining margins, this is not inconsistent.
Figure 29: Brent oil price futures curve ($/bbl)
140
Brent Forward Oil Price ($/bbl, monthly average)
130 120 110 100 90 80 70 60 50 40 30

Actual $28.5 Actual $38.0 Actual $55.3 Actual $66.1
2008 Actual $98.4
2012E Curve $111.2 JPM $95.0
2007 Actual $72.7
2010 Actual $80.3
2011E Curve $112.3 JPM $110.0 2013E Curve $108.0 JPM $90.0
2009 Actual $62.7
20 Jan/03 Jan/04 Jan/05 Jan/06 Jan/07 Jan/08 Jan/09 Jan/10 Jan/11 Jan/12 Jan/13
Future imperfect
In this section we consider the potential implications of a continued long-term drift in refining capacity away from OECD to non-OECD.
The relocation of refining

Refineries historically co-located close to demand centers
Historically, refineries were located close to the key consuming areas, because it was cheaper to move crude oil than to move product and co-locating product output with demand made it easier to respond to changes in seasonal consumption patterns. Furthermore, importing countries wanted to encourage the formation of the refining industry on their shores, for reasons of local employment, inward investment and to ensure strategic control over this important manufacturing industry. For these same reasons and given other key incentives (cheaper labor, special tax incentives in development zones, zero carbon costs etc), as refined product demand patterns have evolved (more sluggish in OECD, faster in non-OECD) and nonOECD has become more import-dependent, the location of new refineries has shifted to the Middle East and Asia, as per Figure 30. In 1965, these two regions held 15% of global capacity; by 2010 this had increased to 40%. We expect this trend will continue given an uneven playing field for emission costing, cheaper labor, cheaper land and special tax incentives (e.g. advantaged capital allowance schedules, specific tax holidays).
Figure 30: Regional distribution of global refining capacity 1965-2010
100% 90%
Refining capacity will continue to migrate to Asia and Middle East
80%
70%
60%
50%
40%
30%
20%
10%
0% 65 70 75 80 Asia Middle East 85 North America 90 Europe 95 RoW 00 05 10
Source: BP 2011 Statistical Review of World Energy Statistics, J.P. Morgan.
China's vehicle manufacturing capacity 24% of global capacity
This substantial and ongoing migration of refining capacity also reflects increased vehicle ownership and vehicle manufacturing capacity in these regions, particularly Asia and most specifically PR China. We note that in 1980 PR China produced 0.4% of total worldwide new vehicles. In 2010, PR China produced 24.0% of all new vehicles. In 1950, the US and Western Europe produced 98% of all new vehicles; by 2010 this had fallen to just 31%.
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We suspect that without changes to government policy to encourage domestic refining, OECD refining will follow the marginalization trajectory of US vehicle manufacturing, as it is gradually displaced by lower cost refining centers in Asia and the Middle East.
Figure 31: New vehicle production by country & region (000s)
80,000
Figure 32: New vehicle production by country & region (%)

100% 90%
3.3% CAGR
70,000
80% 60,000 70% 50,000
60%
40,000
50%
30,000
40%
30% 20,000 20% 10,000
10%
0 50 55 60 65 70 75 80 85 87 88 89 90 91 92 93 94 95 China 96 97 Japan 98 99 Other 00 01 02 03 04 05 06 07 08 09 10 US + Canada W.Europe
0% 50 55 60 65 70 75 80 85 87 88 89 90 91 92 93 94 95 China 96 97 Japan 98 99 Other 00 01 02 03 04 05 06 07 08 09 10 US + Canada W.Europe
Source: Wards Automotive Group, J.P. Morgan.
Source: Wards Automotive Group, J.P. Morgan.
Chinas vehicle park could surpass US by 2021
With respect to vehicle ownership (passenger vehicles plus trucks), PR China surpassed Japan for the first time in 2010 with approximately 78m units (Figure 33). Since 1986 to 2010, Chinas vehicle park has grown at a CAGR of +14% compared to +2% for Japan and just +1% for the USA. If these historical growth rates are sustained, the size of Chinas vehicle park will surpass the size of the USA's vehicle park by 2021, in just ten years time.
Figure 33: Number of vehicles - passenger cars and trucks
450,000,000
400,000,000
Total vehicle park CAGR 1986-2010 PR China +14% Japan +2% USA +1%
350,000,000
300,000,000
250,000,000
200,000,000
150,000,000
100,000,000
50,000,000
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 China Japan USA
Source: Respective Auto Associations, J.P. Morgan.
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Future imperfect
Long-term forecasts can prove very wrong due to technological breakthroughs
From experience, we are mindful that absolute certainty in the oil & gas sector is a myth - it is often those forecasts where we have supreme confidence that prove incorrect. Equally, we are acutely aware that long-term forecasts in the oil & gas industry carry very high risks of being wrong given three key big change drivers: unexpected technological break throughs e.g. we note how development of US gas shale completely up-ended domestic gas supply forecasts and bullish US gas price forecasts. The US Energy Information Administration (EIA) now estimates that production of natural gas from shale plays increased from 4% of total natural gas production prior to 2005 to about 23% of total natural gas production in 2010. unexpected changes to government policies e.g. we note how the Fukushima nuclear disaster has transformed the views of certain governments (e.g. Germany, Switzerland and Thailand) with regard to their dependency on nuclear power. unexpected political change e.g. we note how regime change in Iraq has materially changed this country's oil output capacity potential. We also acknowledge that our capacity growth data for 2011-16 is inevitably errorprone and likely over-states the actual pace of capacity additions. However, it points to a clear refining capacity migration trend, from OECD to non-OECD, that we believe will continue and that will have important long-term implications for refined product trade flows and trade balances.
Worlds key refined product export hubs
Figure 34 shows the 2010 refined product balances of key countries and regions. For example, PR Chinas net imports were 638 kbpd in 2010 (comprising exports of 615 kbpd net of imports of 1,253 kbpd) and the FSUs net product exports were 2,057 kbpd. As per this schematic, the FSU, the Middle East and India were the worlds largest exporters of refined products. Globally, a total of 15.8 million bpd of refined products were imported and exported.
Figure 34: Refined product NET importers (negative) and exporters (positive) in 2010 (kbopd)
FSU NORTH AMERICA -513 EUROPE -1,252 MIDDLE EAST INDIA 2,029 852 SINGAPORE SOUTH AMERICA -253 AUSTRALASIA -135 AFRICA 232 -716 CHINA -561 -638 REST OF ASIA --1102
2,057 JAPAN
Source: BP Statistical Review of World Energy 2011, J.P. Morgan.
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If we fast forward only five years hence to end 2016, based on our capacity addition data to this time horizon, we expect to see some significant changes to these product trade balances. At end 2005 (2010), Asia plus the Middle East held 36% (40%) of global refining capacity (Figure 35). By end 2016, we expect this figure to have risen from 40% to almost 45%. We see absolutely no reason for this trend in regional capacity relocation to change post-2016. Indeed, it may well accelerate given the structural drivers that underpin it. Middle East this region is set to become an even more dominant product exporter. This may enable key OPEC members to exercise more influence over the oil price by controlling more exportable refined product flows. India we expect this country will become a much more significant product exporter. This may have implications for the M&A market as Indian refiners e.g. Essar Energy, look to secure terminal infrastructure and downstream market positions in target import markets. PR China this country could actually extinguish its product import requirements and become a net product exporter. Indeed, it could become an important new export hub for Asia Pacific which may bring it into a competitive conflict with Middle Eastern exporters. However, we suspect that PR China policy will more likely only permit enough refining capacity to be built to satisfy the countrys product needs whilst looking to improve the energy efficiency of its existing refining base. This will leave the country a net exporter / importer at certain times of the year. Europe / North America we expect that the product import requirements of both regions will increase, despite sluggish demand growth, given modest economic growth and engine efficiency gains, as more disadvantaged refineries are closed and no new refineries are added.
Figure 35: Changes to regional refining capacity location (year end, %)
100% 90%
80%
70%
60%
50%
40%
30%
20%
10%
0% 00 01 02 03 04 Middle East 05 Asia 06 07 North America 08 09 South America 10 11E Europe 12E Africa 13E 14E 15E 16E
41
The science and art of separation

Concept of vertical integration has passed its sell-by date
We have long encouraged an active debate about the merits and benefits of a vertically integrated business model in the oil & gas sector. We first proposed consideration of a restructuring to separate upstream from downstream in mid-March 2006 as presented in Figure 36. As the returns from upstream and downstream diverge further (more specifically as downstream returns look set to deterioriate), we believe the case to separate these two parts of the value chain grows ever stronger.
Figure 36: Simple transaction model for upstream-downstream separation a tax free spin-off to shareholders
Vertically integrated oil & gas company (VIOC plc) Spin-off downstream entity UPSTREAM plc Oil & gas assets - producers, developments, acreage Processing & storage facilities Transportation networks - oil & gas pipelines, shipping LNG - liquefaction and re-gasification terminals, shipping Power, Renewables Trading - oil, gas, LNG, power, renewables, carbon
DOWNSTREAM plc Refining - manufacturing Marketing - retail, business Terminals & storage facilities Lubricants - blending & marketing Shipping Chemicals - bulk, specialty Trading - products, carbon
In Table 5, we summarize the pros and cons of vertical disintegration to create two pure parts one upstream and one downstream. This has been done by Marathon Oil, effective 23 June 2011. It originally proposed this restructuring step in 2008, but the plans were abandoned in 2009 as a result of the global financial crisis.
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Figure 37: Marathon Oil - absolute and sector relative performance (rebased)
40 110
Figure 38: ConocoPhillips - absolute and sector relative performance (rebased)

100 110
35
100
90 100 80
30
90 70 90
25
80 60 80
20
70 50
15
60
70 40
10
2008
MARATHON OIL
2009
2010
2011
50
30
2008
CONOCOPHILLIPS
2009
2010
2011
60
MARATHON OIL/US-DS Int Oil & Gas (RH Scale)
CONOCOPHILLIPS/US-DS Int Oil & Gas (RH Scale)
Source: Thomson Reuters Datastream
Source: Thomson Reuters Datastream
Such a move has also been proposed by ConocoPhillips. On 14 July 2011, it announced that it will split into two companies by spinning off its refining business as a separate, publicly traded entity by the end of June 2012, at which time the CEO (Jim Mulva) will retire. Figure 37 and Figure 38 show the absolute and relative share price performance (versus the US Integrated Sector) of these two companies since the beginning of 2008.
Pros of separation outweigh the cons
The announcement by the industry heavyweight ConocoPhillips regarding its intended upstream downstream separation (scheduled to be completed by mid2012) has helped to recharge the debate about this radical form of corporate restructuring. On balance, we squarely believe that for some companies, a separation will ultimately lead to superior performance from and a higher valuation for the two parts versus the single more lowly rated integrated entity.
Figure 39: Correlation between upstream & downstream earnings 1997-2011

600 500 400 300 200 100 0 -100 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Upstream Downstream
Correlation coefficient +0.50
2011
Source: J.P. Morgan. Quarterly post tax earnings for BP, Chevro, Exxon Mobil and RD Shell.
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Table 5: Pros and Cons of upstream-downstream separation

Pros Give investors important choice - the majority of investors prefer the choice between two pure entities across the macro cycle that offer gearing to different parts of the energy value chain and more direct leverage to segment-specific event risk e.g. exploration success for a pure upstream entity. Reduce risk of cross-segment valuation contamination - so if one part of the business performs poorly, it does not bring down the valuation of the whole. Arguably, Macondo (Texas City) damaged the valuation of the whole of BP. Consistent with our bearish downstream outlook, we see an increasing threat that poor downstream results drag down the valuation of the whole. Facilitate necessary downstream consolidation - consistent with our bearish analysis of the global refining outlook, we believe that further consolidation will be required. Figure 36 highlights a highly fragmented landscape of pure downstream players. Such consolidation will be more easily achieved by independent downstream players. The best acquisition opportunities often occur when the cycle is at its worst. Permit more effective management incentives - upstream (downstream) management ought to perform better given a more direct incentive linked to the share price of a pure upstream (downstream) company. Encourage fuller downstream disclosure - this would overcome the current situation where vertically integrated companies give fuller upstream disclosures, but excuse themselves from equivalent downstream disclosure policies due to competitive sensitivities. Shift valuation metric to raise relevance of asset value - we do not agree that the market would be reluctant to price a very large, well run E&P company using a NAV metric, as it does smaller independents. Equally, we believe that the downstream valuation focus could usefully shift to an, EV/EBITDA multiple. Permit tailored capital structuring - the debt capacity and tolerances of an upstream company are different to those of a pure downstream company. Note that ConocoPhillips recently indicated that the separate entities could hold more debt than the combined entity. Permit greater ownership flexibility - many institutional investors face 'big oil' ownership limitations given their heavy index weighting; this issue could be reduced if not eliminated given two smaller listed entities. Avoid the hazards of an internal capital market downstream has never really been able to compete with upstream, which offers superior returns. Downstream would no longer have to compete with upstream and (to a lesser extent) vice versa; this would enable more efficient cross-cycle investment patterns.
Cons It would create two entities with increased earnings volatility - we disagree given the positive correlation between upstream and downstream earnings (see Figure 39). Downstream businesses cannot survive the cycle stand alone - again we disagree and, even if this was true, we cannot see any validation for a good upstream business to subsidize a bad downstream business. It would expose both parts to an increased risk of takeover - this is potentially true, but in our view no bad thing from a shareholder's perspective. Management should not stand in the way of this outcome by sustaining inefficient scale and complexity. It would cost money to separate the businesses - yes, it would, however a tax-free spin-off was delivered by Marathon and ConocoPhillips looks likely to do the same. Furthermore, we believe that the enduring benefits would more than offset the one-off upfront costs of separation and higher overall corporate costs for two separate entities Loss of global procurement efficiency - we accept that some loss of procurement efficiency may be incurred, but we doubt that it would be material. Loss of recruitment / retention power - we simply do not agree that the best people prefer to develop their careers at integrated companies given the greater 'career safety and choices'. Indeed, we believe that the integrated companies have actually suffered a 'brain drain' to the more entrepreneurial, independent sector. Damage trading efficiency - we accept that some loss of trading efficiency may be incurred, but since the market regards this business as low quality, the value implications ought to be very limited indeed. Reduce global access capabilities - we do not agree that a downstream capability is important for upstream access in the 21st century. However, we see a continued risk that certain companies use the offer of a low return downstream investment in order to leverage their access upstream.
BP is a prime candidate to disintegrate
We continue to believe that BP is a prime candidate amongst the stable of integrated names to implement this kind of restructuring. We note that the CEO stated following BPs Q2 2011 results that no strategic option has been ruled out. We believe that the Macondo crisis could be positively resolved via this corporate restructuring remedy and identify five company-specific motivations: Address the very substantial share price to intrinsic value gap Management has publicly acknowledged the value gap and all restructuring options are 'on the table'. Our SOTP for BP is around 800 pence or $77.8 per ADR more than double the current share (ADR) price (Figure 40). Strategy derives little or no integration benefits - BP is one of the few oil majors which is not physically integrated e.g. via refining to chemicals. Furthermore, its share price is clearly not registering any such synergies given the deep discount to its SOTP. So, the natural argument against disintegration, as coherently articulated by companies like Exxon Mobil, does not apply to BP. Shareholders want radical action, sooner not later We believe that this form of corporate restructuring would help to appease BPs long-term shareholders
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who want more radical action to address the stocks long-run underperformance and who do not believe that the current divestment program is a sufficiently profound change for the company. This is substantiated by public comments by a number of BPs UK shareholders.
Figure 40: BP SOTP and share price discount (%)
1000 900 800 (10)% 700 600 500 400 300 (50)% 200 100 0 Jul-04 2005 2006 2007 2008 2009 2010 2011 (60)% (70)% Average discount (28)% (20)% (30)% (40)% SOTP CAGR 6% 10% 0%
SOTP (pence per share, LHA)
Share price premium/(discount)
Table 6: BP Downstream - estimated enterprise value

Segment Refining Shipping Marketing Lubricants Chemicals Corporate Enterprise value ($m) 19,107 3,295 21,205 3,240 5,940 4,388 1,629 58,803 2010 4,883 2,258 7,141 3,906 4,029 28,147 7,037 8.2 13% 15.1 2.1 (p/share) 62 11 68 10 19 14 5 189 2011E 6,639 2,300 8,939 5,311 2,124 3,500 29,347 7,337 6.6 11.1 3.6 2.0 % 32 6 36 6 10 7 3 100 2012E 6,764 2,350 9,114 5,411 2,164 3,500 30,497 7,624 6.5 10.9 3.7 1.9
Retail Commercial Specialities
Downstream financials ($m) EBIT * DD&A EBITDA Post tax earnings if ungeared Potential distribution at 40% payout Capital expenditure Net fixed assets Theoretical net debt capacity given ND/ND+E ratio 25% Implied multiple if valued at EV EV/EBITDA (x) EBITDA CAGR 2010-12E PER (x) Dividend yield (%) Price to NFA (x)
Source: J.P. Morgan estimates. * BP reported H1 2011 downstream EBIT of $3,588m.
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We value debt-free BP Downstream at $59bn, 189 pence per share
As detailed in Table 6, our BP downstream EV, as per our BP SOTP, is $58.8bn or around 189 pence per share. We value BPs fuels retailing business at $21.2bn and its refineries (including working capital) at $19.1bn. These sub-segment valuations imply a unit value of just under $1m per retail site (22,100 sites at year end 2010) and $7,200 per bopd refining capacity (16 refineries with total net capacity 2,667 kbopd at YE 2010). We do not value BPs powerful Trading function instead we assume that the benefits derived from this business are already expressed in the performance of the key businesses that we explicitly value and, ergo, in the total downstream financial performance. In Figure 41, we position BP Downstream's theoretical market capitalisation alongside 27 pure downstream plays that are listed in Europe, the USA and Asia. As per this chart, a debt-free BP Downstream would currently rank as the worlds largest pure downstream entity, just ahead of Reliance Industries. We note that J.P. Morgans analyst for ConocoPhillips (Katherine Minyard) estimates an EV for its downstream business (including Midstream and Chemicals in their present configurations) of just over $31bn. Assuming this downstream entity holds $6bn of net debt, this implies a potential equity value of around $25bn - much larger than the two largest US plays today (Marathon Petroleum and Valero Energy), but less than half the size of a debt-free BP Downstream.
Figure 41: Equity market values of pure downstream names on 1 September 2011
60000
50000
40000
Market Cap ($m)
30000
20000
10000
Source: J.P. Morgan blue US companies, Green European companies, Red Asia and Rest of World companies.
EV of $59bn implies 2012E EV/EBITDA 6.5x
In Figure 42, we show the current trading (2012E EV/EBITDA) multiples of a broad cross-section of these downstream plays. Where possible, we have positioned each
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pure play according to EBITDA CAGR 2010-12E and 2012E EV/EBITDA multiple. The blob size corresponds to current market capitalization. We have also positioned BP Downstream amongst these names assuming the aforementioned enterprise value (equity value given zero net debt assumption). We do not believe that the implied 2012E EV/EBITDA multiple of 6.5x, required to give parity with our estimated EV, looks out of line with these peers (2012E EV/EBITDA median 5.6x) given the unique scale and quality of BP Downstream, which would be the only trans-regional pure downstream player.
Figure 42: Comparable downstream 2012E EV/EBITDA multiples 1 September 2011 (blob size corresponds to market capitalization, $m)
12.0
Average 36%
10.0
HPCL
BPCL Reliance Industries
8.0
Sunoco IOC Showa Shell
EV/EBITDA (2012E)
6.0
PKN Orlen
BP
Hellenic Pet. Bangchak Pet. Thai oil
S-OIL
JX Holdings* Motor Oil
Average 5.6x
ERG SPA
Neste Oil TonenGeneral
Caltex Australia
4.0
SK Innovation Saras SPA Tesoro Western Refining Marathon Petroleum
HollyFrontier
Alon USA Energy * Petroplus Valero Energy
2.0
0.0 -20% 0% 20% 40% 60% EBITDA CAGR (2010 - 2012E, %) 80% 100% 120%
*CAGR taken for 11e-12e (EBITDA for 2010 is -ve) for Alon
Source: J.P. Morgan. Consensus EBITDA data from IBES and current EV based on last disclosed net debt figure. Asian companies colored red; European companies colored green, US companies colored blue.
BP Downstream potentially larger than RIL of India
If listed as a separate entity and assuming zero debt and a value parity with our SOTP, BP Downstream would rank alongside Reliance Industries of India as the world's largest listed, pure downstream company (current market value $57bn). If we assume that net assets are 33% higher than net fixed assets and a net debt to net debt plus equity ratio of 25% (note that US downstream plays bear an average debt to capitalisation ratio around 25%), this would imply a very manageable net debt capacity of around $8bn. This would reduce the implied equity value of BP Downstream to around $50bn. Since we do not know the potential off-balance sheet liabilities of BP Downstream e.g. pension deficit, it is difficult for us to prescribe a capital structure.
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Downstream performance assessment

We have analyzed the downstream performance and strategies of fifteen listed companies over a period of 11 years from 2000-10. International Oil Companies (IOCs) - BP, Essar Energy, ENI, GALP, OMV, RD Shell, Repsol YPF, Reliance Industries, Sasol, Statoil and TOTAL National Oil Companies (NOCs) - IOC, Sinopec, PetroChina and Petrobras. Broadly, these names may be sub-divided in to five core categories, as per Figure 43. All of the OECD IOC names are focused on enduring the cycle, usually via a combination of upgrading, restructuring and shrinking the downstream (extracting capital therefrom). The growth-focused NOCs are less focused on costs and more focused on growth projects, typically in their domestic markets. These often involve moving further downstream in to petrochemicals in order to capture more value from downstream products that are not price regulated. More specifically, we have chosen these companies in order to be able to compare and contrast the strategies and performance (operational and financial) of the worlds best known IOCs and NOCs. We include a strategic analysis of Sasol to underline another bearish factor for refining - the growth in the production of refined products via non-conventional processes i.e. natural gas-to-liquids. We also include IOC and RIL to show examples of two structurally advantaged refiners.
Figure 43: Five categories of downstream strategy
SIT OUT THE CYCLE Chevron ENI Exxon Mobil
UPGRADE GALP Repsol YPF
RESTRUCTURE / SHRINK BP RD Shell Statoil
SELECTIVE GROWTH AGGRESSIVE GROWTH Essar Energy IOC OMV Petrobras Reliance Industries PetroChina Sasol Sinopec PETROCHEMICALS
Source: J.P. Morgan. * Chevron and Exxon Mobil are excluded from the strategic analysis, but data for both is included in the peer group performance analysis.
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Setting the scene

Companies represent 36% of global refining capacity
Before we score and rank these companies, we illustrate the scale and spread of their operations. Combined these companies include many of the world's key listed players and, in aggregate they have a very substantial share of global refining and retailing. As per Figure 44 and Figure 45, at year end 2010 the aggregate refining capacity of these names was approximately 32.6 million bopd this represented 36% of global refining capacity (YE 2010 91.8 million bopd).
Figure 45: Non-OECD companies aggregate refining capacity
14,000
Figure 44: OECD companies aggregate refining capacity

25,000
CAGR 0%
CAGR 5%
12,000 20,000 10,000
15,000
8,000
10,000
6,000
4,000 5,000 2,000
0,000 2000 2001 BP 2002 Chevron ENI 2003 2004 GALP 2005 OMV 2006 Repsol YPF 2007 RD Shell Statoil 2008 TOTAL 2009 2010 Exxon Mobil
0 2000 2001 2002 2003 RIL IOC 2004 Sinopec 2005 Petrochina 2006 Petrobras 2007 2008 2009 2010
As per Figure 46 and Figure 47, in total these companies owned approximately 242 refineries, which represented around 37% of the total number of refineries in the world (c.655). Both categories of companies have clearly been increasing the average unit size of their refineries. OECD names have typically done so by selling smaller plants to increase their average capacity to 128 kbopd. Non-OECD names have typically grown their average capacity, from 109 to 146 kbopd, by building new, larger plants.
Figure 46: OECD companies number & average size of plants
200 180 160 CAGR -2% 130 125 120 115 110 105 100 95 2000
BP
Figure 47: Non-OECD companies - number & average size of plants

90
CAGR 2%
150
80
145
Average refinery capacity (kbopd)
70
140
Number of refineries
140 120 100 80 60 40 20 0 2001 2002

ENI
135
130 50 125 40 120 30 115 20
110
10
105
2003
2004
GALP
2005
OMV
2006
Repsol YPF
2007
2008
2009
2010
0 100 2000 2001 2002 RIL 2003 IOC 2004 Sinopec 2005 2006 2007 Petrobras 2008 Average 2009 2010 Petrochina
Average
Chevron
Exxon Mobil
RD Shell
Statoil
TOTAL
As per Figure 48 and Figure 49, OECD companies clearly have a fuller regional spread compared to the non-OECD names that are naturally more focused on domestic refining needs.
Average size of refinery (kbopd)
60
49
Figure 48: OECD companies - regional refining distribution

100% 90%
Figure 49: Non-OECD companies - regional refining distribution

100% 90%
80%
80%
70%
70%
60%
60%
50%
50%
40%
40%
30%
30%
20%
20%
10%
10%
0% 2000 2001 2002 2003 2004 Europe USA 2005 2006 2007 2008 2009 2010 Rest of World
0% 2000 2001 2002 2003 India 2004 Brazil 2005 China 2006 Rest of the world 2007 2008 2009 2010
In aggregate, at year end 2010, both categories of companies had approximately 216,000 retail outlets. OECD companies have shrunk the size of their networks by an average of 3% per annum, whilst non-OECD companies have grown their networks by an average of 2% per annum.
Figure 50: OECD companies - number of retail sites
200,000 180,000 160,000
60,000
Figure 51: Non-OECD companies - number of retail sites

80,000
CAGR -3%
70,000
CAGR 2%
140,000 120,000 100,000 80,000

30,000 50,000
40,000
60,000 40,000 20,000 0,000 2000

BP Chevron 20,000
10,000
2001
2002
2003
RD Shell
2004
TOTAL
2005
ENI
2006
OMV
2007
2008
2009
GALP
2010
Statoil
0 2003 2004 2005 RIL IOC 2006 Sinopec 2007 Petrochina Petrobras 2008 2009 2010
Exxon Mobil
Repsol YPF
We also group the OECD names to compare their overall downstream performance with the non-OECD names. Figure 52 shows how the non-OECD group sustained higher average refinery utilization rates through the 2008-09 economic slow down. 2010 marked the first year of higher utilization rates following five years of utilization declines for the OECD names. We believe that this reveals a key challenge for the OECD names they have lost refined product market share to their nonOECD rivals. We expect they will continue to do so.
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Figure 52: Refinery utilization

92%
90%
88%
86%
84%
82%
80% 2000 2001 2002 2003 2004 OECD 2005 2006 2007 2008 2009 2010 Emerging Market
Figure 53 highlights that, in most years, OECD downstream operations are more profitable than non-OECD operations they generate a higher profit per barrel of refining throughput and a higher return in net fixed assets. However, the more challenging conditions in 2010 enabled non-OECD players to generate higher unit earnings and to match OECD asset returns. This could be shape of things to come. We note that the average OECD ROFA 2000-10 was 14% and the comparable nonOECD company average was 10%. So, both sets of companies show downstream returns in excess of their respective cost of capital. OECD based companies that pursue non-OECD downstream growth should expect very significant downstream return dilution, bearing in mind that we are measuring the returns of the dominant incumbents ex-OECD. Fortunately, none of the OECD companies that we cover is currently pursuing such growth those that did (e.g. Repsol via YPF) have long since regretted it and their owners have certainly paid for it.
Figure 53: Post-tax earnings per barrel refining throughput ($/bbl)
6.0 5.0
Figure 54: Post tax return on net fixed assets (%)

25% 20%
4.0 15% 3.0 10%
2.0
1.0
5%
0.0 2000 -1.0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
0% 2000 (5)% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
-2.0 (10)%
-3.0
-4.0 OECD Emerging Market
(15)% OECD Emerging Market
Unsurprisingly, non-OECD downstream markets offer more growth opportunities and the incumbents thus show much higher capex to depreciation ratios (Figure 55). This has inevitable consequences for the relative free cash flow generation profiles of the two groups of companies which, in turn, limits the distribution powers of nonOECD players their downstream operations are a sink for not a source of cash. We
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also note how the free cash flow profile of the OECD group deteriorated between 2006 and 2009.
Figure 55: Capex to depreciation ratio (x)
4.0 3.5
Figure 56: Free cash flow per barrel refining throughput ($/bbl)
1.5 1.0
3.0
0.5
0.0 2.5 (0.5) 2.0 (1.0) 1.5 (1.5) 1.0 (2.0) 0.5 2000 2001 2002 2003 2004 OECD 2005 2006 2007 2008 2009 2010 (2.5) OECD Emerging Market Emerging Market 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Company downstream performance ranking

Based on 11 years of historical downstream performance data (2000-10) and using seven simple, specific metrics that we believe correlate most closely with shareholder value and valuation, we rank all our companies in Table 7. A full explanation of each parameter and the detailed scoring mechanism is in given in Appendix I. We weight each factor evenly and by summing the ranking on each parameter we derive an overall ranking. We split the companies - OECD and non-OECD.
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Table 7: Downstream corporate scores and peer group ranking

2000-10 free cash flow per bbl 2000-10 network shrinkage 2000-10 refinery utilization PEER RANKING TOTAL SCORE 2000-10 profit / Tput barrel 2000-10 ROFA 2010 ref. tput to equity oil
2010 average refinery size
BP ENI GALP OMV REPSOL YPF RD SHELL STATOIL TOTAL
2 6 3 10 5 7 9 8
8 9 10 4 7 5 1 3
4 2 10 7 9 6 1 5
5 1 9 10 6 7 3 8
2 7 9 5 3 4 1 8
4 5 8 10 9 7 6 1
6 9 8 10 4 2 1 5
31 39 57 56 43 38 22 38
2nd 5th 8th 7th 6th 3rd= 1st 3rd=
IOC PETROBRAS PETROCHINA SINOPEC RIL
4 4 5 3 1
2 3 5 4 1
5 1 2 3 4
1 4 2 3 5
1 2 5 4 3
2 3 5 4 1
2 3 5 4 1
17 18 29 25 16
2nd 3rd 5th 4th 1st
Source: J.P. Morgan. * We rank OECD companies for network shrinkage, whilst we rank non-OECD companies for network growth. We have not included Essar in this ranking because it does not have a sufficiently long operating history to enable a comparison.
We are not surprised that GALP and OMV score poorly and rank low. We are, however, surprised by the high score and top ranking of Statoil we had never thought of its downstream business as being that high quality it clearly is, ableit very small in a group valuation context. Similarly, we are pleasantly surprised by TOTALs overall ranking third. We, perhaps in common with some investors, had believed that its downstream business was lower quality and would not score as high under scrutiny. Of the non-OECD companies, we are most impressed by the operating and financial performance of Reliance Industries that possesses many, if not all of the competitive advantages that we look for in refining.
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BP
Overweight
Company Data Price (p) Date Of Price Price Target (p) Price Target End Date 52-week Range (p) Mkt Cap ( bn) Shares O/S (mn) 372 06 Sep 11 575 31 Dec 11 515 - 363 69.7 18,755 BP (BP.L;BP/ LN) FYE Dec Adj. EPS FY ($) Bloomberg EPS FY ($) EBIT FY ($ mn) Net Attributable Income FY ($ mn) Dividend (Net) FY (p) Net Yield FY EBITDA FY ($ mn) EV/EBITDA FY 2010A 1.09 1.13 31,388 20,352 4.5 1.2% 31,388 4.8 2011E 1.15 1.16 35,937 22,778 17.7 4.8% 35,937 4.5 2012E 1.11 1.18 34,892 22,155 19.0 5.1% 34,892 4.6
Source: Company data, Bloomberg, J.P. Morgan estimates. NB: unit for EPS figures is .
BP is a European Analyst Focus List stock
Downstream overview
Downstream contents & structure BPs Refining & Marketing business is responsible for the supply and trading, refining, manufacturing, marketing and transportation of crude, petroleum, petrochemicals products and related services to wholesale and retail customers. BPs Refining & Marketing business therefore combines refining, fuels retailing (service stations and wholesale), lubricants (including Castrol), a small specialty chemicals business (BP sold the bulk of its olefins and derivatives business, Innovene, in 2005) and downstream trading. BP has a larger than normal trading function this identifies the best markets and prices for crude oil, sources optimal feedstocks for BP's refineries and provides competitive supply for BP's marketing business. In addition, it generates trading profits from arbitrage, blending and storage opportunities. BP provides very limited detailed financial information on these subsegments, especially its trading operations. BPs downstream business is managed through two main groupings fuels value chains (FVCs) and international businesses (IBs): FVCs - combine refining, logistics (pipelines, terminals etc), marketing (retail stations) and supply and trading on a regional basis. BP has 6 regional FVCs each optimizes crude delivery to the refineries, the manufacture of fuels, pipeline and terminal infrastructure and marketing and sales to customers. IBs these operate on a global basis and include manufacturing, supply and marketing of lubricants, petrochemicals, aviation fuels and liquefied petroleum gas (LPG). The IBs operate in more than 70 countries. In 2010, the IBs accounted for just over half of BP's downstream replacement cost profit ($4.9bn).
Downstream includes chemicals and above-average contribution from trading
Continue to shrink, focus and raise underlying returns
Downstream strategy BP's downstream strategy is to reduce its portfolios exposure to low growth markets (US and Europe) to enhance its focus whilst improving its overall returns and growth potential. As such, its strategy is not focused on scale, but on the quality of its assets and their performance. Ultimately, BP aims for each core piece of its downstream portfolio to generate attractive returns and growth. This strategy may be decomposed into three key areas:
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Reposition US fuels value chains and halve US refining capacity this includes divesting the Texas City refinery and the Southern West Coast Fuels Value Chain (including the Carson refinery), whilst improving the capability of the Whiting refinery and raising the performance of the Cherry Point and Toledo refineries and focusing the marketing and logistics footprint. Improve Eastern hemisphere fuels value chains and access market growth this includes improving refinery yields (e.g. Gelsenkirchen), focusing the marketing and logistics footprint and expanding the marketing margin. Grow high quality International Businesses this includes lubricants, Asian chemicals and Air BP.
EBIT potential of around $7bn by 2012 versus cycle low $3.3bn in 2008
Downstream performance drivers Under the leadership of Iain Conn (Chief Executive Officer, Refining & Marketing since 2007), BP has been restructuring its downstream business since 2007 in order to raise returns and ensure strong free cash flow. Throughout, the number one priority has been safe and reliable operations via an unrelenting focus on process safety risk management and the deployment of its Operating Management System. In this respect, BPs Downstream business shares the groups top three priorities Safety & operational risk management, Rebuilding trust and Pursuing value growth. BPs downstream restructuring continued in 2010-11 and is scheduled to be completed in 2012. It has involved selling assets, simplifying processes (local head offices were closed and replaced by three regional centers), reducing costs (2007-09 headcount excluding retailing was reduced by 4,500 and senior management headcount was also reduced 20%) and driving revenue growth. During 2007-09, pretax earnings gains derived from these self-help measures totaled $4.8bn ($0.6bn costs, $1.4bn simplification and $2.8bn from revenue growth). In 2010, another $0.9bn was achieved with an incremental target of over $1.1bn by 2012 to make a total increment of $6.8bn relative to 2007 EBIT of $3.93 billion. BP estimates that in 2010 its Refining & Marketing cash costs (excluding energy, FX, plant turnaround costs and manufacturing variable costs) had been reduced to their level in 2004. Downstream growth projects BP only has one material downstream project the Whiting Refinery Modernization Project (WRMP). This is a large and complex project that will take five years to complete. It involves the rebuild of its crude distillation unit to process heavy crude oil, the addition of a 100 kbpd six-drum coking unit and the addition of a new worldscale sulfur removal and gas-oil hydro-treating units. The project was 60% completed by end 2010 and is due to be commissioned in 2013. When completed, BP estimates that the plants pre-tax profits will be increased by more than $200m as it captures the WTI-Lloydminster price differential. Indeed, progress on pipeline interconnections was completed in 2010, allowing Whiting early access to cheaper crude imports and product export opportunities. This project will also help BP to access other heavy oil / non-conventional upstream opportunities in Canada. When up and running in H2 2013, the impact on BPs free cash flow ought to be material given an end to project investment (2011E $1bn) and an incremental operating cash flow of up to $1bn at cycle average conditions. BP is also considering an upgrade to the hydrocracker at its wholly owned Rotterdam refinery.
Whiting refinery upgrade is BP's only major downstream project
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BP Downstream Efficiency Overview

BP has led IOC downstream downsizing trend
Refining scale, reach & utilization Following its acquisition of SOHIO (January 1989), BP's downstream business went through two further transformative steps following its merger with Amoco (December 1998) and acquisition of ARCO (April 2000). The size of BPs refining network ultimately peaked following the acquisition of Vebas retail and refining assets in Germany and Central Europe in 2002. Since then, BP has led the trend amongst its IOC peers by downsizing its refining exposure most effectively. This has been primarily achieved by divestments (corporate e.g. Innovene, plus numerous piecemeal asset sales e.g. Tesoro acquired two BP refineries in September 2001; the 58 kbopd Mandan, North Dakota refinery and the 58 kbopd Salt Lake City, Utah refinery. Prior to that, Clark acquired BPs 162 kbopd Lima (Ohio) refinery in August 1998). BP has one US JV with Husky Energy (BP-Husky Refining LLC, April 2008 BP contributed its 160 kbopd Toledo refinery). By end 2010, BP had reduced its capacity from a peak of 3.1 million bopd in 2002 by 14%. BP has sold its interests in 10 refineries (Alliance, Coryton, Grangemouth, Lavera, Mandan, Mombasa, Reichstett, Salt Lake, Singapore and Yorktown), reducing its portfolio from 24 to 16 refineries at end 2010 (given 2 refineries also acquired). In so doing, BP has raised the average size of its retained refineries by 46% - from 114 kbopd in 2000 to 167 kbopd in 2010. BP is currently looking to sell its wholly owned Texas City refinery (475 kbopd gross rated distillation capacity) and its wholly owned Carson refinery in California (266 gross rated distillation capacity). These divestments are due to complete before the end of 2012 they will almost halve BPs US refining capacity. BPs average refinery utilization has returned to very competitive levels (91% in 2010) having fallen to very low levels in 2006-07 following the Texas City tragedy (23 March 2005) which triggered a root and branch review of plant safety and operations.
Product yield shifts to more diesel and aviation fuel, less gasoline
Refining product yield and product / equity oil cover ratio Notwithstanding major divestments, BPs refining slate has actually changed very little over the last decade. The only notable slate shifts have been a small increase in aviation fuel (from 9% to 12% by volume) and fuel oil (from 25% to 29% by volume) and a small reduction in gasoline output (from 38% to 35% by volume). In effect, BPs refinery orientation has become more diesel-capable, which better suits the consumer demand trends in the OECD. As BP has grown its oil production whilst reducing its refining capacity, the ratio of refinery throughput to equity oil production has fallen from 145% in 2000 to 102% in 2010. Given the aforementioned refinery sales (741 kbopd) and notwithstanding upstream asset sales, we expect this ratio to fall below 100% in 2011-12. So, BPs earnings will become less sensitive to refining margins and more sensitive to the oil price. Retailing network BP sells fuels under three power brands - BP, Aral (parts of Europe) and ARCO (West Coast of USA). BPs retail convenience offer includes brands such as ampm, Wild Bean Caf and Petit Bistro. BP also has a retailing partnership with Marks & Spencer. BP has reduced its network scale by an average of 3% per annum over the 11-year period 2000-10. In so doing, it has raised its networks exposure to Europe from 27% to 38% and reduced its US exposure from 60% to 51%. BP also exited retailing in a number of countries e.g. in Africa (Botswana, Malawi, Namibia, Tanzania and Zambia) and France. BP has also de-capitalized its retailing business by shifting its US operations from a Company-Owned to Dealer-Owned model.
Reduced US exposure, raised European exposure
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Consistently profitable and robust returns
Downstream profitability BPs downstream business has never reported a full year loss indeed, since 2000 it has only reported a loss in one quarter (Q4 2007). BP's downstream business has also consistently generated a positive return on net fixed assets, with an average 2000-10 ROFA of 14%. BPs ROFA is buoyed by three factors: (i) it has an above-average exposure to asset-light streams such as lubricants and trading (ii) it includes the remains of its specialty chemicals business which some of its peers (e.g. Exxon Mobil and RD Shell) report separately (iii) it has impaired certain assets and written off goodwill associated with the ARCO acquisition. However, BP has helped itself by always striving to be a low-cost player (e.g. 2009 cash costs reduced to 2004 level). However, we believe that these statistics show that BPs downstream business is relatively high return and generates a more resilient performance than many of its peers. Between 2000 and 2010 BP generated an average of $3.9 post tax per barrel of refinery throughput. Downstream cash generation and capital intensity BP's downstream cash generation (excluding changes to working capital) has swung negative in three years. Negative cash flow in 2000 and 2002 was due to acquisitions (Castrol and then Veba). In 2008, negative cash flow was attributable to a weak operating performance and the asset exchange with Husky Energy Inc. to create an integrated North American oil sands business (which added $1.9bn to BPs reported capital expenditure). These acquisitions have also spiked BPs capital expenditure to depreciation ratio. This ratio has averaged 2.1x 2000-10, which is a robust level of reinvestment we are concerned when this ratio falls much below 2x given relatively fully depreciated assets and the high costs of ensuring asset integrity. We note that the Texas City tragedy also caused higher levels of downstream investment. Adjusted for acquisitions, BPs downstream business has consistently returned cash to BP plc and thus supported the groups cash returns to shareholders. Given much improved performance and two major refinery divestments (Texas City and Carson) which may realize $7-10bn, we expect this very healthy downstream cash flow profile to be continued in 2011-12.
Consistent positive cash flow excluding acquisitions
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Figure 57: BP - refining capacity (kbopd) & utilization (%)

3500 3000 95% Refining capacity (kbopd) 2500 2000 1500 1000 80% 500 0 2000 2001 2002
Europe
Figure 58: BP - number of refineries & average size (kbopd)

100% 25 180 170 20 160 150 140 85% 10 130 120 5 110 75% 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 100
90%
15
2003
USA
2004
2005
Rest of World
2006
2007
2008
2009
2010
Worldwide refinery utilisation
Average net refinery size (kbopd)
Source: J.P. Morgan. All BP data excludes TNK-BP
Figure 59: BP - refinery yield and output / equity oil cover ratio (x)
100% 150% 90% 140% 80% 130%
Figure 60: BP - retailing network size & location

30,000
25,000
CAGR -3%
70%
20,000
120%
60%
50% 110%
15,000
40%
10,000
30% 100%
20% 90% 10%
5,000
0% 2000 2001 2002 Gasolines 2003 2004 2005 Fuel oil 2006 Other products 2007 2008 2009 2010 Aviation fuel Middle distillates Refining throughput / equity oil production
80%
0,000 2000 2001 2002 2003 2004

Europe
2005
USA
2006
Rest of World
2007
2008
2009
2010
Figure 61: BP - downstream profitability ($/bopd) & post-tax ROFA (%)

6.0 20%
Figure 62: BP - downstream cash flow ($m) & capital intensity (x)
5,000 4,000 3,000 5.0 4.5 4.0 3.5 3.0 1,000
5.0 15% 4.0
2,000
3.0
10%
2.5 0,000 (1,000) 2000-10 average 2.1x 2.0 1.5 1.0 0.5 0.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
2.0 5% 1.0
(2,000) (3,000)
0.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
0%
(4,000)
Post tax income per refinery barrel throughput ($/bbl)
Post tax return on NFA (%)
Post-tax free cash flow ($m)
Capex / depreciation (x)
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Summary
Downsized early in the upcycle, shifted focus to asset quality and performance
BP's downstream strategy recognized early the perils of a global presence in refining and retailing focusing instead on asset quality, operational reliability, cost efficiency and local focus owning the right assets in the right markets. As a result, it differentiated itself from the majority of its integrated peers by a more aggressive downsizing and geographical repositioning reshaping the downstream for improved returns and growth. BP is more aggressively transitioning downstream capital employed to upstream. Furthermore, by doing much of its downsizing early in the margin upcycle (2005-08), BP has been able to divest assets at good prices, especially its non-core refineries. Another difference, BP has long been less dependent on the benefits of physical integration and, consequently, more dependent on its trading operations to source and place crude / product optimally and exploit arbitrage opportunities. Unfortunately, investors see this part of the business as a high risk, black box type stream and therefore it typically fails to be accorded a fair value, in our view.
OMS deployed across all downstream operations
Clearly, BPs downstream performance was badly damaged by the Texas City tragedy (March 2005) and the performance of its US retailing network was further damaged by the Macondo incident (April 2010). As is so often the case in this industry, a devastating accident acted as the trigger to improve performance. BPs downstream safety (both process and personal) has improved, helped by its Operating Management System (OMS). This covers all contractor management processes. All of Refining & Marketing's major operations had transitioned to OMS by the end of 2010. It is clearly vital that BP maintains a flawless operational performance. When it has sold its Texas City and Carson refineries (expected by 2012), BP will have total refining capacity of just over 1.9 million bopd with just 14 refineries (average net interest 138 kbopd) - this will rank it one of the smallest refiners amongst the oil majors. BP is already a low cost downstream player - this will protect it from the margin downside risks that we see over coming years. BP is fast becoming a distinctive (growth oriented, consistently high return, consistent positive free cash flow) downstream player with a niche-like position in refining. This ought to be constructive for BP's overall valuation which, in turn, is ever more dependent on its upstream performance.
BP becoming more of a niche refiner
Fuller recognition of $59bn downstream EV is attainable given 2012E EBITDA of $9.2bn
Our downstream EV (as included in our BP sum-of-the-parts) is approximately $59bn or 189 pence per share. This represents 24% of our total sum-of-the-parts value of around 800 pence per share (unchanged). Given the aforementioned performance improvement measures and continued safe and reliable operations, we see downstream EBIT potential in 2012E of approximately $6.8bn assuming no loss of profitability if margins are lower. Adding annual downstream depreciation of around $2.4bn, this implies a 2012E EBITDA of $9.2bn and an EV/EBITDA multiple of 6.5x.
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Figure 63: Downstream post-tax earnings versus global refining margin

6.0
5.0
BP's profitability set to exceed 2004 level at lower margins 2010
2006 2004 2005
Post-tax underlying earnings $/bbl
4.0
2009 2008
2007
3.0
2.0
1.0
0.0 0.0 2.0 4.0 6.0 Refining Global Indicator Margin $/bbl BP RD Shell Exxon Mobil 8.0 10.0 12.0
Source: J.P. Morgan. We have assumed a 20% downstream effective tax rate for BP; RD Shell and Exxon Mobil report downstream profits post-tax.
Given improved underlying returns (i.e. EBITDA growth without material growth in operating capital employed) that should consistently exceed the divisions cost of capital and a stronger downstream portfolio growth orientation, this ought to be an attainable embedded multiple in our view, especially: if the business continues to support the group's dividend as it should given EBITDA of $9.4bn and organic capital expenditure of around $4bn pa.
BPs underlying profitability continues to surpass its closest competitors as it has done 2009-10 (Figure 63) this is not a feature that many fund managers are aware of. since it is not mis-aligned with the EV/EBITDA multiples of the listed pure downstream plays (see the section on the Science and Art of Separation). This, in turn, will bring more of the downstream intrinsic value in to BP's share price which continues to languish at a 50%+ discount to our SOTP. So the performance of BPs downstream business has an important role to play in raising BPs overall valuation recovery story at this critical time in the companys recent volatile history.
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Royal Dutch Shell B

Neutral
Company Data Price (p) Date Of Price Price Target (p) Price Target End Date 52-week Range (p) Mkt Cap ( bn) Shares O/S (mn) 1,993 06 Sep 11 2,400 31 Dec 11 2,352 - 1,730 122.0 6,122 Royal Dutch Shell B (RDSb.L;RDSB LN) FYE Dec 2010A Adj. EPS FY ($) 2.94 Bloomberg EPS FY ($) 3.08 Adj P/E FY 10.9 Dividend (Net) FY (p) 106.8 Net Yield FY 5.4% EBITDA FY ($ mn) 57,118 EBITDA margin FY 9.8% Net Attributable Income FY 18,073 ($ mn)
Source: Company data, Bloomberg, J.P. Morgan estimates.
2011E 4.23 4.40 7.6 104.6 5.3% 82,268 12.9% 27,107
2012E 4.66 4.75 6.9 107.8 5.4% 78,983 12.3% 29,773
2013E 4.77 4.94 6.7 111.0 5.6% 78,216 12.1% 30,186
Downstream overview
Downstream contents & structure RD Shells downstream covers manufacturing, distribution and marketing activities for oil products and chemicals. These activities are organized into globally managed businesses, although some are managed regionally or provided through support units. Manufacturing and supply includes refining, supply and shipping of crude oil. Marketing sells a range of products including fuels (including Shell Aviation and Shell Marine Products), lubricants (key brands include Pennzoil, Quaker State, Shell Helix, Shell Rotella, Shell Tellus and Shell Rimula), bitumen (via Shell Specialties) and liquefied petroleum gas for home, transport and industrial use (via Shell Gas LPG). Downstream also includes some trading. Specifically, Shell Trading supports the downstream businesses by trading gas, power, refined products, chemical feedstocks and environmental products. It also manages a shipping fleet of more than 50 vessels. Downstream also oversees Shells interests in alternative energy (including biofuels, but excluding wind) and CO2 management. Shell's downstream also includes Chemicals. However, since financial information for this sub-segment is disclosed, we exclude it from our comparative financial analysis of Shells downstream business. This makes a comparison with its competitors such as Exxon Mobil, BP and Chevron more meaningful.
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RD Shell Downstream Efficiency Overview

Shell was late to bite the bullet on refinery sales, but progress has improved 2010-11
Refining scale, reach & utilization The size of RD Shells refining network peaked at 4.4 million bopd at year end 2002 following two major transactions: RD Shell completed the acquisition of Texacos interests in Equilon Enterprises LLC, making Shell the 100% owner, and Shell, with Saudi Refining, Inc also jointly acquired Texaco's interest in Motiva Enterprises LLC. Equilon Enterprises was a 56/44 joint venture between Shell Oil and Texaco, respectively, that operated in the western United States and sold motor gasoline and petroleum products under both the Shell and Texaco brand names. Shell contributed its 288 kbopd Wood River (Illinois) and 155 kbopd Martinez (California) refineries to the venture. Texaco contributed its 142 kbopd Anacortes (Washington) refinery; 99 kbopd El Dorado (Kansas) refinery; 91 kbopd Wilmington (California) refinery; and 63 kbopd Bakersfield (California) refinery. As a precondition of the U.S. Federal Trade Commissions approval of the merger of Chevron and Texaco, Texaco sold its ownership in Equilon to Shell Oil, which then consolidated Equilon as of March 2002. Motiva Enterprises was a joint venture between Star Enterprise and Shell Oil that sold motor gasoline and petroleum products under both the Shell and Texaco brand names. After Texaco sold its ownership to its partners as a precondition of the U.S. Federal Trade Commissions approval of the 2001 merger of Chevron and Texaco, Motiva became a 50/50 joint venture between Saudi Refining and Shell Oil. RD Shell bought out RWE-DEA from its 50:50 downstream joint venture in Germany in 2002.
Shell maintains its 50/50 joint venture between Shell Oil and PEMEX (Shell contributed its 216 kbopd Deer Park, Texas refinery in April 1993). PEMEX has no other presence in the U.S. refining/marketing industry outside of this joint venture. Subsequent refinery rationalization was slow to follow. At end 2010 (3,594 kbopd) RD Shell had slightly more capacity than it did at end 2000 (3,525 kbopd). Between 2003 and 2009, modestly sized refinery exits were made from France, Italy, Thailand, Brunei and various African countries. Tesoro acquired RD Shells142 kbopd Anacortes, Washington refinery in August 1998 and its 97 kbopd Wilmington, California refinery in May 2007. With the arrival of a new leadership team and facing the prospect of much thinner margins, the pace of rationalization then accelerated in 2010-11 as part of a formal program to sell 15% (560 kbopd) of disadvantaged refining capacity. Shell has since announced the divestment of refineries in New Zealand (Marsden Point), Germany (Heide), Sweden (Gothenburg) and the UK (Stanlow) with a total net capacity of 465 kbopd. These sales reduced Shells refinery count to 36 at end 2010 and helped to continue the gradual increase in the average scale of its refineries. The potential sale of the Harburg refinery in Germany would reach the target capacity reduction. The sale of under-utilized plants in Europe should help to raise the average utilization of Shells refining portfolio, which has been below 90% since 2006 and reached an alltime low of just 76% in 2009.
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Little change to product slate, but Pearl GTL will raise diesel percentage
Refining product yield and product / equity oil cover ratio RD Shell's refined product slate has changed very little since 2000. The only notable slate shift has been a small increase in gasoline (from 33% to 36% by volume). We may see some more notable shifts in 2011 following completion of the aforementioned divestments and the commissioning of Pearl GTL given its diesel (middle distillate) output. Refining capacity growth combined with successive years of equity oil output declines raised RD Shells refining throughput to equity oil production ratio to a peak of 1.84x in 2007. Refinery divestments coupled to oil production growth in 2010 have reduced this ratio to 1.72x. The completion of the Stanlow and (potentially) the Harburg refinery sales will only reduce this ratio to around 1.6x in 2011 given no change to equity oil output. This ratio is still clearly well above BPs comparable ratio, which is set to fall below 1x in 2012. So, RD Shells earnings will retain an above-average sensitivity to global refining margins. Downstream profitability Measured across the entire 11-year period 2000-10, RD Shells average earnings per barrel processed is $3.5 per bbl, lower than BPs comparable average of $3.9 per barrel. RD Shells average post tax ROFA is 13% versus 14% from BP so RD Shell has been less profitable and generated slightly lower returns. In essence, RD Shell has done slightly better in the upcycle, but much worse in the most recent downcycle. This is important since we believe we are many years from the next pronounced upcycle, if ever one returns RD Shells portfolio just does not seem to be well positioned if our bearish outlook proves to be accurate. We suspect that BPs superior performance in 2008-10 was a factor that encouraged RD Shells new leadership team to rid its retailing and refining portfolios of more underperforming assets. We note that RD Shells downstream business has never reported a full year loss (as per BP), but it has reported a loss in two quarters (Q4 2009 and Q4 2010). Retailing network RD Shell sells fuels, primarily under a single Shell power brand via almost 43,000 sites. In 2010, it sold 135 billion litres of retail fuel. Unfortunately, Shell has not disclosed retail site numbers prior to 2004. However, based on our estimates for 2000-03, we calculate a relatively slow pace of network shrinkage (-1% 2000-10) compared to its peers. In our view, this reflects three key factors (i) Shell did not consummate any large-scale mergers (unlike legacy BP with Amoco and ARCO and Exxon with Mobil) and so had a smaller network rationalization opportunity, since more of its network was built organically under the Shell banner (ii) Shells management was originally reluctant to embrace the need to focus its portfolio and so strengthen its profitability (iii) Shell has the number one brand in a number of countries and regions and has a relatively profitable marketing business. In 2008, Shell finally announced a network rationalization to exit 35% of its retail markets which contain around 5% of Shell-branded service stations. Since the beginning of 2010 it has announced retail divestments (exits) from New Zealand, Greece, Sweden and Chile. It has also announced an agreement to withdraw and partner with Vitol and Helios in 14 African countries (5% of total network in 2010). So, the geographical spread of Shells network, which changed very little in 11 years, with Europe now 25% (versus 23% in 2004) and the USA 33% (versus 34% in 2004), is finally being reset. The formation of the Raizen JV (completed 2011) with Cosan of Brazil has also created a network of 4,500 biofuel sites spread across Brazil this
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High operational leverage shows when the cycle weakens
Slow to embrace the need for network rationalization, but change is underway
will raise the overall exposure to South America. Other markets where Shell has added sites include the UK (via an acquisition from Rontec Investments LLP), Germany and China. Downstream cash generation and capital intensity RD Shell's downstream cash generation (excluding changes to working capital) has been negative in just one year 2002. This was due to three major acquisitions (i) Motiva, Equilon - $2.1bn purchase price plus $1.4bn debt and $0.3bn pension liabilities (ii) RWE-DEA - $1.3bn (iii) Pennzoil-Quaker State Company - $1.8bn equity plus $1.1bn debt. These acquisitions spiked RD Shells downstream capital expenditure to depreciation ratio to 3.2x. We are slightly intrigued by RD Shells otherwise low average downstream reinvestment ratio, which has averaged just 1.2x 2000-10 versus BPs average 2.1x. It is possible that RD Shell has under-invested in its downstream portfolio, but it is unfortunately not possible for us to reach that conclusion with much certainty. However, notwithstanding what appear to have been relatively low levels of reinvestment, we also note that RD Shells downstream cash flow (excluding changes to working capital) contribution to the group has reduced from a peak of $7.2bn in 2004 to just $1.1bn in 2009 and $2.0bn in 2010. A deteriorating downstream cash return has almost certainly been a reason for the dollar dividend freeze since Q1 2009 at 42.0 cents pcq. The question is, are the cash returns from this division likely to improve much from the level in 2010? If not, given a prolonged period of weak refining margins, this is another reason for investors not to expect much dividend growth from RD Shell in 2011-12.
Consistent positive cash flow excluding acquisitions, but low rates of reinvestment might have flattered
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Figure 64: Shell - refining capacity (kbopd) & utilization (%)

4,500 4,000 95%
Figure 65: Shell - number of refineries & average size (kbopd)

60 105 100 50 90% 40 95 90 85 85% 30 80 20 80% 10 75 70 65 75% 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 60
3,500 3,000 2,500 2,000 1,500 1,000 0,500 0,000 2000

Europe
2001
2002
2003
2004
2005
USA
2006
2007
2008
2009
2010
Africa, Asia, Australia, Oceania
Other Americas
Figure 66: Shell - refinery yield and output / equity oil cover ratio (x)
100% 190% 90% 180% 80%
Figure 67: Shell - retailing network size & location

50,000 CAGR -1% 45,000 40,000
70% 170% 60%
35,000 30,000
50%
160%
25,000 20,000
40% 150% 30%
15,000 10,000
20% 140% 10%
5,000
0%
0,000 2000 2001 2002

Europe
2003
2004
2005
2006
Africa
2007
USA
2008
Other Americas
2009
2010
Middle East, Asia Pacific
Figure 68: Shell - downstream profitability ($/bopd) & ROFA (%)

6.0 2000-10 average ROFA 13% 5.0 25%
Figure 69: Shell - downstream cash flow ($m) & capital intensity (x)
8,000 3.5 3.0
20%
6,000
4.0 15%
2.5 4,000 2.0
3.0 10% 2.0 5%
2,000 1.5 0,000 2000-10 average 1.2x (2,000) 0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 1.0
1.0
0.5
0.0
(4,000) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Post-tax free cash flow ($m) Capex / depreciation (x)
0.0
Post tax earnings per refinery barrel throughput ($/bbl)
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Summary
Downsized more in to the downcycle, refining portfolio is still too large
We commend RD Shells leadership team for its efforts in 2009-2011 to reduce the groups downstream footprint whilst pursuing selective growth and striving for operational excellence. However, we would have liked the divestment program to have started and finished much earlier in the upcycle. We are yet to be convinced that RD Shells downstream portfolio is fit for a prolonged bottom to this cycle. We accept that RD Shell has a stronger retail brand than BP and it can thus sustain the largest retailing network in the world (RD Shell 42,816 versus BP 22,100 at year end 2010). However, RD Shells refining portfolio (potentially 34 plants with an aggregate capacity of 3.2 million bopd) is still, in our view, unnecessarily large. As a reminder, BP is shrinking to a 14-refinery portfolio with a capacity of just 1.9 million bopd. RD Shell should sell more refining capacity and further reduce its operating costs too in order to raise the downstream free cash flow. Our downstream EV (as included in our RD Shell sum-of-the-parts) is approximately $68bn or 685 pence per share. This represents 22% of our total sum-of-the-parts value of around 2600 pence per share. So, our estimated value of RD Shells downstream portfolio is larger than our value of BPs smaller portfolio ($59bn). We note that our RD Shell value of $68bn equates to a 2010 EV/EBITDA multiple of almost 10x assuming a 35% downstream tax rate. This seems fair enough, if not generous. Even if we assume that more recent refinery and retailing divestments add $1bn to downstream EBITDA and also add $1bn of downstream cost reductions by 2012, the implied 2012E EV/EBITDA multiple is 7.7x. This is higher than our implied multiple for BPs downstream business of 6.3x.
We would like management to go further
Downstream EV of $68bn or 7.7x 2012E EV/EBITDA is fair, if not generous given underlying performance and cash returns
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ENI
Overweight
Company Data Price () Date Of Price Price Target () Price Target End Date 52-week Range () Mkt Cap ( bn) Shares O/S (mn) 13.02 06 Sep 11 22.50 31 Dec 11 18.66 - 11.83 47.2 3,622 ENI (ENI.MI;ENI IM) FYE Dec Adj. EPS FY () Bloomberg EPS FY () Adj. EBIT FY ( mn) Pretax Profit Adjusted FY ( mn) Net Attributable Income FY ( mn) Adj P/E FY EV/DACF FY Div Yield FY 2010A 1.90 1.88 17,304 17,393 6,869 6.9 5.8 6.1% 2011E 2.39 2.12 20,767 20,976 8,656 5.4 4.6 6.4% 2012E 2.57 2.30 21,803 22,053 9,314 5.1 4.0 6.8% 2013E 2.68 2.53 22,292 22,542 9,700 4.9 3.8 7.1%
Downstream overview
Downstream contents & structure ENI's downstream segment is mainly responsible for the refining and marketing (R&M) of refined products, supply of crude oil, and shipping of crude oil and products. ENI's R&M business is largely concentrated in Italy this extreme exposure to a country experiencing declining product demand means that the operating performance of this business has been very weak in recent years. Please note that for our analysis we have used balanced primary distillation capacity for 2000-03 as for these years the company has not reported distillation capacity (ENI's share). Downstream strategy The key medium-term target for ENI's downstream business is to generate positive free cash flow - the business has reported operating losses and negative free cash flow for the past two years. ENI's downstream portfolio has not changed much over the past decade. Despite management's cautious outlook for refining margins in Europe, ENI has yet to make any divestments in this business. The planned sale of Livorno refinery was withdrawn in 2010 due to lack of interest from buyers. Optimize the refining system ENI plans to selectively upgrade the conversion capacity of its refineries and adapt the refining throughputs to expected product demand trends. The Nelson Complexity Index of ENIs refining system will increase 0.5 by end 2014. Upgrading the retail network ENI is looking to upgrade and rebrand the retail network given the short payback period. Focus on core market Italy will remain the obvious focus for ENI's downstream business it is looking to 'revise its presence outside Italy'.
Refining capacity is largely unchanged over the last decade
Optimize plant portfolio, focus on core areas and target positive free cash flow
Refining scale, reach & utilization AgipPetroli, a wholly owned subsidiary, was merged with ENI in 2003 to form the company's refining and marketing business. Following the acquisition of an additional stake in Ceska Rafinerska and an increase in the refining capacity of Bayrenoil (ENI stake 20%), ENI's refining capacity peaked in 2008. The utilization rate of ENIs refining system has seen a steady decline in this decade due to the challenging operating environment and poor alignment between ENI's refining
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system and market demand. Downstream divestments are still not on management's agenda despite the weak operating performance of its refining assets the company has dropped its planned divestment of its Livorno refinery. Refining product yield and product / equity oil cover ratio ENIs refining slate has changed very little over the past decade. The only slate shifts have been a slight decline in gasoline (from 26% to 24% by volume) and in fuel oil (13% to 11% by volume). Like the majority of its peers, ENI is looking to realign its refining systems output with the demand trends in Europe and plans to increase the middle distillate yield of its refining system. The company is targeting a 0.5 increase in the NCI of its refining system by end 2014. Given robust upstream production, CAGR of 4% 2000-10 and a declining trend in the utilization rate of ENI's refining system, the company's refinery throughput/ equity oil production ratio has declined from over 100% in 2000 to 70% in 2010. Retailing network ENI's marketing business (like its refining business) also has a strong operational bias towards Italy. The size of ENIs retail network almost halved between 2000-10. The key divestments were Agip Brazil (1,500 service stations in 2004), IP in Italy (2,915 service stations in 2005) and various Iberian retail sites (371 service stations in 2008). Downstream profitability ENI's downstream performance has clearly been below par in the recent years with an operating loss in 2009 and 2010. Some key reasons for this weak operating performance are (i) a very challenging operating environment in its home market, (ii) no progress reducing exposure to the low margin refining business, (iii) historical underinvestment means that ENIs refining output is poorly aligned to local market demand trends. Downstream cash generation and capital intensity ENI's post tax free cash flow (excluding changes to working capital) was negative in 2009 and 2010 due to low profitability and rising capital expenditure. We also note that the company has underinvested in the downstream business the average 200010 depreciation to capex ratio is below 1.5x - a key contributor to the below par performance of the segment.
Product yield has been stable
Good progress shrinking network
Low profitability and challenging outlook
Negative free cash flow and underinvestment in downstream business
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Figure 70: ENI - refining capacity (kbopd) & utilization (%)
Figure 71: ENI - number of refineries & average size (kbopd)
Figure 72: ENI- refinery yield and output / equity oil cover ratio (x)
Figure 73: ENI - retailing network size & location
Source: J.P. Morgan Source: J.P. Morgan
Figure 74: ENI - downstream profitability ($/bopd) & post-tax ROFA (%)
Figure 75: ENI - downstream cash flow ($m) & capital intensity (x)
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Summary
Weak downstream performance but very small exposure is a plus
One of the most constructive things that we can say about ENIs downstream business is that it is very small (as a % of the total group EV) compared to its peer group. We regard this as a plus for ENI, especially as the majority of its peers are now looking to shrink their exposure to this business segment. However, the performance of ENI's downstream business has been persistently weak in recent years - reflecting no divestments of low margin/loss-making refineries, historical underinvestment and its concentration in Italy, a very challenging operating environment. Unfortunately, ENIs strategic options are very limited. Attempted divestments have failed and we very much doubt that ENI would consider a wholesale exit from the downstream given its 'national' status.
Downstream EV of 1.9bn seems fair - operating profitability ought to improve
Our downstream EV (as included in our ENI sum-of-the-parts) is approximately 1.9 bn. This represents just 2% of the corporate EV of 111bn. Our SOTP of around 27 per share has come down from 29 per share - we refresh our $/ spot rate, mark to market the Galp, SRG and Saipem stakes and made a downward adjustment in our downstream EV. We note that our total value of 1.9bn equates to a 2012E EV/EBITDA multiple of almost 3.8x - this is signifcantly below the comparable implied average multiple TOTAL. This is appropriate, in our view, given the lower profitability of ENI's downstream asset base. Whilst we concede that given the small downstream footprint, the valuation of this business does not have a very significant impact on ENI's overall valuation, we also believe carrying loss-making/ low margin assets is a negative from an investors perspective.
More aggressive divestment agenda needed, but unlikely
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Essar Energy
Overweight
Company Data Price (p) Date Of Price Price Target (p) Price Target End Date 52-week Range (p) Mkt Cap ( bn) Shares O/S (mn) 241 06 Sep 11 570 30 Jun 12 638 - 233 3.1 1,303 Essar Energy Plc (ESSR.L;ESSR LN) FYE Dec 2010A Adj. EPS FY ($) 0.19 Adj P/E FY 20.3 EBIT FY ($ mn) 602 EBITDA FY ($ mn) 729 Pretax Profit Adjusted FY 357 ($ mn) Net Attributable Income FY 250 ($ mn) EV/EBITDA FY 18.7 EBITDA margin FY 8.1% 2011E 0.31 12.7 966 1,155 577 411 14.8 12.0% 2012E 0.59 6.5 1,824 2,192 1,114 799 8.2 15.5% 2013E 0.77 5.0 2,090 2,542 1,439 1,036 7.2 17.1%
Source: Company data, Bloomberg, J.P. Morgan estimates. *source : company, dated 20/03/2011
Downstream overview
Downstream contents & structure Essar Energys downstream business covers manufacturing, distribution and marketing activities for oil products. Essar Energys downstream business is dominated by its refining business. The company also has a marketing network in India. The refinery at Vadinar is the companys flagship downstream asset and has a nameplate capacity of 230 kbopd. Its fuel retailing assets include an extensive network of 1,385 retail outlets across India. Refining Essar Energy owns 100% of a 230 kbopd (nameplate capacity), 6.1 NCI (Nelson Complexity Index) refinery at Vadinar, near Jamnagar in Gujarat, India. The refinery has an operational capacity of 300 kbopd - a result of two successful debottlenecking programmes undertaken by the company. The refinery started commercial production on 1 May 2008. The project was originally started in 1990s, but faced significant delays and cost overruns. We have used the nameplate capacity for the purpose of our analysis. Essar Energy also has a 50% stake in Kenya Petroleum Refineries, which operates a refinery in Mombasa, Kenya, with a gross nameplate capacity of 80 kbopd. Essar Energy acquired the stake in July 2008 from BP, RD Shell and Chevron; the remaining 50% stake is held by the Government of Kenya. The refinery operates as a 'tolling' refinery for the oil marketing companies in Kenya. In August 2011, Essar Energy completed the acquisition of the Stanlow refinery (in the UK) from RD Shell this plant has a nameplate capacity of 296 kbopd. Marketing The company has an extensive network of 1,385 retail outlets spread throughout India, making Essar one of Indias largest non-PSU fuel retailers. The company also has 29 supply points to service its network 12 terminals and 17 depots. The marketing network is based on a franchisee model which provides the company with the flexibility to grow without making significant investment that burden is taken by the dealer. Given that the Indian product market is not fully liberalized (diesel is subsidized), this segment largely carries an option value of full market deregulation.
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Low cost, India-focused integrated energy company
Downstream strategy Essar Energy's strategy is to emerge as a low cost energy producing company focused on India and to capitalize on the rapidly growing energy demand in the country. Its strategy can be decomposed into two key areas: Capitalize on India's growing energy demand - India has exhibited extremely resilient and above average economic growth since 2005 (average rate of GDP growth 8%+). Whilst conceding that the export sales may need to increase to c.40% of total sales due to new capacity additions by it and the public sector refiners, we also believe that export sales % will decline over the medium term as Indian product demand growth is likely to remain bouyant - led by demand from India's transpostation sector (car density likely to go up significantly from a very low base in India). This underpins Essar Energys expansion plans in the domestic refining segment. Leverage the low-cost base - Essar Energys Indian refining asset base bears materially lower operating costs than comparable assets overseas. We believe that this cost advantage is particularly relevant to the companys refining business as we expect that regional refining margins will remain weak in 2012-13. Key growth project Expansion plan for Vadinar refinery Essar Energy plans to increase its refining capacity to 20 MT in two phases, with phase I taking the capacity to 18 MT or 375 kbopd (Nelson complexity index to rise to 11.8 from 6.1) and a further increase in the capacity to 20 MT or 405 kbopd. The expansion programme will also raise the refinery's complexity and the quality of its refined product slate.
Essar Energy Downstream Efficiency Overview

Refining capacity is slated to increase significantly in 2011/12
Refining scale and reach Essar Energy is a relatively recent entrant to the refining business the company's flagship refinery in Vadinar started commercial production in 2008. Given that the Vadinar refinery has an operational capacity of 300 kbopd, which is significantly higher than the its nameplate capacity of 230 kbopd, it delivered an unusually high utlisation rate in 2009 and 2010 (average 127%) more than offsetting the weaker utilization performance of its only other refinery in Kenya. Following the recent acquisition of the Stanlow refinery in the UK (296 kbopd) and the phase 1 expansion of the Vadinar refinery that is likely to enter commercial production by end 2011/early 2012, Essar Energys total refining capacity will increase to 711 kbopd by end March 2012. It is then slated to grow by a further 30 kbopd (Vadinar refinery optimization project) to 741 kbopd by end March 2013. Refining product yield and product / equity oil cover ratio We have limited historical data given the relatively recent start-up of the Vadinar refinery (the key refining asset) this means that a review of historical trends is not very meaningful for this name and we therefore focus more on the likely evolution of this business as the expansion projects come on-stream. Post completion of phase 1 expansion, the middle distillate yield of the Vadinar refinery will increase from 47% to 49% and conversion of all negative margin fuel oil into value-added products and pet coke. The fuel loss will also decline from 6% to 5%.
Growth in complexity and middle distillate yield as the expansion projects start up
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Essar Energy does not have any upstream projects that are expected to start production of equity volumes and therefore the refining product to equity oil cover ratio is not relevant for this name. Retailing network Essar Energy sells fuels under the Essar Oil brand name in India. Essar Oil is one of Indias largest non-PSU fuel retailers. The company has a plan to increase the number of its fuel stations in India to 1,700 (+23%) but this expansion is subject to the further steps by the Government of India to liberalize the retail fuel market. Given the countrys high rate of inflation, we believe that further retail fuel pricing liberalization is unlikely. Essar Energy has a profitable downstream/refining business the company has delivered strong operating results in both 2009 and 2010 (in the down cycle for the refining industry). Essar Energy's downstream business has also generated a healthy positive return on net fixed assets with an average 2009-10 ROFA of 9%. Essar Energys downstream business is relatively high return, despite the zero/negative contribution from the company's marketing business. Downstream cash generation and capital intensity Essar Energy's downstream cash generation (excluding changes to working capital) was negative in 2010 given the heavy capex on the company's planned Vadinar Phase 1 expansion. The heavier than normal capex in 2010 also spiked Essars capital expenditure to depreciation ratio to 10x.
Aggressive growth plans subject to further product pricing deregulation in India
Profitable business increase in complexity will add to the margins
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Figure 76: Essar - refining capacity (kbopd) & utilization (%)
Figure 77: Essar - Number of refineries & average size (kbopd)
Source: J.P. Morgan
Figure 78: Essar- refinery yield

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2009
Heavy (Fuel oil/other products) Light distillates (Aviation fuel/Kerosene/Gasoline)
Figure 79: Essar - retailing network size

120%
1,400
100%
1,380 1,360 1,340
80%
60%
1,320 1,300 1,280
40%
20%
1,260 1,240 1,220 2009

Retailing stations (Total)
0% 2010
Middle distillates Refining throughput / equity oil production, right
2010
Source: J.P. Morgan
Figure 80: Essar - downstream profitability ($/bopd) & post-tax ROFA (%)
Figure 81: Essar - downstream cash flow ($m) & capital intensity (x)
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Summary
Aggressive growth agenda in refining business
Essar Energy is committed to an aggressive growth strategy in its refining business this is partly inspired by a very positive medium/long-term outlook for product demand growth in India and its ability to export products to quite distant demand centres. We expect the company's net refining capacity to reach around 750 kbopd by end March 2013 from 210 kbopd as at end 2010. This results from a combination of relatively higher margin additional capacity for Vadinar (+195 kbopd) plus the capacity addition from the Stanlow refinery acquisition (+296 kbopd), which brings exposure to weaker European refining margins.
2013E downstream EBITDA of c.$1.4bn clearly supports the $5.3bn EV of downstream business
Our downstream EV (as included in our Essar Energy's sum-of-the-parts) is approximately $5.3bn. This represents 38% of our corporate EV of around $14.1bn (SOTP of around 4.9 per share). Given the aforementioned ramp-up in the refining capacity and complexity by end March 2013, we see downstream EBIT potential in 2013E of approximately $1.2bn. Adding downstream depreciation of around $0.2bn, this implies a 2013E EBITDA of $1.4bn and an EV/EBITDA multiple of only 3.8x which seems conservtive. The stock trades at a discount of c.50%+ to our SOTP. We believe that investors are pricing in excessively high 'execution risk'.
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Galp Energia
Overweight
Company Data Price () Date Of Price Price Target () Price Target End Date 52-week Range () Mkt Cap ( bn) Shares O/S (mn) 13.00 06 Sep 11 20.00 31 Dec 11 16.97 - 11.60 10.8 829 Galp Energia (GALP.LS;GALP PL) FYE Dec Adj. EPS FY () Bloomberg EPS FY () Adj. EBIT FY ( mn) Pretax Profit Adjusted FY ( mn) Net Attributable Income FY ( mn) Adj P/E FY Div Yield FY EV/DACF FY 2010A 0.37 0.40 524 426 306 35.2 1.3% 21.1 2011E 0.46 0.42 676 532 394 28.0 1.3% 17.2 2012E 0.75 0.72 991 836 613 17.3 1.3% 14.8
Galp Energia is a European Analyst Focus List stock
Downstream overview
Downstream contents & structure Galp has evolved into an integrated name from being a pure play Portugal-focused refining name (pre-IPO in 2006). The downstream business of this name is concentrated in Portugal. Galps Refining & Marketing business involves supply, logistics and refining of crude oil and marketing and supply of products. Galp owns two refining assets: (i) Sines started operating in 1979 and has a refining capacity of 220 kbopd and a Nelson complexity index of 6.3 - post upgrade it will increase to 7.7 and (ii) Porto started operations in 1969 and has a refining capacity 90 kbopd. This refinery has a NCI of 7.9 - post upgrade it will increase to 10.7. Galp's downstream segment also includes its chemicals business this is relatively small and we have not separated it from the segmental numbers as Galp does not make any separate disclosure for its chemicals business. Downstream strategy Galp continues to make significant investment in the downstream business both refining and marketing. The company plans to increase profitability by raising refinery complexity and strengthening the refinery products/marketing coverage: Increasing the complexity of the refining system Upgrade projects will be a plus for Galp's gross refining margin mostly benefitting from a higher yield and utilization, lower cost crude diet and lower plant energy costs. Focus of the marketing business is on Iberia Galp consolidated its marketing presence in the region by acquiring the retailing businesses of ENI and Exxon Mobil in Iberia. The company is looking at increasing the synergies arising from these acquisitions.
Aligning the product slate to Portuguese/Iberian demand trends
Sines and Porto upgrade projects
Downstream growth projects Galp's only growth projects are the conversion projects at Sines and Porto these assets lie at the lower end of the complexity range for the refineries located in Europe. Therefore these upgrades will be a plus for Galps gross refining margin potential mostly on account of the improved product mix and crude diet and lower own energy consumption costs. The projects are scheduled to be on-stream end 2011.
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Galp Downstream Efficiency Overview

Stable refining base
Refining scale, reach & utilization Galp's refining base has remain unchanged between 2000-10 the refining capacity will increase from 310 kbopd to 330 kbopd as the upgrade/expansion projects come onstream at the end of this year. The 2000-10 average refinery utilization was 80% this is below the euro sector average. In our view, this is a reflection of the low complexity and ageing refining system of Galp. Also, in recent years, system utilization has suffered from weakening product demand in Iberia. Refining product yield and product / equity oil cover ratio Galp's product slate has remained stable through 2000-2010 given no change to its refining base. The only notable slate shifts have been a small increase in aviation fuel (from 5% to 8% by volume) and fuel oil (from 15% to 17% by volume) and a small reduction in gasoline output (from 38% to 35% by volume) middle distillate yield has remained largely unchanged. Given a very small production base of just 12 kboepd versus a refining capacity of 310 kbopd, Galps product/equity oil cover ratio is not very meaningful. This ratio will rapidly decline as output from the company's Brazilian pre-salt assets ramp up. Retailing network Galp has increased its network scale by 1% CAGR over the 11-year period 2000-10. In so doing, it has raised its networks exposure to Spain from 23% to 49%, mainly a result of Galp's acquisition of Agip's and Exxon Mobil's oil products marketing business in Iberia in 2008 (the addition of 497 service stations). In the same year, Galp also acquired Shell's marketing business in Mozambique, Swaziland and Gambia growing the company's small marketing footprint in Africa (103 service stations). Downstream profitability Galp delivered average earnings per barrel processed of 2 per bbl over the period 2000-10, well below the comparable average for Repsol YPF, the other name with a big downstream exposure to Iberia. Galps average post tax 2004-10 ROFA is 16%, but this declined significantly in the recent downcycle (2008-10 average was only 8%) highlighting the need to realign the company's crude diet and product slate to restore downstream profitability. We support the company's investment in refinery upgrades, which ought to help Galp's downstream margins starting 2012. Downstream cash generation and capital intensity Galp's downstream cash generation (excluding changes to working capital) has been negative in the past three years. This negative cash flow (in 2008-10) is due to the company's acquisition of Exxon and Agip's downstream business in 2008 and higher capex spend on refinery upgrades in 2009-2010 . This increased spend also spiked Galps capital expenditure to depreciation ratio. This ratio has averaged 1.5x 200010, which is low despite the high investment in recent years. We believe that the historical underinvestment (2000-2007) is one of the key reasons for Galps low refining margins in the recent downturn.
Product slate almost unchanged 2000-10
Focused on Iberia rising exposure to Spain
Recent investment has resulted in negative cash flow
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Figure 82: Galp - refining capacity (kbopd) & utilization (%)
Figure 83: Galp - number of refineries & average size (kbopd)
Figure 84: Galp refinery yield
Figure 85: Galp - retailing network size & location
Figure 86: Galp - downstream profitability ($/bopd) & post-tax ROFA (%)
Figure 87: Galp - downstream cash flow ($m) & capital intensity (x)
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Summary
Investment to improve asset quality and profitability
In recent years, Galp has pursued an aggressive downstream investment strategy, which is one of the key reasons for the increase in the companys indebtedness. The company has invested in both its refining and marketing (retail and wholesale) businesses. We believe that the company's refining assets have long suffered from under-investment - 2000-07 average capex/deprecation ratio is only 0.7x - this contributed to their weak performance in the 2009-2010 downcycle. We believe that post upgrades, the profitability of Galp's refining system will improve significantly. Post upgrades (end 2011), we expect a boost to the company's refining margin given a product slate that will be better aligned to market demand, a lower cost crude diet and reduced own energy costs. Our downstream EV (as included in our Galp sum-of-the-parts) is approximately 3.2bn. This represents 15% of our corporate EV of around 20.9bn - we adjust our SOTP to 21 from 22 - as we update for end Q2 net debt and refresh $/ spot rate. We note that our total value of 3.2 bn equates to a 2012E EV/EBITDA multiple of almost 5.1x. .
Improved downstream profitability will support growth ambitions
Downstream EV of 3.2bn seems reasonable given 2012E EBITDA of 0.6bn
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OMV
Neutral
Company Data Price () Date Of Price Price Target () Price Target End Date 52-week Range () Mkt Cap ( bn) Shares O/S (mn) 25.80 06 Sep 11 29.00 31 Dec 11 34.90 - 20.81 7.7 298 OMV (OMVV.VI;OMV AV) FYE Dec Adj. EPS FY () Adj P/E FY Adj. EBIT FY ( mn) Net Attributable Income FY ( mn) Dividend (Net) FY () Gross Yield FY Bloomberg EPS FY () EV FY ( mn) Pretax Profit Adjusted FY ( mn) 2010A 3.76 6.9 2469 1,118 1.00 3.9% 3.99 11,955 2,097 2011E 4.03 6.4 2601 1,316 1.05 4.1% 3.80 11,882 2,401 2012E 4.43 5.8 3081 1,453 1.07 4.2% 4.35 11,861 2,914
Downstream overview
Downstream contents & structure OMVs downstream business spans manufacturing, distribution and marketing activities for oil products and petrochemicals. The company's downstream business has three broad geographical sub-segments Austria/ central Europe, Romania/south eastern Europe and Turkey (following the recent acquisition of an additional stake in Petrol Ofisi). We have excluded the minority stake in Petrom from our analysis and accordingly adjusted the consolidated reported numbers. OMV has not reported segmental details of its net fixed assets and we have therefore used total downstream assets as a proxy in our analysis (2005-10) we concede that this difference unjustifiably burdens OMV's return on net assets when compared to some of its European peers. We encourage OMV to disclose comparable information. The acquisition of Petrom (51% stake) in 2004 brought transformational change to the company's downstream business. Restructuring this business remains the key challenge for management. Downstream strategy OMV's downstream strategy is to adapt and restructure its downstream assets and reduce fixed costs to strengthen the operating performance of the business. The company is also progressing with the divestment/shutdown of non-core low margin/lossmaking assets (e.g. the Arpechim refinery in Austria). Ultimately, OMV aims to have a better downstream profitability. Deliver on Petrom restructuring Weak downstream operating results from Petrom have been a consistent drag on OMV's overall downstream performance. A successful restructuring of Petroms downstream business will give a boost to segmental profitability. OMV is investing in the mordernisation of the Petrobrazi refinery and has shut down the Arpechim refinery. Integrate Petrol Ofisi and capture the profitability upside Management is conscious that Petrol Ofisi is facing a challenging environment in the short term, but remains convinced on the profitability upside for the business.
Deliver on restructuring targets and adapt the downstream portfolio
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Petrobrazi modernization project
Downstream growth projects OMV has only one material downstream project the modernization of its Petrobrazi refinery in Romania. This project entails 2010-14 investment of 750m with the installation of a thermal cracker and bitumen plant. OMV also estimates that post modernization, the own energy consumption of the Petrobrazi refinery will come down from 11.5% to 10% and the plants product yield of middle distillates will increase from 38% to 45%.
OMV Downstream Efficiency Overview

Downstream growth driven by acquisitions
Refining scale, reach & utilization OMVs refining capacity is located in Austria/Bavaria (West) and Romania (East). The refining capacity of the company has more than doubled since 2000 due to two transactions the acquisition of a 45% stake in Bayernoil (2003) and the acquisition of a 51% stake in Petrom (2005). Some of this growth will be offset by the closure of Arpechim in 2011. The refinery utilization for OMV has averaged 89% 2000-2010, but this has clearly fallen in the recent down cycle. Refining product yield and product / equity oil cover ratio OMV does not disclose its yearly product slate but we believe that the complexity of its refining system has declined since 2000 given that Petrom refineries are of very low complexity. OMV's product/equity oil cover ratio declined from 420% (in 2000) to 193% (in 2010) the key reason was the strong growth (> 2x) in its equity oil volumes following the Petrom acquisition in 2005. We expect this ratio to fall further in 2011 following closure of the Arpechim refinery (c.70 kbopd). Retailing network OMV sells fuels under two brands OMV (VIVA shops) in Europe and Petrol Ofisi in Turkey. OMV's retail network has grown by an average of 5% per annum over the 10-year period 2000-2010. This very strong growth in the companys marketing network is due to two key transactions (i) the acquisition of Aral, BP and Avanti filling stations in 2003 and (ii) the Petrom acquisition in 2005. Following the acquisition of Petrol Ofisi in 2011, the marketing business has grown strongly this year, as has OMV's retailing exposure outside Europe. Downstream profitability OMV reported an operating loss for the segment in 2009 the only year in which OMV reposted a downstream loss since 2000. OMV's downstream business has generated a below par return on net fixed assets with an average 2000-2010 ROFA of 5%. We believe that the low margin/loss-making refining business in Romania (Petrom) has been and remains a drag on the company's results. Downstream cash generation and capital intensity OMV's downstream cash generation (excluding changes to working capital) has been negative in 4 of the past 5 years. The reason for this negative cash flow is the high capex spend by the company mostly refinery upgrade spend in recent years (West refineries and now East) and acquisitions. This higher spend has also increased the depreciation to capex ratio, which averaged 2.6x in 2000-10.
Product yield shifts to more diesel and aviation fuel, less gasoline
Exposure to Turkey will increase, reliance on acquisitions for growth
Weak free cash flow profile
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Figure 88: OMV - refining capacity (kbopd) & utilization (%)
Figure 89: OMV - number of refineries & average size (kbopd)
Source: Source: J.P. Morgan.
Figure 90: OMV - retailing network size & location
Figure 91: OMV - downstream profitability ($/bopd) & post-tax ROFA (%)
Figure 92: OMV - downstream cash flow ($m) & capital intensity (x)
Source: J.P. Morgan
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Summary
Delivery on Petrom restructuring is the key near-term target
Whilst we concede that OMV has made good progress in divesting of the lossmaking downstream activities of Petrom (closure of Arpechim refinery, transfer of Petrochemicals business in Romania etc), we also believe that the path ahead remains challenging' - delivery of the Petrobrazi refinery modernisation project is very important for improving the profitability of Petrom's refining business.. OMV's downstream growth strategy has been clearly based on acquisitions (Petrom, Petrol Ofisi etc). We believe that the company needs to now integrate and capture the profitability upside of some key recent acquisitions like Petrol Ofisi. Management has been robust in its defence of the 'integrated business model of OMV' and therefore we believe that it is unlikely that OMV will pursue an agressive downstream divestment strategy. Our downstream EV (as included in our OMV sum-of-the-parts) is approximately 4bn. This represents 26% of our corporate EV of 16.6bn. We reduce our SOTP by 12% to c.37 from 42 this reflects dilution from the company's recent rights issue, some downward adjustments to our downstream EV and we also refresh the spot /$ rate. We note that our total value of 4 bn equates to a 2012E EV/EBITDA multiple of almost 4.9x - this is seems reasonable.
Focus on profitablable growth
Downstream EV of 4bn seems reasonable given 2012E EBITDA of 0.8bn
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Repsol YPF
Neutral
Company Data Price () Date Of Price Price Target () Price Target End Date 52-week Range () Mkt Cap ( bn) Shares O/S (mn) 18.46 06 Sep 11 25.00 31 Dec 11 24.90 - 17.31 22.5 1,221 Repsol YPF (REP.MC;REP SM) FYE Dec Adj. EPS FY () Bloomberg EPS FY () Adj. EBIT FY ( mn) Pretax Profit Adjusted FY ( mn) Net Attributable Income FY ( mn) Adj P/E FY EV/DACF FY Div Yield FY 2010A 1.66 1.74 4,714 3,856 2,032 11.1 5.7 4.8% 2011E 1.97 1.92 5,207 4,538 2,402 9.4 5.4 5.2% 2012E 2.39 2.40 6,399 5,827 2,916 7.7 6.1 5.8%
Downstream overview
Downstream includes chemicals - a drag for operating results
Downstream contents & structure Repsol YPFs downstream business consists of the supply and trading of crude oil and products, oil refining, marketing oil-based products and LPG, as well as the production and marketing of chemical products. The business is mainly concentrated in Spain and Latin America (Argentina). For the purposes of financial reporting, the company now includes its downstream business in Argentina under the YPF segment; we have therefore consolidated YPF downstream (net interest of Repsol YPF) with the group downstream segment. Further, we have not excluded the chemical results from this segment as Repsol YPF does not make a separate disclosure of this sub-segment. In recent years, chemicals operating results have been negative - this is therefore a drag on the downstream performance of Repsol YPF versus other European competitors like TOTAL. Further, Repsol YPF does not report segmental details of its net fixed assets and we have therefore used total downstream assets as a proxy in our analysis we concede that this difference unjustifiably burdens Repsol YPF's return on net assets versus some of its European peers. Again, we would encourage management to raise its disclosure standards. Downstream strategy Repsol YPF has continued to invest in downstream (refinery upgrade projects) through the cycle - a key difference in the company's downstream strategy versus the majority of its competitors in Europe. Increase middle distillate yield Repsol YPF has invested c.4bn (Cartagena and Bilbao refineries) to increase the capacity and complexity of its refining system in Spain it plans to increase its middle distillate yield to supply the diesel short Spanish market. Reduce Argentine exposure This theme cuts across the different business segments a progressive divestment of its stake in YPF has resulted in lower downstream exposure to Argentina.
Investing in downstream growth
Upgrade projects in Spain will help profitability
Downstream growth projects There are two key growth projects for Repsol YPF's downstream business: (i) expansion project for the Cartagena refinery - this expansion project includes a hydrocracker, a coker, new atmospheric and vacuum distillation units and desulphurization and hydrogen plants at its main units. It will double the refinerys
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capacity to 220,000 bopd and (ii) Increase conversion capacity at Bilbao Repsol YPF plans to install a new coker (2MT pa capacity) at the Bilbao refinery. These projects are scheduled to come on-stream end Q3 / early Q4 2011. Post upgrade, the middle distillate yield of the complex will be 50%+ and the FCC equivalent will grow from 43% to 63%.
Repsol YPF Downstream Efficiency Overview

Stable refining capacity in Europe, declining capacity in Latin America
Refining scale, reach & utilization Repsol YPFs refining assets are primarily concentrated in two countries - Spain and Argentina (via YPF). The acquisition of YPF in 1999 grew its downstream business. More recently, the piecemeal divestment of its YPF stake (starting in 2007-2008) has been a key reason for the reduction in the company's exposure to Latin America we use net economic interest of Repsol YPF in YPF for the purpose of our analysis. Repsol YPF's refining capacity will grow this year as the Cartegena expansion (+110 kbopd) comes on-stream in Q3/Q4 2011. Refining product yield and product / equity oil cover ratio Given that the refining assets of Repsol YPF have not changed/gone through major upgrades in last decade, the company's refining slate has also remained largely stable. There has been a marginal decline in fuel oil (from 17% to 14% by volume) and a marginal increase in diesel output (from 46% to 48% by volume). Declining oil production in Argentina has meant that the refining throughput/equity oil production has increased from 158% in 2000 to 236% in 2010. This ratio will increase further as new refining capacity comes on-stream this year and oil production continues to decline in Argentina. Retailing network Repsol YPF sells its products under five brands in Spain (under Repsol, CAMPSA and Petronor brand names) and in Argentina (under YPF and Refinor brand names). Repsol YPF has reduced its network scale by an average of 2% per annum over the 11-year period 2000-10. In so doing, it has raised its networks exposure to Europe from 53% to 67% and reduced its Latin American exposure from 47% to 33%. Repsol YPF recently exited retailing in Brazil (327 stations). Product sales in Spain have declined by an average of 3-4% pa, which is a challenge for the business. Downstream profitability Repsol YPF's downstream business has reported a full year operating and net profit in every year since 2000. Repsol YPF has delivered a return on net fixed assets that has averaged 11% 2000-10. We acknowledge that Repsol YPF's downstream performance has been burdened by the very weak operating results of its Chemicals a disadvantage versus other European competitors. We also highlight that between 2000 and 2010 Repsol YPF generated an average of 3.2 post tax per bbl. Downstream cash generation and capital intensity Repsol YPF's downstream cash generation (excluding changes to working capital) has been negative in only one year (2009) since 2000. Negative cash flow in 2009 was due to high capital expenditure on the upgrade projects and a very weak operating environment. Repsol YPF's depreciation/capex ratio has averaged 1.6x 2000-10 this ratio has increased since 2007 as the company started its investment in the upgrade projects.
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Higher diesel output
Increase in European exposure and reducing exposure to Latin America
Consistently profitable
Increase in capital intensity and consistent free cash flows pre investment
Figure 93: Repsol YPF - refining capacity (kbopd) & utilization (%)
Figure 94: Repsol YPF - number of refineries & average size (kbopd)
Figure 95: Repsol YPF- refinery yield and output / equity oil cover ratio (x)
Figure 96: Repsol YPF - retailing network size & location
Figure 97: Repsol YPF - downstream profitability ($/bopd) & post-tax ROFA (%)
Figure 98: Repsol YPF - downstream cash flow ($m) & capital intensity (x)
Source: J.P. Morgan
Source: J.P. Morgan
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Summary
Growth capex in refining should end this year
Repsol YPF's strategy of heavy investment in European refining is completely at odds with the 'shrinking refining theme' noted with the other euro names. We believe that Repsol YPF's strategy is supported by the market dynamics in Spain (diesel short market) and therefore the incremental investment has the potential to deliver improved returns. However, we also believe that the influence exercised by the Spanish state on the company and the companys role as the national energy champion of Spain means that it must remain committed to Spanish refining. So, we do not expect any shift in Repsol YPF's commitment to Spanish refining even if conditions worsen. Given the significantly improved credentials of the company in the high margin upstream business, we do not expect the company to announce any other major investment projects for the downstream business. Even at existing levels, the companys equity oil production/ refining throughput ratio is amongst the highest in the euro majors. Our downstream EV (as included in our Repsol YPF's sum-of-the-parts) is approximately 11.5bn. This represents 31% of our corporate EV of around 36.5bn ( SOTP of around 28 per share). Post refinery upgrade and expansion projects (Cartegena and Bilbao), we see downstream EBITDA potential in 2012E of approximately 2.7bn assuming no loss of profitability. This implies an EV/EBITDA multiple of 4.2x which seems reasonable, if not a shade conservative. .
Earnings exposure to European refining will remain high
Downstream EV of 11.5bn looks reasonable given the 2012E EBITDA of 2.7bn
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Statoil
Underweight
Company Data Price (Nkr) Date Of Price Price Target (Nkr) Price Target End Date 52-week Range (Nkr) Mkt Cap (Nkr bn) Shares O/S (mn) 121.00 06 Sep 11 145.00 31 Dec 11 161.70 108.10 385.4 3,185 Statoil (STL.OL;STL NO) FYE Dec Adj. EPS FY (Nkr) Bloomberg EPS FY (Nkr) Adj. EBIT FY (Nkr mn) Pretax Profit Adjusted FY (Nkr mn) Net Attributable Income FY (Nkr mn) Adj P/E FY EV/DACF FY Div Yield FY 2010A 13.14 13.40 142,730 141,630 42,232 9.2 6.2 4.6% 2011E 17.22 16.56 171,419 171,419 54,467 7.0 4.6 4.8% 2012E 17.08 18.54 172,468 172,468 54,036 7.1 4.7 5.1%
Downstream overview
Downstream contents & structure Statoil's downstream business is now divided into two business segments Manufacturing and Marketing and Fuel & Retail. This business is responsible for the group's combined operations in the transportation of oil, processing, sale of crude oil and refined products, retail activities and marketing of natural gas in Scandinavia.
Small downstream footprint
Statoil's downstream business is also responsible for the processing and sale of the Norwegian state's production of crude oil and natural gas. The fuel and retail arm of the business was listed in 2010 and therefore this business is now held in a separate company in which Statoil has a 54% stake - we have accordingly for the purpose of our analysis taken the net economic interest of Statoil in Fuel and Retail into consideration. Investor focus on this segment has been understandably limited given Statoil's very limited exposure to the downstream business. Statoil does not report segmental details of its net fixed assets and we have therefore used total non-current assets of the segment as a proxy in our analysis we concede that this difference unjustifiably burdens Statoil's return on net assets versus some of its European peers. Downstream strategy Supports dominant upstream - Focus on maximizing the value of the group's equity oil and NGL production The strategy of Statoil's downstream business is centered around the maximization of the value of the company's upstream production of crude oil and natural gas liquids (NGL). Unlike the majority of its European peers, Statoil has not made significant investments in its downstream business over the last decade. The carving out of the fuel and retail arm in the IPO in 2010 was an innovative strategic step in the right direction. Further reduction in downstream exposure Statoil's management believes that the market fails to reflect the value of the company's non-upstream assets and therefore further divestments remain on the agenda the recent listing of the fuel and retail business is a case in point. Strengthen the global trading arm - Recent capex in the segment has been focused on the oil sales, supply and trading business Statoil is one of the world's biggest net sellers of crude oil because it handles the crude volumes on
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behalf of the Norwegian state. Statoil does not have any significant investment planned for its refining business. Growth in renewable space Statoil is looking to grow its renewable energy business and is looking to utilize its extensive experience from offshore operations.
Statoil Downstream Efficiency Overview

No change in refining capacity since 2000
Refining scale, reach & utilization Statoil's refining capacity has not changed since 2000 given no impact from the 2007 merger with the oil and gas business of Norsk Hydro, which did not bring any additional refining capacity to the group. It is noteworthy that Statoil has not made any growth investments in its refining business even through the business up-cycle (since 2000) a clear indication that the strategic priorities of this company lie upstream. The 2000-10 refinery utilization of the company has averaged a healthy 92%. The decline seen in 2010 was mainly due to the planned turnarounds at the Mongstad and Kalundborg refineries. Refining product yield and product / equity oil cover ratio Given that its refining system has changed little over the past decade, its refining yield has also remained stable. The only notable shifts in product slate have been a small increase in gasoline (from 36% to 38% by volume) and middle distillates (from 37% to 39% by volume) and a small decline in fuel oil yield (from 9% to 7% by volume). The merger with Norsk Hydro upstream in 2007 meant that the equity oil production of the company increased without any compensating increase in refining capacity - the ratio of refinery throughput to equity oil production has therefore fallen from 33% in 2000 to 23% in 2010. We expect the refining throughput to equity oil production ratio to remain low over the medium and long term as Statoil does not have any major identified growth projects in refining. Retailing network In the mid-1980s, Statoil's marketing business expanded outside the Norwegian market. There were two key transactions with Exxon Mobil: (i) purchase of Esso stations in Sweden in 1985 and (ii) acquisition of Exxons Danish fuel station network in 1986. In 2009, Statoil acquired the network of automated stations under the JET brand from ConocoPhillips in Sweden and Denmark. As a condition to clearance of the acquisition, the EU Commission required the sale of the JET branded stations in Norway to a third party and the sale of 158 fuel stations in Sweden, most of which had been gained during the merger between Statoil and Norsk Hydro in 2007. Statoil listed its fuel retail arm in 2010 Statoil Fuel & Retail ASA - a move that helped the company demonstrate the value of a sub-segment, albeit one that had a very limited impact on Statoil's equity value given the small footprint. In the near term we do not believe that Statoil has any intention of reducing its controlling 54% stake in its retail arm. Therefore on a net ownership basis, Statoil has managed to reduce the number of its retail outlets by 5% CAGR 2000-10 given that the company now holds a 54% stake in the fuel and retail business.
Stable refining yield and low refining throughput to equity oil ratio
First euro name to list its marketing business
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Consistently profitable operations
Downstream profitability Statoil's downstream business has delivered positive operating results in every year since 2000. The company has delivered a positive return on net fixed assets, with a very healthy average 2000-10 ROFA of 18%. We believe that Statoil's downstream performance has been helped by strong integration with the upstream resulting in reliable and appropriate quality crude feedstock supplies for its refining business. A dominant marketing position in Scandinavia has also been a strong plus for the downstream profitability. Between 2000 and 2010 Statoil generated an average of Nkr 41 post tax per barrel of refinery throughput. Downstream cash generation and capital intensity Statoils downstream cash generation has been negative in only one year since 2000. Negative cash flow in 2008 was primarily due to the acquisition of the South Riding point crude oil terminal lease. Statoils capital expenditure to depreciation ratio averaged 1.7x 2000-10. This ratio has been buoyed by the company's investments in the oil trading/supply business and associated infrastructure. We do not expect any major shift in the very healthy downstream cash flow profile of Statoil in 2012/13 the company has not announced any major refinery upgrade/expansion projects.
Healthy cash flow generation pre-acquisitions
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Figure 99: Statoil - refining capacity (kbopd) & utilization (%)
Figure 100: Statoil - number of refineries & average size (kbopd)
Figure 101: Statoil- refinery yield and output / equity oil cover ratio (x)
Figure 102: Statoil - retailing network size & location
Figure 103: Statoil - downstream profitability ($/bopd) & post-tax ROFA (%)
Figure 104: Statoil - downstream cash flow ($m) & capital intensity (x)
Source: J.P. Morgan
Source: J.P. Morgan
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Summary
Small downstream business has limited share price relevance
Investors have historically not focused on the downstream business of Statoil given its absolute small downstream footprint and the much larger scale of its upstream business - this will not change. Statoil's listing of its marketing business was clearly a step in the right direction - transitioning downstream capital employed to upstream Statoil's strong retail brand in Scandinavia was a key plus in this process. However, the valuation impact of this listing was not very meaningful to Statoil's equity value. We believe that divestment of the refining business could be the next step on managements agenda - this is clearly not a core focus area for the company and we believe that this small base of refining assets does not get appreciation (value focus) from investors within what is largely a pure play upstream company. We also note that the company has been very active in recent years in monetising the value of its non core assets supporting our contention of a possible divestment of refining assets. Whilst we concede that management has been rightly cautious in its refining investment (no growth in capacity since 2000), we also believe that the company can now be more aggressive and hive off parts of its refining business which are facing more severe margin pressure. Recent listing of the marketing business provides a good template' for the divestment of Statoil's refining assets. The company has not commented explicitly on the likelihood of divestment of refining assets. Our downstream EV (as included in our Statoil's sum-of-the-parts) is approximately Nkr 24 bn. This represents just 4% of our corporate EV of c.Nkr683bn (SOTP c.Nkr190 per share). We note that our Statoil downstream's value of Nkr 24bn equates to a 2012E EV/EBITDA multiple of 3.7x. This seems fair enough, if not conservative in our view, especially given almost one third of our downstream EV is represented by the market value of Statoils 54% stake in Statoil Fuel & Retail ASA.
Refining capacity divestment could be on managements agenda
Downstream EV of Nkr 24bn implies a 2012E EV/EBITDA of c.3.7x - supported by market value of fuel and retail stake
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TOTAL
Neutral
Company Data Price () Date Of Price Price Target () Price Target End Date 52-week Range () Mkt Cap ( bn) Shares O/S (mn) 31.69 06 Sep 11 47.00 31 Dec 11 44.55 - 30.34 71.1 2,245 TOTAL (TOTF.PA;FP FP) FYE Dec Adj. EPS FY () Bloomberg EPS FY () Adj. EBIT FY ( mn) Pretax Profit Adjusted FY ( mn) Adj P/E FY Div Yield FY EV/DACF FY Dividend (Net) FY () 2010A 4.64 4.65 21,503 21,277 6.8 5.8% 5.3 2.28 2011E 5.56 5.32 26,061 25,681 5.7 6.2% 5.1 2.44 2012E 5.43 5.38 25,051 24,711 5.8 6.6% 5.0 2.56
Downstream overview
Downstream contents & structure TOTAL's downstream segment includes the company's refining, marketing, trading and shipping businesses. TOTAL's downstream business is concentrated in Western Europe and Africa. In 2010, TOTAL's worldwide sale of refined products was 3,776 kbpd. Refining - TOTAL holds interests in 24 refineries, including 12 (pre-CEPSA divestment) that it operates. The company produces a wide range of specialty products such as lubricants, liquefied petroleum gas (LPG), jet fuel, special fluids, bitumen, marine fuels and petrochemical feedstock. Marketing TOTAL markets a wide range of specialty products which it produces from its refineries and other facilities. TOTAL has a strong presence in specialty products which are sold in approximately 150 countries. Trading & Shipping - The Trading division operates extensively on physical and derivatives markets, both organized and over the counter. The groups Shipping division arranges the transportation of crude oil and refined products necessary for the groups activities.
Optimization of the downstream portfolio shrinking the refining base in Europe
Downstream strategy TOTALs downstream strategy is to optimize its portfolio with a focus on improving downstream profitability - it has a target to increase this segments ROACE by 4% and to double its net cash flow by 2015. Management has acted to rid its downstream portfolio of underperforming/non core assets (divestment of CEPSA stake), and plans to focus on large projects and growing markets (e.g. via a 37.5% stake in the Jubail refinery in Saudi Arabia). Shrinking the European refining base and focus on most competitive assets In an effort to concentrate on its most competitive refining assets, TOTAL targeted a reduction over 2007-11(e) of 500 kbopd or around 20% of its global refining capacity. The company is largely on track to exceed this target - key actions have been the closure of its Dunkirk refinery and the sale of its CEPSA stake. Realigning the existing assets to the market TOTAL is aiming to improve the product slate of its refining system, increasing the output of middle distillates (higher margins) and reducing production of loss-making/lower margin products.
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Growing in emerging markets TOTAL is looking to make downstream investments in selective growing markets to gain exposure to the Middle East, Africa and Asia.
TOTAL Downstream Efficiency Overview

Active downsizing in 2010/11 of its refining footprint in Europe
Refining scale, reach & utilization TOTAL's downstream business was transformed by two key mergers, first between TOTAL and Petrofina in 1999. In the same year, the merged entity, renamed Totalfina, offered to acquire Elf Aquitaine the boards of both companies ultimately recommended a friendly merger. The size of TOTAL's refining network peaked in 2005. The process of rationalizing the company's refining capacity was started by the new management team, now led by Christophe de Margerie, in 2007 - stressing the need to improve downstream profitability. The process has gathered momentum in 2010/11 the company has divested its stake in CEPSA and closed the Dunkirk refinery. Refining product yield and product / equity oil cover ratio TOTALs refining slate has changed a little over the past decade. The notable shifts in the product slate have been a decline in gasoline (from 26% to 18% by volume) and a small increase in other products (from 15% to 18% by volume) and fuel oil output (from 10% to 12% by volume). TOTAL plans to increase the middle distillate yield of its refining system via the divestment of some low complexity projects and investment in new higher complexity projects (like the Jubail refinery on the east coast of Saudi Arabia). Very modest production growth in the last decade means that TOTAL's equity oil to refining throughput ratio has remained above 150% - we expect this ratio to decline in 2011 (given the recent refining divestments) before increasing again as the Jubail refinery comes on-stream in 2013. Retailing network TOTALs marketing network includes TOTAL and Elf branded stations. In Italy, TotalErg (a joint venture between TOTAL 49% and Erg 51%) operates under both TOTAL and ERG brand names. After a steady decline 2000-09, TOTAL's marketing network grew strongly in 2010, mainly a result of the aforementioned JV with ERG. TOTALs marketing business (like its refining business) is strongly concentrated in Western Europe and the company is looking to grow selectively in the growth markets (Asia, Central Europe and Latin America). Downstream profitability TOTAL has delivered an average 2000-10 post tax return on capital employed of c.22% - near the top among euro-integrated names. We have used capital employed in our analysis (instead of net fixed assets) given the material contribution made by affiliates in TOTAL's downstream results. TOTAL's downstream performance is helped by its focus and concentration in key markets and measured rates of reinvestment. TOTALs management has also been very active in restructuring the company's downstream portfolio in the past 12-18 months (e.g. the divestment of its stake in CEPSA, divestment of marketing assets in UK, closure of the Dunkirk refinery in France, tie-up with ERG in Italy). We believe pressure on downstream margins in Europe and a view that such pressure will not relent has been a catalyst for this more proactive stance by management.
Product yield has changed a little with less gasoline
Heavy exposure to Western Europe
Impressive downstream profitablity and robust returns
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Generates positive cash flow excluding acquisitions
Downstream cash generation and capital intensity Consistent with its strong downstream profitability, TOTAL's post tax free cash flow (excluding changes to working capital) has been negative in only one year in the period 2000-10. In 2009, negative cash flow (in common with the majority of its European peers) was attributable to a very weak operating environment and higher than normal capital expenditure. The acquisition/investment in 2008 meant that the company's capex/depreciation ratio was above 2x versus a 2000-10 average of 1.4x. With this exception, TOTAL's downstream business has consistently generated cash for the group and thus contributed to the groups dividend. We also believe that the recent portfolio changes and investments will help TOTAL to regain some of the downstream profitability lost in the recent years.
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Figure 105: TOTAL - refining capacity (kbopd) & utilization (%)
Figure 106: TOTAL - number of refineries & average size (kbopd)
Figure 107: Total- refinery yield and output / equity oil cover ratio (x)
Figure 108: TOTAL - retailing network size & location
Source: J.P. Morgan
Source: J.P. Morgan
Figure 109: TOTAL - downstream profitability ($/bopd) & post-tax ROFA (%)
Figure 110: TOTAL - downstream cash flow ($m) & capital intensity (x)
Source: J.P. Morgan. Source: J.P. Morgan.
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Summary
High-grading of portfolio will help restore good profitability
TOTAL has made good progress in 2010-11 upgrading and restructuring its downstream business, especially downsizing its exposure to a challenging European refining environment. Management's strategy of 'shrinking in Europe and growing in emerging markets/ Asia' is sensible, albeit fairly undifferentiated. Whilst we believe that TOTAL has made significant progress in realigning its downstream portfolio to changes in the operating environment, we also believe that there is room for further portfolio improvements especially reducing exposure to low complexity refining in France. Post the CEPSA divestment in 2011, TOTALs refining capacity will have declined 13% from its peak in 2005. The next increase will occur in 2013 when the Jubail refinery is scheduled to be commissioned this will add 150 kbopd of capacity net to TOTAL (37.5% of 400 kbopd plant). Management is looking for a 4% increase in its downstream ROCE 2010-15 - we believe that this is an achievable, albeit a tough objective. The achievement of this target has three drivers - divestment of low margin/loss-making assets (marketing stations in UK, sale of stake in CEPSA, closure of Dunkirk etc), investment in higher margin assets (Jubail refinery) and cost reduction (control of fixed costs, reducing costs of major turnarounds, improving energy efficency etc).
Downstream EV of 18.6 bn implies 2012E EV/EBITDA multiple of 5.9x
Our downstream EV (as included in our TOTAL sum-of-the-parts) is approximately 18.6 bn or 8.3 per share. This represents 14% of our corporate EV of 129bn. We see downstream EBIT potential in 2012E of approximately 1.8bn. Adding downstream depreciation of around 1.3bn, this implies a 2012E EBITDA of 3.1bn and an EV/EBITDA multiple of only 5.9x which seems fair at the higher end of the EV/EBITDA multiple range for euro integrated names given that historical profitability of TOTAL's downstream assets has been good.
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Caio M Carvalhal
(55-11) 4950-3946 caio.m.carvalhal@jpmorgan.com Banco J.P. Morgan S.A.
Petrobras
PETROBRAS ON
PETROBRAS ON (PETR3.SA;PETR3 BZ) FYE Dec 2010A EPS Reported (R$) FY 2.70 P/E FY 8.3 EBITDA FY (R$ mn) 60,325 EV/EBITDA FY 7.0 Bloomberg EPS FY (R$) 3.31
Neutral
Company Data Price (R$) Date Of Price 52-week Range (R$) Mkt Cap (R$ mn) Fiscal Year End Shares O/S (mn) Price Target (R$) Price Target End Date 2011E 2.78 8.1 63,394 5.8 2.96 2012E 3.54 6.4 76,610 5.1 3.33 22.51 06 Sep 11 33.92 - 20.00 293,627.70 Dec 13,044 35.00 31 Dec 12
PETROBRAS ON ADR
Neutral
Company Data Price ($) Date Of Price 52-week Range ($) Mkt Cap ($ mn) Fiscal Year End Shares O/S (mn) Price Target ($) Price Target End Date 27.42 06 Sep 11 42.74 - 24.51 178,805.10 Dec 6,522 41.00 31 Dec 12 PETROBRAS ON ADR (PBR;PBR US) FYE Dec EPS Reported ($) FY P/E FY EBITDA FY ($ mn) EV/EBITDA FY Bloomberg EPS FY ($) 2010A 3.01 9.1 35,239 7.5 3.70 2011E 3.76 7.3 40,429 6.9 3.79 2012E 4.46 6.1 48,839 6.4 4.06
Downstream contents & structure

Refining, Transportation and Marketing (RTM) is one of the five Petrobras Business Units, that comprises the downstream activities in Brazil, including refining, logistics, transportation, oil products and crude oil exports and imports and petrochemicals.
Table 8: Refining, Transportation and Marketing Key Statistics
(U.S.$ million) Net operating revenues Income (loss) before income tax Total assets at December 31 Capital expenditures
Source: Petrobras
2010 97,540 2,278 69,487 15,356
2009 74,307 9,980 49,969 10,466
2008 95,659 -3,017 27,166 7,234
Petrobras is the dominant player in domestic refining - As an integrated company, Petrobras has a dominant market share in the Brazilian market, with a limited international presence. Petrobras owns and operates 12 refineries in Brazil, with a total net distillation capacity of 2,007 kbopd, one of the worlds largest refiners. As of December 31, 2010, Petrobras operated 90% of Brazils total refining capacity, supplying almost all of the refined product needs of third-party wholesalers, exporters and petrochemical companies, in addition to the needs of its own distribution segment. Petrobras operates a large and complex infrastructure of pipelines and terminals and a shipping fleet to transport oil products and crude oil to domestic and export markets. Most of its refineries are located near crude oil pipelines, storage facilities, refined product pipelines and major petrochemical facilities, facilitating access to crude oil supplies and end-users.
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Petrobras also imports and exports crude oil and oil products, with diesel being the most important import product, as Brazilian demand exceeds domestic output. The companys strategy is to reduce this gap in the future, with new refining capacity and upgrades to existing plants to facilitate the processing of domestically produced crudes. The RTM business unit also includes petrochemical operations and two fertilizer plants.
Table 9: Petrobras' Refining Capacity
(mbbl/d) LUBNOR RECAP (Capuava) REDUC (Duque de Caxias) REFAP (Alberto Pasqualini) REGAP (Gabriel Passos) REMAN (Isaac Sabb) REPAR (Presidente Getlio Vargas) REPLAN (Paulnia) REVAP (Henrique Lage) RLAM (Landulpho Alves) RPBC (Presidente Bernardes) RPCC (Potiguar Clare Camaro) Total
Source: Petrobras
Location Fortazleza (CE) Capuava (SP) Rio de Janeiro (RJ) Canaoas (RS) Betim (MG) Manaus (AM) Araucria (PR) Paulinia (SP) Sao Jose dos Campos (SP) Mataripe (BA) Cubato (SP) Guamar (RN)
2010 7 53 242 189 151 46 189 396 252 279 170 34 2,007
2010 8 36 256 145 143 42 170 316 238 250 160 33 1,798
2009 7 44 238 169 140 41 185 341 241 220 165 1,791
2008 6 45 256 142 143 39 183 324 205 254 168 1,765
Investments in existing refineries, with a focus to improve fuel quality, reached $6.7bn in 2010. In recent years, Petrobras has made substantial investments in its refinery system to improve gasoline and diesel quality (to comply with environmental regulations) and to increase crude slate flexibility to process more Brazilian crude (taking advantage of light/heavy crude price differentials). In 2010, Petrobras invested approximately $6.7bn in its refineries, of which $5.3bn went into hydro-treating units to improve the quality of diesel and gasoline and $1.2bn into coking units to convert heavy oil into lighter products (compared to a total RTM capex of $15.4 bn in 2010). By the end of 2013, Petrobras is expected to reduce the maximum sulfur content of the diesel produced from 1800 ppm to 500 ppm, with some of its refineries already producing 50 ppm sulfur diesel. Petrobras also owns and operates an extensive network of crude oil and oil products pipelines connecting its terminals, refineries and other primary distribution points. On December 31, 2010, onshore and offshore, crude oil and oil products pipelines extended 15,199 km (9,397 miles), with 28 marine storage terminals and 20 other tank farms with nominal aggregate storage capacity of 63 million barrels. The marine terminals handle an average 10,422 tankers annually, and the company is working in partnership with other companies to develop and expand Brazils ethanol pipeline and logistics network. Until 1998, Petrobras held the monopoly on oil and natural gas pipelines in Brazil and shipping oil products to and from Brazil. The deregulation of the Brazilian oil sector in that year permitted open competition in the construction and operation of pipeline facilities and gave the ANP the power to authorize entities other than Petrobras to transport crude oil, natural gas and oil products. In accordance with this deregulation, Petrobras transferred its transportation and storage network and fleet to a separate wholly owned subsidiary, Petrobras Transporte S.A.Transpetro, to allow third parties to access its excess capacity on a non-discriminatory basis. Petrobras
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enjoys preferred access to the Transpetro network based on historical usage levels. In practice, third parties make very limited use of this network. Petrobras petrochemicals operations provide a growing outlet for the crude oil and other hydrocarbons, increasing value add and providing domestic sources for products that would otherwise be imported. Petrobras strategy is to increase domestic production of basic petrochemicals and engage in second generation and biopolymer activities through investments in companies in Brazil and abroad, capturing synergies within all its businesses. The Brazilian petrochemical industry was developed with the formation of 3 petrochemical poles: Sao Paulo (1972); Bahia/Camaari (1978) and Rio Grande do Sul/Triunfo (1982), all of them created through the stimulation of industrial settlements close to 3 of the largest Petrobras refineries and mainly controlled by the national oil company. Until today, it is around these 3 poles that almost all the firstand second-generation petrochemicals production capacity is located. This first phase of the petrochemical industry was heavily promoted by the Petroquisa action, the petrochemical arm of Petrobras, which controlled the raw material supply to the poles and was a mandatory partner of all the second-generation companies, with onethird participation (the so-called three-party model). In the 1990s, when Petroquisa was partner in no less than 36 companies, a process began of reducing the state weight in the sector, consequently expanding the role of private conglomerates. As a consequence, until recently, the Brazilian petrochemicals industry was fragmented, with a large number of small companies, many of which were not internationally competitive and were therefore poor customers for petrochemical feedstock. In a series of mergers and a capital subscription completed in 2010, Petrobras consolidated and restructured the Brazilian petrochemicals industry by creating Brazils largest petrochemicals company and one of the largest producers of thermoplastic resin in the Americas, Braskem. Braskem is a publicly traded company in which Petrobras holds a 36.1% interest. The controlling shareholder, with 38.3%, is Odebrecht S.A. (Odebrecht). Braskem operates 31 petrochemical plants, produces basic petrochemical and plastics, and conducts related distribution and waste processing operations. The table below sets forth the primary production capacities of Braskem as of December 31, 2010:
Table 10: Braskem Nominal Capacity by Petrochemical Type MT pa
Ethylene Propylene Polyethylene Polypropylene PVC Cumene
Source: Petrobras
3.77 1.59 3.06 2.88 0.51 0.32
Brazilian pricing dynamics From its total refined products output, approximately 40% is subject to loose prices, immediately adjusted for international price variations (e.g., jet kero, petrochemical naphtha and fuel oil). However, for gasoline and diesel, Petrobras adopts a policy of not automatically passing through the international oil price variations, until the price reaches (and stabilizes) at what could be considered a new standard. The concept is vague enough to encourage analysts to spend long hours
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anticipating the next move, as any variation could impact the companys earnings almost immediately. Are we in the new standard oil prices yet? We dont think so. Our position is explained more by the lack of confidence in a stable international oil price level than by inflationary concerns. We believe that the Brazilian government is opposed to further price increases. Since 2002, Petrobras has strictly followed its policy of working as a buffer to international variations in oil prices, without automatically passing through any variation, up or down. From that date on, refined price adjustments took place only when the companys realization price was below the international oil price and when the international oil price kept its upward trend. We believe the recent ups and downs in international oil prices will enable government policymakers to justify a soon-to-be-considered stabilization in international oil prices at a different and higher level. That said, inflationary concerns will complete the picture and possibly help to keep ex-refinery prices down.
Downstream strategy
Petrobras says increasing domestic fuel demand could require all new refining throughput capacity. In our view, this makes more sense of Petrobras downstream expansion than its prior argument of exporting diesel to Europe. We are at the beginning of what could be called a fourth phase in Brazil's downstream history, or a second round of green field expansion. We can classify the previous phases in the downstream segment in Brazil as the following: Creation of the countrys refinery park: the current refinery park was almost entirely created up until the late 1970s, when the countrys (and consequently, the companys) strategy was to add value to the imported crude trough refining, as there was no perspective of a domestic production to supply local demand. Increasing capacity and improving operational design: the discoveries in the Campos Basin transformed the countrys perspectives in terms of oil balance. Nevertheless, the oil discovered was not suited for the installed refinery park, designed to process lighter imported crude. So from the late 1980s to the late 1990s, refinery investments were focused on improving the refineries operational design to cope with the increased domestic oil and changing consumption patterns. Improving fuel quality driven by growing environmental concerns: the last decade was marked by the increased international concern in relation to fuel quality. As a late arrival, at least in terms of gasoline and diesel quality, Petrobras was mandated by the government to invest heavily in improving its overall fuel quality. Consequently, almost 50% of the record high RTM capex released in the 2010-14 business plan was related to fuel quality improvement. Greenfield refinery construction: After more than 30 years since the last greenfield project, Petrobras is entering now into what could be called a fourth phase in Brazil's downstream history, or a second round of greenfield expansion. Petrobras is currently building two new refining facilities, with further expanstion projects for the short term: Complexo Petroqumico do Rio de Janeiro - Comperj, an integrated refining and petrochemical complex, broke ground in 2008, and began construction in 2010. The 165 kbopd refinery operation is scheduled to start
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up in 2013. A second phase, scheduled for 2018, will increase capacity to 330 kbopd and add petrochemicals manufacturing. Abreu e Lima this is a refinery in Northeastern Brazil that was originally proposed as a partnership with Petrleos de Venezuela S.A. (PDVSA), the Venezuelan state oil company. However, given the lack of commitment from the Venezuelan company, Petrobras looks likely to pursue the project alone. Indeed, Petrobras budgets for a 100% commitment to Abreu Limas construction cost, estimated at $13bn. This refinery is designed to process 230 kbopd of crude oil to produce 162 kbpd of low sulfur diesel (10 ppm) as well as LPG, naphtha, bunker fuel and petroleum coke. The company targets the beginning of operations for 2013. Further expansion options - In addition, Petrobras is planning two new refineries in Northeastern Brazil. Both refineries are in their design phase to process 20 API heavy crude oil, maximize production of low sulfur diesel, and also to produce LPG, naphtha, low sulfur kerosene, bunker fuel and petroleum coke. Both will be integrated with marine storage terminals: i) Premium I in the State of Maranho this will be built in two phases of 300 kbopd each; ii) Premium II in the State of Cear this will have processing capacity of 300 kbopd. In the petrochemical segment, Petrobras has three new projects under construction at various stages of engineering and design: Complexo Petroqumico do Rio de Janeiro - Comperj: plans to develop a petrochemicals complex to be integrated with the Comperj refinery to produce materials for the plastics industry; PetroqumicaSuape Complex in Pernambuco - to produce purified terephthalic acid (PTA), polyethylene terephthalate (PET) resin, and polymer and polyester filament textiles; and Companhia de Coque Calcinado de Petrleo - Coquepar: petroleum coke plants in Rio de Janeiro and Paran. We have a more positive stance on Petrobras recent expansion plans We differ from the Street in believing that the market overestimates the potential downside driven by downstream investments, given that: Approximately half of the 2010-14 downstream budget is non-discretionary, being related to the Brazilian regulatory agency requirement on increasing the fuel quality in Brazil. Going forward, investments related to this requirement are expected to decrease, as the largest bulk is targeted for the 2010-12 period. Budgeted capex is not necessarily the same as executed capex, and if this is expected to apply to the whole investment portfolio, this is particularly true for Petrobras new refinery plans. Due to a combination of historical focus on upstream and a restrictive regulatory environment for infrastructure projects in Brazil, downstream projects are likely to take longer than anticipated. Future refining units are expected to cost significantly less than the underconstruction RNEST plant, as they will be designed for the lighter pre-salt oil (25 API, compared to the 16 API of the RNEST), configured for only one train (as opposed to two at RNEST), and built from replicated structures, potentially
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offering standardization benefits. The companys Design Competition system for new refineries targets a 30% capex reduction. We welcome the initiative, but we prefer to wait and see the results of such program. Petrobras has contracted UOP Honeywell to provide the state of art technology for Refineries Premium I and II. The two refineries will be constructed in single-trains of 300 kbopd each. UOP will be responsible for better integrating the units, with maximization of energy generation and using the best technology for each single unit. RNESTs total cost could have been lower if it was not designed to process Venezuela's synthetic oil. Petrobras conceived RNEST in two different units of 115 kbopd. The first will process Marlim's field heavy crude (26 API) while the second will process Venezuelan synthetic heavy crude (16 API). Among the worlds listed oil companies, Petrobras is the one with the largest captive downstream market this provides an unusual security of demand at almost any price. It is worth mentioning that in 2008, when international prices dropped from $140/bbl in June to $40/bbl in December, Petrobras kept selling its gasoline and diesel at the same price. Petrobras targets an 8% return for its investments in downstream. The number is somewhat similar to PBRs WACC of 8%, mentioned by the companys CEO during the 5bn boe transfer of rights.
Investment Thesis
We see three potential triggers for Petrobras stocks in 2011 and 2012, but as of now we only see reasons to factor two of them into our investment thesis: the updated business plan and domestic oil production growth. We are not considering any increase in refinery prices for gasoline and diesel for the time being. The updated Business Plan: We view the new Business Plan as a positive for the company, although with the potential impact partially offset by the lengthy approval process. Detailed assumptions for the next five years were pretty much in line with our model. International oil prices . . . Our international commodities team is bullish on oil prices, albeit some cautiousness in the short term is appropriate after the OECD oil destocking announcement. . . . and what is left for Petrobras. Conventional wisdom is only partially correct when assuming no upside for Petrobras from international oil prices. From its total refined products slate, approximately 40% is subject to loose prices, immediately adjusted for international price variations (e.g., jet kero, petrochemical naphtha and fuel oil). However, it is for gasoline and diesel that the bells toll. It is well known that Petrobrass long-term policy has been to not automatically pass through international oil price variations until the price reaches (and stabilizes) at what could be considered a new standard. The concept is vague enough to encourage analysts to spend long hours anticipating the next move, as any variation could impact the companys earnings almost immediately. Nevertheless, we stand alongside those who are not yet comfortable about anticipating any such move for the 2H 2011. Are we in the new standard oil prices yet? We dont think so. Our position is explained more by the above-mentioned lack of confidence in a stable international oil price level than by inflationary concerns. Although strategists were anticipating
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an oil price increase even before the Arabic Spring events triggered in Tunisia, it is the new geopolitical climate that has accounted for most of the recent increase rather than market fundamentals. Given the intrinsically sporadic effects of a revolutionary situation and the recent drop in international oil prices, we believe the Brazilian government has more than enough arguments to resist attempts by other stakeholders to convince it otherwise.
Valuation & Price Target Discussion

We rate the four Petrobras stocks that we cover Neutral. Our end-2012 price target for PBR is $41/ADR. Our R$35/sh YE12 price target for PETR3 is based on the PBR target using a year-end 2012 BRL exchange rate of R$1.7/USD. Our YE12 price target of $37/ADR for PBR/A applies a 10% discount to our price target for PBR. Our R$31/sh YE12 price target for PETR4 applies JPMs year-end 2012 BRL exchange rate of R$1.7/USD to our target price for PBR/A. We value E&P portfolio of PBR using a reserve depletion model and value each of the pre-salt projects independently. We also value the downstream projects under a DCF approach that is applied for all refining system of PBR.
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Figure 111: Petrobras - refining capacity (kbopd) & utilization (%)

2,500 95%
Figure 112: Petrobras - number of refineries & average size (kbopd)

20 150
2,000 90% Refining capacity (kbopd) 15 145
1,500 85% 1,000 10 140
80% 500
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0 2000 2001 2002

Brazil
75% 2003 2004 2005 2006 2007 2008 2009 2010
0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
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Rest of World
Figure 113: Petrobras - refinery yield and output / equity oil cover ratio
100% 95% 90%
Figure 114: Petrobras - retailing network size & location

10,000 9,000 8,000 CAGR +1%
80% 90% 70%
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Figure 115: Petrobras - downstream profitability ($/bopd) & ROFA (%)

12.0 10.0 2000-10 average ROFA 11% 8.0 6.0 10% 4.0 5% 2.0 0.0 2000 -2.0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 0% -5% -10% 30% 25% 20% 15%
Figure 116: Petrobras - downstream cash flow ($m) & capital intensity
4,000 2,000 12.0 0,000 (2,000) (4,000) (6,000) (8,000) (10,000) (12,000) 0.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2000-10 average 5.2x 3.0 6.0 15.0
9.0
Source: J.P. Morgan. Source: J.P. Morgan.
Post-tax free cash flow ($m)
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China: Refining and Marketing structure

Hong Kong, China Oil, Gas and Petrochemicals Brynjar Eirik Bustnes, CFA
(852) 2800-8578 brynjar.e.bustnes@jpmorgan.com
AC
J.P. Morgan Securities (Asia Pacific) Limited
China R&M has generally been under strict regulatory control, effectively setting the prices for gasoline, diesel and jet kerosene, in the last ten years. Naphtha and fuel oil are priced at international prices. During this period, China has been a marginal exporter and importer of products, with little impact from this on refinery economics. Prior to 2005, this price control model worked fine as oil prices were rangebound at $20-30 per barrel, and the NDRC (the regulating body) changed prices according to a basket of international products. Later, the pricing formula became a cost-plus structure, referenced to a basket of crudes, but this was only effectively put in place in early 2009 and relatively well adhered to until this year (we show Brent, as the crude basket generally traded at a slight discount to Brent). As oil prices started to move up in late 2004/early 2005, NDRC did not follow with enough price hikes, effectively pushing refiners into losses. As the majority (80%) of refining capacity in China was contained within two state-owned enterprises (SOEs), they had no choice but to continue to run refineries in order to avoid product shortages. Some ad hoc subsidies were given to Sinopec and PetroChina to compensate for losses, but these subsidies were not enough to cover losses. A refund of VAT on imported crude and some products was also implemented, alleviating some of the losses. Downstream product price controls in China work at different levels, including exrefinery gate, wholesale and retail levels (i.e. marketing margins are controlled), with a +/-10% flexibility for marketers. There is also a consumption tax (currently Rmb1,385/ton for gasoline and Rmb941/ton on diesel, up from Rmb277/ton and Rmb118/ton, respectively, in Jan 2009) and 17% VAT charged, adding up to retail prices. Hence, even with refiners running at losses and appearing to be subsidizing the consumers, with these taxes, Chinese retail prices have been lower than US retail prices only for very short periods (mid-2008). Hence, the notion of Chinese consumers getting subsidized fuel is generally a misnomer. Jet kerosene has recently been decontrolled, now being priced relative to Singapore import parity on a monthly basis. In addition to controlling refining in China, the two SOEs also control marketing, with over 50% of retail stations under their names (with 80-90% of overall throughput). Either through control by NDRC or through internal pricing, the marketing segment of Sinopec and PetroChina generally report profits throughout refining loss periods. This has partially to do with a guaranteed marketing margin available to independent marketers, but is also likely an effective way for authorities to isolate losses in the refining segment. Independent refineries (teapots) have been and still are a meaningful aspect of Chinese refining. They generally refine fuel oil (imported) as they do not have a crude import license. We estimate around 1.5 million bopd of capacity in this segment, with CNOOC (parent) controlling around 0.4 million bopd (in addition to their large-scale 0.24 million bopd Huizhou refinery). Facility run rates for these teapots range from 30-45% depending on prevailing economics. The governments strategy is, however, to eradicate this segment of inefficient (energy and environmentally) facilities and to replace them with large scale SOE-owned facilities. The higher consumption tax on fuel oil in early 2009 squeezed teapot economics. However, they continue to play a major role as swing producers when profitability allows operation to continue. The ongoing closure of teapots could act as
JPM China GRM is made up of 38% diesel, 18% gasoline, 10% kerosene and the rest at a 20% discount to crude. Prices are exrefinery prices.
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a counterweight to the likely overcapacity in China developing over the next five years.
Figure 117: China GRM based on product prices and one month delayed crude (US$/bbl)
20 10 (10) (20) (30) 150 120 90 60 30 -
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
China GRM (delayed crude)

Source: J.P. Morgan estimates, Bloomberg data, NDRC.
China GRM Qtrly (delayed crude)
Brent delayed 1M (RHS)
Figure 118: China product and Brent prices (Rmb/ton)

10,000 8,000 6,000 4,000 2,000 10,000 8,000 6,000 4,000 2,000 -
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Diesel
Source: J.P. Morgan estimates, Bloomberg data, NDRC.
Gasoline
Jetkero
Brent
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PetroChina
Underweight
Company Data Shares Outstanding (mn) Market Cap (Rmb mn) Market Cap ($ mn) Price (HK$) Date Of Price Free float (%) Avg Daily Volume (mn) Avg Daily Value (HK$ mn) Avg Daily Value ($ mn) HSCEI Exchange Rate Fiscal Year End 183,021 2,203,573 344,831 9.69 07 Sep 11 13.3% 126 1,411 181 10,347 7.79 Dec PetroChina (Reuters: 0857.HK, Bloomberg: 857 HK) Rmb in mn, year-end Dec FY09A FY10A FY11E Revenue (Rmb mn) 1,019,275 1,465,415 1,432,924 Net Profit (Rmb mn) 103,387 139,992 162,089 EPS (Rmb) 0.56 0.76 0.89 DPS (Rmb) 0.27 0.29 0.40 Revenue Growth (%) (5%) 44% (2%) EPS Growth (%) (10%) 35% 16% ROCE 14% 17% 18% ROE 13% 16% 16% P/E 14.1 10.4 9.0 P/BV 1.7 1.5 1.4 EV/EBITDA 6.8 5.5 4.8 Dividend Yield 3.5% 3.7% 5.0%
FY12E 1,327,399 148,506 0.81 0.37 (7%) (8%) 15% 14% 9.8 1.3 5.0 4.6%
FY13E 1,332,663 150,654 0.82 0.37 0% 1% 14% 13% 9.7 1.2 4.7 4.7%
Downstream overview
PetroChina has Chevron JV in Singapore (SRC 290 kBOPD) and INEOS JV in Europe (Grangemouth, UK 210 kBOPD, Lavera, France 210 kBOPD, and trading JV)
Downstream contents & structure PetroChinas Refining & Marketing business is responsible for the supply, trading, refining, manufacturing and marketing of crude and petroleum products and related services to wholesale and retail customers. We believe most of the pipeline infrastructure-related profits are reported within the Natural Gas and Pipeline segment (so not included here). Most of PetroChinas operation is domestic China, with deals in Singapore, Japan and Europe in the last 2-3 years adding an international presence that includes refining assets (including expansion of trading). PetroChina also has a relatively big petrochemical business, which we exclude from this analysis. Its parent CNPC also has stakes in refineries in Sudan, Algeria and Kazakhstan. PetroChinas R&M operation is still predominantly in Northern and Western China, as a legacy of how oil & gas assets were split up in the late 90s (PetroChina/CNPC north of the Great Wall, and Sinopec to the south). This is also how E&P assets were divided, leaving PetroChina with substantially greater upstream versus Sinopecs much greater downstream presence in southern/eastern China. Most of PetroChina refineries are built for domestic supply, predominantly processing light and sweet crudes. PetroChina has been increasingly involved in international trading of crude and products, but due to lack of transparency, it is not entirely clear whether this is done as part of R&M, E&P (Russian imports of crude is through E&P segment) or through the parent CNPC's operations. PetroChina has E&P producing upstream assets in Venezuela, Kazakhstan, Iraq and its parent CNPC has operations in Sudan, all of which supply international crude into PetroChinas refining system, in addition to third party crude. Until recently, PetroChina reported R&M as one segment analysts were also given access to a split between refining and marketing without further details. In 2010, PetroChina switched to reporting marketing separately, while reporting refining and chemical together, again providing split between the two in less detail.
CNPC has stakes in Sudan (100 kbopd and 20 kbopd refineries), Kazakhstan (105 kbopd) , Algeria (12 kbopd) and JX JV in Japan (Osaka refinery 115 kbopd)
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PetroChinas downstream business is managed through two main groupings refining and marketing: Refining this grouping is primarily the operation of refineries domestically and abroad, and possibly includes the trading of some crudes internationally. Refining includes the production of transport fuel, in addition to lubricants, asphalt, chemical feedstock and other refined products. Other than in 2001, refining has in recent years struggled to generate profits. Marketing this grouping encompasses primarily wholesale and retailing of transport fuels and other products from the refineries. There may be an element of trading in products internationally, in addition to more recent ramp-up of non-fuel business in retail stations.
Downstream strategy
PetroChina will be focusing on upgrading complexity of existing refineries and adding presence in south/eastern China along with taking marketing market share
PetroChina, resident in the fastest petroleum product growth country in the world, will continue to grow capacity and related marketing network. Being an SOE, profitability is not paramount, resulting in increasing capital commitments, while profitability and returns are still in the hands of the regulator (NDRC). PetroChina is also planning to increase its international presence, through acquiring refining assets (or stakes) as a base for increased trading activities in crude and products. This is possibly to pre-empt a greater need for international interaction, whether for imports or exports in the future. Especially for crude, this will very likely become increasingly important, as Chinas demand grows faster than domestic crude production. Building to a position of excess domestic refining capacity will at times also necessitate greater exports, which should benefit from an expanded global trading presence. Downstream performance drivers price control and our view We believe the current price controls will be relaxed over time, initially with the price adjustments made more frequently than currently. Current adjustments are theoretically to be made every time the 22 daily moving average of a crude basket has moved more than 4%. Due to the transparency (in theory) of this formula, and market participants taking advantage of it, we believe the window will be shortened and at some point pricing will be left entirely to the market participants (likely under the watchful eyes of regulators as is the case most places in non-OECD). This liberalization will to a great extent depend on the path of oil prices in the next year or two. In the meantime, we expect gross refining margins next year (always next year) to normalize at around $5-6 per barrel, which is a level where PetroChina will be able to generate positive EBIT. Adding in less volatile marketing margins should result in EBIT in the range of Rmb20-25,000 per annum. There is potentially some upside to this structurally, as PetroChina starts to utilize its vast retail network for non-fuel sales, which could add a few billion Rmb to the EBIT line over five years. Downstream growth projects PetroChina will spend most of its efforts downstream on growing refining capacity and increasing the complexity of existing refineries. Increasing its ability to refine heavier and sourer crude is vital, as China (and PetroChina) will have to increase its import dependency on foreign oil. PetroChina should increase refining capacity from a current 3 million bopd to around 4.5 million bopd by 2015. Half will be from expansions and the rest from greenfields, including JVs with foreign partners, linked
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R&M EBIT potential of around US$3-4bn in an average year under controlled product prices upside from non-fuel sales
PetroChina to grow refining faster than Sinopec
to crude purchase agreements. PetroChina will also likely add retail stations in the south/eastern part of China in order to attempt to gain market share on the back of expanded refining market share.
Table 11: China refining capacity addition PetroChina to add an estimated 1.5 million bopd cumulative capacity over 2011-15
(000 bopd) PetroChina Sinopec China overall 2011 180 238 748 2012 370 240 730 2013 250 530 780 2014 471 300 1,010 2015 260 300 740 Total 1,531 1,608 4,008
Source: Company estimates, J.P. Morgan estimates
PetroChina Downstream Efficiency Overview

PetroChina has one of the worlds largest refining bases, and is expected to expand it
Refining scale and reach PetroChina has 26 refineries in China in addition to 50% stakes in 4 refineries overseas. Total equity refining capacity is 3.4 million bopd as of June 2011, and we expect this to grow to 4.5 million bopd by 2015, excluding any further acquisitions abroad. The average size of its refineries has increased from less than 100 kbopd in 2000 to close to 115 kbopd. The plan is to expand a group of existing refineries further in addition to new large-scale refineries, raising energy efficiency and reducing environmental impact in line with the governments 12th five-year plan. Although these refining complexes will be more expensive than historically, the operating economics of the new refineries should also improve PetroChinas overall refining performance. Refining product yield and product / equity oil cover ratio Product yield has remained relatively stable, as domestic demand has not changed significantly during the last eleven years. Diesel yield around 42-44% is slightly above the domestic demand profile, while gasoline yield is 20%. Kerosene yield at 2% is too low, making China a net importer of jet kerosene (although not reported as such due to international airlines filling up counting as exports). PetroChina has gone from being net long crude to now being net short due to crude production growth lagging its refinery expansion. However, including CNPCs equity production abroad, CNPC as a group is close to 100% covered now. We expect PetroChinas equity oil cover ratio to drop further as it expands, with domestic production stagnating and international production likely not keeping up (unless Iraq can ramp-up according to plan). The impact on financials from this is that PetroChina will be increasingly dependent on what NDRC does to product prices (or any liberalization). PetroChina no longer sells crude (on a netted basis), and since two thirds of refined products are NDRC-controlled, less than one third of PetroChinas production (fuel oil, naphtha, LPG etc) will be exposed to international oil prices (this is something not fully appreciated by investors). Taking into account cost escalation downstream from higher crude prices, without NDRC raising product prices, higher crude is likely negative for PetroChinas earnings. We do, however, as mentioned above, expect NDRC to follow the current pricing formula and at some point to liberalize prices, exposing PetroChina to more normal earnings dynamics of an international integrated company (at least within certain oil price limits).
Middle distillates make up more than 50% of China demand base PetroChina matches this
Without NDRC response to higher crude, it is actually negative for PetroChinas earnings
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PetroChina is going south/east where demand growth is strongest
Retailing network PetroChina owns around 18,000 retail stations, predominantly in the north/western part of China. With refinery expansions, we expect its retail network will also expand, and also make room for PetroChinas move south/east to compete with Sinopec for market share. This could have the effect of pressuring marketing margins, especially at the retail level, although we expect competition to be friendly enough to maintain a relatively strong marketing margin. PetroChina is, along with Sinopec, also targeting to expand its non-fuel business from the retail network, which could add substantial revenues for the marketing segment. Downstream profitability PetroChinas R&M profitability has been very volatile historically due to the controlled pricing regime it operates under. Marketing makes stable profits, while refining has swung from big losses to reasonable profits. Overall, its return on segment assets is below 6% (on fixed assets closer to 10%), reflecting the challenged pricing environment. Future investments will also not likely generate much higher returns, depending on how pricing develops. New and larger scale assets may have greater profitability, but will come at higher capital cost, hence maintaining returns at relatively low levels. Downstream cash generation and capital intensity PetroChinas operating cash generation in downstream turned slightly positive in 2009 after more than an estimated $10 billion in negative free cash flow in 2008, from refining losses because NDRC did not permit higher product pricing. Operating cash flow in 2010 remained fairly stable as marketing margins improved while refining declined from 2009, but a lower capex spend for 2010 resulted in around $1 billion in free cash flow for the year. Due to relatively old and depreciated downstream assets on PetroChinas balance sheet, its capex to depreciation ratio is relatively high at 2x. It has been decreasing in recent years as segment depreciation has picked up more than capex. Going forward, we expect refining to be weak this year (losses for the full year) and depending on where oil prices go and NDRCs response to this, we expect a pick-up in refining next year, while marketing should turn in a normal stable profit. Slightly higher capex in 2011/12 versus 2010 will result in negative free cash flow in 2011 and possibly $1-2 billion in 2012 (normalized), according to our estimates.
Risk of losses decreasing due to pricing formula
Positive operating cash flow expected, but FCF will be only around US$1-2 bn normalized
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Figure 119: PetroChina - refining capacity (kbopd) & utilization (%)

3500 3000 2500 2000 83% 1500 81% 1000 500 0 2000 2001 2002
China
Figure 120: PetroChina - Number of refineries & average size (kbopd)

27 120 115 110 25 105 100 95 90 22 85 80 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
91% 89% 87% 85%
26
Refining capacity (kbopd)
24
23
79% 77% 75% 2003 2004 2005 2006 2007 2008 2009 2010
21
Rest of World
Number of ref ineries
Source: Company reports, J.P. Morgan estimates
Source Company reports, J.P. Morgan estimates
Figure 121: PetroChina - refinery yield and output / equity oil cover ratio (x)
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 120% 100% 80% 60% 40% 20% 0%
Figure 122: PetroChina - retailing network size & location

30,000
25,000 CAGR 5%
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Aviation fuel/Kerosene Middle distillates Other products
Gasolines Fuel oil Refining throughput / equity oil production

0,000 2000 2001 2002 2003 2004
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Rest of World
Figure 123: PetroChina - downstream profitability ($/bopd) & post-tax ROFA (%)
6.0 4.0 2.0 0.0 2000 -2.0 -4.0 -6.0 -8.0 -10.0 -12.0 -14.0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 20% 15% 10% 5% 0% -5% -10% -15% -20% -25% -30% -35% -40% -45% -50% -55%
Figure 124: PetroChina - downstream cash flow ($m) & capital intensity (x)
500 (500) (1,000) (1,500) (2,000) (2,500) (3,000) (3,500) (4,000) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0
Post-tax f ree cash flow ($m)
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Summary
Growing capacity to feed the dragon
PetroChina is moving in the opposite direction of IOCs by increasing downstream refining capacity, to match domestic petroleum product demand in China. Ideally, it wants to increase market share, especially in south/east China by adding marketing outlets in that part of China. Unfortunately, economics in China are very much in the hands of the regulator NDRC, which sets prices for transportation fuels. Prices are in theory set at cost plus, but recent higher oil prices have resulted in negative margins in refining. Marketing makes relatively stable margins and is a growth segment with upside from non-fuel sales. We do expect liberalization over the next couple of years, depending on where oil prices move. In order to be better prepared for the greater dependency on international crude for its growing refining capacity and to facilitate channels for excess products, PetroChina has in the last few years acquired refining and trading operations abroad. An increased exposure to international upstream has also been necessary, as domestic production is maturing and overall crude coverage declining. This should result in PetroChina becoming more influential in the international crude and product market over the next few years, in our view. Our R&M EV (as included in our PetroChina DCF value) is approximately $40 billion or HK$1.40 per share. This represents 19% of our total sum-of-the-parts value of around HK$7.50 per share. Under normalized circumstances (ie gross refining margin of around $5-6/bbl), we see downstream EBIT potential in 2012E of approximately $3.5bn assuming stable profitability in marketing. Adding annual downstream depreciation of around $3bn, this implies a 2012E EBITDA of $6.5bn and an EV/EBITDA multiple of 6.2x. In our view an EV/EBITDA multiple of 6.2x for a stable marketing business (half of EBIT) and, in theory, a stable refining business (cost plus formula) is not very demanding. However, the risk to refining profitability will continue to induce an overall multiple discount, until liberalization of product prices or lower stable oil prices brings this risk down. Also, the related investments into the segment for capacity growth will require profits to stay at these levels and grow with investments in order to maintain a slightly positive free cash flow position which is required to justify any value from this segment.
PetroChina becoming more international in both downstream and upstream
Normalized R&M EBITDA of around US$6-7 bn justifies our R&M EV value of around US$40 bn
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Sinopec Corp H
Overweight
Company Data Shares Outstanding (mn) Market Cap (Rmb mn) Market Cap ($ mn) Price (HK$) Date Of Price Free float (%) Avg Daily Volume (mn) Avg Daily Value (HK$ mn) Avg Daily Value ($ mn) HSCEI Exchange Rate Fiscal Year End 86,702 684,082 107,050 7.73 07 Sep 11 19.6% 205 1,098 141 10,347 7.79 Dec Sinopec Corp - H (Reuters: 0386.HK, Bloomberg: 386 HK) Rmb in mn, year-end Dec FY09A FY10A FY11E Revenue (Rmb mn) 1,345,052 1,913,182 2,634,625 Net Profit (Rmb mn) 61,760 71,800 79,816 EPS (Rmb) 0.71 0.83 0.92 DPS (Rmb) 0.18 0.21 0.23 Revenue Growth (%) (10%) 42% 38% EPS Growth (%) 117% 16% 11% ROCE 16% 19% 19% ROE 18% 18% 18% P/E 8.9 7.7 6.9 P/BV 1.5 1.3 1.1 EV/EBITDA 5.2 4.2 3.9 Dividend Yield 2.8% 3.3% 3.7%
FY12E 2,385,530 84,118 0.97 0.25 (9%) 5% 19% 16% 6.5 1.0 3.6 3.9%
FY13E 2,377,818 80,556 0.93 0.24 (0%) (4%) 16% 14% 6.8 0.9 3.3 3.7%
Downstream overview
Downstream contents & structure Sinopec is Asia's largest crude oil refiner and refined products producer and ranks 2nd globally (along with Exxon Mobil and RD Shell) in terms of primary distillation capacity. Sinopecs Refining & Marketing business is responsible for the supply and trading, refining, manufacturing, marketing and transportation of crude, petroleum and related services to wholesale and retail customers. Sinopec also has a relatively big downstream chemicals business which we exclude from this analysis. Sinopec's refineries are predominantly located around the south/east coastal region of China which is a legacy effect of the way the upstream and downstream assets were re-organised by the Chinese government (Sinopec was established in 1983 from the downstream assets of MPI (Ministry of Petroleum Industry) and the Ministry of Chemical Industry). As a result, the company's refining assets are located close to the major consumption centers, which helps it save on downstream transportation cost. In addition to domestic supply, Sinopec also exports some of its gasoline to Southeast Asia and Middle East. The company at present operates 34 refining units in China with a total refining capacity (end-2010) of 4.9 million bopd, of which 11 refineries have a capacity of over 200 kbopd. It also has the largest sales and distribution network for refined products in China, with retail, wholesale and direct sales operating under a unified Sinopec brand. Sinopecs downstream business is managed through two main groupings refining and marketing: Refining combines purchase of crude from Sinopecs E&P and third parties for feeding refineries and processing crude into refined products and selling the products to the marketing segment. Marketing consists of purchase of products from Sinopec's refining segment and third parties and marketing and distributing those products to wholesale and retail customers through its service network. Sinopecs refineries are better designed to run heavy crude compared to PetroChina, which is somewhat a reflection of the flagship crude fields of both the companies
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(PetroChinas Daqing produces light crude and Sinopecs Shengli produces heavier crude).
Downstream strategy
Sinopec will continue to add capacity primarily by brownfield expansion
Sinopecs downstream strategy is to maintain its foothold in its traditional South and South-East China markets as well as to expand into North/North-East China (which have traditionally been PetroChina strongholds). On its home turf, it faces added competition from PetroChinas capacity expansion plans and CNOOCs Huizhou refinery (in the Southern Guangdong province) which it is planning to expand in addition to two new planned refineries in Liaoning and Hebei provinces (North East and North China respectively). Sinopec plans to add capacity in the coastal regions to maintain its stronghold in those markets. However, the capacity addition is predominantly from debottlenecking and brownfield expansions. For Sinopec, being an SOE, securing the products supplies ranks over profitability, but Sinopec has recently increased its upstream focus to increase production and reserves and reduce earnings volatility. Downstream performance drivers Refining and marketing margins are the primary downstream performance drivers for Sinopec. At present China controls the pricing through its economic planning agency (NDRC) for diesel and gasoline (over 50% of the refining yield) at the retail and the wholesale level, effectively determining the marketing margins for the controlled products. Jet fuel prices have been recently aligned more closely to Singapore market prices. Under the current pricing mechanism, the product prices are adjusted if the moving average of crude prices moves +/-4% over a 22-day trading period. However, in practice the adjustments are done on an ad-hoc basis and in theory the transparency of this mechanism lends itself to market manipulation. To tackle these shortcomings we believe the window will be shortened and at some point pricing will be left to the market participants (draft of the proposed reforms was sent to the 3 SOEs for comments in June, but no timeline for change has been committed to). This liberalization will to a great extent depend on the path of oil prices in the next year or two. Sinopec normally maintains stable marketing segment EBIT of around Rmb30bn and adjusts for the margin volatility in the refining segment. We believe the refining segment can generate Rmb 20-25bn in an average year with less volatile refining margins. There is further upside from reforming the fuel-oil business by leveraging on the bonded bunker franchise license, as well as from the non-fuel business (Easy JOY stores) which have grown about 3x from around 5,000 stores in 2008 to over 15,000 in 2010 with similar growth in turnover. Downstream growth projects Sinopec will spend most of its efforts downstream in adding refining capacity by debottlenecking and brownfield expansion in the coastal China areas to face increasing competition from PetroChina. Sinopec will also look to revamp crude adaptability in the face of increasing volatility amongst crude spreads (eg China looking to reduce its purchase of West African crude grades; Cabinda, Hungo and Girassol in favor of similar Qatari Al-Shaheen grade, which is about $5/bbl cheaper).
R&M EBIT potential of around $7-8bn in an average year with crude prices under $100/bbl and controlled pricing
Upside from the non-fuel EASY JOY stores business which is growing at about 20-25% CAGR.
Sinopec to add 1.6 million bopd capacity over 2011-15
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Sinopec has plans to build a 300 kbopd green field refinery with Kuwait Petroleum in Zhanjiang, Guangdong province, for which it received NDRC approval in March, 2011. We understand Sinopec is pushing forward the construction date of this refinery to compete with PetroChinas 400 kbopd Jieyang refinery in Guangdong (still awaiting NDRC approval). Sinopec may also be looking to bring forward its 200 kbopd Tieshan refinery in Guangxi to compete with PetroChina's new Qinzhou refinery in Guangxi. It has also proposed a new 600 kbopd Lianyungang plant in Jiangsu for which a co-operation agreement was signed in June 2011 with the Jiangsu provincial government. Sinopec is also looking at construction of new retail stations, storage facilities and pipelines in its traditional coastal China markets to service the incremental demand and defend its leading position.
Table 12: China refining capacity addition Sinopec to add an estimated 1.6 million bopd cumulative capacity over 2011-15
(000 bopd) PetroChina Sinopec China overall 2011 180 238 748 2012 370 240 730 2013 250 530 780 2014 471 300 1010 2015 260 300 740 Total 1531 1608 4,008
Source: Company estimates, J.P. Morgan estimates
Sinopec Downstream Efficiency Overview

Sinopec is the worlds 2nd largest and Asias largest refiner
Refining scale and reach As of December 2010 Sinopec operated 34 refineries in China with a total primary distillation capacity of 4.9 million bopd. Sinopecs refining capacity has seen a steady rise over the last decade from 2.6 million bopd in 2000 to 4.9 million bopd at present. We expect its refining capacity to further increase to 6.5 million bopd by 2015 (Sinopecs target is 5.5-5.9 million bopd). The number of refineries Sinopec operates has increased from 25 in 2000 to 34 at present. The newer additions have been larger, bringing the overall average net refinery size from 105 kbopd in 2000 to 145 kbopd in 2010. Currently 11 of the 34 refineries Sinopec operates are of over 200 kbopd capacity (Zhenhai, Shanghai, Maoming, Guangzhou, Jinling, Yanshan, Gaoqiao, Qilu, Qingdaolianhua, Fujian and Tianjin). The bigger ones are also situated close to the biggest consumption centres (coastal region); the provinces of Shandong, Jiangsu, Zhejiang, Fujian, Guangdong (and the Shanghai and Tianjin municipality). The product marketing operations of Sinopec consist of three parts. First is the product retailing directly through service stations run by its marketing units. This accounts for about 63% of its GDK sales (by volume, GDK: Gasoline, Diesel, Kerosene). Second is the wholesale centers operated by the marketing units to supply oil products to designated agents and retail companies. This accounts for around 15% of its entire marketing business. The third comprises selling products to large customers (Direct sales) and this comprises around 23 % of its marketing business.
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Diesel yield at 36% is around twice that of gasoline.
Refining product yield and product / equity oil cover ratio Despite the almost 7% per annum refining throughput growth from 2000-2010, which has almost doubled the output from 2.1 million bopd in 2000 to 4.3 million bopd in 2010, Sinopecs refining slate has changed very little. Jet/Kero, diesel and gasoline account for about 60% of the products, with naphtha, lubes, LPG, fuel oil, asphalt etc accounting for the rest. In line with the consumption trends of China, the diesel yield at 36% is almost the double of gasoline yield at 17%. With equity oil production CAGR at 3% lagging that of the refining throughput (7% CAGR), the ratio of equity oil production to throughput has fallen from around 1/3 to 1/5th in the previous decade. Currently, Sinopec produces roughly 20% of its crude requirement internally and purchases the rest from the open market (CNOOCs domestic production accounts for another 3-4% and imports about 75%). To decrease its dependency on imported crude, Sinopec has been expanding its overseas upstream reach; most recently in Angola (listco), Nigeria-focused Addax Petroleum (by parent Sinopec Group), Brazil (via Repsol Sinopec JV again parent) and Argentina (via purchase of Occidental's Argentina assets by the parent). There are also reports of Sinopec and CNOOC considering forming a downstream alliance which would provide Sinopec with assured crude supply from CNOOCs increasing domestic production (in addition to the already existing trading JV: CNOOC-Sinopec United International Trading, owned 60%:40% by CNOOC and Sinopec respectively, for CNOOC's overseas crude imports). Retailing network Sinopec has the biggest downstream retailing network in China, with around 30,000 service stations. The company sells its products under a unified Sinopec Group brand. Moreover, around half of the total service stations have convenience stores (EASY JOY stores) which have seen around 25% per annum top-line growth in the past 2 years. Sinopec also has a cooperation agreement with McDonald for drivethrough fast food service. Sinopec also operates about 500 service stations with BP in the Zhejiang province, has a JV with RD Shell for operating service stations in Jiangsu province and a JV with Saudi Aramco for service stations in Fujian province. Sinopec plans to expand in the West China market, with plans to build around 500 gas stations in Xinjiang by 2015. Downstream profitability Sinopecs R&M profitability has been impacted historically due to the controlled pricing regime it operates under. Marketing makes stable profits, while refining bears the swings in margin volatility. However, the big change in downstream profitability came in when in 2009 NDRC changed the refined product pricing mechanism to "cost-plus", which basically swung the refining operating profit into positive in 2009/10 from losses in 2005-2008 period. Overall in 2010 the return on the segments net fixed assets was about 20%, which was about twice that of PetroChinas, reflecting the relatively higher profitability of the assets. Future profitability depends on the direction of pricing reforms, but in general the downstream returns are expected to be much better for Sinopec compared to PetroChina due to the better asset productivity and efficiency. In 2009-10 Sinopec has generated an average of US$4.1/bbl post tax per barrel of refinery throughput compared to PetroChinas average US$3.2/bbl.
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Equity oil production coverage is about 20%.
Sinopec has Chinas biggest retailing network and sells around half of the total products sold in China
Sinopec has relatively better downstream assets and profitability compared to PetroChina
Downstream cash generation and capital intensity Sinopecs estimated post tax free cash flow turned positive in 2009 after posting an estimated $5 billion in negative free cash flow in 2008, from refining losses on NDRC not pricing up products. We estimate Sinopec can generate about $7-8 billion R&M EBIT and around $3.5 billion free cash flow per year under less volatile and in a controlled pricing environment. Due to still some old refining assets and the addition of newer capacity (almost 40% growth in refining capacity over 2006-2010 period) the capex to depreciation ratio has been relatively high at an average 2.4x for the past five years. Going forward, we expect refining to be weak this year (break even for the full year) and depending on where oil prices go and NDRCs response to this, we expect next year to pick up in refining, while marketing should turn in a normal stable profit.
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Figure 125: Sinopec - refining capacity (kbopd) & utilization (%)

6,000 93% 91% 5,000 89%
Figure 126: Sinopec - Number of refineries & average size (kbopd)

40 35 30 135 25 20 83% 15 10 110 5 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 105 100 130 125 120 115 150 145 140
Refining capacity (kbopd)
4,000
87% 85%
3,000
2,000
81% 79%
1,000 77% 2000 2001 2002 2003

China
75% 2004 2005 2006 2007 2008 2009 2010
Number of ref ineries
Figure 127: Sinopec - refinery yield and output / equity oil cover ratio (x)
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2000 2001 2002 Other products Middle distillates Gasolines 2003 2004 2005 2006 2007 2008 2009 2010 Fuel oil Aviation fuel/Kerosene Refining throughput / equity oil production, right 500% 450% 400% 350% 300% 250% 200% 150% 100% 50% 0%
Figure 128: Sinopec - retailing network size & location

30,000 29,000 28,000 27,000 26,000 25,000 24,000 23,000 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
CAGR 2%
Retailing stations (Total)
Figure 129: Sinopec - downstream profitability ($/bopd) & post-tax ROFA (%)
6.0 5.0 4.0 3.0 2.0 1.0 0.0 2000 -1.0 -2.0 -3.0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 40% 35% 30% 25% 20% 15% 10% 5% 0% -5% -10% -15%
Figure 130: Sinopec - downstream cash flow ($m) & capital intensity (x)
5,000 4,000 3,000 2,000 1,000 2.5 (1,000) (2,000) (3,000) (4,000) (5,000) (6,000) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2.0 1.5 1.0 0.5 0.0 5.0 4.5 4.0 3.5 3.0
Post-tax f ree cash flow ($m)
Source: Company reports, J.P. Morgan estimates; 2008 includes a direct subsidy of Rmb40.5bn (US$6.2bn)
Source: Company reports, J.P. Morgan estimates; 2008 includes a direct subsidy of Rmb40.5bn (US$6.2bn)
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Summary
Growing capacity to feed the dragon
In common with PetroChina, Sinopec is also moving in the opposite direction of IOCs by increasing downstream refining capacity, to match domestic petroleum product demand in China. Ideally, it wants to increase market share, especially in north/north-east China, through adding marketing outlets in that part of China (and refineries). Unfortunately, economics in China are very much in the hands of regulator NDRC, setting prices for transport fuels. Prices are in theory set at cost plus, but recent higher oil prices have resulted in negative margins in refining. Marketing makes relatively stable margins and is a growth segment with upside from non-fuel sales. We do expect liberalization over the next couple of years, depending on where oil prices move. Sinopec has for many years had a strong international presence in the crude and product trading segment, done through Unipec (a subsidiary of its parent). Sinopec has, however, not acquired any downstream operating assets, while its parent has made some purchases upstream. Last year one of these was sold down to listco (Angolan assets), while the rest remains with its parent (Addax, Repsol JV in Brazil, Oxy assets in Argentina). Greater exposure to international upstream has been necessary, as domestic production is maturing and crude coverage declining from current low levels. Sinopec is an influential trader in the regional crude and product market due to its large crude requirements and at times import and export activities. Our R&M EV (as included in our Sinopecs PT) is approximately $50 billion or HK$3.5 per share. This represents 40% of our total sum-of-the-parts value of around HK$9.40 per share. Under normalized circumstances (ie GRM of around $5.56.5/bbl), we see downstream EBIT potential in 2012E of approximately $8 billion assuming stable profitability in marketing. Adding annual downstream depreciation of around $3bn, this implies a 2012E EBITDA of $11bn and an EV/EBITDA multiple of 4.5x. An EV/EBITDA multiple of 4.5x for a stable marketing business (half of EBIT) and in theory stable refining (cost plus formula) is not very demanding, but reflects the greater importance of R&M for Sinopec and the risk inherent in the current pricing regime. The risk to refining margins will continue to induce an overall multiple discount, until liberalization of product prices or lower stable oil prices brings this risk down. Also, the related investments into the segment for capacity growth will require profits to stay at these levels and grow with investments in order to maintain a positive free cash flow position which is required to justify value in this segment.
Sinopec is lagging PetroChina in internationalization downstream and upstream
Normalized R&M EBITDA of around US$11 bn more than justifies our R&M EV value of around US$50 bn
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India: Refining and Marketing structure

The retail fuel pricing environment in India is regulated by the government, with prices of major fuels (diesel, LPG, kerosene 58% of Indias oil product consumption) being subsidized to end consumers. The price of gasoline was deregulated in June last year, but is still subject to some degree of government intervention (as was seen by the absence of any price hikes during Jan-May 2011 a period with important state assembly elections).
Pricing of key auto (diesel) and cooking (kerosene/LPG) fuels are subsidized. Petrol pricing was de-regulated only in June 10.
The subsidy regime has been a cause of uncertainty in earnings, with profitability essentially linked to the level of government support paid out to compensate for losses on the subsidized fuels. Typically, the upstream SOEs (ONGC, Oil India and GAIL) are expected to share a certain percentage of these losses (as these upstream companies benefit from higher crude prices), with the government coming in with a larger share (usually over 50%), as the downstream SOE companies have a limited ability to absorb the losses.
Table 13: Subsidy losses (for fiscal year)
With high crude, subsidy losses have reached unsustainable levels, necessitating partial reform.
Rs bn Auto Fuel subsidy (Rs bn) Cooking Fuel Subsidy (Rs bn) TOTAL SUBSIDY (Rs bn) Upstream SOE share (Rs bn) Government share (Rs bn) Downstream SOE share (Rs bn)
Source: J.P. Morgan estimates, company data.
FY09 580 465 1045 320 713 12
FY10 140 320 460 140 260 60
FY11 351 429 780 301 410 69
FY12E 465 470 934 421 434 80
FY13E 113 339 452 271 126 55
As can be seen from the table above, the level of subsidies has reached critical levels, with crude prices remaining elevated. The government is also faced with fiscal deficit reduction targets that will be difficult to meet in the absence of price reforms. This is, however, balanced by the need to control inflation (at 9.44%) and related political concerns.
Figure 131: Crude levels implied by product prices
$120 $100 $80 $60 $40 $20 $0 Petrol
Source: J.P. Morgan estimates.
Diesel
LPG
Kerosene
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Table 14: Sensitivity of subsidies to crude (for fiscal year)

With only partial reforms carried out, high crude levels represent a drag on fuel marketing earnings. FY12E Rs bn Auto fuels Cooking fuels TOTAL SUBSIDY Upstream share Govt. share Downstream share
Source: J.P. Morgan estimates.
JPMe -$106.25 465 470 934 421 434 80
$100 322 418 741 333 327 80
$110 550 501 1,051 473 498 80
$115 664 542 1,206 543 583 80
The government has reacted to the high price of crude oil by de-regulating the price of petrol (June 2010). In addition, the price of diesel and LPG has been raised twice (June 2010 and June 2011), while kerosene prices were raised once. The government has a stated intention of freeing up the pricing of diesel, but has not set a timeframe for this to be implemented. In June, the government also cut excise/customs duties on crude/petroleum products, helping reduce absolute subsidy borne by the downstream companies, without raising consumer prices. However, we expect the government will scale back some level of subsidy support, with the upstream having to pay 4560% of the subsidy bill in FY12/13. The government has also announced plans to implement direct targeting of subsidies particularly for cooking fuels. Implementation of these schemes would be a big positive for fuel pricing reform in India. For now, the current subsidy regime (and ad-hoc nature of government compensation) does hamper investment plans for the downstream SOEs, and is the reason for the private sector scaling back its presence in the fuel marketing segment.
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Indian Oil Corporation

Neutral
Company Data Shares O/S (mn) Market Cap (Rs mn) Market Cap ($ mn) Price (Rs) Date Of Price Free float (%) 3-mth trading value (Rs mn) 3-mth trading value ($ mn) 3-mth trading volume (mn) BSE30 Exchange Rate Fiscal Year End 2,428 769,904 16,698 317.10 07 Sep 11 34.2 0.7 0.0 16,863 46.11 Mar Indian Oil Corporation Limited (Reuters: IOC.BO, Bloomberg: IOCL IN) Rs in mn, year-end Mar FY10A FY11A FY12E Revenue (Rs mn) 2,711,105 3,288,532 3,871,018 Net Profit (Rs bn) 102.2 74.5 45.2 EPS (Rs) 42.10 30.67 18.60 DPS (Rs) 12.63 9.20 5.58 Revenue Growth (%) -11.3% 21.3% 17.7% EPS growth (%) 240.4% -27.2% -39.3% ROCE 9.9% 8.6% 5.9% ROE 21.6% 14.1% 7.1% P/E 7.5 10.3 17.0 P/BV 1.5 1.4 1.1 EV/EBITDA 7.9 8.2 9.4 Dividend Yield 4.0% 2.9% 1.8%
FY13E 3,648,493 82.8 34.08 10.22 -5.8% 83.2% 10.9% 11.1% 9.3 1.0 5.7 3.2%
Downstream overview
IOC is a large refiner (largest in India including Chennai Petroleum) and runs the largest fuel retailing network in the country.
Downstream contents & structure IOCs downstream businesses are in the areas of crude refining, fuel marketing and petrochemicals production. IOC has the largest fuel retailing network in India. Refining: IOC runs eight refineries across India, with a combined capacity of ~1.1 million bopd. It also owns a significant stake in Chennai Petroleum (210 kbopd). Petrochemicals: IOC has a relatively small petrochemicals business, with one naphtha cracker and presence in polyester intermediaries (PTA/PX). Marketing: IOC runs the largest fuel retailing network in India, with ~19,500 outlets in total. The company has a dominant share in domestic fuel retail in India (Market share of 45%-65% for gasoline/diesel/LPG/kerosene).
Downstream strategy
IOC is incrementally raising capacity in refining, and is building a new refinery in eastern India. Petrochemicals capacity is being added as well.
Refining: IOC continues to invest in its refining assets, raising capacity/modernizing the refineries at Panipat and Haldia. In addition, IOC is also building a new refinery at Paradip on the east coast (~300 kbopd); this will make IOC Indias largest refining company. Marketing: The marketing business has been hampered by subsidized prices, and the need to bear a portion of the losses on the sale of retail fuels. However, with incremental reforms (petrol pricing has been de-regulated, while diesel / LPG / kerosene prices have been hiked), IOC continues to invest in its retail network, positioning for further fuel de-regulation. Petrochemicals: Petrochemicals is a focus area for IOC, as it allows a diversification away from retailing a business dogged by subsidized prices and periods of heavy losses. To this end, IOC has built a major petrochemicals facility at its Panipat refinery.
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Marketing remains a volatile business, with profitability determined by the extent of govt. support on subsidies.
Downstream performance drivers Key performance drivers of the downstream business are refining margins (which tend to move along with regional benchmarks) and the level of subsidies to be borne by the company (the extent of losses depends on the crude prices, level of price adjustment allowed by the Government of India and subsidy support from upstream SOEs, GoI). Key drivers on the petrochemical side are polymer and polyester intermediate spreads with the commissioning of the Panipat facilities. Downstream growth projects Downstream growth is to come from the completion of the Paradip refinery on the east coast, which is expected to have a capacity of 300 kbopd. While the company maintains that the project will be completed by March 2012, we expect most secondary units to come on-stream later.
IOC Downstream Efficiency Overview

Refining scale and reach IOC has a current nameplate capacity of ~1.1 million bopd across its eight directly operated refineries spread across India with large capacities in Western and Northern India. Increases in capacity have been through incremental additions to the existing portfolio through upgrade and expansions. This will change with the commissioning of the Paradip refinery (~300 kbopd) - while the company is targeting a March 2012 start-up, we believe secondary units could be delayed. Refining product yield and product While IOC does not disclose yearly product yields, the company enjoys dominant positions in the fuel market in India (market leader in domestic petrol / diesel / LPG / kerosene sales) its refining product slate largely mirrors this, and is focused on supplying the domestic market. Retailing network IOC has ~19,500 fuel retail outlets, the largest network in India. IOC enjoys a dominant position in fuel retailing, with shares of 45%-65% in gasoline / diesel / LPG / kerosene. However, with subsidized prices for diesel / LPG / kerosene, IOC incurs significant losses on sales. A key driver of profits/losses in the marketing business is the extent of government/upstream SOE support. Incremental pricing reforms (gasoline was de-regulated in June 2010, and diesel prices have been hiked twice over the last year) raise some hope of a move towards market-determined pricing for auto fuels in coming years. Downstream profitability As retail fuel (diesel / LPG / kerosene) prices are subsidized (petrol was de-regulated only in June last year), IOCs downstream profitability is closely linked to the level of compensation received from the government and the upstream SOEs (which benefit from higher crude). Years with high crude prices (and consequently high losses due to subsidies), such as FY09 and FY11, have seen low levels of overall profitability.
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Downstream cash generation and capital intensity While IOC has in most years generated positive cash flows (excluding working capital changes), the extent of these has been dependent more on compensation for fuel retailing losses than refining margins. Reinvestment has been healthy, with growth in the retail network (across the country), and upgrade/expansions carried out at various refineries (e.g the capacity at Panipat and Haldia was raised in recent years).
Figure 132: IOC refining capacity (kbopd) and utilization rate
1,200 105% 100% 1,000 95% 90% 85% 600 FY01 FY03 FY05 FY07 FY09 FY11 Refinery capacity (kbopd)
Source: J.P. Morgan estimates, Company data.
Figure 133: IOC - number of refineries and average size (kbopd)

150 9.0
100 8.0
800
50
80% Utilization rate
FY01 FY03 FY05 FY07 FY09 No. of refineries FY11 Average size (kbopd)
7.0
Figure 134: IOC - No. of retail outlets

20,000 16,000 12,000
Figure 135: IOC - downstream profitability ($/bbl) & post-tax ROFA

8 6 4 30% 25% 20% 15% 10% 5% 0% FY03 FY05 FY07 Net Income ($/bbl) FY09 ROFA FY11
8,000 4,000 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 Retail outlets
Source: Infraline, Company data.
2 0
Source: J.P. Morgan estimates, Company data. Note: US$/Re is average for fiscal year.
Figure 136: IOC - downstream cash flow ($m) & capital intensity
1,200 900 600 300 (300) (600) FY03 FY05 FY07 FY09 FY11 Post tax Free cash flow (US$ mn) Capex/depreciation 4.0 3.5 3.0 2.5 2.0
Source: J.P. Morgan estimates, Company data. Note: US$/Re is average for fiscal year.
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Summary
IOCs refining business is focused on the domestic market (feeding its own retail network), and IOC has maintained a leadership position in the retailing of various products. However, with the prices of key auto (diesel) and cooking (LPG / kerosene) fuels being subsidized, the marketing business is dependent on compensation for losses from the government and the upstream SOEs. Government support is unpredictable and this has caused swings in company profitability - also hampering investment decisions. As a result, IOC has tried to diversify away from this dependency on government policy through investments in other parts of the hydrocarbon chain - an investment in petrochemicals is amongst them, along with investments in E&P assets (Carabobo project in Venezuela among them). The company is also setting up a new refinery on the east coast (Paradip) which would add ~300 kbopd of capacity to the company. Petrol pricing has been de-regulated (though there remains an element of government control, as seen from the lack of price hikes from mid-January to mid-May this year), and diesel prices have been hiked 10-15% over the past year, raising hopes of a market-determined pricing regime - in such a scenario, IOC is well placed to capture significant incremental value. Our EV for IOC is $19.6bn (~$8.1/share). This includes value from the R&M, petrochemical and pipeline businesses. In addition, IOC has net cash/investments of $1.2/share, leading to our fair value of $9.3 (Rs420). We expect GRMs of $6/bbl over FY12/13E. We use an EV/EBITDA multiple of 6x for IOC this is at a discount to regional refining peers, which we feel is justified, given the continuing uncertainty over sharing of subsidies by downstream SOEs while we build in a sharing of Rs80bn/Rs55bn over FY12/13 for the downstream (implying 9-12% share), in a high crude environment, the government could expect the state-owned refiners to bear a larger loss.
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Reliance Industries Ltd

Overweight
Company Data Shares O/S (mn) Market Cap (Rs mn) Market Cap ($ mn) Price (Rs) Date Of Price Free float (%) 3-mth trading value (Rs mn) 3-mth trading value ($ mn) 3-mth trading volume (mn) IN 3,274 2,729,213 59,192 833.50 07 Sep 11 50.2% 2,307.97 50.06 1.38 Reliance Industries Ltd (Reuters: RELI.BO, Bloomberg: RIL IN) Rs in mn, year-end Mar FY10A FY11A FY12E Revenue (Rs mn) 2,037,400 2,658,106 3,132,220 Net Profit (Rs mn) 158,180.00 192,715.20 220,537.76 EPS (Rs) 53.12 64.65 73.98 DPS (Rs) 7.00 8.00 10.00 Revenue growth (%) 34.7% 30.5% 17.8% EPS growth (%) -4.2% 21.7% 14.4% ROCE 12.0% 13.0% 12.6% ROE 16.5% 17.5% 17.3% P/E 15.7 12.9 11.3 P/BV 2.4 2.1 1.8 EV/EBITDA 9.3 7.0 5.9 Dividend Yield 0.8% 1.0% 1.2%
FY13E 3,005,420 258,286.67 86.64 10.00 -4.1% 17.1% 13.3% 17.6% 9.6 1.6 5.1 1.2%
FY14E 2,946,670 293,954.39 98.61 10.00 -2.0% 13.8% 13.8% 17.5% 8.5 1.4 4.3 1.2%
Downstream overview
Downstream contents & structure RILs downstream businesses are concentrated in the areas of crude refining and petrochemicals production, in which the company enjoys a dominant position in India, and has achieved global scale. RIL also has a retail fuel network - however, this business is fairly small, due to regulated auto fuel pricing in India.
RIL runs the worlds largest single refining location at Jamnagar, and is a dominant player in the Indian petrochemicals market
Refining: RIL runs two mega-refineries at the Jamnagar refining complex, with a combined nameplate capacity of 1.24 million bopd (current utilization rates are ~110%). The two refineries have significant secondary processing facilities. The Nelson Complexity Index for the old refinery is 11.3 and the newer refinery has a NCI of 14 allowing RIL to process a variety of tough and sour crudes. The new refinery based in a special economic zone (SEZ) exports its entire output. Petrochemicals: RIL has a significant petrochemicals business, with 55-85% of Indian capacities across various products. RIL is among the largest producers of polyester fiber and yarn, polypropylene and paraxylene in the world. The company has fairly even revenue/earnings split between the polyester and polymer chains.
Downstream strategy
A focus on high demand, high value products has seen RIL consistently earn premiums over benchmark refining margins
Refining: RIL has focused on products with strong demand (particularly in Asia) such as diesel (diesel accounts for over 40% of its product slate) - it destroys or upgrades most of the low value-added fuel oil, to maximize margins. With its high secondary processing ability, RIL has consistently been able to deliver GRMs at a premium to benchmarks. While its refineries have a nameplate capacity of 1.24 million bopd, RIL has operated at rates consistently over this (105-110% utilization) maximizing the scale advantage its two giant refineries enjoy. A key component of RILs refining advantage is the low capital costs associated with its refineries - the new 580 kbopd refinery had a capital cost of $6bn ($10,400 per bpd). In terms of expansions, the company is setting up a petcoke gasification facility at the refinery, to generate revenue from the bottom of the barrel and is setting up off-gas-based petrochemical facilities.
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Petrochemicals is a focus area, and RIL is investing heavily to consolidate its leadership in India, and ensure global scale
Petrochemicals: Petrochemicals is a major focus area for RIL, with the company earmarking $12bn in investments for expansions over the next 4-5 years. A key theme is achieving global scale across a range of products. The company aims to bring these new capacities on-stream at a time when global capacity additions are expected to be muted, and margins stable. Downstream performance drivers Key performance drivers on the refining side are 1) middle distillate spreads diesel constitutes over 40% of the product slate 2) refining utilization levels - RIL consistently runs its assets at over 100% throughput and 3) light-heavy crude differentials. Given scale advantage, relatively new refineries (older refinery is 11 years old) and low labor costs RILs refining costs per bbl are very competitive (US$2.5/bbl) With an even split in production between the polyester and polymer chains, a key driver over the past few quarters on the petrochemicals side has been polyester margins. However, with a correction in cotton prices (and consequently across the polyester chain), earnings from this segment are moderating. A pick-up in polymers (our regional analysts expect a bottom in 2HCY11) should help buttress earnings. Downstream growth projects Downstream growth is largely restricted to the petchemicals business. RIL has planned $12bn of investments over the next 4-5 years (out of a company-wide investment of $19bn) with significant additions to PX, PE, MEG, PET and polyester fibre/yarn capacities.
Table 15: Petrochemical expansions

Plant/Project Ethylene + Propylene HDPE/LLDPE Paraxylene Poly Butadiene Rubber SBR PTA MEG PET PFY/Polyester Chip PSF/Acrylic Fibre/Chip Incremental Petrochem netback (JPMe) FY11 Petrochemical netback (JPMe)
Source: J.P. Morgan estimates, company data.
Current capacity (MTPA) 2,643,200 1,117,500 1,856,000 80,000 2,050,000 733,400 290,000 822,725 741,612
Expansion (MTPA) 1,500,000 1,000,000 1,800,000 35,000 150,000 2,300,000 700,000 650,000 400,000 300,000
% increase 57% 89% 97% 44% 112% 95% 224% 49% 40%
Incremental netback (based on FY11 prices) - Rsmn 39,825 34,425 1,122 2,827 29,498 18,585 4,388 10,260 5,063 145,991 146,982
RIL Downstream Efficiency Overview

Refining scale and reach RIL has a current nameplate capacity of 1.24 million bopd, across its two Jamnagar refineries, with the new refinery having begun operations in December 2008. At present, the company does not have any announced plans to further add significant refining capacity - incremental enhancements to production have taken place, with utilization rates reaching 105-110%.
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Refining product yield RILs product slate has a clear tilt towards diesel, which accounts for over 40% of output from both refineries diesel is a product that sees significant demand across Asia. The new refinery (export-oriented) has significantly raised RILs output of gasoline and also produces alkylates, while bringing down the proportion of LPG. Petcoke from the refinery will form the feedstock for a petcoke gasification facility which is being set up in Jamnagar. The two refineries have no production of fuel oil. Downstream profitability RIL has consistently delivered profits from its refining business, delivering better than industry average returns a function of consistently delivering better than benchmark refining margins. The high complexity of both refineries allows RIL to capture value through widening light-heavy differentials, along with a product skew towards high demand middle distillates. Downstream cash generation and capital intensity RIL has typically delivered reasonably large positive cash flows from its refining business excluding a period from FY05-08 (including negative cash flows in FY07), when investments were made in the new SEZ refinery. The investment in the new refinery was made through a separate entity (RPL, 75% owned by RIL), which later merged into RIL we have included the total capex impact on RIL in this discussion. With an uptick in margins over the past 12 months, the refining business is once again a key driver of company profitability. With both assets being relatively new, maintenance capex requirements have been comparatively small.
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Figure 137: RIL refining capacity (kbopd) and utilization rate (%)
1,400 1,200 1,000 800 600 400 FY01 FY03 FY05 FY07 FY09 FY11 Refinery capacity (kbopd)
Source: Company reports.
Figure 138: No. of refineries and average size (kbopd)

110% 105% 100% 95% 90% 85% 80% 400 FY01 FY03 FY05 FY07 FY09 FY11 Average size (kbopd)
Source: Company reports.
700
2.0 1.5 1.0
600
500
0.5 0.0 No. of refineries
Utilization rate
Figure 139: RIL - indicative refinery product yield

50% 40% 30% 20% 10% 0% Old New
Figure 140: RIL - downstream profitability ($/bbl) and post tax ROFA
10 8 6 4 2 0 FY03 FY05 FY07 FY09 ROFA FY11 Net Income ($/bbl) 50% 40% 30% 20% 10% 0%
Source: J.P. Morgan estimates, Company data. Note: US$/Re is average for fiscal year
Figure 141: RIL - downstream cashflow ($ mn) and capital intensity x)

2,500 1,500 500 6 (500) (1,500) (2,500) FY03 FY05 FY07 FY09 FY11 Post tax Free cash flow (US$ mn) Capex/depreciation 3 0 12 9
Source: J.P. Morgan estimates, Company data. Npte: US$/Re is average for fiscal year
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Summary
RIL's downstream businesses have been key profitability drivers over the past year, as the expected ramp-up in upstream natural gas production has been delayed. High complexity allows the refinery to realize a premium to regional benchmark Singapore GRMs. An even mix in production between polyester and polymers (whose cycles are not concurrent) allows for a certain level of profitability from the petrochemicals business - however, while these businesses may generate higher than average returns, they are not immune from cyclical slowdowns. In the refining business, RIL has focused on producing high demand products such as diesel - which enjoys healthy growth both in India (with product subsidies) and in the wider Asian region (the second refinery exports its output) - diesel spreads have remained robust, and coupled with wide light-heavy differentials, RIL has generated significant profits from refining.
Figure 142: RIL GRMs vs. Singapore GRMs
16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0
(US$/bbl)
2Q07
3Q07
4Q07
1Q08
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09
4Q09
1Q10
2Q10
3Q10
4Q10
1Q11
2Q11
3Q11
4Q11
Diff. (US$/bbl)
RIL GRMs
Singapore GRMs
Source: Company data, Bloomberg
In petrochemicals, RIL is concentrating on building global scale across a range of products, adding capacity in polyester yarn/fiber, polyester intermediary and polymer segments at a time when global capacity additions are expected to be small (less likelihood of supply overhangs, as seen in 2010/2011). Its presence across the polyester chain allows RIL to capture value across the chain, boosting profitability. Challenges for these businesses largely emanate from the risk of a renewed global slowdown, and on the polyester side, a correction in cotton prices, which has already seen some level of margin compression (though these remain above levels seen last year). We estimate an EV of $30.6bn for RILs refining business, and $21.5bn for petrochemicals, leading to a value of Rs717/share ($16/share). This represents ~60% of our SOTP valuation of Rs1200. We expect GRMs of $9.5-10/bbl over FY12/13. The stock price appears to price in a significant slowdown in the global economy reflecting GRMs of $6.5/bbl (low during GFC: $6.6/bbl; Singapore GRMs $2.7/bbl), along with a ~30% contraction in petrochemicals EBITDA, leading to an estimated contribution of ~Rs415/share ($9.2/share). The implied EV of the refining business is ~$16bn an EV/boe of $12,800, which we believe is unjustified, as RIL has consistently delivered superior margins to benchmark Singapore GRMs due to its high complexity and scale, cost economics. RIL also has significant scale across
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1Q12
various petrochemical products, and its even mix between polyester and polymer along with large level of integration allow for a more stable earnings stream from this business, which we believe justifies a premium valuation for the downstream business.
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Sasol
Overweight
Company Data Price (c) Date Of Price Price Target (c) Price Target End Date 52-week Range (c) Mkt Cap (R bn) Shares O/S (mn) 31,115 06 Sep 11 39,800 01 Aug 12 40,355 28,060 207.8 668 Sasol Ltd. (SOLJ.J;SOL SJ) FYE Jun Adj. EPS FY (R) EV/EBITDA FY Adj P/E FY EBITDA FY (R mn) EBITDA margin FY Revenue FY (R mn) OpFCF FY (R mn) FCF Yield FY 2010A 2,656.67 6.7 11.7 30,651 25.1% 122,256 5,181 2.7% 2011E 3,440.63 5.7 9.0 38,263 26.6% 144,011 122 -0.7% 2012E 3,772.72 5.3 8.2 42,574 28.1% 151,580 2,844 0.7% 2013E 4,788.39 4.3 6.5 50,923 30.5% 167,229 12,998 6.2%
Although the macro looks unappealing, Sasol is already discounting an oil price at $90 per barrel, in our view. In addition, the companys balance sheet strength, Rand hedge characteristics and improving internal drivers add to downside protection. Looking forward, Sasols burgeoning gas franchise and GTL technology offer longterm upside potential, in our view. Volumes Sasol should see the biggest uplift in volumes in a decade in 2012FY with the absence of major shutdowns and the feed in of additional gas from Mozambique to the Secunda plant. Gas Franchise - Sasol now has access to a burgeoning gas franchise which if fully developed as indicated by the company could lead to ~ 240,000 boepd of gas from Canadian shale by 2020 versus current production at Secunda of ~ 160,000 bopd. Sasols GTL technology ensures that even if natural gas prices stay low, a market for its Canadian resources can be guaranteed. Moreover, if oil and gas prices continue to remain disconnected, as seems likely, Sasol should benefit from increasing opportunities to build further GTL plants. Chemicals We expect a squeeze in chemical spreads in the near-term but supply constraint and structural changes in Chinese demand continue to suggest the cycle will tighten going forwards. Sasols under appreciated chemicals business should see EBIT recover from R 5.5bn in 2010 to ~ R 13.5bn by 2015. Management - We wait to see what track Sasol's new CEO (the first from outside the company) will take, but over time there is potential to adopt a more aggressive and dynamic strategy towards both cost cutting and M&A. Valuation - In uncertain times asset values and technicals provide useful guidance. Sasol is now trading on 1.45x our FY2012E book value versus its trough during the 2008 financial crisis of 1.50x. The stock is also trading at less than 50% of replacement cost and at close to an historical trough versus the spot rand oil price.
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GTL - Global Opportunity

Overview Shale gas has revolutionized the US energy landscape and an apparent abundance of gas and a paucity of oil have caused US oil and natural gas prices to decouple. With many expecting the shale revolution to spread to other parts of the globe there is increasing pressures not just on spot gas prices but on the extent of the linkage between oil and gas prices in long-term gas and LNG contracts. Unsurprisingly, under this scenario gas producers are increasingly looking at alternative options to increase the value of their gas resources.
Figure 143:Brent, US and UK gas prices in USD/bbl
Brent , Henry Hub and UK gas price in USD BOE
Figure 144: US HH gas futures as % of Brent oil price

40% 35% 30% 25% 20% 15% 10% 5% Apr-12 Apr-13 Apr-14 Oct-11 Oct-12 Oct-13 0% Apr-15 Apr-16 Apr-17 Apr-18 Apr-19 Oct-14 Oct-15 Oct-16 Oct-17 Oct-18 Oct-19 US Gas Future as % Oil Energy Parity
150 130 110 90 70 50 30 10

Dec-05 -10 Aug-06 Apr-07 Dec-07 Aug-08 Apr-09 Dec-09 Aug-10 Apr-11
US Nat Gas Price
Oil Price
UK Gas Price
Source: Bloomberg
Source: Bloomberg
GTL offers an arbitrage between gas and oil prices with GTL plants acting as gas refineries producing liquid fuels using gas feedstock. Consequently, GTL offers gas owners a product selling price guaranteed to be at a premium to the prevailing oil price. GTL has suffered its set backs but with questions over future LNG pricing, interest in the technology is coming to the fore. After a series of problems, Sasols 32,400 bpd Oryx plant has run at 80-90% capacity over the last 12 months and should report a RoIC of ~60% for the 2011FY and generate 10% of the companys EPS. Further debottle necking should increase Oryx capacity by 10% over the next year or so. RD Shells giant 140,000 bpd Pearl plant has sold its first cargoes and is ramping up production. Consequently, the technology risks surrounding GTL have largely dissipated in our view. From an economic perspective we estimate GTL can make > 10% RoIC with oil at USD 100/bbl, provided gas feedstock can be sourced at < $4 per mmbtu. In our view there should be plenty of remote gas available at ~ $4 per mmbtu or less and longterm oil prices look secure at ~ $100 per barrel. Moreover, our analysis suggests that GTL is preferable to LNG to monetize gas unless the selling price of the LNG is greater than 55-60% of oil parity. In conclusion, we view the economics of GTL as similar to oil sands in-terms of its position on the oil cost curve. The technology has many advantages over LNG in terms of reduced product risk and can also be used in land locked locations.
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Table 16: Recoverable gas resources and indicative production cost by type and region
Conventional TCM USD/MBTU 136 2 to 6 116 2 to 7 33 4 to 8 45 3 to 9 23 3 to 8 28 3 to 7 22 4 to 9 404 2 to 9 TCM 11 9 20 16 15 9 84 Tight Gas USD/MBTU 3 to 7 4 to 8 4 to 8 3 to 7 3 to 7 3 to 8 TCM 14 51 55 35 29 16 204 Shale USD/MBTU CBM TCM 83 12 21 USD/MBTU 3 to 6 3 to 8 3 to 8
E. Europe & Eurasia Middle East Asia/ Pac OECD N America Lat Am Africa OECD Europe World
Source: IEA
3 to 7
3 to 7
118
3 to 8
How big could GTL be?

Currently, the market for GTL is relatively small with less than 100,000 bpdof products being produced globally from dedicated gas fed GTL plants. Moreover, although Sasol and a number of smaller players have plans for a number of new plants, given the construction time lines, it is unlikely that GTL will have a material impact on liquid fuel volumes until well into the next decade. European middle distillates imports are expected to increase from ~ 1.1 million bopd to ~ 1.4 million bpd by 2016 according to the IEA. Consequently, RD Shell and Sasol combined would be supplying only ~7% of European supply even if all the production from their respective Qatari plants was exported into Europe. However, this not to say the potential for a greater expansion of GTL is not there. If gas resources are available at an economic price - and with shale gas expansion that looks likely - then there should be potential for a significant ramp-up in GTL projects. In our view, GTL is competitive with oil sands as a source of liquid fuels and consequently we see the potential at up to one million bpd by 2030 (IEA 2011 forecast 750,000 bpd). To take things to the extreme, we calculate the US could entirely remove its dependence on importing 5.6 million bpd of OPEC oil if it converted 0.5 TCM a year of gas into GTL products. Clearly, that would involve a massive infrastructure investment and require a huge amount of gas but assessments of US resources continue to move upwards. In addition, the IEA suggests that if half the worlds flared gas was converted to fuels using GTL, an extra 700,000 bpd of liquid product could be produced. The flared gas market is one which a number of companies are targeting via smaller modular GTL plants of below 3,000 bpd, with Velocys/ Oxford catalyst looking at floating GTL projects and due to test a facility with Petrobras later this year.
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Table 17: GTL plants existing and planned

Company Sasol/ QP PetroSA RD Shell RD Shell Sasol/ Chevron Sasol/ Petronas/ Uzbekneftegaz Sasol/ Talisman Sasol/ QP Smaller Scale Players Velocys Compact CGTL Syntroleum Rentech
Source: J.P. Morgan, Company data
Project Oryx Mossel Bay Bintulu Pearl Escravos Uzbekistan Farrell Creek Oryx expansion
Size bbl/d 32,400 36,000 14,600 140,000 32,400 38,000 48,000 96,000 66,000
Status Running at 80-90% Running out of feedstock Running at >95% Ramping up first 70,000 bpd phase Terrorist activity has forced up costs and delayed startup now expected to start up in 2014 Feasibility study nearly completed decision on progression to next phase to be taken before year end Feasibility study underway expected to take until end of 2012 CY Current moratorium on further expansion in Qatar Small demonstration with Petrobras Small demonstration with Petrobras Demonstration scale Demonstration scale
Existing Commercial GTL Plants
Planned Major GTL Plants
Sasols competitive position

With coal to liquids projects now firmly on the back burner, Sasol views GTL as the companys future and has been buying up shale gas assets in order to provide security of supply for GTL projects and to act as a hedge should natural gas prices rise and negate the gas-oil arbitrage, which GTL relies on. We believe Sasol has now ironed out many of the production issues which dogged the start-up of its Oryx plant. The slurry phase process should offer capex cost advantages over RD Shells fixed bed process and is better suited to smaller gas deposits. Provided the dis-connect between gas and oil prices is maintained we see a bright future for GTL. Sasol has several projects in the pipeline and whilst it is difficult to speculate beyond these, it is reasonable to assume that, provided the oil gas price ratios remain attractive, Sasol projects could generate ~ 450,000 bpd of GTL by 2030.
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Overview of GTL
Process and Chemistry Gas to liquids plants can be thought of essentially as Gas Refineries using natural gas as opposed to oil as the feedstock to produce liquid fuels. Simplistically, the GTL process involves three steps: 1) Gas reforming: The manufacture of syngas (a mix of carbon monoxide and hydrogen) by the partial oxidation of purified natural gas. CH4 + O2 CO + 2H2 2) FisherTropsch Synthesis: Syngas is catalytically reformed into a mixture of long chain hydrocarbons. nCO + (2n +1) H2 CnH2n+2 + H2O 3) Product Work-Up: The hydrocarbon mixture is separated and processed into various products e.g. diesel, gasoline, naphtha, LPG, waxes, olefins etc.
Figure 145: GTL Schematic
Source: Sasol
Technology Considerations Fisher-Tropsch synthesis is a process which dates from the 1930s and hence is not a new technology. However, like most chemical processes a significant amount of work has been done over time to improve overall yields and product specificity. Depending on reaction conditions i.e. reactor design, temperature, pressure and catalyst used, different hydrocarbon mixtures can be produced and hence plant conditions can be designed to yield differing quantities of diesel, gasoline or chemical feedstock as required. Generally speaking, GTL plants have more flexibility on end product slate than conventional refineries. Whilst many companies have GTL pilot plants or small scale demonstration reactors currently only three companies run commercial scale GTL plants of any scale: Sasol, RD Shell and the South African government owned PetroSA. Sasol and RD Shell are clearly leading the globalization of GTL via their large scale Oryx and Pearl GTL
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projects in Qatar. Both companies are using low temperature F-T processes utilizing cobalt catalysts designed to raise yields of middle distillates and particularly diesel. However, there are important differences between both companies approach.
RD Shell
RD Shells GTL plants use what it calls the Shell Middle Distillate Syntheses process. (SMDS). The process utilizes fixed bed multi tubular reactors and these are used at its 14,700 bpd Bintulu plant in Malaysia and at its 140,000 bpd Pearl plant in Qatar. These reactors consist of thousands of narrow tubes with cobalt catalyst inside. Gas is injected into the top of the reactor and passed down the tubes and reacts with the catalyst contained within. The waxy reaction products are collected at the bottom of the reactor and further processed into the desired hydrocarbon fractions. RD Shell has been using fixed bed reactors successfully for a long period of time, notably at its Bintulu plant in Malaysia, and they have a number of advantages. Chief amongst these are reliability and ease of operation. In addition, the performance of fixed bed reactors can be predicted with reasonable certainty from pilot plant reactors. RD Shells Bintulu plant has run at operating rates close to 100% for many years. In addition, scale up is relatively easy via the addition of more tubes to each reactor and by adding further reactors. Catalyst improvements also increase capacity by raising activity levels. Pearls reactors have ~ 13% more tubes (29,0000 each) than at Bintulu and catalyst improvements mean each reactor will produce 5,800 bpd versus 3,600 bpd at Bintulu. Importantly, in the process there is complete separation of catalyst and product which eliminates the need for complex catalyst and product separation, and ensures minimal catalyst losses and product contamination. The simplicity of design and operating track record at Bintula has enabled RD Shells Pearl plant to start up in good time and it has begun to sell its first cargoes of product. However, there are limitations and disadvantages with fixed bed reactors. The interaction of catalyst with syngas is limited by the design which can slow the reaction rate and hinder product specificity. This means large numbers of tubes have to be used to scale up production, and output per ton of reactor is lower than in other systems and capex costs are consequently higher. Catalyst loading/ unloading can be difficult although RD Shells catalyst should be able to be regenerated and has a three year life expectancy.
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Figure 146:Pearl fixed bed reactor
Figure 147:Pearl GTL - product slate
36% 21% 25% 18%
Gasoil
Base oil
Kerosene
Naphtha
Source: RD Shell
Source: Shell
Sasol
Sasol has been operating commercial F-T plants for longer than any other firm and has run the full gambit of reactor designs and catalyst types. Currently, Sasol runs a mixture of fluidized bed and slurry phase reactors in South Africa. The advantage of these types of reactor is that they allow for greater interaction between catalyst and syngas, and hence higher degrees of conversion per unit size of reactor and hence lower capex and construction costs. Sasols latest design is based on a low temperature slurry phase reactor using cobalt catalysts. This design allows for very high catalyst - syngas interaction since the catalyst is suspended in liquid wax with gas bubbled through the slurry. This design allows for high conversion to wax, good product specificity and smaller unit reactor size. Sasols Oryx slurry phase reactors are 60m high and weigh 2,200tons and have name plate capacity of 7.3 bpd per ton of reactor. This compares to Shells Pearl fixed bed reactors which are 20m high, weigh 1,200 tons and have name plate capacity of 4.8 bpd per ton of reactor. There are however practical issues with the use of slurry phase reactors and their use was for a long time held up by problems associated with separating the wax products from the catalyst. The separation issue is made more acute by the tendency of the catalyst to break-up into small pieces (fines) under attrition caused by the turbulent conditions inside slurry phase reactors. Sasol thought it had solved the problem after pilot plant tests but when its 32,400 bpd Oryx plant started up in Q2 2007, catalyst attrition led to clogging of the filtration units and the plant had to be shut down and then run at low operating rates to allow for effective filtration. Sasol has since refined operating conditions and strengthened its catalysts, with the result that performance and service life have improved significantly. For the 2011FY, Oryx is expected to run at ~ 80-90% utilization and barring scheduled shut downs should run at ~ 90% in 2012FY. De-bottle necking is expected to add 10% to effective capacity over the next couple of years.
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Figure 148: Slurry phase reactor
Figure 149:Sasol Oryx product slate
75%
15% Diesel Naphtha
10% LPG
Source: Sasol/ J.P. Morgan
Source: Oxford Catalysts
The Oryx reactors are ~ 16,200 bpd units, but Sasol is targeting 24,000 bpd from the same sized reactors with its improved catalysts with a line of sight to > 30,000 bpd. From an operating cost perspective, Sasol expects to get catalyst costs down by 50% going forwards and changes to reformation technology should also cut syngas plant capex costs by ~ 20%. Improvements to unit costs should help capex and construction costs to be kept under control.
Costs
Costs are key for GTL plants and particularly capex and gas feedstock costs. Historically, company estimates of capex and operating costs have proved light versus actual experience. Sasols Oryx plant cost ~ $1bn and although it had technical difficulties and much higher operating costs than expected, it was constructed at a cost reasonably close to its initial budget. RD Shells Pearl plant on the other hand was originally supposed to cost $6bn but ended up close to $20bn and Sasols Nigerian GTL plant, of the same size as Oryx, has seen huge cost escalation and is now expected to cost close to ~ $10bn. The estimated returns of Oryx and Pearl are indicated below assuming a $100 per barrel oil price and a $10 per barrel product spread. Oryxs returns are boosted by its relatively low construction costs. Conversely, its higher operating cost are due to higher catalyst attrition rates, higher utility costs and higher feedstock costs due to purchase of gas and utilities over the fence. RD Shell has lower operating costs due to scale and its back integrated into the upstream allows for very cheap feedstock and utility costs. RD Shell is yet to show operating and financial statistics, so estimates are based on company presentations and JPM estimates as opposed to actual reported figures. Sasol has a 49% share in Oryx with 51% owned by QP. RD Shell has 100% ownership of Pearl but has an upstream production sharing agreement with Qatar. The Pearl projects returns are boosted significantly through the production of 120,000 bpd of condensate, the impact of which is not shown in our analysis.
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Table 18: GTL plant costs and returns assuming oil at USD 100/bbl and a product spread of USD 10/bbl. Assumes plants run at 100% of design capacity.
EPC Start-up Capacity Cost USDm Capex Cost per $/bbl Depreciation $/bbl Gas cost $/bbl Employee Costs $/bbl Utilities $/bbl Maintenance/ Other $/bbl Catalyst/ Other $/bbl Total Costs USD/bbl Margin Pre Tax Project RoIC Pre-tax RoIC to Sasol/ RD Shell2 Oryx GTL est 2003 2007 32,400 1,040 32,099 7 10 5.1 7.0 4.0 7.0 40 64% 80% 80% Pearl GTL est 2006 2011 140,000 15,7701 112,643 15 3 2.5 2.0 3.5 2.0 28 75% 27% 16% New Sasol GTL Plant est 48,000 4,800 100,000 14 26.0 5.0 5.0 5.0 4.0 59 46% 19% 19%
Source: J.P. Morgan, Sasol, Shell. 1) Assumes 83% of Pearl cost GTL, 10% Processing/ Condensate and 7% Upstream. 2) RD Shell has PSA agreement with QP which reduces returns. Returns for Pearl assessed on just the GTL component
The costs of building new GTL plants are highly location specific. We currently estimate Sasols construction costs at 2-3x the cost of the original Oryx plant at the same location. We believe there are several advantages to the Sasol technology versus RD Shells which should lead to lower capex costs per unit of production. Sasols more complex technology has obviously suffered from operating/ reliability issues, hopefully these are now largely behind the company. Sasol is investigating building new GTL plants in a number of different locations but perhaps the most interesting is in Canada based off of shale gas. GTL plants economics depend largely on capex costs, feed stock costs and end selling price assumptions. Our model suggests, assuming oil at $100 per barrel and capex costs at $100,000 per barrel, that a post tax RoIC > 10% is possible assuming gas feed stock costs of up to $4 per mmbtu. With shale extraction costs continuing to fall and conventional extraction costs typically considerably below $4 per mmbtu, this should mean there are ample locations with gas extraction costs which make GTL viable.
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Table 19: GTL Model based on prospective 48,000bbl/d Sasol plant in Canada
Pricing Assumptions Brent USD/bbl Refining margin Price of Diesel USD/b Low Sulphur Premium Price of Low Sulphur Diesel Naptha Spread Price of Naptha USD/b Average Product Selling Price Capacity and Capex Assumptions Utilisation Project size bbl/d Production bbl/d GTL Diesel bbl/d GTL Naphtha Capex Cost USD/bbl Total Investment USDm Tons CO2 produced per bbl Costs per USD/ bbl Gas Cost USD per MMBtu Conversion efficiency Cost of gas USD/bbl Depreciation per USD/bbl Labour USD/bbl Maintenance USD/bbl Utilities USD/bbl Catalysts / Other USD/bbl CO2 costs Total Op Costs Total Costs USD/ bbl
Source: J.P. Morgan
100 8 108 1.5 109.5 3 103 108 100% 48,000 36,000 12,000 48,000 100,000 4,800 0.22 2.7 10 26.1 13.7 5 5 5 4 0 19 59
Operating & Production Stats Total Gas used 25 years TCF Gas used per year bn BTU Gas used mmBTU Efficiency Barrels a year produced Revenue & Profitability Diesel USDm Naphtha USDm Total Sales USDm Cost of gas USDm Other operating costs USDm Depreciation USDm Total Costs USDm EBIT USDm Margin % Investment USDm Returns Pre Tax Year 1 RoIC Post Tax Year 1 RoIC Pre Tax IRR Post Tax IRR
4.2 169 101,616,000 60% 17,520,000 1439 451 1,890 457 333 240 1030 860 45% 4,800
18% 13% 15% 13%
Figure 150: IRR at different levels of Capex cost

IRR at USD 100/bbl gas at USD 2.7/ BTU
25% 20% 15% 10% 5% 0% 70,000 80,000 90,000 100,000 110,000 120,000 130,000 140,000 Capex Cost USD bbl
Figure 151: Ratio of Oil Price in USD bbl to Input Gas Price in USD BTU to make IRR of 10%
140 130
Oil Price USD bbl
7.0 6.0
Gas Prices USD BTU
120 110 100 90 80 70 10% 10% 10%

Oil Price
5.0 4.0 3.0 2.0 1.0 0.0 10% 10% 10% 10% 10% 10% 10%
Feedstock US Gas Price
Source: J.P. Morgan
Source: J.P. Morgan
Environmental Issues
CO2 GTL plants are not very energy efficient ~ 60% and whilst they emit significantly less CO2 than CTL plants they still emit meaningful amounts of CO2 and far higher
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amounts than an ordinary refinery in the production process. However, on a Well-toWheel basis, GTL plants emit comparable amounts of CO2 to an ordinary refinery given the benefits derived from the higher quality fuel slate produced by a GTL plant. Hence, in theory, GTL plants should not suffer any material additional costs from CO2 legislation versus an ordinary refinery. There may well also be methods of reducing / capturing GTL CO2 emissions.
Figure 152: Environmental Emission GTL vs Refinery diesel Figure 153: CO2 emissions comparison of Sasols Natref refinery and Oryx plant Well to-Wheel basis
CO2 Production Extraction + Emissions process Kgs of transport to Kgs/bbl CO2/bbl refinery Natref Oryx
Source: J.P. Morgan/ Sasol
Combustion Total Wellto-Wheel 60 20 400 280 503 520
43 220
Source: Sasol
Product quality The products produced via the GTL process are extremely pure and almost devoid of sulphur and the diesel is of particularly high quality with a high cetane number. This enables marketers of GTL products to achieve a premium over and above that achieved for ordinary low sulphur diesel and naphtha.
GTL versus LNG

GTL effectively competes with pipeline and LNG as a route to getting stranded gas to market. Five years ago there was, similar to today, great excitement about the potential for GTL. At one point Sasol was predicting that with its partners it would have 450,000 bpd of GTL in production by 2014. In fact, even if Escravos (Nigerian GTL plant) is running flat out by 2014, the maximum Sasol will have with partners is ~68,000 bpd. The problem has been that resource owners have preferred to commit gas assets to LNG projects as opposed to GTL. The reasoning behind this has been the lower capex cost of LNG, the simpler and more proven nature of the technology and most importantly the fact that LNG customers have been prepared to lock in long-term LNG contracts at prices close to oil parity - essentially negating the economic point of GTL. However, with a wave of new technologies unlocking unconventional (shale, CBM, FLNG, tight gas) gas reserves, the outlook might be changing as gas supply threatens to outstrip demand. Consequently, whilst we think a link to oil prices will likely remain in many LNG contracts, the slope or ratio of oil price to LNG contract price looks under threat and increasingly LNG customers are turning to the spot market and locking in less under long-term contract. We note that India and Pakistan in particular have been keen to shift away from oil indexation and have been using a mixture of oil and Henry Hub prices in some of their LNG contracts. Consequently, we believe it will become increasingly difficult for LNG producers to get close to oil parity for their gas. This should favour GTL as a competing technology to monetize the gas.
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GTL vs LNG A Canadian Comparison Assessing the economics of different LNG and GTL plants in different locations is very difficult. However, one location where both LNG and GTL are being proposed is Western Canada. Apache and EOG are looking to build an LNG export facility at Kitimat 400miles north of Vancouver on the BC coast to be fed from Horn River shale gas. Whereas Sasol/ Talisman are looking a GTL plant supplied by Montney shale gas.
Figure 154: Canadian LNG vs GTL
Source: Petroleum economist
A final investment decision on Kitimat is expected some time this year, but initial estimates of costs from Apache were $3.0bn for the 5 million ton pa facility with $1.1bn for associated pipelines. This looks a little light to us given recent cost inflation and Canadas weather-related construction issues. We would estimate realistic costs in 2011 money at $5.1bn for a 5 million ton pa LNG plant and associated pipeline or roughly $800 per ton of liquefaction capacity. For a GTL 48,000 bpd we would estimate capex costs at $100,000 bpd (~3x the cost of Oryx) Assessing capex and operating costs for different plants is fraught with potential for error and the experience at Oryx has been that operating cost are far higher than at first expected. However, Oryxs costs are coming down and we believe for a new GTL plant of Oryx next generation design operating costs per bbl should be ~$18-20 per bbl. Our analysis suggests that a year one post tax RoIC of 10% can be made with oil at $90/bbl for a GTL plant based off Canadian shale gas. In terms of whether LNG or GTL is the better option for monetizing gas will ultimately depend on what selling price is achieved for the LNG. Given that Kitimat is likely to be serving the Asian LNG market it may well be that LNG proves to be the more economic outlet. Our analysis suggest that LNG from Kitimat would have to be priced at ~55% of energy parity with oil, equivalent to $8.6 per mmbtu to make a10% year one RoIC. Energy parity of 55% is equivalent to a 13% discount to oil price parity, roughly in-line with what our Australian analysts are forecasting for new long-term LNG contract prices to Asia from the new raft of Australian LNG projects. This is, however, still some way from the ~90% parity being seen until recently and hence it may well be that LNG proves the better option.
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Table 20: GTL vs LNG based on British Columbia Shale Gas

Total Feedstock TCF (for 25yrs) Feedstock requirement BCF/year Carbon efficiency Effective Gas Feed MMBTU/year Production mbbl/yr /Mt/yr Capacity per bbl/d - MMBTU/d Depreciable Life Time Capital Cost USD per bbl/d - MMBTU/d Capital Cost USDm total Capital Charge per bbl/d - MMBTU/d Operating costs per bb/d USDMMBTU Input Gas cost USD/BTU Gas cost per project (bbl equv btu) Transportation/ Re Gas Total Costs Per BBL/ MMBTU Selling Prices Gas Per BTU US Crude Diesel spread Naptha spread Low Sulphur Premium Sales USD Costs USD EBIT USD Pre- Tax RoIC Post Tax RoIC
Source: J.P. Morgan
GTL 4.2 169 60% 101,616,000 17,520,000 48,000 20 100,000 4,800 13.7 19 2.7 27 60 GTL 90 8 3 1.5 1,688 (1,030) 658 14% 10%
LNG 7.2 288 90% 259,000,000 5.00 667,123 20 7,645 5,100 1.0 0.5 2.7 1.5 5.7 LNG 8.6
2,099 (1,400) 699 14% 10%
Whether the economics of GTL/ LNG stacks up relative to selling gas into the US market remains to be seen. Our model suggests that at $100/bbl oil, if Henry Hub prices are above $5.25 per mmbtu then the better option would be to just sell the gas into the US market and not bother building a GTL plant. However, todays Henry Hub price is some 30% below that level.
Figure 155:GTL vs LNG economics based off of BC shale gas
12.0
Figure 156: Pipe to the US vs GTL/LNG economics

9.00
10.0
LNG Favoured
8.00
LNG PriceUSD/BTU
Henry Hub price USD/BTU
Pipeline favoured
8.0
7.00 6.00 5.00 4.00 3.00
6.0
GTL Favoured
4.0
GTL/ LNG Favoured
2.0
GTL vs LNG
0.0 50 60 70 80 90 100 110 120
Pipeline vs GTL/ LNG

82 85 89 92 95 99 102 105 109 112 115 118 122 125
2.00
Oil Prices USD/bbl
Oil Price USD/bbl
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Appendix I: Downstream performance analysis

Avoid complex measures of downstream performance
In this section, we define the key downstream performance metrics and, where appropriate, highlight their pros and cons. As per our approach upstream, we avoid complex and derived measures of performance. In a complicated sector we always find that investors want a simple explanation of what matters and an easy line of sight thereto. As per Table 21, whilst all companies include refining, fuels retailing, wholesale marketing and lubricants, some also include speciality chemicals whilst others exclude certain logistics and shipping from their reported downstream segment results.
Table 21: Downstream segment configuration

PetroChina Reliance Industries Petorbras RD Shell Chevron Sinopec
Essar Energy
TOTAL
Repsol YPF
Statoil
Exxon Mobil
GALP
OMV
DOWNSTREAM SEGMENT CONFIGURATION
Refining Fuels retailing Wholesale marketing Lubricants Pipelines, terminals Shipping Trading LPG Petrochemicals
SEGMENT EXPOSURE
Market leader
Significant exposure
Some exposure
IOC
ENI
BP
No exposure
Make the best of poor disclosure levels
From an investor perspective, the downstream industry suffers from generally poor levels of public disclosure e.g. segment profits are not disaggregated into refining, marketing, lubricants etc, there are different definitions of capital employed and working capital disclosures are very limited. Underlying costs for refineries are rarely disclosed by any company on a regular basis. This is in contrast to the upstream where SEC regulations enforce much fuller, systemmatic annual disclosures. As a result, it is more difficult to benchmark downstream performance than upstream performance. Indeed, we can but feel less than satisfied with the insights that we can provide - we are disclosure constrained. Given the downstream data that is available and comparable, we focus on the following eight metrics:
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Capital efficiency return on net fixed assets. Profitability and cash flow net profit per barrel of refining throughput, capital expenditure to depreciation ratio, free cash flow per barrel of refining throughput. Volume average net size of refinery, refinery utilization, refinery throughput to equity oil production and retail network churn. The following tables summarize the data for the 11-year period 2000-10 (for some companies, data is not available for all years). This 11-year observation period captures a multi-year upcycle in refining margins (2002-07), followed by a two-year downcycle (2008-09) and the subsequent modest recovery. In each year, we show the group average and identify the worst-performing (colored red) and best-performing (colored blue) companies. We rank each company based on their score in each year and, where appropriate, over the entire 11-year period. The score is the sum of the scores in each year based on the number of standard deviations from the groups average this sets the overall ranking. We rank the OECD and non-OECD companies separately. CAPITAL EFFICIENCY BASED METRICS
Fixed assets are a good capital employed proxy
Return on net fixed assets Ideally, we would like to measure express capital efficiency as a post-tax return on total downstream capital employed. Unfortunately, companies disclose capital employed using different definitions (net versus operating, pre-tax versus post-tax). So, to enable a more meaningful comparison using a very common disclosure, we calculate a net return on downstream net fixed assets. We acknowledge that this may mis-state measured returns since it excludes working capital (primarily crude oil and refined product inventories). However, we believe that it is a useful measure of downstream capital productivity. Furthermore, there is not necessarily a material difference between net fixed assets and capital employed. As we show in Figure 157, for Exxon Mobil year-end net fixed assets and average capital employed in Refining & Marketing have been quite similar. Over the period 2000-10, its fixed assets have been on average 12% higher than capital employed. So, in our view downstream net fixed assets are a reasonable proxy for downstream capital employed.
Figure 157: Exxon Mobil - R&M net fixed assets & capital employed $m
35,000 130% 30,000 125%
120% 25,000 115% 20,000 110% 15,000 105% 10,000 100%
5,000
95%
0,000 2000 2001 2002 2003 Net fixed assets ($m) 2004 2005 2006 2007 2008 2009 2010 Capital employed ($m) NFA / CE (x, RHA)
90%
We note that OMV has generated the lowest ROFA in six of the eleven years under observation. With the exception of OMV and Repsol YPF PetroChina, we also note robust 2000-2010 average ROFAs for all of the companies.
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Table 22: Post-tax return on net fixed assets

Post tax return on net fixed assets (% ) BP Chevron ENI Exxon Mobil GALP OMV Repsol YPF RD Shell Statoil TOTAL Average STDEV Average 2000-10 2000 18% 9% 22% 13% 4% 7% 14% 10% 21% 13% 6% 14% 2001 19% 15% 22% 17% 11% 8% 14% 10% 21% 16% 5% 2002 7% 0% 8% 5% 6% 5% 7% 4% 8% 6% 2% 2003 12% 13% 14% 12% 11% 7% 9% 10% 16% 11% 3% 2004 19% 29% 20% 21% 15% 15% 10% 19% 11% 24% 20% 6% 2005 19% 24% 27% 28% 19% 8% 14% 22% 28% 26% 22% 7% 2006 18% 35% 17% 29% 23% 4% 10% 20% 20% 22% 21% 9% 2007 13% 30% 7% 32% 17% 3% 10% 17% 16% 21% 18% 9% 2008 11% 24% 11% 28% 15% 12% 12% 15% 18% 19% 17% 6% 2009 11% 3% (4)% 6% 3% (3)% 4% 4% 8% 6% 5% 5% 2010 14% 17% (1)% 12% 5% 3% 6% 6% 13% 8% 9% 6% Score 1.7 4.2 (1.5) 6.0 (2.8) (13.0) (11.1) (2.2) (2.0) 7.2 Rank 4 3 5 2 8 10 9 7 6 1 Average 15% 18% 13% 18% 14% 7% 8% 13% 14% 17%
Post tax return on net fixed assets (%) RIL IOC Sinopec Petrochina Petrobras Average STDEV Average 2000-10 2000 7% (8)% 24% 6% 16% 10% 2001 3% (2)% 28% 8% 16% 2002 11% 25% 8% 2% 12% 9% 8% 2003 16% 27% 9% 4% 20% 12% 9% 2004 25% 14% 9% 9% 9% 10% 7% 2005 24% 14% 4% (14)% 16% 6% 15% 2006 32% 18% 2% (20)% 17% 6% 20% 2007 41% 19% 14% (12)% 12% 10% 19% 2008 17% 11% (12)% (50)% (4)% -12% 26% 2009 11% 19% 33% 13% 15% 18% 9% 2010 17% 14% 19% 9% 4% 10% 6% Score 8.3 7.3 2.1 (9.5) 3.7 Rank 1 2 4 5 3 Average 21% 18% 9% -6% 14%
Figure 158: Dispersion of returns and profit per barrel

22%
2000-10 9%, $1.5
Sinopec
17%
2000-10 Chevron 21%, $4.6 RIL 2000-10 BP 18%, $3.2 2000-10 18%, $2.6 2000-10 18%, $4.3 2000-10 -6%, -$1.2
Petrochina TOTAL RD Shell GALP IOC
2000-10 15%, $3.9

Statoil
12% ROFA (2010) (%)
Exxon Mobil
2000-10 14%, $6.3
2000-10 17%, $2.8

7%
2000-10 14%, $3.7

Repsol YPF
2000-10 13%, $3.4
2000-10 14%, $2.5
2000-10 8%, $3.9
Petrobras
2000-10 13%. $2.3

-1.5 ENI -0.5
2%
2000-10 6%, $2.4
OMV
0.5 -3%
1.5
2.5
3.5
Net fixed assets $67.2bn
4.5
5.5
Net income per throughput (2010) ($/bbl)
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PROFITABILITY & CASH FLOW BASED METRICS

Sinopec has the worlds largest downstream earnings
Figure 159 shows the post-tax earnings in 2010 of the OECD and non-OECD names. Some investors may be surprised to see that Sinopec generated the largest downstream earnings and BPs downstream earnings exceeded Exxon Mobils. Furthermore, Sinopec has delivered an impressive downstream earnings CAGR 2000-2010 of 22%.
Figure 159: Downstream earnings in 2010 ($m) and 2000-10 downstream earnings CAGR (%) *
6,000 22% profit 2000-10 CAGR
5,000
4,000
1% 0%
3,000
4% NM 8% -3%
2,000
5%
6%
19%
-3%
1,000 3% 6% 0,000 8% NM NM
-1,000
Source: J.P. Morgan. * Profit CAGRs for RIL and IOC are calculated 2002-2010.
Net profit per barrel of refinery throughput Since refineries hold and consume most of downstream capital and for most downstream players are the source of product from which margins are made, we believe that a good holistic measure of downstream profitability and one that neutralizes for operational scale ties downstream post-tax profits to annual refinery throughput.
We look for profit augmentation beyond the refinery gate
Clearly, profits will be generated outside refineries (retailing, lubricants marketing etc) and consume less capital employed than refining. A downstream portfolio skewed away from refining is a positive and desirable attribute that will bolster a companys score and ranking on this measure. For companies that do not report in US dollars, we have converted from the reporting currency (, Real etc) to US dollar using the annual average FX rate. For companies that do not report post-tax earnings (i.e. only disclose EBIT), we have estimated a notional tax rate based on the geographical mix of statutory tax rate exposures. We note that BP generated the highest unit profits in four of the eleven years and ranks second overall amongst the OECD names behind Statoil. We note that PetroChina has generated the lowest unit profits in ten of the eleven years.
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Table 23: Net income per refinery throughput barrel ($/bbl)

Net income per refinery throughput barrel ($/bbl) BP Chevron ENI Exxon Mobil GALP OMV Repsol YPF RD Shell Statoil TOTAL Average STDEV Average 2000-10 Low 2000 3.8 1.5 3.2 1.7 1.0 2.1 2.5 2.6 4.2 2.3 2.3 1.0 3.4 1.0 2001 4.1 2.6 3.1 2.1 0.9 2.8 2.6 2.6 4.0 2.3 2.6 0.9 0.9 2002 1.7 0.0 1.3 0.7 2.1 1.4 1.6 1.6 1.8 0.9 1.1 0.6 0.0 2003 3.1 2.1 3.0 1.7 3.0 2.5 2.6 2.2 3.5 1.8 2.2 0.6 1.7 2004 5.0 4.6 4.2 3.0 2.8 4.7 3.7 4.6 4.9 3.2 3.8 0.8 2.8 2005 4.9 4.1 5.3 3.8 3.2 5.4 6.2 5.3 10.6 4.1 4.5 2.1 3.2 2006 5.3 5.8 3.6 4.1 3.4 2.8 4.3 5.3 8.8 3.9 4.6 1.7 2.8 2007 4.0 5.4 1.7 4.7 2.9 3.0 5.1 5.2 8.1 3.9 4.6 1.8 1.7 2008 3.4 4.7 3.2 4.1 4.6 7.3 6.5 4.7 13.0 4.4 4.5 2.9 3.2 2009 3.5 0.7 (2.0) 0.9 1.1 (1.5) 2.7 1.6 4.3 1.7 1.5 2.0 -2.0 2010 4.4 3.6 (0.9) 1.9 2.4 2.6 4.9 2.1 5.9 2.1 2.6 1.9 -0.9 Score 9.0 (0.6) (2.2) (4.9) (3.8) 0.1 5.0 3.0 21.5 (3.0) Rank 2 6 7 10 9 5 3 4 1 8 Average 3.9 3.2 2.3 2.6 2.5 3.0 3.9 3.4 6.3 2.8
Net income per refinery throughput barrel ($/bbl) RIL IOC Sinopec Petrochina Petrobras Average STDEV Average 2000-10 2000 1.0 (1.5) 3.5 0.8 2.5 2.4 2001 0.6 (0.4) 3.8 1.1 2.2 2002 1.9 4.5 1.8 0.5 1.4 1.7 1.5 2003 2.8 5.1 2.1 0.7 3.2 2.4 1.6 2004 4.2 3.5 1.9 1.6 1.8 2.2 1.1 2005 4.9 3.5 0.6 (2.6) 4.1 1.2 3.1 2006 6.0 4.2 0.4 (3.7) 4.9 1.1 4.0 2007 9.0 5.2 2.3 (2.6) 5.1 2.5 4.3 2008 7.2 2.8 (2.3) (11.3) (1.4) -3.1 6.9 2009 2.3 5.3 4.7 3.6 10.5 5.3 3.1 2010 3.5 4.4 3.5 2.8 4.0 3.5 0.6 Score 6.5 9.1 (1.0) (10.5) 7.5 Rank 3 1 4 5 2 Average 4.6 4.3 1.5 (1.2) 3.7
Capex to depreciation is a health check for asset integrity spend
Capital expenditure: depreciation ratio Under-investment can flatter downstream free cash flow generation and earnings (a lack of asset renewal will allow depreciation to run down over time). This can endanger operational reliability with potentially catastrophic consequences which, in turn, can trigger a period of much higher capital expenditure to improve asset integrity. So, we look at this measure as an indicator of asset integrity as well as a lead indicator of new asset formation. We note that GALP ranked lowest in the OECD group 2002 to 2007 and has since played catch-up. Clearly, the rates of downstream investment of the non-OECD names are much higher than the OECD names.
Table 24: Capital expenditure / depreciation (x)

Capex / depreciation (x) BP Chevron ENI Exxon Mobil GALP OMV Repsol YPF RD Shell Statoil TOTAL Average STDEV Average 2000-10
Capex / depreciation (x) RIL IOC Sinopec Petrochina Petrobras Average STDEV Average 2000-10 2000 3.1 2.2 1.6 2.5 0.8 2.6 2001 3.5 2.0 1.7 2.7 1.0 2002 0.8 2.4 1.7 1.6 2.4 1.8 0.6 2003 1.4 2.2 1.9 1.6 2.7 1.9 0.5 2004 0.9 3.5 3.1 2.0 2.6 2.5 1.0 2005 3.4 2.2 3.1 1.8 1.8 2.4 0.7 2006 11.2 2.2 2.9 1.6 2.1 2.9 4.1 2007 4.4 2.6 2.4 2.4 3.9 2.9 1.0 2008 3.0 3.9 2.0 1.0 4.8 2.3 1.5 2009 0.3 2.8 2.0 2.4 8.7 3.1 3.2 2010 0.3 3.0 2.7 2.0 14.0 3.8 5.5 Score (0.1) 2.5 1.6 (5.7) 5.6 Rank 4 2 3 5 1 Average 2.9 2.8 2.6 1.9 4.2
2000 4.9 1.7 1.1 0.9 0.6 2.3 1.0 0.5 1.6 1.1 1.7 1.3 1.6
2001 1.2 2.1 1.0 1.0 0.8 1.5 1.0 0.9 0.4 1.2 1.2 0.4
2002 2.9 1.5 1.1 1.1 0.5 2.0 0.9 3.2 1.0 1.2 2.1 0.9
2003 1.4 1.0 1.5 1.2 0.8 4.2 1.1 0.8 1.1 1.4 1.2 1.0
2004 1.2 1.3 1.5 0.9 0.7 1.9 1.9 0.8 2.6 1.4 1.2 0.6
2005 1.2 2.1 1.4 1.0 0.7 2.6 1.5 1.0 0.8 1.5 1.3 0.6
2006 1.4 2.8 1.5 1.2 0.7 5.3 1.2 1.3 1.3 1.2 1.5 1.4
2007 2.3 2.9 1.6 1.4 1.0 3.7 3.2 1.5 1.7 1.3 1.9 0.9
2008 3.0 3.4 1.6 1.5 7.5 2.5 2.1 1.4 4.0 1.8 2.2 1.8
2009 1.8 3.2 1.7 1.4 2.2 0.9 2.4 1.2 1.9 2.1 1.7 0.7
2010 1.8 2.2 2.1 1.1 4.1 2.9 1.7 1.1 1.8 1.4 1.6 0.9
Score 4.6 8.4 (1.0) (5.0) (1.1) 12.6 1.8 (4.0) (0.3) (1.1)
Rank 3 2 6 10 7 1 4 9 5 8
Average 2.1 2.2 1.5 1.2 1.8 2.7 1.7 1.2 1.7 1.4
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Of note, the downstream capex to depreciation ratio for all the OECD names is not very different to their upstream capex to depreciation rate (Figure 160). In 2010, both segments showed a ratio of around 1.5x.
Figure 160: Upstream versus Downstream Capex to Depreciation (OECD names only)
2.5
2.0
1.5
1.0
0.5
0.0 2000 2001 2002 2003 2004 Upstream 2005 2006 Downstream 2007 2008 2009 2010
Source: J.P. Morgan. * Upstream capex is development plus net acquisition expenditures.
Downstream must support the dividend
Free cash flow generation per barrel of refinery throughput - The downstream, like any business, must earn its keep and return an appropriate level of free cash flow to the integrated owner, not least to be accorded value and to contribute to the group's dividend. We derive a simple measure of free cash flow as net income plus depreciation less capital expenditure. All that we are missing is changes to downstream working capital, but over many years this effect should not be significant. In order to neutralize for operational scale when comparing one company to another, we divide this parameter by refinery throughput to derive a $ per bbl cash flow metric (as per our earnings metric). Clearly, OMV has shown the most consistently weak net free cash flow generation of the group of OECD names. Of note, Statoil ranks first and RD Shell second when measured over the eleven year period.
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Table 25: Free cash flow per refinery throughput barrel ($/bbl)
Free cash flow per throughput barrel ($/bbl) BP Chevron ENI Exxon Mobil GALP OMV Repsol YPF RD Shell Statoil TOTAL Average STDEV Average 2000-10
Free cash flow per throughput barrel ($/bbl) RIL IOC Sinopec Petrochina Petrobras Average STDEV Average 2000-10 2000 (0.5) (1.2) 1.1 (0.1) 1.2 (0.2) 2001 (0.9) (0.6) 1.3 (0.1) 1.2 2002 0.8 1.0 0.3 (0.1) 0.2 0.3 0.5 2003 0.8 1.3 0.3 (0.1) 0.6 0.5 0.5 2004 1.6 (0.0) (0.3) 0.0 0.1 0.1 0.7 2005 0.5 0.6 (0.7) (1.4) 1.2 (0.2) 1.0 2006 (3.5) 0.8 (0.7) (1.8) 1.2 (0.6) 1.9 2007 1.0 0.9 (0.0) (1.9) (0.1) (0.3) 1.1 2008 1.3 (0.5) (1.4) (4.1) (3.3) (2.2) 2.2 2009 1.2 0.9 1.1 (0.3) (0.7) 0.4 0.9 2010 1.6 0.3 0.3 (0.3) (6.0) (0.8) 3.0 Total 7.4 7.4 (0.3) (7.8) 1.3 Rank 1 2 4 5 3
2000 (1.5) 0.1 0.8 0.6 0.9 (0.1) 0.9 1.4 1.0 0.8 0.5 0.8 0.6
2001 1.3 0.4 0.9 0.8 0.6 0.5 0.9 1.0 1.9 0.8 0.9 0.5
2002 (1.3) (0.3) 0.3 0.2 1.3 (0.2) 0.6 (0.8) 0.6 0.3 (0.2) 0.8
2003 0.8 0.8 0.4 0.6 1.3 (1.1) 0.9 0.9 1.2 0.5 0.7 0.7
2004 1.6 1.5 0.7 1.1 1.4 0.4 0.6 1.8 0.3 0.9 1.3 0.5
2005 1.6 0.9 1.2 1.4 1.5 (0.1) 1.9 1.9 4.1 1.2 1.5 1.1
2006 1.5 1.2 0.7 1.4 1.6 (2.8) 1.4 1.7 2.8 1.3 1.3 1.5
2007 0.0 0.8 0.1 1.5 1.1 (2.1) 0.9 1.5 1.6 1.3 1.1 1.1
2008 (0.8) 0.3 0.5 1.3 (4.8) 0.4 1.2 1.4 (0.1) 1.0 0.7 1.8
2009 0.4 (1.0) (1.0) 0.2 (1.2) (0.1) (0.6) 0.4 0.1 (0.3) (0.1) 0.6
2010 0.9 0.6 (0.8) 0.6 (2.6) (2.0) 0.6 0.7 0.9 0.4 0.5 1.3
Total (2.4) (3.6) (4.5) 1.2 (4.1) (14.9) 0.7 4.3 7.3 (0.4)
Rank 6 7 9 3 8 10 4 2 1 5
VOLUME & SCALE BASED METRICS

Refinery size is a driver of profitability..
Average net size of refinery As we have highlighted in our summary of downstream competitive advantages, the profitability and returns from a well run refinery are greater if the refinery is larger rather than smaller. The data in Table 26 shows the average size of each companys refinery. We have taken net refining capacity and divided that by the number of refinery interests this penalizes companies with small, minority interests. As we have highlighted, refining capacity growth 2011-2016 is characterized by ever larger facilities. This will leave smaller (higher unit cost) plants more disadvantaged, emphasizing the need for companies to focus their refinery portfolios on large units. RD Shell's portfolio has shown the smallest average refinery size in almost of year.
Table 26: Average size of refinery

Average size of refinery (kbopd) BP Chevron ENI Exxon Mobil GALP OMV Repsol YPF RD Shell Statoil TOTAL Average STDEV 2000 114 98 95 146 155 131 121 67 89 95 103 28 2001 135 98 90 145 155 131 131 69 89 96 106 29 2002 130 95 82 146 155 131 103 80 89 95 107 27 2003 124 109 76 154 155 123 103 78 89 96 108 28 2004 149 111 98 154 155 123 103 82 89 96 114 28 2005 149 111 98 155 155 106 103 84 89 100 115 27 2006 157 107 98 176 155 106 103 80 89 100 117 33 2007 163 107 101 175 155 106 103 86 89 104 120 32 2008 158 114 103 173 155 104 110 88 89 104 122 31 2009 167 130 103 173 155 104 110 89 89 104 125 32 2010 167 130 103 174 155 104 116 100 89 98 128 31 Score 11.6 (1.8) (7.3) 17.0 15.1 0.5 (1.9) (12.3) (9.6) (5.9) Rank 3 5 8 1 2 4 6 10 9 7
Average size of refinery (kbopd) RIL IOC Sinopec Petrochina Petrobras Average STDEV 2000 542 98 105 83 133 109 196 2001 542 103 105 85 133 110 196 2002 643 106 107 86 135 113 239 2003 663 106 110 90 140 117 247 2004 663 106 120 87 142 119 246 2005 663 110 124 93 141 123 245 2006 663 125 131 99 148 130 241 2007 663 125 135 99 144 131 241 2008 663 125 127 99 148 128 241 2009 623 129 134 103 148 138 222 2010 623 136 145 114 148 146 218 Score 24.3 (0.4) (0.1) (1.4) 0.9 Rank 1 4 3 5 2
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.as is refinery utilization
Refinery utilization - Refineries, like most industrial plants, have relatively high fixed costs. So, their profitability is partly indexed to plant load factor or refinery utilization. This is measured as annual refinery crude throughput to nameplate operating capacity. We grade companies accordingly. This is an indicator of management efficiency, robust plant integrity (a well maintained refinery should not experience material unplanned outages) and market requirements (strong demand will consistently pull product through the system). Statoil has shown the highest utilization rate in five of the eleven years under observation. GALP ranks last in the OECD group with an average utilization of just 80% versus 87% for the group. Overall, Reliance Industries is the clear leader with an average utilization of 98%.
Table 27: Average refinery utilization (%)

Average refinery utilisation (% ) BP Chevron ENI Exxon Mobil GALP OMV Repsol YPF RD Shell Statoil TOTAL Average (%) STDEV Average 2000-10
Average refinery utilisation (%) RIL IOC Sinopec Petrochina Petrobras Average (%) STDEV Average 2000-10 2000 95% 85% 81% 78% 79% 81% 7% 89% 2001 107% 83% 78% 80% 84% 82% 12% 2002 89% 83% 79% 78% 84% 82% 4% 2003 92% 89% 82% 84% 82% 84% 5% 2004 100% 87% 86% 89% 86% 88% 6% 2005 93% 88% 91% 88% 87% 89% 2% 2006 96% 89% 91% 84% 85% 88% 5% 2007 96% 95% 90% 87% 91% 91% 4% 2008 100% 103% 82% 90% 87% 88% 9% 2009 100% 99% 80% 85% 89% 87% 9% 2010 105% 98% 86% 83% 90% 89% 9% Score 19.2 7.0 (2.2) (3.9) (1.4) Rank 1 2 4 5 3 Average 98% 91% 84% 84% 86%
2000 95% 91% 91% 90% 75% 88% 84% 91% 92% 94% 91% 6% 87%
2001 92% 92% 93% 89% 81% 94% 85% 89% 91% 96% 90% 4%
2002 89% 93% 95% 87% 76% 95% 85% 88% 90% 88% 88% 5%
2003 91% 94% 88% 88% 82% 95% 86% 92% 96% 92% 90% 4%
2004 92% 91% 85% 90% 84% 94% 89% 93% 95% 93% 91% 4%
2005 85% 88% 88% 90% 86% 90% 89% 93% 95% 88% 89% 3%
2006 78% 91% 86% 88% 87% 92% 90% 89% 95% 88% 88% 5%
2007 77% 89% 82% 88% 81% 85% 91% 88% 93% 87% 87% 5%
2008 80% 90% 77% 87% 79% 86% 92% 85% 90% 88% 86% 5%
2009 86% 90% 74% 86% 69% 82% 80% 76% 88% 83% 83% 7%
2010 91% 91% 75% 84% 75% 76% 80% 82% 85% 85% 84% 6%
Score (3.4) 5.8 (6.8) (0.2) (18.1) 2.9 (2.9) 0.7 9.6 2.9
Rank 8 2 9 6 10 4 7 5 1 3
Average 87% 91% 85% 88% 80% 89% 87% 88% 92% 89%
Refinery throughput: equity oil production This is the ratio of annual refinery throughput to equity oil production. It gives a useful sense of how biased a company's operations are to upstream, specifically oil (ratio < 1) or downstream (ratio > 1). Given our bearish outlook for refining margins, we prefer companies which are long upstream and thus show a ratio close to or less than one. Whatever an investors preference, they can use this metric to steer their investment choices. This ratio highlights a clear winner (ENI) and a clear loser (Repsol YPF).
Table 28: Refinery throughput / equity oil production (%)
Refinery throughput / equity oil production (% ) BP Chevron ENI Exxon Mobil OMV Repsol YPF RD Shell TOTAL Average STDEV
Refinery throughput / equity oil production (% ) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
2000 145% 96% 104% 221% 420% 158% 140% 168% 154% 104%
2001 135% 100% 88% 218% 453% 156% 146% 170% 152% 116%
2002 139% 102% 67% 218% 465% 179% 165% 148% 153% 122%
2003 128% 100% 61% 219% 450% 179% 166% 149% 152% 119%
2004 103% 104% 73% 222% 459% 193% 173% 147% 150% 122%
2005 94% 102% 70% 227% 266% 208% 175% 149% 148% 70%
2006 88% 106% 71% 209% 290% 212% 176% 163% 147% 74%
2007 88% 102% 73% 213% 276% 233% 184% 160% 149% 74%
2008 90% 110% 70% 225% 268% 282% 176% 162% 152% 80%
2009 90% 100% 69% 224% 248% 248% 166% 156% 144% 72%
2010 102% 98% 70% 217% 227% 236% 172% 155% 146% 64%
Score 5.5 5.9 9.6 (8.9) (22.3) (8.2) (2.5) (1.0)
Rank 3 2 1 7 8 6 5 4
Reliance Industries Limited IOC Sinopec Petrochina Petrobras
314% 72% 89%
277% 74% 91%
286% 74% 84%
316% 82% 78%
359% 87% 83%
382% 91% 77%
413% 94% 83%
413% 98% 86%
425% 98% 81%
446% 98% 79%
473% 105% 77%
Figure 161: Refinery utilization, capacity and average size

7000
6000
2000-10 88%
Exxon Mobil
5000 Refinery capacity 2010 (kbopd)
Sinopec
2000-10 84%
4000
2000-10 88%
3000
RD Shell
2000-10 Petrochina 84%

TOTAL
BP Petrobras Chevron
2000-10 87% 2000-10 91% 2000-10 91%
Average refinery size 623 kbopd
2000
2000-10 85%
1000 ENI
2000-10 89% 2000-10 Repsol YPF 87% 2000-10 89%

80%
2000-10 86%
IOC
RIL
2000-10 98%
2000-10 OMV GALP 80%

0 70% 75%
Statoil 85%
2000-10 92%
90% Refinery utilization 2010 (%) 95% 100% 105% 110%
We look for healthy retail churn we prefer OECD names to focus and non-OECD names to capture growth efficiently
Retail network management Integrated oil companies can gather assets like a ship gathers barnacles. Some companies just sit on their assets regardless, citing long-term strategic benefits of retained ownership, so opting for scale rather than value and efficiency. Other companies are simply better at churning their assets to right-size and optimize their portfolios and to exploit variations in the asset pricing cycle. This releases capital for efficient redeployment, back to the business or to shareholders. We believe that the concept of a global fuels retailer, present in most countries, is a flawed strategic aspiration - retailers must focus. As per Figure 162, RD Shell has the world's largest fuels retail network.
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Figure 162: Scale of retail networks (YE 2010) & 2000-10 network CAGR
45,000 -1.3 % CAGR '00-10 40,000
35,000 1.7 % -2.7 % 25,000 7.2 % 20,000 4.7 % -0.8 %
30,000
1.2 % -6.5 %
15,000
10,000
-1.7 % 7.3 % 1.3 % 1.3 % 1,539
5,000 1,233
Retail sites at YE 2010
* For IOC CAGR is calculated for 2003-10
So, we examine which have managed down their retailing exposure best from 200010. We score and rank each company on the average rate of network shrinkage measured over 2000-10. We prefer OECD companies that release capital from their retail networks and focus their market positions. Conversely, we look for non-OECD companies that successfully capture market growth via efficient network expansion.
Table 29: Retail network size
Marketing outlets at year end BP Chevron ENI Exxon Mobil GALP OMV Repsol YPF RD Shell Statoil TOTAL Total Y-o-Y growth 11 year marketing outlet CAGR 2000 29,000 20,349 12,085 45,001 1,353 1,136 7,224 48,830 2,006 18,957 185,941 (3)% 2001 26,800 20,404 11,707 42,853 1,310 1,160 6,636 48,347 1,889 18,051 179,157 (4)% 2002 29,200 20,368 10,762 41,786 1,181 1,232 6,629 47,868 1,883 17,755 178,664 (0)% 2003 27,800 19,615 10,647 39,488 1,148 1,782 6,614 47,394 1,989 17,284 173,761 (3)% 2004 26,500 20,220 9,140 37,374 1,154 1,773 6,913 46,925 1,984 16,857 168,840 (3)% 2005 24,600 20,354 6,282 35,432 1,123 2,451 6,853 45,765 1,998 16,976 161,834 (4)% 2006 23,900 20,493 6,294 33,848 1,108 2,540 6,806 44,725 1,803 16,534 158,051 (2)% 2007 23,300 19,657 6,440 32,386 1,100 2,538 6,514 45,160 2,477 16,497 156,069 (1)% 2008 22,600 19,457 5,956 28,674 1,605 2,528 5,818 44,605 2,426 16,425 150,094 (4)% 2009 22,400 16,350 5,986 27,720 1,549 2,433 5,838 43,912 2,297 16,299 144,784 (4)% 2010 22,100 14,638 6,167 26,278 1,539 2,291 5,818 42,816 1,233 17,490 140,370 (3)% CAGR (2.7)% (3.2)% (6.5)% (5.2)% 1.3% 7.3% (2.1)% (1.3)% (4.8)% (0.8)% Rank 5 4 1 2 9 10 6 7 3 8
Marketing outlets at year end RIL IOC Sinopec Petrochina Petrobras Total Y-o-Y growth 2003-10 year marketing outlet CAG R 2% 2000 25,493 11,350 7,000 43,843 2001 28,246 12,102 7,261 47,609 9% 2002 28,127 13,160 7,120 48,407 2% 2003 0 11,926 30,242 15,231 6,998 64,397 33% 2004 0 13,528 30,063 17,403 8,331 69,325 8% 2005 0 15,275 29,647 18,164 6,933 70,019 1% 2006 0 16,607 28,801 18,207 6,554 70,169 0% 2007 0 17,803 29,062 18,648 6,436 71,949 3% 2008 0 18,547 29,279 17,438 6,350 71,614 (0)% 2009 0 18,643 29,698 17,262 7,221 72,824 2% 2010 0 19,463 30,116 17,996 7,873 75,448 4% Score 0.0% 7.2% 1.7% 4.7% 1.2% Rank 5 1 3 2 4
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Appendix II: Refinery transactions

Transaction data is a crosscheck for our refinery valuations
We track refinery transactions in order to sense-check our downstream asset valuations and to assess management's ability to optimize the timing of refinery sales and purchases given a cyclical variation in refinery valuations. We record buyer / seller, price paid ($m including amount paid for plant working capital) and net capacity transferred (kbopd). Where appropriate, for mixed asset transactions, we estimate the value assigned to non-refining assets in order to distill a pure value for the refinery. Since the beginning of 2007, we have tracked a total of 42 refinery transactions where the price paid has been publicly disclosed. As per Figure 163, we note the following features of this specific M&A trend: A cyclical variation in transaction frequency We recorded a total of 12 transactions in 2007, 5 in 2008, 7 in 2009, 9 in 2010 and 9 YTD 2011. So, perhaps unsurprisingly, there was a reduction in transaction frequency during the oil price / capital market / industry hiatus in 2008-09 as both buyers and sellers withdrew from the market. However, transaction frequency has picked up nicely in 2010 and 2011 as more companies look to offload marginal plants within their portfolios. Europe has been the most liquid market, then the USA - We have noted the highest number of transactions (20 or just less than 50% of total) in Europe (excluding the most recently announced ConocoPhillips/Hyesta Energy transaction for which price has not been disclosed), 16 in the USA and just 6 in the Rest of the World. Refineries in Asia are very infrequently traded we have public data for only six transactions 2007-2011. A significant cyclical variation in asset prices - This is not surprising either since the purchaser will likely shift its forecast margins and utilization rates when valuing the asset, just as a purchaser of an upstream asset will shift its near, medium and long-term oil (gas) price forecast. Furthermore, during margin upcycles there are likely to be more interested buyers with more acquisition firepower. It would appear that refinery values peaked in 2007 and then bottomed out in 2010-11, but have since started to recover.
Asset prices vary significantly across the cycle.so does transaction frequency
156
Figure 163: Refinery transaction values ($ 000 per bopd capacity)
35
USA EUROPE
283 kbopd
30
RoW
25 $k per bopd
Circle size reflects refinery size
20
Asset prices bottomed and turned
15
10
2007 0
10
2008 15
2009 20
2010 25
30
2011 35
40
Source: J.P. Morgan. We include working capital in our transaction multiples and adjust, where possible, for the value of other assets e.g. pipelines, retail outlets etc.
Cross-cycle average value around $9k per bopd
Limited regional average price dispersion over the cycle As per Table 30, we see limited cross-cycle variation in asset prices when compared across the three key regions of the USA (2007-11 average $8,600 per bopd), Europe (200711 average $8,500 per bopd) and the Rest of the World (2007-11 average $9,100 per bopd). Measured globally, over the past 4.5 years, 42 refineries have traded for a total of $49bn at an average unit price of $8,600 per bopd. Our downstream asset values rely on lower, more conservative unit assumptions for companyspecific refineries.
Number of Deals 20 16 6 42 Total refining capacity (kbopd) 3,275 1,924 507 5,706 Total value ($m) 27,942 16,453 4,621 49,016 Average value ($000/bopd) 8.5 8.6 9.1 8.6
Table 30: Refinery transaction data 2007-2011 YTD

Region Europe USA Rest of world TOTAL
Number of refineries on the market
In the public domain, we are aware of at least 18 refineries / stakes in refineries that are either on the market and being actively marketed or are likely still available for sale following an unsuccessful auction (Table 31). The total capacity is almost 2.4 million bopd, of which over half (1.53 million bopd) is located in the USA where there are at least six refineries for sale. In addition to these refineries, Saras continues to look for an NOC partner for its 300 kbopd Sarroch refinery in Italy.
157
Table 31: Refineries for sale

Country Caribbean Czech Republic France Ireland Italy Lithuania Libya USA Location Aruba Kralupy Litvinov Berre L-Etang Whitegate Livorno Orlen Lietuva Zawia Ardmore (Oklahoma) Trainer (Pennsylvania) Carson (California) Texas City Marcus Hook Philadelphia Esso Thailand stake Milford Haven Killingholme (Lindsey) Indeni Capacity kbopd 285 30 54 105 71 85 190 60 92 185 270 475 175 330 116 130 225 19 2,897 Vendor Valero RD Shell / ENI * RD Shell / ENI Lyondell-Basell ConocoPhillips ENI PKN Orlen LNOC Valero ConocoPhillips BP BP Sunoco Sunoco Exxon Mobil Murphy TOTAL TOTAL Comments Valero confirmed it has had talks with PetroChina & Pemex Reported $232m offer from Mero CRaccording to Platts Unipetrol (51%) has pre-emption right. Company confirmed plant for sale on 31 May 2011. Pulled following talks with PE Klesch, as confirmed by ENI Platts reported that may be selling 25% to Rosneft for $425m Libyan Investment Authority was selling prior to civil unrest Likely transaction in 2012 according to BP. Likely transaction in 2012 according to BP. Possible transaction in 2012 according to Sunoco (6 Sept) Will take an impairment charge of $1.9-$2.2bn with Q3 2011 results In our view, the natural buyer is Thai Oil TOTALs CFO said (29 July) that exclusive talks failed because unnamed buyer was refused financing.
Thailand UK Zambia
Source: J.P. Morgan. RD Shell has 16.4% and ENI has 32.5% stake in the Kralupy plant.
Refinery transfers can stall retirement and return retired capacity to operations
Further to our core research theme of surplus refining capacity, we note that changes to refinery ownership can add to this risk. For example, Valero shut its Delaware City refinery (210 kbopd) in November 2009 due to weak margins and then sold it to PBF Investments LLC in February 2010. Following a plant upgrade, PBF re-opened the refinery in Q2 2011. Similarly, ConocoPhillips has announced the sale of its Wilhemshaven refinery in Germany (260 kbopd) to Hyesta Energy. The latter is backed by private equity firms (Riverstone/Carlyle Global Energy and Power Funds, a group of energy-focused private equity funds managed by Riverstone and AtlasInvest) - it intends to re-open the plant that has been closed since a fire in May 2010.
158
Appendix III: Refinery projects data

The following tables detail our database on global refining projects - by country, location, primary sponsor and primary distillation capacity. We only include additions, either brownfield expansion or green field, to primary distillation capacity we therefore exclude upgrading additions. Our experience when tracking these projects is that they have a notable tendency to complete and commission later than scheduled. We also include capacity that has been or is expected to re-open. Figure 164 shows how the regional capacity growth profiles may evolve 2010 to 2016E.
Figure 164: Regional net refining capacity growth (kbopd)
EUROPE
NORTH AMERICA
MIDDLE EAST ASIA PACIFIC
SOUTH AMERICA
AFRICA
In the data tables, we have shaded those projects that are sponsored by NOCs / government controlled entities these total over 130 (52%) of the 250 projects that we have identified in these lists, but these represent a much larger percentage of new capacity. Of the aggregate new capacity identified 2011-16 (c.27.4 million bopd), NOCs are sponsoring 67% (c.18.5 million bopd).
159
Table 32: Refinery projects

2010 Country ARGENTINA CHINA CHINA CHINA CHINA CHINA CHINA CHINA CHINA CHINA CHINA CUBA GREECE GREECE HUNGARY IRAN IRAN IRAQ IRAQ IRAQ INDIA INDIA INDIA JAMAICA KUWAIT PAKISTAN S. ARABIA S. KOREA SYRIA TUNISIA UAE USA YEMEN TOTAL NOC sponsored Location San Lorenzo Qinzhou Jilin expansion Qingyang - Gansu Tahe expansion Changling - Hunan Shandong Zhejiang Shanghai Gaoqiao Luoyang - Henan Yingkou - Liaoning Santiago Elefsina, South Greece Agioi, Theodoroi Szazhalombatta Arak refinery Isfahan Suleimaniya Najaf Samawah Panipat, Haryana Haldia, West Bengal Kochi, Southern Kerala Kingston Mina Abdullah Baluchistan Jubail , East Coast Yeosu Banias La Skhira, Tunisia Dubai - Jebel Ali Garyville, Louisiana Ras Issa Primary sponsor Petrobras PetroChina PetroChina PetroChina Sinopec Sinopec Sinopec Sinopec Sinopec Sinopec CNOOC Cupet / PDVSA Hellenic Motor Oil MOL National Iranian Oil National Iranian Oil Kar Group Kar Group Kar Group IOC IOC BPCL Petrojam KNPC Bosicor Oil Pakistan SASREF GS Caltex ETAP ENOC Marathon Reliance Industries Capacity (kbopd) 15 200 60 24 70 60 40 60 34 40 20 28 60 120 25 30 100 75 10 10 60 30 38 25 260 115 100 20 50 120 50 180 50 2,179 1,669 2011E Country Location AUSTRALIA Chinchilla CHAD N'Djamena CHINA Daxie - Zhejiang CHINA Liaoyang CHINA Fushun - Liaoning CHINA Dongmin CHINA Shangdong CHINA Shandong CHINA Beihai / Tieshan CHINA Ningxia Hui IRAQ Khabat, near Erbil IRAQ Koia INDIA Guru Gobind Singh INDIA Bina INDIA Vadinar JAPAN Sakai JAPAN Kashima JAPAN Shikoku MEXICO Minatitlan N. ZEALAND Marsden Point NIGERIA Akwa Ibom State PERU Talara QATAR Pearl RUSSIA Niznhekhamsk S. KOREA Incheon SPAIN Cartagena USA Delaware TOTAL NOC sponsored Primary sponsor Linc CNPC / SHT CNOOC PetroChina PetroChina Dongmin Pchem ChemChina ChemChina Sinopec CNPC KRG Cicsco HPCL / Mittal BORL Essar Cosmo Oil Japan Energy Taiyo Oil Pemex Refinacion New Zealand R Co. Amakpe Intl. Petroleos de Peru Royal Dutch Shell Tatneft SK Energy Repsol YPF PBF * Capacity (kbopd) 5 20 40 70 50 60 80 70 100 67 40 70 181 120 75 67 30 25 111 35 20 28 140 140 40 120 210 2,014 905
Source: J.P. Morgan. * Plant was closed by Valero in November 2009, but re-opened by PBF in Q2 2011 following substantial upgrade.
160
Table 33: Refinery projects (continued)

2012E Country ALGERIA CHINA CHINA CHINA CHINA GERMANY IRAQ IRAQ INDIA INDIA JORDAN PAKISTAN PAKISTAN PORTUGAL RUSSIA RUSSIA SUDAN USA USA USA VENEZUELA VENEZUELA TOTAL NOC sponsored Location Skikda Pengzhou Anqing expansion Juliang Huabei - expansion Wilhelmshaven * Basra Basra Vadinar Mangalore Zarqa refinery Mouza Thatta Sines Tuapse Kirishi Khartoum Port Allen Port Arthur Mandan Santa Ines Caripito Primary sponsor Sonatrach (Naftec) PetroChina Sinopec Sinopec PetroChina Hyesta Energy Basra Refiney Basra Refiney Essar MRPL MENA Bosicor Oil Indus Refinery Ltd Galp Rosneft Surgutneftegas CNPC / SEM Placid Motiva Tesoro PDVSA PDVSA Capacity (kbopd) 7 200 60 70 96 260 70 20 30 61 30 30 93 50 163 100 100 25 325 10 100 50 1,950 1,097 2013E Country ALGERIA BRAZIL CHINA CHINA CHINA CHINA COLOMBIA C. RICA CUBA ISRAEL KAZAKHSTAN MALAYSIA SAUDI ARABIA S. KOREA TARTASTAN THAILAND USA TOTAL NOC sponsored Location Arzew Abreu e Lima Hohot Wuhan - Hubei Quanzhou Urumqi Cartagena Moin Cienfuegos Ashdod Pavlodar Melaka Jubail Daesan Nizhnekamsk Sriracha Illinois Primary sponsor Sonatrach (Naftec) Petrobras PetroChina Sinopec Sinochem PetroChina Ecopetrol CNPC Cupet / PDVSA Paz Group KazMunaiGaz Petronas Saudi Aramco Hyundai Oilbank Tatneftekhiminvest Thai Oil ConocoPhillips Capacity (kbopd) 27 230 60 60 240 40 165 42 85 13 50 30 400 52 140 25 50 1,709 1,454
Source: J.P. Morgan. * Plant was closed by ConocoPhillips in May 2010, but new owner (Hyesta Energy) likely to re-open it in 2012.
2014E Country ALGERIA BAHRAIN BRAZIL CHINA CHINA CHINA CHINA IRAQ INDIA INDONESIA MONGOLIA NIGERIA NIGERIA RUSSIA RUSSIA THAILAND TURKEY UAE VIETNAM YEMEN TOTAL NOC sponsored Location Algiers Sitra Comperj Tianjin Jieyang Donghai Is. Yunnan Nassiriyah Paradip Tuban Darkhan City Edo State Escravos GTL Nizhni Novgorod Tuapse Map ta Phut Port of Ceyhan Ruwais Vung Ro Mariboil Primary sponsor Sonatrach (Naftec) BAPCO Petrobras CNPC CNPC Kuwait Petroleum CNPC / Saudi Aramco SCOP IOC Pertamina Mongol Sekiyu TFS Financial Services Chevron Lukoil Rosneft IRPC Petrol Ofisi Anonim Sirket ADNOC Technostar Yemen govt Capacity (kbopd) 21 125 165 260 400 300 200 300 240 200 44 12 30 60 200 50 192 417 80 15 3,311 3,017
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Table 34: Refinery projects (continued)

2015E Country Location ARGENTINA Refineria del Sur ALGERIA Tiaret ANGOLA Lobito BRAZIL Ceara P1 BRUNEI Pulau Muara BRUNEI Pulau Muara BULGARIA Silistra CANADA Newfoundland CHINA Dushanzi CHINA Maoming CHINA Guizhou CUBA Matanzas IRAQ Karbala IRAQ Missan IRAQ Kirkuk INDIA Koyali, Gujarat INDIA Vadinar INDONESIA Selayar Island INDONESIA Banten West INDONESIA Dumai MALAYSIA Manjung NIGERIA Rivers State PAKISTAN Khalifa Point RUSSIA Kola Bay RUSSIA Chelyabinsk RUSSIA Teriberka S. ARABIA Yanbu S. ARABIA Jazan S. ARABIA Ras Tanura S. AFRICA Richards Bay SRI LANKA Cuddalore SRI LANKA Sapugaskanda TAIWAN Changhua TANZANIA Dar Es Salaam TURKEY Port of Ceyhan TURKEY Port of Ceyhan TURKEY Aliaga UGANDA Hoima USA Port Arthur USA St Charles USA McKee VENEZUELA Cabruta VIETNAM Thanh Hoa TOTAL NOC sponsored Primary sponsor Bridas Sonatrach Sonangol Petrobras PetroBru Zhejiang Petromaxx Harvest En. PetroChina Sinopec Guizhou Yufu Cupet Govt. Oil Ministry Oil Ministry IOC Essar Pertamina Pertamina Pertamina Gulf Petm. Shaygaz Pak-Arab Sintez Petm. Quality En. Gazprom Saudi Aramco Saudi Aramco Saudi Aramco Drako O & G Nagarjuna Oil Ceypetco Kuokuang PC Noor Oil STEAS Calik Enerji SOCAR Essar Valero Valero Valero PDVSA PetroVietnam Capacity (kbopd) 100 300 200 300 200 135 55 75 120 240 100 150 200 150 150 44 345 300 300 80 150 200 250 120 180 100 400 325 400 300 120 50 300 175 200 212 200 200 100 60 25 400 200 8,211 5,009 2016E Country ARGENTINA ALGERIA BANGLADESH BRAZIL BRAZIL BOLIVIA CANADA CHINA CHINA CHINA CHINA ECUADOR EGYPT EGYPT EGYPT INDIA IRAN IRAN IRAN IRAN IRAN IRAN IRAQ INDIA INDIA INDONESIA JORDAN KUWAIT MALAYSIA MEXICO MOZAMBIQUE NIGERIA NIGERIA PAKISTAN PAKISTAN PAKISTAN PANAMA RUSSIA S. AFRICA SUDAN SUDAN SYRIA SYRIA UAE UKRAINE USA VIETNAM VIETNAM TOTAL NOC sponsored Location Chubut Tinrhert Chittagong Ceara P2 Maranhao La Paz Newfoundland Huizhou Anning Jiangsu Ningdong Manta TBC TBC Cairo Jamnagar Hormuz Pars Anahita Caspian Khoaestan Shahriyar Kurdistan Lote Kochi Balongan Aqaba Nr Az-Zour Kedah Tula TBC Central Kogi Lagos Baluchistan Port Qasim Morgah Puerto Armuelle Ust-Luga Mthombo Port Sudan Akon Furoqios Deir Al-Zur Fujairah Odessa Arizona Quang Nai Nam Van Phong Primary sponsor TBC Sasol Eastern Refinery Ltd Petrobras Petrobras YPFB Newfoundland & Labrador Ref. CNOOC CNPC Sinopec Sasol PDVSA EGPC Citadel Capital ERC Reliance Industries TBC TBC TBC TBC TBC TBC Make Oil HPCL BPCL Pertamina Kuwait govt. Kuwait National Petroleum Co Merapoh Resources Pemex Refinacion OilMoz NNPC NNPC OGDC KPC Attock Refinery Ltd Occidental Guvnor PetroSa Petronas Southern Sudan govt PDVSA Nour Investment Company IPIC Ukraine / Libya Arizona Clean Fuels LLC PetroVietnam Petrolimex Capacity (kbopd) 150 36 50 300 300 35 300 200 200 240 80 300 130 200 94 540 300 120 150 300 180 150 250 360 121 200 100 615 350 300 350 150 300 168 200 10 350 160 400 175 200 140 140 175 220 150 58 205 10,202 6,992
162
Appendix IV: Global Integrated Valuation Update

Table 35: Global Integrated Valuation Update
Global Integrated Oils - Analyst Team UK Integrateds Fred Lucas (AC) (44-20) 7155 6131 fred.lucas@jpmorgan.com Em erging Oils -South Africa Alex Com er (44-20) 7325 1964 alex.r.comer@jpmorgan.com Prices as of c.o.b. Company OECD Exxon Mobil BP RD Shell A RD Shell B Average BG Group Chevron ConocoPhillips Hess Marathon Murphy Occidental Cenovus Energy Husky Energy Suncor ENI Essar Energy GALP OMV Repsol YPF Statoil TOTAL Average Em erging Market Sinopec PetroChina S-Oil SK Innovation Gazprom Gazprom Neft Lukoil Rosneft Surgutneftegaz Tatneft MOL Sasol* Ecopetrol Reliance Industries** Average 06-Sep-11 SOTP Prem ium per share (Discount) 86.0 787 29.4 2,600 1,908 101.0 91.0 96.0 35.0 68.0 100.0 43.0 28.0 47.0 29.4 5.20 18.4 42.7 28.7 184.8 53.8 (17)% (53)% (24)% (23)% (29)% (36)% (5)% (28)% (41)% (28)% (26)% (17)% (21)% (15)% (38)% (56)% (54)% (29)% (39)% (36)% (34)% (41)% (32)% PER (x) 11E 8.5 5.2 7.4 7.6 7.2 15.4 6.8 7.7 8.1 5.7 8.8 10.2 18.6 10.1 9.9 5.5 12.6 28.0 6.4 9.3 7.0 5.7 10.6 6.7 8.9 9.0 6.4 3.4 5.1 4.7 5.4 4.4 5.7 5.4 9.0 13.3 12.7 7.1 EV/DACF (x) 11E 6.1 3.8 5.3 5.4 5.2 11.2 5.1 5.6 4.4 3.1 4.3 6.8 9.8 5.9 6.3 4.1 13.8 14.0 4.5 4.9 4.5 4.3 6.8 4.6 5.8 21.2 8.6 3.8 5.3 4.2 5.2 1.5 5.9 2.7 8.3 10.3 7.0 6.7 Dividend Yield (%) 10A 11E 2.4 1.2 6.3 5.4 3.8 1.1 3.0 3.3 0.7 4.0 2.1 1.7 3.9 5.1 1.4 7.7 0.0 1.5 3.9 5.7 5.2 7.2 3.3 3.4 3.7 2.4 1.4 1.5 3.1 3.7 1.3 2.5 3.5 0.0 3.4 3.1 0.9 2.4 2.5 4.8 6.0 5.2 4.6 1.2 3.2 4.0 0.7 4.0 2.1 2.1 5.8 5.1 1.4 8.1 0.0 1.5 4.0 6.3 5.4 7.7 3.7 3.8 5.1 4.7 1.5 1.9 4.0 3.8 1.5 3.8 5.3 4.4 3.9 3.7 1.0 3.4 YE Net debt / (cash) (m) 10A 11E 12E 8,422 19,278 30,888 30,888 4,466 -4,509 18,353 1,848 4,404 1,335 549 3,631 3,982 11,098 26,119 3,934 2,840 5,167 10,958 69,681 13,031 8,825 16,239 22,659 22,659 7,950 -8,772 16,648 1,522 3,600 1,235 483 3,775 4,359 8,077 24,228 7,081 3,597 4,445 9,894 30,626 12,310 -10,135 16,360 14,781 14,781 11,162 -10,620 13,753 125 1,985 1,467 -1,401 3,169 4,828 6,169 21,777 7,876 3,782 4,423 11,367 36,725 10,324 Ne t Debt / Equity (%) 10A 11E 12E 6 20 21 21 17 26 -4 27 11 19 16 2 36 26 30 47 92 105 46 42 31 22 33 32 20 23 58 14 29 15 36 -36 23 70 -1 NM 37 25 6 14 14 14 12 41 -7 24 8 14 14 1 35 26 20 39 151 116 34 36 12 18 34 31 27 34 24 14 27 8 21 -38 13 38 -8 NM 17 16 -5 12 8 8 6 51 -7 17 1 7 14 -3 24 26 13 32 143 107 32 39 12 14 31 24 29 7 11 7 17 3 11 -42 1 30 -11 NM -12 6 European Integrateds Nitin Sharma (44-20) 7155 6133 nitin.sharma@jpmorgan.com US Integrateds Kathe rine Lucas Minyard, CFA (1-212) 622 6402 katherine.l.minyard@jpmorgan.com Emerging Oils - Asia Brynjar Eirik Bustnes (852) 2800 8578 brynjar.e.bustnes@jpmorgan.com Em erging Oils - Russia Nadia Kazakova (7-495) 937 7329 nadia.kazakova@jpmorgan.com Em erging Oils - LatAm Caio Carvalhal (55-11) 3048 3946 caio.m.carvalhal@jpmchase.com
For s pecialist sales advice please contact: Ham ish Clegg (44-20) 7325 0878 hamish.w .clegg@jpmorgan.com
10A 11.4 5.5 10.7 10.9 9.6 15.9 10.0 11.1 11.0 6.9 11.3 14.4 32.1 18.0 16.8 6.9 20.1 35.2 6.9 11.0 9.2 6.8 14.8 7.5 10.3 17.7 11.4 4.4 6.4 4.7 6.6 5.8 8.6 15.5 11.7 19.6 15.5 10.4
12E 6.2 5.3 6.8 6.9 6.3 14.2 6.0 5.0 4.8 4.7 5.5 7.5 9.4 7.9 6.3 5.1 6.5 17.3 5.9 7.7 7.1 5.9 7.5 6.4 9.7 9.4 7.6 3.5 5.7 5.1 7.9 4.5 5.7 5.5 8.2 10.6 11.1 7.2
10A 7.6 9.2 8.3 8.4 8.4 10.9 5.8 5.7 4.5 3.9 5.0 8.2 10.8 7.2 8.8 5.0 -34.0 17.9 4.5 5.1 5.6 4.5 4.7 5.3 6.3 36.9 12.0 4.5 4.4 4.4 8.8 1.6 6.5 4.1 9.7 13.7 34.7 10.9
12E 6.3 3.9 4.8 4.9 5.0 10.1 6.0 5.8 4.7 3.0 4.2 7.0 8.2 6.1 7.8 3.7 7.2 11.9 4.0 5.3 4.6 4.4 6.2 4.3 5.4 13.3 8.5 3.1 4.3 3.8 5.1 1.4 4.6 2.8 6.5 8.8 7.7 5.7
12E 2.6 5.1 6.2 5.4 4.8 1.4 3.3 4.4 0.7 4.0 2.2 2.2 10.7 5.2 1.4 8.5 0.0 1.5 4.1 6.9 5.7 8.1 4.1
4.0 135,344 146,894 132,423 4.6 187,911 274,883 324,134 3.8 1,062,689 1,782,255 442,996 1.6 6,312,558 3,668,442 1,918,263 1.8 28,643 34,214 19,763 3.5 5,380 6,131 4,518 4.4 8,658 5,276 2,116 1.7 19,401 14,016 7,861 3.7 -15,686 -18,901 -23,038 5.3 2,526 1,640 95 4.3 4,810 3,437 3,002 4.0 -902 -9,002 -14,550 5.5 4,968 3,334 3,226 1.2 376,024 196,210 -162,325 3.5
Source: Company data, J.P. Morgan estimates
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Appendix V: Downstream glossary of terms

Refining
The core refining process is simple distillation (Table 36). Crude oil is heated and put into a distillation column - different products boil off and are recovered at different temperatures. The lighter products - LPG, naptha and gasoline - are recovered at the lowest temperatures. Middle distillates - jet fuel, kerosene, distillates (heating oil and diesel) - boil off next. The heaviest products (residuum) are recovered at temperatures that may exceed 1,000 degrees F. The simplest refineries stop at this point. In a more complex refinery, additional processes follow which take the heavy, low-valued streams and convert them into lighter, higher-valued output. A catalytic cracker converts gasoil into finished distillates (heating oil, diesel and gasoline). A hydro-treater removes sulfur. A reforming unit produces higher octane components for gasoline from lower octane feedstock recovered during distillation. A coker uses the heaviest output (the residue) to produce lighter feedstock and petroleum coke.
Table 36: Refining process - simple overview
Temp Deg F <90 90-200 Product recovered Butane & lighter Light straight naptha Naptha Product sent to Gas processing Gasoline blending Catalytic reforming Hydrotreating Distillate fuel blending Fluid catalytic cracking Coking
Distillation column
200-350
Crude oil
350-450
Kerosene
450-650
Distillate
650-1,000
Heavy Gas Oil
1000+
Residuum
The downstream industry contains no fewer technical terms than the upstream. We summarize the most commonly used terms to enable investors to see through more of the 'jargon', specifically relating to the refining process. Acid treatment A process in which unfinished petroleum products such as gasoline, kerosene and lubricating oil stocks are treated with sulphuric acid to improve colour, odor or other properties. Additive chemicals added to petroleum products in small amounts to improve quality or add special characteristics. Air fin coolers a radiator-like device used to cool or condense hot hydrocarbons.
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Alicyclic hydrocarbons ringed hydrocarbons in which the rings are made up only of carbon atoms. Aliphatic hydrocarbons hydrocarbons characterized by open-chain structures e.g. ethane, propane, butane. Alkylation a process using sulfuric acid or hydrofluoric acid as a catalyst to combine olefins (usually butylenes) and isobutene to produce a high-octane product known as alkylate. API gravity an arbitrary scale expressing the density of crude oil and petroleum products. A lower figure (gravity) indicates higher density, more viscous fluid and a higher gravity indicates a lower density (lighter, thinner) fluid. Over the last 20 years, the EIA estimates that the average API of US crude imports has fallen from 32.5 degrees to 30.2 degrees. Aromatic organic compound with one or more benzene rings. Asphaltenes the asphalt compounds soluble in carbon disulfide but insoluble in paraffin napthas. Atmospheric tower a crude distillation unit operated at atmospheric pressure. Barrel the American standard unit of measurement for oil; one barrel is 35 imperial gallons or 159 litres. Bitumen an extremely heavy semi-solid product of oil refining made up of long chain (heavy) hydrocarbons. It is used for road-building and roofing. Blending the process of mixing two or more petroleum products with different properties to produce a finished product. Bottoms tower bottoms are residue remaining in a distillation unit after the highest boiling point material to be distilled has been removed. Tank bottoms are the heavy materials that accumulate in the bottom of storage tanks, usually comprised of oil and water. BTX - industry term referring to the group of aromatic hydrocarbons benzene, toluene and xylene. Catalyst - a substance which alters the rate of a chemical reaction without being used up itself in the reaction. Caustic wash - a process in which distillate is treated with sodium hydroxide to remove acidic contaminants that contribute to poor odor or stability. Coke a high carbon content residue that remains following the destructive distillation of petroleum residue. Coking a process for thermally converting and upgrading heavy residual into lighter products and by-product petroleum coke. Coking also is the removal of all lighter distillable hydrocarbons that leaves a residue of carbon in the bottom of units
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or as buildup or deposits on equipment and catalysts. The accumulated coke can be removed from the coking vessels during an off cycle and either sold, primarily as a fuel for electricity generation, or used in gasification units to provide power, steam, and/or hydrogen for the refinery. Condenser reflux condensate that is returned to the original unit to assist in giving increased conversion or recovery. Cracking the process of breaking down larger molecules of hydrocarbons into smaller ones. When this is done by heating the oil it is known as thermal cracking. If a catalyst is used, it is known as catalytic cracking. Crude assay a procedure for determining the general distillation and quality characteristics of crude oil. Debottlenecking a process that improves the flow and better matches capacity among different refining units by turning more and more to computer control of processing. Dehydrogenation - A reaction in which hydrogen atoms are eliminated from a molecule. Dehydrogenation is used to convert ethane, propane, and butane into olefins (ethylene, propylene and butene). Desulphurization any process or process step that results in the removal of sulphur from organic molecules. Distillates the products obtained by condensation during the fractional distillation process. Feedstock stock from which material is taken to be fed (charged) into a processing unit. Flashing - the process in which a heated oil under pressure is suddenly vaporized in a tower by reducing pressure. Flash point lowest temperature at which a petroleum product will give off sufficient vapor so that the vapor-air mixture above the surface of the liquid will propagate a flame away from the source of ignition. Fluid catalytic cracking (FCC) a process for converting high boiling gas oils to lighter liquids, primarily gasoline range naptha and diesel range gas oils. Fraction one of the portions of fractional distillation having a restricted boiling range. Fractional distillation a separation process which uses the difference in boiling points of liquids. Fuel gas refinery gas used for heating. Fuel oil a heavy residual oil used for power stations, industry and marine boilers.
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Gas oil a middle distillate petroleum fraction with a boiling range 350-370 deg F, usually includes diesel fuel, kerosene, heating oil and light fuel oil; used to produce diesel fuel and to burn in central heating systems. Gross product worth (GPW) this is the weighted average value of all refined product components (less an allowance for refinery fuel and loss) of a barrel of the marker crude. GPW is computed by multiplying the spot price of each product by its percentage share in the yield of the total barrel of crude. Gross refining margin (GRM) - this is the net difference in value between the products produced by a refinery and the CIF value of the crude oil used to produce them, taking into account the marginal refinery operating costs. Refining margins will thus vary from refinery to refinery and depend on the cost and characteristics of the crude used, its yield and the value of its products (and hence its location). For forecasting purposes the J.P. Morgan European Oil & Gas Team uses BPs Refining Marker Margin (RMM) so that we have a long, continuous and comparable data series for regional GRMs. BPs RMM uses regional crack spreads to calculate the margin indicator and does not include estimates of fuel costs and other variable costs. The RMM is calculated using the following marker crudes and product yields.
Table 37: Regional Refining Marker Margin definitions
Region US Gulf Coast US West Coast US Midwest NW Europe Mediteranean Singapore
Source: BP
Crude Mars ANS LLS Brent Azeri Light Dubai / Tapis
Refinery Coking Coking Coking Cracking Cracking Cracking
Gasoline 66.7% 66.7% 66.7% 50.0% 50.0% 50.0%
Gasoil 33.3% 33.3% 33.3% 50.0% 50.0% 50.0%
Heavy vacuum gas oil (HVGO) an intermediate product produced in the vacuum distillation unit which is further processed to produce gas oil or gasoline. Hydrocarbon a compound containing hydrogen and carbon only. Hydrocarbons may exist as solids, liquids or gases. Hydro-cracking - A process used to convert heavier feedstock into lower-boiling, higher-value products. The process employs high pressure, high temperature, a catalyst, and hydrogen. Hydro-desulfurization - A catalytic process in which the principal purpose is to remove sulfur from petroleum fractions in the presence of hydrogen, which produces hydrogen sulphide that can be easily removed from the crude stream. Hydro-finishing - A catalytic treating process carried out in the presence of hydrogen to improve the properties of low viscosity-index naphthenic and medium viscosity-index naphthenic oils. It is also applied to paraffin waxes and microcrystalline waxes for the removal of undesirable components. This process consumes hydrogen and is used in lieu of acid treating. Hydrogenation the chemical addition of hydrogen to a material in the presence of a catalyst.
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Idle capacity the component of operating capacity that is not in operation and not under active repair, but capable of being placed in operation within 30 days; plus capacity not in operation but under active repair that can be completed within 90 days. Isomerization - A reaction that catalytically converts straight-chain hydrocarbon molecules into branched-chain molecules of substantially higher octane number. The reaction rearranges the carbon skeleton of a molecule without adding or removing anything from the original material. Iso-octane a hydrocarbon molecule (2,2,4-trimethylpentane) with excellent antiknock characteristics on which the octane number of 100 is based. Kerosene a medium light oil use for lighting, heating and aviation fuel. Light vacuum gas oil (LVGO) the lightest fraction from the vacuum column that is blended in to the gas oil mix. Liquefied petroleum gas (LPG) - commercial LPG usually contains mixtures of propane and butane. Marine distillate or residual fuel oil is used for marine applications. Additives help to stabilize fuel consumption in four stroke engines, reduce piston deposits, lower smoke emissions and reduce lube oil fouling. Methane the main component of natural gas; it is the smallest hydrocarbon molecule with only one carbon atom and four hydrogen atoms. Methyl-t-butyl-ether (MTBE) an oxygen-containing fuel component used in reformulated gasoline; commonly made from methanol and isobutene. Naphtha A general term used for low boiling hydrocarbon fractions that are a major component of gasoline. Aliphatic naphtha refers to those naphthas containing less than 0.1% benzene and with carbon numbers from C3 through C16. Aromatic naphthas have carbon numbers from C6 through C16 and contain significant quantities of aromatic hydrocarbons such as benzene (>0.1%), toluene, and xylene; used to produce petrol and as a raw material for the petrochemical industry to make plastics. Nelson complexity index (NCI) the NCI was developed by Wilbur L. Nelson in a series of articles in Oil & Gas Journal in 1960-61 to quantify the relative costs of the components that constitute the refinery. The Nelson complexity index assigns a complexity factor to each major piece of refinery equipment based on its complexity and cost in comparison to crude distillation, which is assigned a complexity factor of 1.0. For example vacuum distillation 2.0, thermal processes 2.75, catalytic reforming 5.0, coking 6.0, aromatics / polymerization 10.0 and lubes 60.0. The complexity of each piece of refinery equipment is then calculated by multiplying its complexity factor by its throughput ratio as a percentage of crude distillation capacity. Adding up the complexity values assigned to each piece of equipment, including crude distillation, determines a refinerys complexity on the Nelson Complexity Index. The Nelson complexity index indicates not only the investment
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intensity or cost index of the refinery but also its potential value addition. Thus, the higher the index number, the greater the cost of the refinery and the higher the value of its products. The NCI method uses only the Refinery Processing Units or the "Inside Battery Limits " ( ISBL ) Units, and does not account for the costs of Offsites and Utilities or the " Outside Battery Limits " ( OSBL ) Costs, such as Land, Storage tanks, terminals, utilities required etc. A high NCI means that a refinery can (i) process inferior quality crude or heavy sour crudes (ii) produce a superior product slate comprising a high percentage of LPG, light distillates and middle distillates and a low percentage of heavies and fuel oil. Net refining margin this is the gross product worth (calculated by multiplying the spot price of each product by its percentage share in the yield of he total barrel of crude) Less variable refinery operating costs; defined to include the feed-dependent costs for power, water, chemicals, additives, catalyst and refinery fuels beyond own production Less fixed refinery operating costs; defined to include labor, maintenance, taxes and overhead costs adjusted monthly to take account of escalations based on industry cost indices Less refinery delivered crude cost; defined to include transport and credit allowance costs Transport costs; marginal crude freight, insurance and ocean loss (in case of an FOB crude), and applicable fees and duties, assuming a single voyage for an appropriately sized tanker chartered on the spot market Less Credit allowance; representing the financial effect of the time delay between paying for crude versus when it is received in the refinery (crude credit, crude transit time). Paraffins a family of saturated aliphatic hydrocarbons (alkanes) with the general formula CnH2n+2 Polyforming - the thermal conversion of naphtha and gas oils into high-quality gasoline at high temperatures and pressure in the presence of re-circulated hydrocarbon gases. Polymerization the process of combining two or more unsaturated organic molecules to form a single (heavier) molecule with the same elements in the same proportions as in the original molecule. Quench oil - oil injected into a product leaving a cracking or reforming heater to lower the temperature and stop the cracking process. Raffinate - the product resulting from a solvent extraction process and consisting mainly of those components that are least soluble in the solvents. The product recovered from an extraction process is relatively free of aromatics, naphthenes, and other constituents that adversely affect physical parameters. Recycle gas high hydrogen content gas returned to a unit for reprocessing. Refinery a plant where the components of crude oil are separated and converted into useful products. Refinery processing gain - the volumetric amount by which total refinery output is greater than input for a given period of time. This difference is due to the processing of crude oil into products, which, in total, have a lower specific gravity than the crude oil and feed stocks processed (e.g. in conversion processes).
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Refinery product yields - these are used for refinery margin calculations and, as per Table 38, vary with crude feedstock and refinery configuration.
Table 38: Refined product yields
Refinery product yield (%, bbl) Petroleum Gasoline / gases naptha Distillate 3.3 35.6 42.3 3.0 22.7 42.8 2.9 28.9 39.4 1.6 13.4 37.1 4.6 42.1 42.9 7.9 46.1 41.6 2.8 43.0 25.4 2.6 14.6 39.8 5.8 24.7 50 3.7 30.6 43.7 8.1 36.4 52.9
Region Europe
Input crude Brent Urals
US Gulf Coast US West Coast Singapore
LLS Mars Blend ANS Dubai Tapis
Refinery type Catalytic cracking Hydroskimming Catalytic cracking Hydroskimming Catalytic cracking Coking Catalytic cracking Hydroskimming Hydrocracking Hydroskimming Hydrocracking
Fuel oil 14.0 29.9 23.6 46.9 10.7 1.6 30.7 41.7 22.3 19.5 3.5
Reflux - portion of the distillate returned to the fractionating column to assist in attaining better separation into desired fractions. Reformate - an upgraded naphtha resulting from catalytic or thermal reforming. Regeneration - in a catalytic process the reactivation of the catalyst, sometimes done by burning off the coke deposits under carefully controlled conditions of temperature and oxygen content of the regeneration gas stream. Resid - an abbreviation for residuum; the general term given to any refinery fraction that is left behind in a distillation. Atmospheric resid, sometimes called long resid or atmospheric tower bottoms (ATB) is the undistilled fraction in an atmospheric pressure of crude oil. Vacuum resid, short resid, or vacuum tower bottoms (VTB), is the undistilled fraction in a vacuum distillation. Scrubbing purification of a gas or liquid by washing it in a tower. Sour gas natural gas that contains corrosive, sulfur-bearing compounds such as hydrogen sulfide and mercaptans. Stabilization a process for separating the gaseous and more volatile liquid hydrocarbons from crude petroleum or gasoline and leaving a stable (less-volatile) liquid so that it can be handled or stored with less change in composition. Straight-run gasoline - Gasoline produced by the primary distillation of crude oil (as opposed to conversion). It contains no cracked, polymerized, alkylated, reformed, or vis-broken feedstock. Stripping the removal (by steam-induced vaporization or flash evaporation) of the more volatile components from a cut or fraction. Sweetening - processes that either remove obnoxious sulfur compounds (primarily hydrogen sulfide, mercaptans, and thiophens) from petroleum fractions or streams, or convert them, as in the case of mercaptans, to odorless disulfides to improve odor, color, and oxidation stability.
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Switch loading - the loading of a high static-charge retaining hydrocarbon (i.e. diesel fuel) into a tank truck, tank car, or other vessel that has previously contained a lowflash hydrocarbon (gasoline) and may contain a flammable mixture of vapor and air. TAN total acid number is the standard measure for crude corrosiveness; it indicates the number of milligrams of potassium hydroxide needed to neutralize the acid in 1 gram of oil. The most corrosive crudes, with TANs greater than 1, require significant accommodation to be processed. Tail gas the lightest hydrocarbon gas released from a refining process. Thermal cracking - the breaking up of heavy oil molecules into lighter fractions by the use of high temperature without the aid of catalysts. Turnaround a planned complete shutdown of an entire process or section of a refinery, or of an entire refinery to perform major maintenance, overhaul, and repair operations and to inspect, test, and replace process materials and equipment. For example, US demand for product is lower in the colder months and higher in the warmer months. As refineries move out of the gasoline (driving) season in early autumn, refiners routinely perform maintenance. The depth of maintenance is influenced by the margin environment and outlook e.g. if product inventories are high and demand is slack, maintenance activities are likely to be longer and deeper. Upgrading oil extra heavy oils, like those from the Orinoco region (Venezuela) and the Alberta tar sands (Canada), are typically upgraded to produce high quality synthetic crude (syncrude) which is then refined. Utilization represents the utilization rate of the atmospheric crude oil distillation units. The rate is calculated by dividing the gross input to these units by the operating capacity of the units. Vacuum distillation The distillation of petroleum under vacuum which reduces the boiling temperature sufficiently to prevent cracking or decomposition of the feedstock. Vis-breaking Viscosity breaking is a low-temperature cracking process used to reduce viscosity or pour point of straight-run residuum. Wet gas - a gas containing a relatively high proportion of hydrocarbons that are recoverable as liquid. WTI West Texas Intermediate crude is a light (low density, high API), sweet (low sulfur, <0.5% content by weight) crude that is produced in the USA. This combination of characteristics makes it an ideal crude oil to be refined since it yields a greater proportion of its volumes as lighter products. Premium (heavier) crudes yield c.70% (c.50%) of their volume as light products.
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Retailing
The modern forecourt today may have multi-pump dispensers, a car wash and a convenience store. A modern high volume throughput filling station may sell more than 5 million liters per year and cost $3-4m to build (subject to location and real estate value). About 60% of this capital is equipment that is not seen but which is essential to the safe and more environmentally friendly operation of a modern site. Underground storage tanks and fuel lines are either made from steel set in concrete or special plastic. Tanks are usually double skinned and both tanks and connecting pipes have detectors which warn of the slightest leak before it becomes a problem. Storage tanks also have vapor recovery systems which recover vapors emitted from the tank when it is being filled with petrol from a road tanker. Often called "Stage 1" recovery, this system is being extended as "Stage 2" to capturing vapors when a vehicle is filled. Also underground out of sight is the drainage interceptor system. This collects water off the forecourt which may contain fuel or oil and stops it getting into surface drains and watercourses. The ownership and branding of retail forecourt sites is complex, but broadly falls into three areas: Dealer-owned, Dealer-Operated (DODO) - The forecourt is owned by an independent business, acting as a distributor for an oil company, which supplies fuel and usually a branding package. Company-Owned, Dealer-Operated (CODO) - The forecourt is owned by an oil company which also supplies the fuel, but the site and store are operated by an independent business. Company-Owned Company-Operated (COCO) The forecourt is owned by an oil company and operated by its employees according to instructions from Head Office, as with any other multiple retail business. Company-Owned Group-Operated (COGOP) - This is a similar model to CODO, with the key difference being that a group of stores are run by another independent company rather than an independent dealer. We follow with a brief glossary of terms for fuels retailing. Advanced performance fuels - these are high octane and high cetane formulations that are designed to burn more efficiently; some also help to clean the engine. Chemical additives are typically splash-blended at the terminal. Biodiesel - a biodegradable transportation fuel for use in diesel engines that is produced through trans-esterification of organically derived oils or fats. Biodiesel is used as a component of diesel fuel. In the future it may be used as a replacement for diesel. Convenience stores these sell a range of non-petroleum products that include alcohol, baked goods, chilled food, confectionary, fast food, frozen food, fruit & vegetables, health & beauty products, household goods, lottery tickets, milk, newspapers & magazines, packaged groceries, snacks, soft drinks and tobacco.
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Diesel - a light oil fuel used in diesel engines. Clean diesel is an evolving definition of diesel fuel with lower emission specifications which strictly limit sulfur content to 0.05% weight. Fuel additives for both diesel and gasoline, these help fuel economy, engine cleanliness, friction, emissions, power restoration and compatibility with biodiesel blends. E10 (Gasohol): Ethanol/gasoline mixture containing 10% denatured ethanol and 90% gasoline, by volume. E85: Ethanol/gasoline mixture containing 85% denatured ethanol and 15% gasoline, by volume. Gasoline an alternative term for petrol. A blend of napthas and other refinery products with sufficiently high octane and other desirable characteristics to be suitable for use as fuel in internal combustion engines. Octane rating a measure of the performance (antiknock characteristics) of gasoline; a high octane rating gives efficient ignition.
Lubricants
Synthetic base stocks synthetic motor oils are made from the following classes of lubricants: polyalphaolefins (PAO), synthetic esters and hydro-cracked lubricants. Chevron, Shell, and other petrochemical companies developed a catalytic conversion of feedstocks under pressure in the presence of hydrogen to produce high-quality mineral lubricating oil. In 2005, production of GTL (gas-to-liquid) Group III base stocks began, the best of which perform much like polyalphaolefin. Synthetic lubricants these are a combination of synthetic base oil plus thickeners and additives that will give the grease or oil lubricant a number of performance advantages over conventional mineral based lubricants. Such advantages include their ability to perform under extreme conditions e.g. low and high temperatures and chemical resistance. Semi-synthetic oils - also called 'synthetic blends' are blends of mineral oil with no more than 30% synthetic oil. They are designed to have many of the benefits of synthetic oil without matching the cost of pure synthetic oil.
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Appendix VI: Valuation Methodology and Risks

BP (Overweight Price Target: 575p)
Valuation Methodology : Our 575p Dec-11 price target for BP captures (i) the reinstatement of BP's dividend with its Q4 2010 results (ii) a positive resolution to the risk of gross negligence versus negligence, as per our Central Case Macondo Liability analysis (iii) further progress towards its $25bn - $30bn divestment target (iv) further evidence that BP's abilities to access new high potential exploration acreage (as per BP's alliance with RIL in the Krishna Godavari Basin, off the East Coast of India) is intact. Our price target still assumes a discount of around 30% to our sum-of-the-parts value of around 800 pence that is consistent with our Central Case and compares to BP's long run average discount of 26%. Risks to Our View : Macro factors As an integrated oil & gas company, BPs earnings and cash flow are naturally sensitive to oil and natural gas prices and refining margins. BP does not hedge any of these top line macro exposures. US dollar BP is US dollar long and has a US dollar-based dividend policy. Dollar weakness could erode BPs sterling dividend which is important given the dividend yield sensitivity of the UK market. Asset integrity / project execution Unexpected asset integrity issues eg field or refinery downtime, delays to projects and capital budget over-runs can damage perceptions of management quality and, ergo, BPs stock market valuation. Industrial accidents Unexpected industrial accidents involving BP assets could expose the company to loss of earnings, asset confiscation and potential litigation risk. Russian risk Via its 50% stake in TNK-BP, BP carries a significant production, reserve, cash flow and earnings exposure to assets in Russia. The perceived value of this asset is vulnerable to an escalation in Russian country risk and any signs of company-specific corporate governance problems. Gross Negligence - There is risk that BP will be found grossly negligent and thus face much higher overall Macondo related liabilities than our Central Case. Divestment program fails - Although it is a seller's market for upstream assets, there is a risk that this changes and BP fails to complete its $25bn to $30bn divestment program.
Royal Dutch Shell B (Neutral Price Target: 2,400p)

Valuation Methodology : We leave our SOTP at 2,650p: we apply our long-term oil price of $85/bbl (US natural gas price of $5.90/mmbtu) and RD Shells 2010 Form 20-F disclosures relating to upstream reserves, downstream assets and off balance sheet liabilities. We still believe that a 10% discount to our SOTP is appropriate and therefore keep our price target at 2,400p.
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Risks to Our View : Macro factors As an integrated oil & gas company which does not hedge prices or margins, RD Shells earnings and cash flow are naturally sensitive to oil and natural gas prices and refining margins. Industrial accidents Unexpected industrial accidents involving RD Shell assets could expose the company to loss of earnings, asset confiscation and potential litigation risk. Fiscal regimes Unexpected or adverse changes to the upstream fiscal regimes that apply to any of RD Shells key operating areas could reduce its value. Acquisition risk - RD Shell's balance sheet is strengthening fast as larger than expected divestments and a higher than expected oil price raise cash flow. A large acquisition could dilute returns and perceptions of capital controls. LNG pricing risk As one of the largest IOC producers of LNG, a prolonged period of LNG market over-capacity could dilute the returns from RD Shells LNG projects. This damage could prove more permanent if LNG's pricing relationship with the oil price is weakened.
ENI (Overweight Price Target: 22.50)

Valuation Methodology : Our end Dec 2011 price target of 22.5 is derived from our SOTP valuation. Our price target for the stock is set at a 24% discount to our SOTP very close to average long term discount on this name. We expect this discount to narrow as ENI's asset structure becomes simpler. Risks to Our View : The main generic risks to our rating and price target come from crude oil or natural gas prices or refining margins significantly below/above our projections. Specifically for ENI, downside risks include a further decline in the natural gas demand in Italy which is likely to put pressure on the operating margin of the company.
Essar Energy (Overweight Price Target: 570p)

Valuation Methodology : We maintain our price target for Essar Energy at 5.70 - a premium to our SOTP for the stock. Whilst we acknowledge that majority of the integrated names under our coverage trade at a discount vs SOTP, we believe that strong growth profile of Essar Energy will help it trade at a premium to our SOTP. Risks to Our View : Execution risk - Bringing in large capital projects on time and on budget is crucial in the creation and/or preservation of shareholder value. The scale of the task is amplified by the fact that company is executing ambitious growth projects in both power and refining business. We acknowledge that the presence of EPC contracting capability within the Essar Group is a plus for the companys expansion plans and would help the company in partially mitigating this key risk. Sustained weakness in GRMs we believe that a sustained weakness in GRMs could exert pressure on the companys near term cash flows. We also see a negative
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read across for the timing of phase II expansion, if the weakness in GRMs continues through 2011. Fuel supply - We believe that the security of the fuel supply is very important for the company's expansion plans in the power sector. We highlight that the pit head coal reserves are a key contributor to the value of some of the major phase 1 projects (like Mahan). Mahan - We also highlight the expiry of the coal block allocation contract as a risk to our valuation for this key project. Project clearances Whilst we acknowledge that majority of the Phase II expansion projects are brownfield and company has secured land, water and fuel, we also note that on a number of these projects are yet to secure the environmental clearance/PPA agreements - a potential risk, in our view, to the development timeline for these projects. Sales tax deferral under litigation - Essar Oil has received a favorable verdict from the Gujarat High Court but the government of Gujarat has appealed against the verdict in the Supreme Court. Sales tax deferral benefit contributes c. $507mn (c,3% of GAV) to our SOTP for the company.
Galp Energia (Overweight Price Target: 20.00)

Valuation Methodology : Our end Dec 2011 revised price target of 20 is derived from our SOTP valuation. Our price target for the stock is set at a discount of just 9% to our SOTP we expect the discount vs SOTP to narrow (from c.18%) given the likely near term upside from the company's capital increase in Brazil. We also believe that the differentiated growth profile of Galp will also be a plus for the re-rating of the stock. Risks to Our View : The main generic risks to our rating and price target come from crude oil or natural gas prices or refining margins significantly below our projections. For Galp specifically, downside risks include possible disappointments in the deepwater Brazil exploration programme, and the timely delivery of the Tupi project. Other risks come from further weakness in downstream.
Indian Oil Corporation (Neutral, Price Target: Rs420)

Our Mar-12 price target of Rs420 is based on 6x EV/EBITDA. Our earnings are based on a benign subsidy sharing mechanism (<10% share for the downstream SOEs). We value IOC at a discount to regional peers due to continuing uncertainty on the level of subsidies to be borne by the SOE R&M companies. Key upside risks to our call are structural reforms on fuel pricing and sustained low crude prices. Downside risks are a global slowdown leading to lower refining margins and a higher share of retail fuel losses.
OMV (Neutral Price Target: 29.00)

Valuation Methodology : Our end Dec 2011 price target of 29 is derived from our SOTP valuation - no change to our key assumptions or our SOTP valuation. Our price target for the stock is set at a 28% discount to our SOTP of c.40 - very close to the 12 month average
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discount to the share price. OMV's higher than average sector discount is justified by the concentration of its asset risk in Romania with associated exposure to regulated gas prices in the country and the challenges that OMV faces turning around its upstream performance. Risks to Our View : The main generic risks come from crude oil or natural gas prices or refining margins significantly below our projections. Upside risks include faster-than-expected increases in Romanian gas prices and faster delivery of restructuring benefits from the Petrom acquisition. Downside risks could come from the acquisition of additional stake in Petrol Ofisi, downgrades to production targets, further delays in the Petrom refinery upgrades or failure of the Romanian government to raise gas prices at the rate we had expected.
Petrobras (Neutral)
We rate the four Petrobras stocks that we cover Neutral. Our end-2012 price target for PBR is $41/ADR. Our R$35/sh YE12 price target for PETR3 is based on the PBR target using a year-end 2012 BRL exchange rate of R$1.7/USD. Our YE12 price target of $37/ADR for PBR/A applies a 10% discount to our price target for PBR. Our R$31/sh YE12 price target for PETR4 applies JPMs year-end 2012 BRL exchange rate of R$1.7/USD to our target price for PBR/A. We value E&P portfolio of PBR using a reserve depletion model and value each of the pre-salt projects independently. We also value the downstream projects under a DCF approach that is applied for all refining system of PBR. Risks to Rating and Price Target Downside risks: Sensitivity to oil prices: PBR generates incremental EBITDA of $500 million and incremental earnings of $300 million for every $1/bbl rise in reference oil prices. Should oil prices retreat or fail to meet our 2011 assumption of $106/bbl (Brent), share prices would likely decline. Returns over new investments could be lower than estimated. The company has a capital expenditures plan for 2011-15 of $224 billion. While we believe the investments devoted to E&P projects are strategic and therefore unlikely to be modified, investments in segments such as in refining could have returns lower than the companys weighted average cost of capital. Upside risks: Addition of new production licenses in large reservoirs such as Libra. Faster production growth than assumed. Faster upturn in oil prices than assumed. Demonstrating better economics in pre-salt fields already in portfolio. A $1/boe increase in the NPV per barrel of pre-salt assets would boost PBRs NAV by $2.4/ADR. Demonstrating larger scale of pre-salt fields already in portfolio. An increase of 1 bn boe in pre-salt resource base would boost PBRs NAV by $0.7/ADR. Potential savings in execution of refinery budgets. Potential sizable discoveries in existing licenses.
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PetroChina (Underweight, Price Target: HK$9.00)

Valuation Methodology: Our Dec-11 PT of HK$9.00 is based on 20% premium to DCF value for PetroChina. DCF is based on using LT oil price of US$85/bbl and 10.4% WACC. We apply a 20% premium to this DCF value due to current oil prices being substantially higher than our LT forecasts, reflecting markets focus on earnings and earnings multiples rather than long term intrinsic value. Risks to Our View: Main risks to our UW is higher oil and gas prices coupled with NDRC raising product prices. Operationally, stronger than expected production upstream and less losses from natural gas imports will also be positive for PetroChina.
Repsol YPF (Neutral Price Target: 25.00)

Valuation Methodology : Our end Dec 2011 price target of 25 is derived from our SOTP valuation. Our price target is set at a c.12% discount to our SOTP, this is lower than the long-term average discount for Repsol YPF. We believe that near-term catalysts like YPF divestment, exploration results from Brazil, West Africa etc will help the stock's performance. Risks to Our View : The main generic risks to our rating and price target come from crude oil or natural gas prices or refining margins significantly below our projections. Specifically for Repsol, downside risks include a further weakness in the refining margins and possible disappointments in the company's ongoing exploration campaign - offshore Brazil, GoM and Venezuela.
Reliance Industries (Overweight, Price Target Rs1200)

Our Mar-12 price target of Rs1200 is SOTP-based, and values the refining business at 8x EVBITDA, the petchem business and PMT E&P business at 7.5x EV/EBITDA, and an NPV valuation of the E&P business (multiples in line with peer group). We use the SOTP to fully capture the value on RIL's balance sheet. Key risks to our view include a global slowdown impacting the cyclical refining and petchem businesses, along with harsh regulatory action on the E&P business.
Sinopec Corp - H (Overweight, Price Target HK$9.40)

Valuation Methodology: Our Dec-11 PT of HK$9.40 is based on 5x 2011E EV/EBITDA (same as PetroChina at our PT of HK$9.00). We use LT oil price of US$85/bbl and 10.4% WACC. Risks to Our View: Main risks to our OW is higher than expected oil prices and NDRC not following up with product prices.
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Statoil (Underweight Price Target: Nkr145.00)

Valuation Methodology : Our end Dec 2011 price target of Nkr145 is derived from our SOTP valuation - no change to our key assumptions or our SOTP valuation. Our price target for the stock is set at a c.24% discount to our SOTP of NKr190 this is in-line with the 12 month average discount suffered by the stock. We still believe that a discount will prevail until Statoil shows a clearer, sustainable improvement in its upstream performance. Risks to Our View : The main generic risks come from crude oil or natural gas prices or refining margins significantly below our projections. For Statoil specifically, negative risks include any slippage to production targets resulting from higher core decline rates in Norwegian production or if lower crude prices prevent Statoil from sanctioning new projects. Positive risks include further success in the international portfolio, notably in the deepwater US Gulf and offshore Brazil. Changes in crude prices affect Statoils shares more than its peers given its greater upstream leverage.
TOTAL (Neutral Price Target: 47.00)

Valuation Methodology : Our end Dec 2011 price target is 47- no change to our key assumptions or our SOTP valuation. Our price target for the stock is set at a 14% discount to our SOTP slightly below the 12 month average discount suffered by this name. Risks to Our View : The following risks could prevent the stock from achieving our price target and rating. The main generic risks come from crude oil or natural gas prices or refining margins significantly below our projections. For Total specifically, negative risks could come from project slippage relative to the last guidance, but positive risks could come from better-than expected volume growth in 10-11.
Sasol (Overweight Price Target: 39,800c)

Valuation Methodology : We derive our 12-month target price from the average of our DCF valuation (R382) and our 2012E HEPS of R 37.7 at Sasols average historical trailing P/E multiple of 11x (R415). This gives us an average value of R398. Risks to Our View : We believe the key risks that could keep our target price from being achieved include the following: BEE covenants Sasol has share price covenants attached to debt provided by third party banks to support its BEE deal. If its share price falls below R 211 it has to assume R 4.5bn in debt from the banks and if it falls below R 191 a further 2.5bn has to be absorbed. The share price has to remain below the trigger points for 10 days VWAP.
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Weaker long-term oil price Our recommendation hinges on the basic assumption of a higher than previously witnessed long-term oil price. If investors do not believe in relatively high long-term oil prices (USD 80-110), we recommend they avoid investing in Sasol. Macro factors Sasol is very exposed to macro factors, particularly the oil price and Rand/USD. Sasol estimates that for 2011, a USD1 per barrel movement in the oil price would have a ~R615m impact on its EBIT. The company estimates that for 2011, a 10c weakening or strengthening in the Rand/USD would impact Sasols EBIT by ~R632m. Engineering competency and geography Our recommendation depends on Sasol continuing to operate its Oryx GTL and Iranian Chemicals expansion without further issues (note both these plants have had significant problems). In addition, Sasol is exposed to projects in areas of relatively high political risk e.g. Iran, Nigeria, and China, which creates relatively high specific risk in Sasol. Management capacity We are assuming that Sasol can negotiate contracts and bring onstream a significant number of major GTL projects over the next 10 years. Given the relatively limited number of experienced engineers in this area, we see a significant risk that our expectations overestimate the capacity and availability of Sasols pool of qualified individuals. Environmental factors Sasols key CTL technology produces significant amounts of CO2 and we believe Secunda to be one of the worlds largest single-point CO2 emitters. Given global concerns over CO2 emissions, Sasol will likely have to satisfy increasingly stringent environmental rules, which will likely place additional costs and technical burdens on the company. CO2 legislation could also lead to taxes and or charges for CO2 emissions. Sasol also has exposure to shale gas which also has potential environmental issues associated with it. Competition We are relying on Sasol being able to deliver equity stakes in major GTL projects going forward. Whilst we believe Sasol is the global leader in GTL technology, competition is increasing and resource owners may decide to partner with others or progress projects on their own.
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BP: Summary of Financials

Profit and Loss Statement $ in millions, year end Dec E&P R&M Other & Corporate Total Segmental EBIT Finance Costs Pre-Tax Income Less: Tax Tax Rate Minorities Adjusted Net Income Growth Avg. shares in issue (m) Adjusted EPS (cents) EPS growth(%) Adjusted EPS (pence) EPS growth(%) DPS (cents) DPS growth(%) DPS (pence) DPS growth(%) FY09 21,616 3,607 -2,550 22,673 (1,302) 21,371 (6,613) 30.9% 181 FY10 27,389 4,868 -869 31,388 (1,025) 30,363 (9,613) 31.7% 399 FY11E 31,354 5,633 -1,050 35,937 (975) 34,962 (11,637) 33.3% 546 Valuation, performance and production FY12E $ in millions, year end Dec FY09 FY10 FY11E FY12E 30,103 - Brent crude, $/bbl 62.67 80.34 110.00 95.00 5,839 - US Gas, $/MMBtu 4.16 4.38 4.33 5.40 -1,050 34,892 - Valuation Mkt Cap ($ bn) (875) - P/E adjusted 9.2 6.5 6.4 6.6 34,017 - P/CF 2.9 6.0 2.6 2.7 (11,366) - P/FCF -26753.6% 1251.6% 2991.2% -75424.3% 33.4% - EV/DACF 547.8% 1059.3% 461.8% 484.6% 495 - CF Yield 0.4% 0.2% 0.4% 0.4% FCF Yield 7.6% 7.2% 5.9% 4.0% 22,155 - FCF yield ex-w/c 1.4% 3.4% 4.4% 1.4% (2.7%) - Dividend Yield 7.7% 1.0% 3.9% 4.2% 19,898.02 - Buyback Yield 0.0% 0.0% 0.0% 0.0% Combined Yield 7.7% 1.0% 3.9% 4.2% 1.11 NM - Ratios 69.3 - Net debt to equity 25.7% 20.7% 13.7% 12.2% -3.1% - Net Debt to Capital Employed 20.5% 17.2% 12.1% 10.9% 30.5 - ROE 14.3% 21.8% 20.5% 17.4% 7.0% - ROCE 11.9% 16.9% 19.0% 16.4% 19.0 7.0% - Production Group oil, kbopd 2,535 2,374 2,133 2,111 Group gas, mmcfpd 8,485 8,401 8,011 8,382 Group Total, kboepd 3,950 3,774 3,468 3,508 Y/Y growth 4.2% -4.4% -8.1% 1.2% Cash flow statement FY12E $ in millions, year end Dec FY09 FY10 FY11E FY12E 17,272 - Consolidated Net Income 14,577 20,352 22,778 22,155 76,226 - DD&A 12,699 11,539 11,924 12,482 93,498 - Cash tax payable (6,324) (6,610) (9,613) (11,637) 134,253 - Other items 9,285 -5,443 13,521 17,124 77,794 - Cash Earnings 30,237 19,838 38,611 40,124 212,047 - Change in working capital (2,294) 2,182 (3,000) (2,000) 305,545 - Cash flow from Operations 32,531 17,656 41,611 42,124 14,022 71,479 - Capex (20,073) (18,421) (18,153) (19,653) 85,501 - Other investing cash flow 2,681 17,455 -6,837 -6,500 Cash Flow from Investing -17,392 -966 -24,990 -26,153 25,957 57,691 - Share Buybacks 0 0 0 083,648 - Dividends (s/h & minorities) (10,483) (2,627) (5,478) (5,963) 169,149 - Other cash flow from financing 9,742 (367) 4,952 5,437 134,342 - Cash flow from Financing -741 -2,994 -526 -526 2,054 - Change in Net debt 1,120 -6,883 -3,039 121 136,396 305,545 - Debt adjusted cash flow 29,210 14,323 34,947 33,436 Free cash flow (321) 6,883 3,039 (121) 16,360 - FCF ex-W/Capital Changes 1,973 4,701 6,039 1,879 150,703 - CFPS 1.6 1.1 1.9 2.0 -
14,577 20,352 22,778 (44.5%) 39.6% 11.9% 18,732.46 18,791.23 19,825.52 0.78 NM 49.7 -34.1% 56.0 0.9% 35.3 8.9% 1.09 39.5% 70.3 41.5% 7.0 (87.5%) 4.5 (87.3%) 1.15 5.8% 71.5 1.8% 28.5 307.1% 17.7 295.5%
Balance sheet $ in millions, year end Dec Cash and cash equivalent Other current assets Current assets Tangible fixed assets Other non current assets Total non current assets Total assets Short term debt Other current liabilities Total current liabilities Long term debt Other non current liabilities Total non current liabilities Total liabilities Shareholders' equity Minorities Total Equity Total Liabilities and Shareholders Equity
FY09 8,339 7,178 67,653 108,275 10,046 168,315 235,968 9,109 15,007 59,320 25,518 49,017 74,535 133,855 101,113 500 101,613 235,968
FY10 14,354 73,654 88,008 107,516 65,915 173,431 261,439 14,022 70,041 84,063 25,957 57,269 83,226 167,289 93,138 1,012 94,150 261,440 19,278 112,416
FY11E 17,393 73,597 90,989 120,582 75,703 196,285 287,274 14,022 70,109 84,131 25,957 57,478 83,435 167,566 118,150 1,558 119,709 287,275 16,239 134,390
Net debt/ (cash) 26,161 Capital Employed 127,774 Source: Company reports and J.P. Morgan estimates.
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Royal Dutch Shell B: Summary of Financials

Profit and Loss Statement $ in millions, year end Dec Exploration & Production Gas & Power Oil Products Chemicals OIS & Corporate Total Segmental EBIT Finance Costs Pre-Tax Income Less: Tax Tax Rate Minorities Adjusted Net Income Growth Avg. shares in issue (m) Adjusted EPS (cents) EPS growth(%) Adjusted EPS (pence) EPS growth(%) DPS (cents) DPS growth(%) DPS (pence) DPS growth(%) FY09 18,333 2,423 2,291 410 408 23,865 FY10 33,230 4,060 2,969 1,983 -719 41,523 FY11E 54,030 4,877 4,420 2,067 -649 64,745 FY12E 49,392 5,495 5,823 2,734 -643 62,801 Valuation, performance and production FY13E $ in millions, year end Dec FY09 48,159 Brent crude, $/bbl 62.67 6,021 US Gas, $/MMBtu 4.16 6,578 2,377 Valuation -636 Mkt Cap ($ bn) 62,499 P/E adjusted 17.0 P/CF 0.7 407 P/FCF -252.5% 62,906 EV/DACF 1186.9% (31,817) CF Yield 0.1% 50.6% FCF Yield 2.3% 497 FCF yield ex-w/c -1.4% Dividend Yield 4.7% 30,186 Buyback Yield 0.0% 1.4% Combined Yield 4.7% 6,412.83 Ratios 4.77 Net debt to equity 18.6% 2.4% Net Debt to Capital Employed 15.7% 297.1 ROE 8.5% 2.4% ROCE 7.3% 181.7 0.0% Production 111.0 Group oil, kbopd 1,680 3.0% Group gas, mmcfpd 8,483 Group Total, kboepd 3,094 Y/Y growth -3.3% Cash flow statement FY13E $ in millions, year end Dec FY09 39,344 Consolidated Net Income 11,553 99,450 DD&A 14,458 138,794 Cash tax payable (9,243) 168,478 Other items 2,389 62,601 Cash Earnings 19,157 231,078 Change in working capital (2,331) 369,872 Cash flow from operations 21,488 (9,951) 101,178 Capex (27,838) 91,227 Other investing cash flow 1,604 Cash Flow from Investing Acitivites -26,234 (34,381) 116,864 Share Buybacks 0 72,532 Dividends (s/h & minorities) (10,526) 163,759 Other cash flow from financing 9,803 199,630 Cash flow from Financing -723 3,242 Change in Net debt 17,233 202,872 369,873 Debt adjusted cash flow 20,610 Free cash flow (5,469) 4,988 FCF ex-W/Capital Changes -3,138 207,860 CFPS 3.1 FY10 FY11E FY12E FY13E 80.34 110.00 95.00 90.00 4.38 4.33 5.40 5.90
1,664 (140) (406) (123) 25,529 41,383 64,338 62,678 (12,194) (23,117) (37,136) (32,551) 47.8% 55.9% 57.7% 51.9% 118 333 502 476 11,553 18,073 27,107 29,773 (59.3%) 56.4% 50.0% 9.8% 6,128.90 6,139.28 6,312.83 6,362.83 1.89 NM 120.3 -50.0% 168.0 5.0% 106.3 14.5% 2.94 56.2% 190.4 58.3% 168.0 0.0% 106.8 0.5% 4.23 43.7% 263.4 38.3% 174.7 0.0% 104.6 (2.0%) 4.66 10.2% 290.2 10.2% 181.7 3.0% 107.8 3.0%
10.9 7.6 6.9 6.7 0.5 0.3 0.3 0.3 371.4% 172.9% 182.0% 147.6% 915.6% 604.3% 531.3% 496.4% 0.2% 0.3% 0.3% 0.3% 6.1% 8.1% 8.0% 8.9% 4.4% 7.2% 7.4% 8.4% 4.7% 4.6% 4.7% 4.9% 0.0% 0.0% 0.0% 0.0% 4.7% 4.6% 4.7% 4.9%
20.9% 17.3% 12.2% 10.7%
13.8% 12.1% 16.5% 14.7%
8.0% 7.4% 16.2% 15.4%
2.5% 2.4% 14.9% 15.0%
1,709 9,305 3,259 5.4% FY10 18,073 15,595 (15,362) 3,115 21,421 (5,929) 27,350
1,706 1,681 1,720 9,837 10,857 11,105 3,345 3,490 3,571 2.6% 4.3% 2.3% FY11E 27,107 17,523 (17,523) 7,480 34,587 (7,732) 42,319 FY12E 29,773 16,182 (16,182) 8,757 38,531 (8,586) 47,117 FY13E 30,186 15,717 (15,717) 9,855 40,041 (8,859) 48,900
Balance sheet $ in millions, year end Dec Cash and cash equivalent Other current assets Total current assets Tangible fixed assets Other non current assets Total non current assets Total assets Short term debt Other current liabilities Total current liabilities Long term debt Other non current liabilities Total non current liabilities Total liabilities Shareholders' equity Minorities Total Equity Total Liabilities and Shareholders Equity
FY09 9,719 86,738 96,457 131,619 64,105 195,724 292,181 (4,171) 88,960 84,789 (30,862) 104,290 69,257 154,046 134,727 1,704 136,431 292,181
FY10 13,444 99,450 112,894 142,705 66,961 209,666 322,560 (9,951) 110,503 100,552 (34,381) 116,560 72,228 172,780 146,246 1,767 148,013 322,560
FY11E 21,673 99,450 121,123 146,854 65,152 212,006 333,129 (9,951) 103,602 93,651 (34,381) 116,864 72,532 166,183 162,409 2,269 164,678 333,129
FY12E 29,551 99,450 129,001 157,683 63,870 221,553 350,555 (9,951) 101,500 91,549 (34,381) 116,864 72,532 164,081 180,984 2,745 183,730 350,555
(25,399) (28,214) (28,214) (27,714) 3,427 5,000 175 175 -21,972 -23,214 -28,039 -27,539 0 0 0 0 (9,584) (10,442) (10,722) (11,043) 7,931 (435) (478) (526) -1,653 -10,876 -11,200 -11,569 5,574 -8,229 -7,879 -9,793 27,042 42,056 46,698 48,375 3,725 8,229 7,879 9,793 9,654 15,961 16,465 18,652 3.5 5.5 6.1 6.2
Net debt/ (cash) 25,314 30,888 22,659 14,781 Capital Employed 161,745 178,901 187,337 198,510 Source: Company reports and J.P. Morgan estimates.
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ENI: Summary of Financials

Profit and Loss Statement in millions, year end Dec Exploration & Production Gas & Power Refining & Marketing Chemicals Corporate & other Total Segmental EBIT Finance Costs Pre-Tax Income Less: Tax Tax Rate Minorities Adjusted Net Income Growth Avg. shares in issue (m) Adjusted EPS EPS growth(%) DPS DPS growth(%) FY09 9,484 3,683 -357 -426 528 12,912 149 13,061 7,049 54.0% 950 FY10 13,884 3,119 -171 -113 585 17,304 89 17,393 9,459 54.4% 1,065 FY11E 16,288 3,375 -13 183 935 20,767 209 20,976 11,105 52.9% 1,215 FY12E 16,702 3,571 133 183 1,214 21,803 250 22,053 11,318 51.3% 1,421 FY13E 16,846 3,720 228 183 1,315 22,292 250 22,542 11,332 50.3% 1,510 Valuation, performance and production in millions, year end Dec FY09 Brent crude, $/bbl 62.67 US Gas, $/MMBtu 4.16 Valuation Mkt Cap (bn) P/E adjusted P/CF P/FCF EV/DACF CF Yield FCF Yield FCF yield ex-w/c Dividend Yield Buyback Yield Combined Yield Ratios Net debt to equity Net Debt to Capital Employed ROE ROCE Production Group oil, kbopd Group gas, mmcfpd Group total, kboepd Y/Y growth Cash flow statement in millions, year end Dec Consolidated Net Income DD&A Cash tax payable Other items Cash Earnings Change in working capital Cash flow from Operations FY10 80.34 4.38 FY11E 110.00 4.33 FY12E 95.00 5.40 FY13E 90.00 5.90
5,062 6,869 8,656 9,314 9,700 (50.2%) 35.7% 26.0% 7.6% 4.2% 3,622.10 3,622.10 3,622.10 3,622.10 3,621.60 1.40 NM 1.00 (23.1%) 1.90 35.7% 1.00 0.0% 2.39 26.0% 1.05 5.0% 2.57 7.6% 1.10 5.0% 2.68 4.2% 1.16 5.0%
9.3 6.9 5.4 5.3 4.0 3.3 -3722.8% 3355.9% 1051.0% 7.4 5.8 4.6 18.9% 24.8% 30.5% 4.5% 6.9% 9.5% 0.5% 5.9% 11.2% 6.1% 6.1% 6.4% 0.0% 0.0% 0.0% 6.1% 6.1% 6.4% 42.4% 31.4% 10.1% 7.2% 43.4% 31.9% 12.3% 8.9% 35.8% 28.1% 14.0% 10.3%
5.1 2.9 927.7% 4.0 34.0% 10.8% 10.8% 6.8% 0.0% 6.8% 28.7% 24.1% 13.6% 10.5%
4.9 2.8 840.7% 3.8 35.2% 11.9% 11.9% 7.1% 0.0% 7.1% 22.3% 19.9% 12.8% 10.5%
1,007 4,374 1,796 0.4% FY09 5,062 9,811 7,049 -4,099 17,823 (1,901) 19,724
997 4,540 1,816 1.1% FY10 6,869 9,392 9,459 -3,949 21,771 (1,726) 23,497
947 3,915 1,654 -9.0% FY11E 8,656 9,327 11,105 -994 28,094 (1,000) 29,094
1,020 4,410 1,816 9.8% FY12E 9,314 9,559 11,318 1,171 31,361 0 31,361
1,075 4,287 1,849 1.8% FY13E 9,700 9,741 22,663 -10,071 32,034 0 32,034
Balance sheet in millions, year end Dec Tangible fixed assets Other non current assets Total non current assets Cash and cash equivalent Total assets Short term debt Long term debt Total liabilities Shareholders' equity Minorities Total Equity Total Liabilities and Equity Net debt Capital Employed
FY09 63,287 16,676 79,963 1,625 73,339 137 24,800 23,038 46,323 3,978 50,301 73,339 23,038 73,339
FY10 67,133 20,058 87,191 1,549 81,847 115 27,783 26,119 51,206 4,522 55,728 81,847 26,119 81,847
FY11E 70,400 20,058 90,458 3,457 86,114 98 27,783 24,228 56,149 5,737 61,887 86,114 24,228 86,114
FY12E 74,787 20,058 94,845 5,908 90,501 98 27,783 21,777 61,565 7,159 68,723 90,501 21,777 90,501
FY13E 78,994 20,058 99,052 8,821 94,706 98 27,783 18,864 67,173 8,669 75,841 94,706
Capex Other investing cash flow Cash Flow from Investing Share Buybacks Dividends (s/h & minorities) Other cash flow from financing 18,864 Cash flow from Financing 94,706 Change in Net debt Debt adjusted Cash Flow Free cash flow Free cash flow (ex-w/c) CFPS
(13,695) (13,870) 847 931 -12,848 -12,939 0 0 (2,956) (4,099) 4,224 2,285 1,268 -1,814 4,662 11,117 (1,582) 319 4.9 3,081 14,605 1,755 3,481 6.0
(14,094) (13,945) (13,948) 1,500 0 0 -12,594 -13,945 -13,948 0 0 0 (3,713) (3,898) (4,092) 0 0 1 -3,713 -3,898 -4,091 -1,891 17,989 5,604 6,604 7.8 -2,450 20,044 6,349 6,349 8.7 -2,913 20,702 7,004 7,004 8.8
Source: Company reports and J.P. Morgan estimates.
183
Essar Energy: Summary of Financials

Profit and Loss Statement $ in millions, year end Dec Revenues EBITDA Depreciation Total EBIT Finance Costs Other income Pre-Tax Income Less: Tax Tax Rate Minorities Post tax inventory adjustment Adjusted Net Income Growth Reported Net Income Avg. shares in issue (m) Per share amounts Reported EPS Adjusted EPS DPS Balance sheet $ in millions, year end Dec Total l/term assets Cash and cash equivalent Other current assets Current assets Total assets Total Debt Total liabilities Minorities Shareholders' equity Total Equity Total Liabilities & Shareholders Equity Net debt Capital Employed FY10 8,959 729 127 602 (272) 45 357 71 20.0% 36 0 250 135.4% 250 FY11E 9,656 1,155 189 966 (390) 577 123 21.3% 43 0 411 64.6% 411 FY12E 14,122 2,192 368 1,824 (711) 1,114 245 22.0% 70 0 799 94.3% 799 FY13E 14,873 2,542 452 2,090 (650) 1,439 315 21.9% 88 0 1,036 29.8% 1,036 Valuation, performance and production $ in millions, year end Dec FY10 Valuation Mkt Cap ( bn) P/E adjusted P/BV EV/Sales EV/EBITDA EV/DACF (Dynamic EV) FY11E FY12E FY13E
20.3 12.7 6.5 5.0 1.2 1.1 1.0 0.8 1.5 1.8 1.3 1.2 18.7 14.8 8.2 7.2 -5209.4% 2660.7% 1447.4% 1154.9%
FCF Yield Dividend Yield
-28.7% 0.0%
-27.1% 0.0%
-0.8% 0.0%
3.4% 0.0%
1,303.00 1,346.00 1,346.00 1,346.00 0.19 0.19 0.00 FY10 8,412 564 1,520 2,083 10,495 4,498 5,852 360 3,922 4,282 10,495 3,934 8,576 0.31 0.31 0.00 FY11E 11,761 300 1,773 2,073 13,833 7,381 8,736 403 4,289 4,693 13,833 7,081 12,178 0.59 0.59 0.00 FY12E 13,082 250 2,116 2,366 15,447 8,126 9,480 474 5,018 5,492 15,447 7,876 13,842 0.77 0.77 0.00 FY13E 14,314 200 2,314 2,514 16,828 8,382 9,736 562 5,966 6,528 16,827 8,182 15,272
Ratios Net debt to equity Net Debt to Capital Employed Net Debt/EBITDA ROE ROCE Cash flow statement $ in millions, year end Dec Consolidated Net Income Tax DD&A Other (including non-recurring) Cash Earnings Increase in working capital Cash flow from operations Capex Cash Flow from Investing Dividends (S/H & Minorities) Cash flow from Financing Change in Net debt
84.7% 45.9% 5.4 5.8% 2.9% FY10 250 17 127 -1,664 -1,270 (1,008) (262) (2,496) -2,612 3,312 2,052
138.9% 58.2% 6.1 8.8% 3.4% FY11E 411 -512 189 555 643 0 643 (3,349) -3,349 0 2,494 2,884
132.0% 56.9% 3.6 14.5% 5.8% FY12E 799 -955 368 1,026 1,237 0 1,237 (1,321) -1,321 0 34 745
115.4% 53.6% 3.2 15.9% 6.8% FY13E 1,036 -965 452 1,053 1,576 0 1,576 (1,232) -1,232 0 -394 256
Debt adjusted Cash Earnings Free cash flow FCF ex-W/Capital Changes CFPS
-262 (2,874) -1,866 -1.0
643 (2,706) -2,706 0.5
1,237 (84) -84 0.9
1,576 344 344 1.2
Source: Company reports and J.P. Morgan estimates.
184
Galp Energia: Summary of Financials

Profit and Loss Statement in millions, year end Dec Exploration & Production Refining & Marketing Gas & Power Other Total Segmental EBIT Valuation, performance and production FY10 FY11E FY12E FY13E in millions, year end Dec FY09 61 121 147 263 Brent Crude, $/bbl 62.67 193 253 498 508 US Gas, $/MMBtu 4.16 181 213 241 244 89 90 105 105 Valuation 524 676 991 1,121 Mkt Cap (bn) P/E adjusted 48.5 Finance Costs (76) (98) (145) (155) (171) P/CF 12.9 Pre-Tax Income 281 426 532 836 950 P/FCF 11352.3% Less: Tax 61 115 133 218 287 EV/DACF 14.8 Tax Rate 21.7% 27.0% 25.0% 26.0% 30.2% CF Yield 7.7% Minorities (6) (5) (5) (5) (5) FCF Yield 1.8% FCF yield ex-w/c 0.9% Adjusted Net Income 214 306 394 613 658 Dividend Yield 1.3% Growth (54.7%) 43.2% 28.7% 55.8% 7.2% Buyback Yield 0.0% Combined Yield 1.3% Shares in issue (mn) 829.0 829.0 829.0 829.0 829.0 Ratios Adjusted EPS 0.27 0.37 0.46 0.75 0.79 Net debt to equity 79.8% EPS growth(%) NM 37.8% 26.0% 61.3% 5.6% Net Debt to Capital Employed 44.7% DPS 0.20 0.20 0.20 0.20 0.20 ROE 9.0% DPS growth(%) (37.5%) 0.0% 0.0% 0.0% 0.0% ROCE 5.1% Production Group Total, kboepd 10 Y/Y growth -1.5% Balance sheet Cash flow statement in millions, year end Dec FY09 FY10 FY11E FY12E FY13E in millions, year end Dec FY09 Tangible fixed assets 3,190 3,588 4,575 5,211 5,740 Consolidated Net Income 214 Investments in associates 227 253 253 297 297 DD&A 459 Other non current assets 999 1,916 1,916 1,848 1,848 Cash tax payable (176) Total non current assets 4,416 5,757 6,744 7,356 7,885 Other items 195 Cash and cash equivalent 244 188 (567) (752) (785) Cash Earnings 1,043 Other current assets 2,583 3,202 3,202 3,203 3,203 Change in working capital 0 Total Current assets 2,827 3,390 2,635 2,451 2,418 Cash flow from Operations 1,043 Total assets 7,243 9,147 9,379 9,808 10,303 Capex (800) Short term debt 423 616 618 618 618 Other investing cash flow -4 Other current liabilities 2,083 2,562 2,562 2,562 2,562 Cash Flow from Investing -804 Long term debt 1,747 2,412 2,412 2,412 2,412 Other non current liabilities 599 846 726 726 726 Dividends (s/h & minorities) (127) Total liabilities 4,856 6,436 6,273 6,273 6,318 Other cash flow from financing 105 Shareholders' equity 2,360 2,678 3,068 3,492 3,982 Cash flow from Financing -22 Minorities 27 32 37 42 47 Total Equity 2,387 2,710 3,105 3,534 4,029 Change in Net debt 62 Total Liabilities and Equity 7,243 9,146 9,378 9,807 10,347 Debt adjusted Cash Flow 1,017 Free cash flow 116 Net debt 1,926 2,840 3,597 3,782 3,815 Free cash flow (ex-w/c) 116 Capital Employed 4,313 5,550 6,702 7,315 7,844 CFPS 1.3 Source: Company reports and J.P. Morgan estimates. FY09 68 79 135 75 357 FY10 80.34 4.38 FY11E 110.00 4.33 FY12E 95.00 5.40 FY13E 90.00 5.90
35.2 28.0 17.3 17.3 13.5 11.5 -22704.6% -1753.6% -7199.6% 21.1 17.2 14.8 5.8% 7.4% 8.7% 0.4% -4.5% -0.1% -0.4% -5.7% -1.4% 1.3% 1.3% 1.3% 0.0% -0.0% -0.0% 1.3% 1.3% 1.2%
16.4 10.8 -43615.6% 13.9 9.3% 1.0% -0.2% 1.3% -0.0% 1.2%
103.6% 51.2% 11.3% 6.2% 11 16.7% FY10 306 317 (195) -37 781 0 781 (1,371) -22 -1,393 (108) 770 662 914 760 (58) -58 0.9
114.5% 53.7% 12.7% 6.4% 14 18.4% FY11E 394 285 (278) 7 963 0 963 (1,362) 90 -1,272 (166) (145) -311 757 976 (751) -751 1.2
105.8% 51.7% 17.4% 8.8% 22 63.4% FY12E 613 220 (373) 4 1,210 0 1,210 (962) 105 -857 (166) (155) -321 185 1,148 (183) -183 1.5
93.6% 48.6% 16.3% 8.7% 29 31.1% FY13E 658 217 (458) 5 1,338 0 1,338 (852) 105 -747 (166) (171) -337 33 1,221 (30) -30 1.6
185
OMV: Summary of Financials

Profit and Loss Statement in millions, year end Dec Exploration & Production Refining & Marketing Gas & Power Corporate & Other Total Segmental EBIT Finance Costs Pre-Tax Income Less: Tax Tax Rate Minorities Adjusted Net Income Growth Avg. shares in issue (m) Adjusted EPS EPS growth(%) DPS DPS growth(%) FY09 1,596 -222 254 -133 1495 (228) 1,266 478 37.7% 145 644 (61.4%) 297.70 2.17 NM 1.00 0.0% Valuation, performance and production FY10 FY11E FY12E FY13E in millions, year end Dec FY09 2,099 2,253 2,536 2,352 Brent crude, $/bbl 62.67 225 65 260 289 279 393 396 503 Valuation -133 -110 -110 -110 Mkt Cap (bn) 2469 2601 3081 3034 P/E adjusted 11.9 P/CF 4.2 (373) (200) (167) (119) EV/DACF 6.2 2,096 2,401 2,914 2,915 CF Yield 23.7% 684 642 1,117 1,075 FCF Yield 4.6% 32.6% 26.7% 38.3% 36.9% FCF yield ex-w/c 4.3% 294 443 344 322 Dividend Yield 4.4% Combined Yield 4.4% 1,118 1,316 1,453 1,518 73.8% 17.7% 10.4% 4.4% Ratios 297.70 326.20 326.20 326.20 Net debt to equity 33.0% Net Debt to Capital Employed 24.8% 3.76 4.03 4.43 4.63 ROE 6.4% 73.6% 7.1% 10.2% 4.5% ROCE 4.9% 1.00 1.05 1.07 1.09 0.0% 5.0% 2.0% 2.0% Production Group oil, kbopd 127 Group gas, mmcfpd 562 *Group Total, kboepd 227 Y/Y growth 1.4% Cash flow statement FY10 FY11E FY12E FY13E in millions, year end Dec FY09 946 1,528 1,550 1,915 Consolidated Net Income 644 6,598 6,598 6,598 6,598 DD&A 1,261 7,544 8,126 8,148 8,513 Cash tax payable (249) 12,829 14,619 15,570 16,239 Other items -375 5,841 5,841 5,841 5,841 Cash Earnings 1,778 18,670 20,460 21,412 22,080 Change in working capital (317) 26,404 28,776 29,749 30,783 Cash flow from Operations 2,096 968 968 968 968 5,252 5,273 5,421 5,601 Capex (2,206) 6,220 6,241 6,389 6,569 Other investing cash flow 997 Cash Flow from Investing -1,210 5,005 5,005 5,005 5,005 3,330 4,080 4,080 4,080 Dividends (s/h & minorities) (336) 8,335 9,085 9,085 9,085 Other cash flow from financing (322) 15,092 15,863 16,011 16,191 Cash flow from Financing -658 9,081 10,239 10,720 11,252 Change in Net debt -119 2,232 2,675 3,018 3,340 11,312 12,914 13,739 14,592 Debt adjusted Cash Flow 1,618 26,404 28,777 29,749 30,783 Free cash flow (27) FCF ex-W/Capital Changes 291 5,167 4,445 4,423 4,058 16,479 17,359 18,162 18,650 FY10 FY11E FY12E FY13E 80.34 110.00 95.00 90.00
6.9 2.4 4.1 42.3% 8.9% 15.0% 4.4% 4.4%
6.4 2.6 4.1 38.7% 4.0% 8.5% 4.6% -6.0%
5.8 2.3 3.6 43.5% 6.8% 0.3% 4.7% 4.7%
5.6 2.3 3.5 43.8% 11.5% 5.3% 4.8% 4.8%
45.7% 31.4% 9.9% 7.5%
34.4% 25.6% 10.2% 7.8%
32.2% 24.3% 10.6% 8.2%
27.8% 21.8% 10.4% 8.2%
127 102 563 557 227 202 0.2% -11.3%
133 571 235 16.3%
129 584 233 -0.5%
Balance sheet in millions, year end Dec Cash and cash equivalent Other current assets Total current assets Tangible fixed assets Other non current assets Total non current assets Total assets Short term debt Other current liabilities Total current liabilities Long term debt Other non current liabilities Total non current liabilities Total liabilities Shareholders' equity Minorities Total Equity Total Liabilities and Shareholders Equity
FY09 675 4,947 5,622 11,370 4,245 15,615 21,414 674 4,058 4,732 3,197 3,157 6,354 11,381 8,098 1,936 10,034 21,415
FY10 FY11E FY12E FY13E 1,118 1,316 1,453 1,518 1,604 1,580 1,799 1,757 (310) (442) (950) (956) -586 1 2 3 2,446 3,339 4,204 4,234 (750) 0 0 0 3,197 3,339 4,204 4,234 (2,088) (2,750) (2,750) (2,426) -787 -601 0 0 -2,875 -3,351 -2,750 -2,426 (334) 589 256 1,853 2,886 272 1,022 (441) 1,477 1,036 -722 2,897 582 582 (486) 4 -482 -22 3,254 22 22 (493) 6 -487 -365 3,278 365 365
Net debt 3,314 Capital Employed 13,348 Source: Company reports and J.P. Morgan estimates.
186
Repsol YPF: Summary of Financials

Profit and Loss Statement in millions, year end Dec Exploration & Production Refining & Marketing YPF Gas Natural LNG Corporate Total Segmental EBIT Finance Costs Pre-Tax Income Less: Tax Tax Rate Minorities Adjusted Net Income Growth Avg. shares in issue (m) FY09 884 647 789 745 50 -354 2,761 (468) 2,293 832 36.3% 166 FY10 FY11E FY12E FY13E 1,473 1,917 2,360 2,245 977 865 1,393 1,528 1,625 1,549 1,800 1,899 849 933 939 961 127 259 253 279 -336 -316 -345 -349 4,714 5,207 6,399 6,561 (858) 3,856 1,561 40.5% 263 (669) 4,538 1,870 41.2% 267 2,402 18.2% (572) 5,827 2,587 44.4% 324 2,916 21.4% (571) 5,990 2,599 43.4% 339 3,052 4.6% Valuation, performance and production in millions, year end Dec FY09 Brent Crude, $/bbl 62.67 US Gas, $/MMBtu 3.66 Valuation Mkt Cap (bn) P/E adjusted P/CF P/FCF EV/DACF CF Yield FCF Yield FCF yield ex-w/c Dividend Yield Buyback Yield Combined Yield FY10 80.34 4.38 FY11E 110.00 4.34 FY12E 95.00 5.40 FY13E 90.00 5.90
1,295 2,032 (50.6%) 57.0%
17.4 4.9 -4225.8% 7.5 20.5% 4.8% -0.2% 3.9% 0.0% 3.9%
11.1 9.4 7.7 7.4 4.1 4.0 4.3 3.4 653.7% 3663.4% -1835.7% -52790.2% 5.7 5.4 6.1 4.9 24.4% 25.0% 23.4% 29.1% 18.3% 7.5% -0.2% 5.6% 17.5% 9.0% -2.7% 7.3% 4.8% 5.2% 5.8% 6.3% 0.0% 0.0% 0.0% -0.0% 4.8% 5.2% 5.8% 6.3%
Ratios 1,221.00 1,221.00 1,221.00 1,221.00 1,221.00 Net debt to equity Net Debt to Capital Employed Adjusted EPS 1.06 1.66 1.97 2.39 2.50 ROE EPS growth(%) NM 57.0% 18.2% 21.4% 4.6% ROCE DPS 0.85 1.05 1.16 1.27 1.40 Production DPS growth(%) (19.1%) 23.5% 10.0% 10.0% 10.0% Group oil, kbopd Group gas, mmcfpd Group Total, kboepd Y/Y growth Balance sheet Cash flow statement in millions, year end Dec FY09 FY10 FY11E FY12E FY13E in millions, year end Dec Tangible fixed assets 31,900 33,585 33,493 34,781 36,689 Consolidated Net Income Other non current assets 11,410 12,168 12,172 12,181 12,177 DD&A Total non current assets 43,310 45,753 45,665 46,962 48,866 Cash tax payable Total Current assets 14,773 21,878 23,349 21,876 21,824 Other items Total assets 58,083 67,631 69,014 68,838 70,689 Cash Earnings Change in working capital Cash flow from Operations Short term debt 3,499 4,362 4,362 4,362 4,362 Other current liabilities 8,494 11,411 11,411 9,380 9,381 Capex Total Current Liabilities 11,993 15,773 15,773 13,742 13,743 Other investing cash flow Cash Flow from Investing Long term debt 15,411 14,940 14,940 14,940 14,941 Other non current liabilities 9,288 10,932 10,932 10,932 10,932 Dividends (s/h & minorities) Total non current liabilities 24,699 25,872 25,872 25,872 25,873 Other cash flow from financing Total liabilities 36,692 41,645 41,645 39,614 39,616 Cash flow from Financing Shareholders' equity 19,951 24,140 25,260 26,766 28,266 Minorities 1,440 1,846 2,113 2,437 2,776 Change in Net debt Total Equity 21,391 25,986 27,373 29,203 31,042 Total Liabilities and Shareholders Equity 58,083 67,631 69,018 68,817 70,658 Debt adjusted Cash Flow Free cash flow Net debt 14,654 10,958 9,894 11,367 11,420 FCF ex-W/Capital Changes Capital Employed 34,605 35,098 35,154 38,133 39,686 CFPS Source: Company reports and J.P. Morgan estimates.
73.4% 45.4% 42.4% 31.2% 6.1% 7.8% 4.2% 5.8% 438 2,808 906 -4.8% 437 2,700 887 -2.1%
39.2% 28.1% 8.8% 6.8% 401 2,491 816 -8.0% FY11E 2,402 4,166 (1,776) -1,486 6,858 (1,693) 8,551 (6,500) 0 -3,417 (1,282) (669) -1,950 -1,064 6,774 738 2,431 5.6
42.5% 29.8% 10.0% 8.0% 437 2,394 836 2.5% FY12E 2,916 3,599 (2,457) -928 8,045 (733) 8,778 (5,240) 0 -5,240 (1,410) (572) -1,982 1,473 6,321 (1,473) -740 6.6
40.4% 28.8% 9.8% 7.8% 431 2,322 818 -2.2% FY13E 3,052 3,574 (2,469) -775 8,321 (2,031) 10,352 (5,240) 0 -5,240 (1,552) (572) -2,123 53 7,882 (51) 1,980 6.8
FY09 FY10 1,295 2,032 2,886 3,876 (1,168) (1,627) 770 106 6,119 7,641 (590) (590) 6,709 8,231 (9,003) (5,106) 56 -27 -7,854 -73 (1,935) (806) 4,440 (653) 2,505 -1,459 7,796 -3,696 5,541 (640) -50 5.0 6,604 4,137 4,727 6.3
187
Statoil: Summary of Financials

Profit and Loss Statement Nkr in millions, year end Dec FY09 FY10 FY11E Exploration & production 111,881 125,730 158,516 Marketing, Process mgt & Renewable Enrgy 16,500 13,500 12,335 Manufacturing & Marketing 2,100 1,700 Other Operations -1,100 -400 -1,100 Total Segmental EBIT 130,881 142,730 171,419 Valuation, performance and production FY13E Nkr in millions, year end Dec FY09 FY10 FY11E FY12E FY13E 148,521 Brent crude, $/bbl 62.67 80.34 110.00 95.00 90.00 14,113 US Gas, $/MMBtu 4.16 4.38 4.34 5.40 5.90 -1,100 Valuation 163,406 Mkt Cap (Nkr bn) P/E adjusted 10.0 9.2 7.0 7.1 7.5 Finance Costs (300) (1,100) 0 0 0 P/CF 5.9 5.3 4.3 4.3 4.4 Pre-Tax Income 129,081 139,593 170,551 171,517 162,334 P/FCF 7092.3% 8349.4% 1087.1% -7694.9% Less: Tax 92,286 98,800 116,185 117,626 111,859 EV/DACF 6.9 6.2 4.6 4.7 4.9 Tax Rate 70.7% 69.8% 67.8% 68.2% 68.5% CF Yield 16.9% 18.7% 23.4% 23.0% 22.6% Minorities (598) (598) (767) (805) (861) FCF Yield 6.8% 5.7% 13.8% 3.6% 3.1% FCF yield ex-w/c 2.7% 4.8% 10.5% 0.1% -0.7% Adjusted Net Income 37,697 42,232 54,467 54,036 50,686 Dividend Yield 4.4% 4.6% 4.8% 5.1% 5.3% Growth (34.7%) 12.0% 29.0% (0.8%) (6.2%) Buyback Yield 0.1% 0.1% 0.0% 0.0% 0.0% Avg. shares in issue (m) 3,185.00 3,182.00 3,182.00 3,182.00 3,182.00 Combined Yield 4.5% 4.7% 4.8% 5.1% 5.3% Adjusted EPS (Nkr) 12.07 13.14 17.22 17.08 16.04 Ratios EPS growth(%) NM 8.8% 31.1% NM NM Net debt to equity 37.6% 30.8% 11.7% 12.5% 14.0% DPS (Nkr) 6.00 6.24 6.55 6.88 7.22 Net Debt to Capital Employed 27.3% 23.5% 10.5% 11.1% 12.3% DPS growth(%) (17.2%) 4.0% 5.0% 5.0% 5.0% ROE 18.8% 18.7% 20.9% 18.3% 15.7% ROCE 13.7% 14.3% 18.7% 16.3% 13.7% Production Group oil, kbopd 1,061 968 962 987 976 Group gas, mmcfpd 4,440 4,428 4,160 4,543 4,356 Group Total, kboepd 1,801 1,706 1,655 1,744 1,702 Y/Y growth 2.8% -5.3% -3.0% 5.4% -2.4% Balance sheet Cash flow statement Nkr in millions, year end Dec FY09 FY10 FY11E FY12E FY13E Nkr in millions, year end Dec FY09 FY10 FY11E FY12E FY13E Cash and cash equivalent 24,723 30,337 69,392 63,293 54,697 Consolidated Net Income 37,697 42,232 54,467 54,036 50,686 Other current assets 91,661 118,425 118,282 118,313 118,313 DD&A 43,547 41,435 42,768 46,843 48,072 Current assets 116,384 148,762 187,674 181,606 173,010 Cash tax payable 100,773 93,266 110,376 111,745 106,266 Net fixed assets 340,835 348,204 358,487 391,046 422,255 Other items -13,930 -18,281 -2,313 -7,519 -7,053 Other non current assets 105,621 101,152 100,754 100,754 100,754 Cash Earnings 168,087 158,652 205,298 205,105 197,971 Total non current assets 446,456 449,356 459,241 491,800 523,009 Change in working capital (5,687) (15,429) (5,809) (5,881) (5,593) Total assets 562,840 643,008 691,597 718,086 740,699 Cash flow from operations 173,774 174,081 211,107 210,986 203,564 Short term debt 8,150 11,730 11,730 11,730 11,730 Other current liabilities 103,655 124,405 118,596 112,714 107,121 Capex (75,150) (74,155) (89,463) (83,872) (83,872) Total current liabilities 111,805 136,135 130,326 124,444 118,851 Other investing cash flow -206 -2,063 48,366 0 0 Cash Flow from Investing Acitivites -75,356 -76,218 -41,097 -83,872 -83,872 Long term debt 95,962 99,797 99,797 99,797 99,797 Other non current liabilities 154,955 171,458 169,729 169,729 169,730 Share Buybacks -343 -294 0 0 0 Total non current liabilities 250,917 271,255 269,526 269,526 269,527 Dividends (s/h & minorities) (23,085) (19,095) (19,974) (20,973) (22,022) Total liabilities 362,722 416,613 399,852 393,970 388,378 Other cash flow from financing 34,719 19,956 0 0 0 Shareholders' equity 198,319 219,542 254,358 287,748 316,752 Cash flow from Financing 11,291 567 -19,974 -20,973 -22,022 Minorities 1,799 6,853 6,853 6,853 6,853 Change in Net debt 29,304 -5,586 -39,055 6,099 8,596 Total Equity 200,118 226,395 261,211 294,601 323,605 Total Liabilities and Shareholders Equity 562,840 643,008 661,062 688,571 711,984 Debt adjusted cash flow 73,001 80,815 100,731 99,242 97,298 Free cash flow 6,085 5,164 39,660 (5,603) (8,596) Net debt 75,267 69,681 30,626 36,725 45,321 FCF ex-W/Capital Changes 11,772 20,593 45,469 278 -3,003 Capital Employed 275,385 296,076 291,837 331,326 368,926 CFPS 52.8 49.9 64.5 64.5 62.2 Source: Company reports and J.P. Morgan estimates. FY12E 157,737 14,080 -1,100 172,468
188
TOTAL: Summary of Financials

Profit and Loss Statement in millions, year end Dec Exploration & production Refining & marketing Chemicals Corporate & other Total Segmental EBIT FY09 FY10 FY11E FY12E FY13E 13,885 19,003 23,981 22,435 22,965 1,173 1,518 1,298 1,853 1,695 314 1,124 1,162 1,143 1,184 290 -143 -380 -380 -379 15,663 21,503 26,061 25,051 25,466 Valuation, performance and production in millions, year end Dec FY09 Brent crude, $/bbl 62.67 US Gas, $/MMBtu 4.16 FY10 80.34 4.38 FY11E 110.00 4.33 FY12E 95.00 5.40 FY13E 90.00 5.90
Valuation Mkt Cap (bn) P/E adjusted Finance Costs (264) (226) (380) (340) (285) P/CF Pre-Tax Income 15,399 21,277 25,681 24,711 25,181 P/FCF Less: Tax (7,436) (10,755) (13,321) (12,867) (12,834) EV/DACF Tax Rate 48.3% 50.5% 51.9% 52.1% 51.0% CF Yield Minorities (178) (234) (260) (310) (311) FCF Yield FCF yield ex-w/c Adjusted Net Income 7,785 10,288 12,100 11,534 12,035 Dividend Yield Growth (44.1%) 32.2% 17.6% (4.7%) 4.4% Buyback Yield Combined Yield Avg. shares in issue (m) 2,217.00 2,217.00 2,217.00 2,217.00 2,217.00 Ratios Adjusted EPS 3.48 4.64 5.56 5.43 5.65 Net debt to equity EPS growth(%) NM 33.4% 19.8% NM 4.2% Net Debt to Capital Employed DPS 2.28 2.28 2.44 2.56 2.69 ROE DPS growth(%) 0.0% 0.0% 7.0% 5.0% 5.0% ROCE Production Group oil, kbopd Group gas, mmcfpd Group Total, kboepd Y/Y growth Balance sheet Cash flow statement in millions, year end Dec FY09 FY10 FY11E FY12E FY13E in millions, year end Dec Tangible fixed assets 51,590 54,964 62,375 69,071 74,360 Consolidated Net Income Other non current assets 26,406 30,548 29,650 27,674 27,675 DD&A Total non current assets 77,996 85,512 92,025 96,745 102,035 Cash Tax Payable Other items Cash and cash equivalent 11,662 14,489 16,256 18,242 19,877 Cash Earnings Other current assets 38,095 42,447 42,447 42,447 42,447 Change in working capital Total Current assets 49,757 56,936 58,703 60,689 62,324 Cash flow from Operations Total assets 127,753 143,718 150,727 157,433 164,357 Capex Short term debt 6,994 9,653 9,653 9,653 9,653 Other investing cash flow Other current liabilities 27,411 30,597 30,598 30,598 30,598 Cash Flow from Investing Total Current Liabilities 34,405 40,250 40,251 40,251 40,251 Share Buybacks Long term debt 19,437 20,783 20,783 20,783 20,783 Dividends (s/h & minorities) Other non current liabilities 20,369 21,216 21,216 21,216 21,216 Cash flow from Financing Total non current liabilities 39,806 41,999 41,999 41,999 41,999 Change in Net debt Total liabilities 74,211 82,249 82,250 82,250 82,250 Shareholders' equity 52,552 60,414 67,355 73,750 80,362 Debt adjusted Cash Flow Minorities 987 857 1,117 1,427 1,738 Free cash flow Total Equity 52,552 60,414 67,355 73,750 80,362 FCF ex-W/C Changes Total Liabilities and Shareholders Equity 127,753 143,718 150,727 157,433 164,356 CFPS Net debt 13,566 13,031 12,310 10,324 8,689 Capital Employed 62,891 69,782 76,555 81,869 86,563 Source: Company reports and J.P. Morgan estimates.
9.1 6.8 5.7 5.8 5.6 6.9 4.6 4.5 4.5 4.1 -13169.1% 3069.8% 4910.0% 4371.4% 5308.7% 7.9 5.3 5.1 5.0 4.5 14.5% 21.6% 22.4% 22.3% 24.4% 5.1% 9.1% 8.3% 8.9% 8.8% 3.0% 3.8% 2.0% 2.3% 1.9% 5.8% 5.8% 6.2% 6.6% 6.9% -0.0% -0.1% 0.0% 0.0% 0.0% 5.8% 5.8% 6.2% 6.6% 6.9%
25.3% 21.6% 14.8% 12.4% 1,381 4,923 2,260 -2.6% FY09 7,785 6,291 7,700 -5,032 16,744 (3,316) 20,060
21.3% 18.7% 17.0% 14.7% 1,339 5,674 2,352 4.1% FY10 10,288 6,413 10,980 1,296 28,977 (496) 29,473
18.0% 16.1% 18.0% 15.8% 1,309 5,684 2,324 -1.2% FY11E 12,100 6,454 13,701 512 32,767 1 32,766
13.7% 12.6% 15.6% 14.1% 1,362 5,650 2,371 2.0% FY12E 11,534 6,614 13,207 850 32,205 0 32,205
10.6% 10.0% 15.0% 13.9% 1,428 5,542 2,417 2.0% FY13E 12,035 8,022 13,120 851 34,028 0 34,028
(11,711) (12,278) (13,865) (13,310) (13,310) -922 -735 0 0 0 -10,268 -11,957 -11,888 -11,334 -13,310 22 (5,086) -2,868 2,895 12,624 (659) 2,657 7.6 49 (5,098) -3,348 -535 18,719 2,827 3,323 13.1 0 (5,409) -5,409 -721 19,445 1,767 1,766 14.8 0 (5,679) -5,679 -1,985 19,338 1,985 1,985 14.5 0 (5,963) -5,963 -1,635 21,193 1,635 1,635 15.3
189
PETROBRAS ON: Summary of Financials

Income Statement - Annual Revenues % change YoY Upstream, % Downstream, % Gas & Energy, % International,% EBITDA % change YoY EBITDAmargin, % EBIT % change YoY EBIT margin, % Net Interest Expense EBT % change YoY Tax Net Income % change YoY Shares outstanding, mn EPS, R$/share Fully Diluted EPS Balance Sheet Cash and cash equivalents Accounts receivable Inventories Others Current Assets Taxes Others LT ASSETS Net PP&E Total Assets ST Loans Payables Dividends Others Current Liabilities LT Debt Other LT liabilities LT Liabilities Total Liabilities Minority Interests Shareholders Equity Liabilities and Equity Eneterprise Value FY10A FY11E FY12E FY13E 213,274 230,851 256,353 240,484 16.7% 8.2% 11.0% (6.2%) 60,325 63,394 76,610 73,371 13.5% 13.2% 18.8% (12.8%) 29.0% 27.8% 30.5% 30.5% 47,058 48,333 60,251 58,234 15.4% 12.4% 21.5% (10.2%) 22.0% 20.9% 23.5% 24.2% 0 (113) (237) (883) 49,621 51,102 63,810 58,146 14.6% 3.0% 24.9% (8.9%) (12,236) (14,146) (16,367) (17,444) 35,190 36,237 46,143 36,673 (13.3%) 15.0% 24.1% (26.2%) 13,044 13,044 13,044 13,044 2.70 2.78 3.54 2.81 FY10A FY11E FY12E FY13E 56,340 43,594 31,794 13,407 17,334 18,763 18,763 18,763 19,816 25,751 25,751 25,751 13,195 15,338 15,338 15,338 106,685 103,446 91,646 73,259 14,626 15,918 14,981 13,766 413,285 465,662 524,700 582,118 282,838 332,954 389,320 444,827 519,970 569,107 616,346 655,377 15,492 16,737 16,737 16,737 17,044 18,616 18,616 18,616 24,298 25,468 25,468 25,468 56,834 60,821 60,821 60,821 102,051 111,561 126,517 142,492 50,860 55,859 55,859 55,859 152,911 167,420 182,376 198,351 209,745 228,241 243,197 259,172 3,459 3,631 3,631 3,631 306,766 337,235 369,518 392,574 519970.00 569107.29 616346.00 655377.15 283,801 246,627 259,018 271,974 Cash Flow Statement EBIT Depreciation Working Capital changes Taxes CFO Capex FCFF Net Interest Expense FCFE Equity raised/ (repaid) Debt raised/ (repaid) Dividends Other Change in cash Beginning cash Ending cash DACF DPS, R$/share Operating Data & Ratio Analysis Reserves (SPE), kboed Production,kboed % change YoY Liquids, kbd Gas, mcmd Prices Brent, US$/bbl - as per JPM Dom. Realization price,US$/bbl Petrobras discount to brent Ratios SG&A/revenues, % Interest Coverage Net Debt (incl.pension liab) Net Debt to Total Capital, % Net Debt to Equity, % Net debt to EBITDA, (x) Capex/Depreciation, (x) Net Margin Revenues/Assets, (x) Assets/Equity, (x) ROE (%) ROCE (%) Div. Yield (%) FCF Yield (%) FY10A FY11E FY12E FY13E FY14E 47,058 48,333 60,251 58,234 (14,881) (15,061) (16,359) (16,881) 3,542 (736) (664) (1,262) (12,236) (14,146) (16,367) (17,444) 53,435 54,079 63,260 52,291 (73,169) (67,449) (72,725) (72,388) (52,482) (11,178) (9,395) (5) 2563.00 5651.79 7353.79 706.26 70499.00 (12147.44) (11799.32) 1628.96 120,249 0 0 0 12,147 12,448 14,956 15,975 (9,415) (13,417) (17,360) (14,341) -
1,289 29,034 30,323 33,625 1.98 FY10A 2,575 2.4% 2147.75 2,399 79.71 74.63 6.37% 7.8% 63,903 13.6% 15.8% 1.1 5.4 16.2% 0.4 1.7 10.6% 11.0% 8.8% -
(11,698) 30,323 18,625 37,049 1.60 FY11E 2,663 3.4% 2211.50 2,537 111.81 100.00 10.56% 7.5% 87,404 22.1% 28.8% 1.4 4.5 15.7% 0.4 1.7 10.7% 8.7% 7.1% -
(11,799) 18,625 6,825 41,492 1.95 FY12E
1,629 6,825 8,454 29,495 1.40
FY13E FY14E -
2,877 3,121 8.0% 8.5% 2372.73 2576.73 2,830 3,054 115.00 85.00 101.00 71.00 12.17% 16.47% 7.3% 8.5% 0.0 0.0 114,159 148,521 25.9% 29.5% 35.4% 42.3% 1.4 1.9 4.4 4.3 18.0% 15.2% 0.4 0.4 1.7 1.7 12.9% 9.7% 9.6% 7.2% 8.7% 6.2% -
Source: Company reports and J.P. Morgan estimates. Note: R$ in millions (except per-share data).Fiscal year ends Dec
190
PETROBRAS ON ADR: Summary of Financials

Income Statement - Annual Revenues % change YoY Upstream, % Downstream, % Gas & Energy, % International,% EBITDA % change YoY EBITDAmargin, % EBIT % change YoY EBIT margin, % Net Interest Expense EBT % change YoY Tax Net Income % change YoY Shares outstanding, mn EPS, $/share Fully Diluted EPS Balance Sheet Cash and cash equivalents Accounts receivable Inventories Others Current Assets Taxes Others LT ASSETS Net PP&E Total Assets ST Loans Payables Dividends Others Current Liabilities LT Debt Other LT liabilities LT Liabilities Total Liabilities Minority Interests Shareholders Equity Liabilities and Equity Eneterprise Value FY10A FY11E FY12E FY13E 121,329 135,589 154,571 128,694 30.1% 11.8% 14.0% (16.7%) 35,239 40,429 48,839 42,075 13.5% 14.7% 20.8% (13.8%) 29.0% 29.8% 31.6% 32.7% 26,741 30,876 38,277 33,383 15.4% 15.5% 24.0% (12.8%) 22.0% 22.8% 24.8% 25.9% (1,481) (233) (320) (500) 27,126 33,677 39,921 33,189 24.2% 24.2% 18.5% (16.9%) (6,948) (8,906) (10,246) (9,957) 19,609 24,529 29,118 20,934 (13.3%) 25.1% 18.7% (28.1%) 6,522 6,522 6,522 6,522 3.01 3.76 4.46 3.21 0.00 0.00 0.00 0.00 FY10A FY11E FY12E FY13E 33,913 21,044 12,775 1,902 10,434 11,111 10,458 9,610 11,928 14,918 14,041 12,902 7,943 9,393 8,840 8,123 64,218 56,466 46,113 32,537 393.0 1293.0 1232.0 0.0 14,626 15,871 14,938 13,726 248,772 296,909 314,835 320,175 170,251 213,978 234,949 245,733 312,990 353,374 360,948 352,712 9,325 10,372 9,762 8,970 10,259 11,626 10,942 10,055 0.0 0.0 0.0 0.0 14,626 15,871 14,938 13,726 34,211 37,869 35,641 32,751 61,428 70,253 74,917 77,478 30,615 33,599 31,623 29,059 92,043 103,852 106,540 106,537 126,254 141,721 142,182 139,288 2,082 2,132 2,006 1,844 184,654 209,522 216,760 211,580 312989.83 353374.09 360947.60 352712.11 267,193 290,045 302,144 Cash Flow Statement EBIT Depreciation Working Capital changes Taxes CFO Capex FCFF Net Interest Expense FCFE Equity raised/ (repaid) Debt raised/ (repaid) Dividends Other Change in cash Beginning cash Ending cash DACF DPS, $/share Operating Data & Ratio Analysis FY10A FY11E FY12E FY13E FY14E 26,741 30,876 38,277 33,383 (8,474) (8,820) (9,501) (9,687) 2,091 (1,032) (672) (715) (6,948) (8,906) (10,246) (9,957) 30,481 33,563 38,688 29,906 (45,619) (46,226) (44,087) (40,782) (16,104) (12,663) (5,399) (10,876) 1514.23 5834.98 3608.47 111.72 (14724.49) (14347.53) (7371.93) (10294.87) 0 0 0 0 12,755 6,925 9,000 9,000 (11,375) (8,610) (10,973) (8,419) -
17,270 16,643 33,913 33,625 1.74 FY10A 2,575 2.4% 2147.75 2,399 79.71 74.63 6.37% 7.8% 0.0 38,466 13.6% 15.8% 1.1 5.4 16.2% 0.4 1.7 10.6% 11.0% 6.4% 0.0%
2,791 18,253 21,044 36,097 1.32 FY11E 2,694 4.6% 2242.50 2,538 106.81 93.52 12.45% 7.7% 0.0 61,268 21.1% 27.0% 1.5 5.2 18.1% 0.4 1.7 11.7% 9.1% 4.8% 0.0%
4,906 7,869 12,775 42,170 1.68 FY12E 2,896 7.5% 2391.93 2,830 114.00 100.00 12.28% 7.4% 0.0 73,493 24.3% 32.4% 1.5 4.6 18.8% 0.4 1.7 13.4% 9.9% 6.1% 0.0%
1,363 539 1,902 30,042 1.29
FY13E FY14E 3,141 8.5% 2596.89 3,054 85.00 71.00 16.47% 8.9% 0.0 86,006 27.3% 37.9% 2.0 4.2 16.3% 0.4 1.7 9.9% 7.2% 4.7% 0.0% -
Reserves (SPE), kboed Production,kboed % change YoY Liquids, kbd Gas, mcmd Prices Brent, US$/bbl - as per JPM Dom. Realization price,US$/bbl Petrobras discount to brent Ratios SG&A/revenues, % Interest Coverage Net Debt (incl.pension liab) Net Debt to Total Capital, % Net Debt to Equity, % Net debt to EBITDA, (x) Capex/Depreciation, (x) Net Margin Revenues/Assets, (x) Assets/Equity, (x) ROE (%) ROCE (%) 314,495 - Div. Yield (%) FCF Yield (%)
Source: Company reports and J.P. Morgan estimates. Note: $ in millions (except per-share data).Fiscal year ends Dec
191
PetroChina: Summary of Financials

Income Statement Rmb in millions, year end Dec Revenues % change Y/Y EBITDA % change Y/Y EBIT % change Y/Y EBIT Margin Net Interest Earnings before tax % change Y/Y Tax as % of EBT Net income (reported) % change Y/Y Shares outstanding EPS (reported) % change Y/Y Cash flow statement FY09 FY10 FY11E FY12E FY13E Rmb in millions, year end Dec 1,019,275 1,465,415 1,432,924 1,327,399 1,332,663 EBIT (5%) 44% (2%) (7%) 0% Depr. & amortization 235,703 300,986 360,025 357,094 367,833 Change in working capital (7%) 28% 20% (1%) 3% Taxes 143,444 187,777 230,596 209,496 207,096 Cash flow from operations (10%) 31% 23% (9%) (1%) 14% 13% 16% 16% 16% Capex -3,813 -4,338 -9,559 -10,159 -6,372 Disposal/(purchase) 140,032 189,305 227,255 205,924 207,699 Net Interest (14%) 35% 20% (9%) 1% Other -33,473 -38,513 -49,996 -45,303 -45,694 Free cash flow 23.9% 20.3% 22.0% 22.0% 22.0% 103,387 139,992 162,089 148,506 150,654 Equity raised/(repaid) (10%) 35% 16% (8%) 1% Debt raised/(repaid) 183,021 183,021 183,021 183,021 183,021 Other 0.56 0.76 0.89 0.81 0.82 Dividends paid (10%) 35% 16% (8%) 1% Beginning cash Ending cash DPS Balance sheet Ratio Analysis Rmb in millions, year end Dec FY09 FY10 FY11E FY12E FY13E Rmb in millions, year end Dec Cash and cash equivalents 86,925 45,709 43,737 14,486 36,238 EBITDA margin Accounts receivable 33,053 50,960 49,830 46,160 46,344 Operating margin Inventories 114,781 134,888 131,897 122,184 122,669 Net margin Others 59,624 54,835 53,686 49,954 50,140 Current assets 294,383 286,392 279,150 232,785 255,390 Sales per share growth LT investments - Sales growth Net fixed assets 1,075,467 1,238,599 1,429,169 1,569,871 1,622,448 Net profit growth Total Assets 1,450,288 1,656,487 1,839,815 1,934,152 2,009,334 EPS growth Liabilities Interest coverage (x) Short-term loans 148,851 102,268 102,268 102,268 82,268 Payables 204,739 270,191 264,200 244,744 245,714 Net debt to equity Others 34,963 57,277 57,277 57,277 57,277 Sales/assets Total current liabilities 388,553 429,736 423,745 404,289 385,259 Assets/equity Long-term debt 85,471 131,352 216,352 236,352 236,352 ROE Other liabilities 68,563 85,270 85,270 85,270 85,270 ROCE Total Liabilities 542,587 646,358 725,367 725,911 707,468 Shareholders' equity 847,223 938,926 1,028,075 1,109,753 1,194,906 BVPS 4.63 5.13 5.62 6.06 6.53 Source: Company reports and J.P. Morgan estimates. FY09 FY10 FY11E FY12E FY13E 143,444 187,777 230,596 209,496 207,096 92,259 113,209 129,430 147,598 160,737 37,833 31,741 -721 -2,342 117 -16412 -26169 -49996 -45303 -45694 258,159 306,348 305,968 305,877 322,859 -277,518 -265,571 -320,000 -288,300 -213,313 -3,813 -4,338 -9,559 -10,159 -6,372 -19,359 40,777 -14,032 17,577 109,546 0 0 0 0 0 77,401 52,656 85,000 20,000 0 49,037 -35,320 0 0 -20,000 -50,092 -53,198 -72,940 -66,828 -67,794 33,150 86,925 45,709 43,737 14,486 86,925 45,709 43,737 14,486 36,238 0.27 0.29 0.40 0.37 0.37 FY09 23% 14% 10% FY10 21% 13% 10% FY11E 25% 16% 11% FY12E 27% 16% 11% FY13E 28% 16% 11%
(5%) (5%) (10%) (10%) 61.82 17% 0.77 1.56 13% 14%
44% 44% 35% 35% 69.38 20% 0.94 1.66 16% 17%
(2%) (2%) 16% 16% 37.67 27% 0.82 1.72 16% 18%
(7%) (7%) (8%) (8%) 35.15 29% 0.70 1.74 14% 15%
0% 0% 1% 1% 57.72 24% 0.68 1.68 13% 14%
192
Sinopec Corp - H: Summary of Financials

Income Statement Rmb in millions, year end Dec Revenues % change Y/Y EBITDA % change Y/Y EBIT % change Y/Y EBIT Margin Net Interest Earnings before tax % change Y/Y Tax as % of EBT Net income (reported) % change Y/Y Shares outstanding EPS (reported) % change Y/Y Cash flow statement FY09 FY10 FY11E FY12E FY13E Rmb in millions, year end Dec 1,345,052 1,913,182 2,634,625 2,385,530 2,377,818 EBIT (10%) 42% 38% (9%) (0%) Depr. & amortization 134,918 164,227 179,366 189,663 185,580 Change in working capital 86% 22% 9% 6% (2%) Taxes 84,431 105,004 117,437 124,676 118,511 Cash flow from operations 221% 24% 12% 6% (5%) 3% 3% 2% 3% 2% Capex -7,105 -7,312 -10,656 -10,785 -9,567 Disposal/(purchase) 80,568 103,693 108,772 118,435 113,027 Net Interest 264% 29% 5% 9% (5%) Other -16,084 -25,689 -26,947 -29,341 -28,001 Free cash flow 20.0% 24.8% 24.8% 24.8% 24.8% 61,760 71,800 79,816 84,118 80,556 Equity raised/(repaid) 117% 16% 11% 5% (4%) Debt raised/(repaid) 86,702 86,702 86,702 86,702 86,702 Other 0.71 0.83 0.92 0.97 0.93 Dividends paid 117% 16% 11% 5% (4%) Beginning cash Ending cash DPS Balance sheet Ratio Analysis Rmb in millions, year end Dec FY09 FY10 FY11E FY12E FY13E Rmb in millions, year end Dec Cash and cash equivalents 8,750 17,008 10,458 29,929 100,096 EBITDA margin Accounts receivable 26,592 43,093 59,343 53,732 53,559 Operating margin Inventories 141,611 156,546 215,578 195,196 194,565 Net margin Others 23,091 42,450 58,458 52,931 52,759 Current assets 201,280 260,229 344,969 332,919 402,111 Sales per share growth LT investments - Sales growth Net fixed assets 584,968 630,299 682,021 730,686 726,125 Net profit growth Total Assets 877,842 995,154 1,133,606 1,174,765 1,243,479 EPS growth Liabilities Interest coverage (x) Short-term loans 58,898 17,019 17,019 17,019 17,019 Payables 97,749 132,528 165,830 151,186 150,777 Net debt to equity Others 156,772 186,859 225,425 208,467 207,992 Sales/assets Total current liabilities 313,419 336,406 408,275 376,672 375,788 Assets/equity Long-term debt 108,828 136,465 141,465 146,465 151,465 ROE Other liabilities 56,742 71,915 71,915 71,915 71,915 ROCE Total Liabilities 478,989 544,786 621,655 595,052 599,168 Shareholders' equity 375,661 419,047 478,623 541,409 601,536 BVPS 4.33 4.83 5.52 6.24 6.94 Source: Company reports and J.P. Morgan estimates. FY09 84,431 50,487 15,571 -4027 152,075 FY10 FY11E FY12E FY13E 105,004 117,437 124,676 118,511 59,223 61,929 64,987 67,069 -1,109 -19,421 -83 92 -25689 -26947 -29341 -28001 170,333 130,010 157,505 156,558
-112,875 -97,637 -121,320 -121,703 -70,963 594 16,126 0 0 0 -7,105 -7,312 -10,656 -10,785 -9,567 39,200 72,696 8,691 35,802 85,596 -4,116 11,687 -13,559 -16,391 7,008 8,728 8,750 17,004 0.18 0.21 FY09 5% 3% 2% FY10 4% 3% 2% 5,000 -20,241 17,008 10,458 0.23 FY11E 3% 2% 2% 5,000 5,000 -21,332 -20,428 10,458 29,929 29,929 100,096 0.25 0.24 FY12E 4% 3% 2% FY13E 4% 2% 2%
(10%) (10%) 117% 117% 18.99 42% 3.25 2.22 18% 16%
42% 42% 16% 16% 22.46 32% 4.09 2.23 18% 19%
38% 38% 11% 11% 16.83 31% 4.95 2.37 18% 19%
(9%) (9%) 5% 5% 17.59 24% 4.13 2.17 16% 19%
(0%) (0%) (4%) (4%) 19.40 11% 3.93 2.07 14% 16%
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Indian Oil Corporation: Summary of Financials

Income Statement Rs in millions, year end Mar Revenues % change Y/Y Gross Margin EBITDA % change Y/Y EBITDA Margin EBIT % change Y/Y EBIT Margin Net Interest Earnings before tax % change Y/Y Tax as % of EBT Net income (reported) % change Y/Y Shares outstanding EPS (reported) % change Y/Y Balance sheet Rs in millions, year end Mar Cash and cash equivalents Accounts receivable Inventories Others Current assets FY10 FY11 FY12E FY13E 2,711,105 3,288,532 3,871,018 3,648,493 (11.3%) 21.3% 17.7% (5.8%) 0.8% 0.5% 5.5% 7.5% 123,196 132,718 97,678 147,261 62.1% 7.7% -26.4% 50.8% 4.5% 4.0% 2.5% 4.0% 90,925 87,251 61,313 108,972 92.6% NM NM 77.7% 3.4% 2.7% 1.6% 3.0% 50,136 3,708 1,415 5,960 141,061 90,959 62,729 114,932 225.9% -35.5% -31.0% 83.2% -46,020 -16,504 -12,546 -22,986 32.6% 18.1% 20.0% 20.0% 102.2 74.5 45.2 82.8 246.5% -27.2% -39.3% 83.2% 2,428 2,428 2,428 2,428 42.10 30.67 18.60 34.08 240.4% (27.2%) (39.3%) 83.2% FY10 13,151 57,993 364,041 158,886 580,920 FY11 12,944 88,697 492,845 238,877 820,419 FY12E 14,239 84,844 530,277 243,411 858,531 FY13E 15,662 79,967 499,794 248,035 827,795 Cash flow statement Rs in millions, year end Mar EBIT Depr. & amortization Change in working capital Taxes Others Cash flow from operations Capex Disposal/(purchase) Free cash flow Equity raised/(repaid) Debt raised/(repaid) Other Dividends paid Beginning cash Ending cash DPS Ratio Analysis Rs in millions, year end Mar EBITDA margin Operating margin Net margin FY10 90,925 32,271 27,565 FY11 87,251 45,467 22,331 FY12E FY13E FY14E 61,313 108,972 36,364 38,289 -35,593 187,554 -80,916 -35,000 0 0 -51,354 158,415 -
-131,123 -125,321 0 0 45,569 -71,027 9,711 -4,058 0 -34,586 7,980 13,151 12.63
0 0 0 81,676 -230,956 -83,015 0 0 0 -25,196 -15,284 -28,003 13,151 12,944 14,239 12,944 14,239 15,662 9.20 5.58 10.22
FY10 4.5% 3.4% 3.8%
FY11 4.0% 2.7% 2.3%
FY12E 2.5% 1.6% 1.2%
FY13E FY14E 4.0% 3.0% 2.3% -
LT investments Net fixed assets 628,497 708,351 591,071 587,781 Total Assets 998,753 1,144,028 1,085,028 1,065,956 Liabilities Short-term loans 0 0 0 0 Payables Others 447,517 593,134 510,522 497,092 Total current liabilities 447,517 593,134 510,522 497,092 Long-term debt 445,663 527,339 296,383 213,368 Other liabilities 47,561 63,366 68,384 77,579 Total Liabilities 493,224 590,705 364,767 290,947 Shareholders' equity 505,529 553,323 720,261 775,009 BVPS 208.21 227.90 296.65 319.20 Source: Company reports and J.P. Morgan estimates.
Sales per share growth Sales growth Net profit growth EPS growth Interest coverage (x) Net debt to total capital Net debt to equity Sales/assets Assets/equity ROE ROCE
(12.8%) (11.3%) 246.5% 240.4% 22.7% 41.3% 2.79 2.42 21.6% 9.9%
21.3% 21.3% -27.2% (27.2%) 31.4% 57.6% 3.07 2.14 14.1% 8.6%
17.7% 17.7% -39.3% (39.3%) 14.4% 20.9% 3.47 2.16 7.1% 5.9%
(5.8%) (5.8%) 83.2% 83.2% 6.6% 8.5% 3.39 1.38 11.1% 10.9%
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Reliance Industries Ltd: Summary of Financials

Income Statement Rs in millions, year end Mar FY09 FY10 FY11 FY12E FY13E Revenues 1,512,245 2,037,400 2,658,106 3,132,220 3,005,420 % change Y/Y 13.3% 34.7% 30.5% 17.8% (4.1%) Gross Margin 27.3% 24.1% 23.1% 56.9% 58.6% EBITDA 237,633 308,940 380,436 392,255 440,679 % change Y/Y 6.5% 30.0% 23.1% 3.1% 12.3% EBITDA Margin 15.7% 15.2% 14.3% 12.5% 14.7% EBIT 181,123 199,480 239,228 263,330 299,254 % change Y/Y 3.7% 10.1% 19.9% 10.1% 13.6% EBIT Margin 12.0% 9.8% 9.0% 8.4% 10.0% Net Interest -2,720 87,320 1,321 21,184 33,438 Earnings before tax 175,123 372,860 240,550 284,514 332,692 % change Y/Y -35.6% 112.9% -35.5% 18.3% 16.9% Tax -29,190 -42,560 -47,834 -63,976 -74,406 as % of EBT 16.7% 11.4% 19.9% 22.5% 22.4% Net income (reported) 152,492.60 158,180.00 192,715.20 220,537.76 258,286.67 % change Y/Y -0.1% 3.7% 21.8% 14.4% 17.1% Shares outstanding 2,749 2,978 2,981 2,981 2,981 EPS (reported) 55.46 53.12 64.65 73.98 86.64 % change Y/Y 5.6% (4.2%) 21.7% 14.4% 17.1% Balance sheet Rs in millions, year end Mar FY09 FY10 FY11 FY12E FY13E Cash and cash equivalents 227,421 138,908 301,390 561,259 570,266 Accounts receivable 48,450 100,829 156,952 109,575 105,875 Inventories 201,096 343,933 385,194 414,881 392,310 Others 110,494 107,409 137,273 139,952 142,699 Current assets 651,816 822,203 1,324,271 1,625,113 1,648,625 LT investments Net fixed assets 1,498,880 1,375,761 Total Assets 2,150,696 2,197,964 Liabilities Short-term loans 83,675 66,192 Payables Others 483,833 532,815 Total current liabilities 567,508 599,007 Long-term debt 678,891 579,863 Other liabilities 0 0 Total Liabilities 1,246,399 1,178,870 Shareholders' equity 904,296 1,019,093 BVPS 328.91 342.20 Source: Company reports and J.P. Morgan estimates. Cash flow statement Rs in millions, year end Mar FY09 FY10 FY11 FY12E FY13E EBIT 181,123 199,480 239,228 263,330 299,254 Depr. & amortization 56,510 109,460 141,208 128,925 141,424 Change in working capital -46,221 -143,128 25,257 -98,787 1,656 Taxes -12740 -31250 -44124 -60512 -70026 Others Cash flow from operations 159,502 210,573 359,180 240,279 380,568 Capex Disposal/(purchase) Free cash flow Equity raised/(repaid) Debt raised/(repaid) Other Dividends paid Beginning cash Ending cash DPS Ratio Analysis Rs in millions, year end Mar EBITDA margin Operating margin Net margin -437,983 -219,210 -150,474 -175,500 -267,000 -278,481 -8,638 208,705 388,779 113,568 68,056 -116,128 -1,973 0 0 398,046 -116,511 195,007 -42,682 -31,802 -22,195 -24,286 -34,729 -34,729 -34,729 6.90 7.00 8.00 10.00 10.00
FY09 15.7% 12.0% 10.1%
FY10 15.2% 9.8% 7.8%
FY11 FY12E FY13E 14.3% 12.5% 14.7% 9.0% 8.4% 10.0% 7.2% 7.0% 8.6%
Sales per share growth - Sales growth 1,385,028 1,107,602 1,233,178 Net profit growth 2,709,299 2,732,715 2,881,803 EPS growth Interest coverage (x) 131,886 131,662 131,662 Net debt to total capital - Net debt to equity 685,329 571,544 549,675 Sales/assets 817,215 703,206 681,337 Assets/equity 709,176 666,718 634,916 ROE 0 0 0 ROCE 1,526,391 1,369,924 1,316,253 1,182,908 1,362,791 1,565,550 396.81 457.16 525.17
19.8% 13.3% -0.1% 5.6% 87.36 35.2% 52.1% 0.87 1.84 19.8% 13.6%
24.4% 34.7% 3.7% (4.2%) 22.6% 36.9% 0.94 1.67 16.5% 12.0%
30.3% 17.8% (4.1%) 30.5% 17.8% (4.1%) 21.8% 14.4% 17.1% 21.7% 14.4% 17.1% 10.6% -7.8% -10.7% 16.6% -11.9% -15.4% 1.08 1.15 1.07 1.53 1.43 1.84 17.5% 17.3% 17.6% 13.0% 12.6% 13.3%
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Sasol: Summary of Financials

Profit and Loss Statement Sales EBITDA D&A EBIT Financing Associates PBT Tax Minorities Net Profit Ave No Shares HEPS DPS CF/Share FY10 FY11E FY12E FY13E FY14E Production 122,256 144,011 151,580 167,229 175,524 Vol bbl/d 30,651 38,263 42,574 50,923 56,370 Growth 6,712 7,508 9,246 9,957 10,966 Secunda costs per barrel 23,939 30,754 33,328 40,966 45,404 (782) (800) (900) (900) (900) Macro 217 279 302 371 653 23,372 30,231 32,728 40,435 45,155 (6,985) (9,037) (9,493) (11,096) (12,219) Global GDP est (446) (620) (674) (704) (733) Rand/USD (Sasol Year) 15,941 20,575 22,561 28,635 32,202 Oil Price Brent (Sasol Year) 595.80 598.00 598.00 598.00 598.00 Refining Margin 2,656.67 3,440.63 3,772.72 4,788.39 5,385.01 Forecast Macro Effect on EBIT 1,050.00 1,204.22 1,245.00 1,580.17 1,777.05 Oil Hedge gain/ (loss) 4,569.78 5,680.31 6,890.37 8,042.04 9,175.40 Valuation Balance Sheet FY FYE FYE FYE FYE EV/ Sales Fixed Assets 102,761 121,624 141,994 156,813 179,704 EV/EBITDA Current Assets 53,723 60,390 62,585 67,123 69,529 EV/EBIT Current Liabilities (22,869) (25,242) (26,067) (27,774) (28,679) EV/ Invested Capital LT Liabilities -36,373 -45,379 -51,166 -48,720 -50,571 RoIC Net Assets 97,242 111,393 127,346 147,442 169,983 P/E Invested Capital 120,406 143,563 165,302 182,952 207,345 FCF yield Net debt -902 -9,002 -14,550 -10,143 -10,843 Debt/ EBITDA Net Working Capital 21,761 26,055 27,425 30,256 31,757 Interest Cover Cash Flow FY FYE FYE FYE FYE EBIT 23,939 30,754 33,328 40,966 45,404 D&A 6,712 7,508 9,246 9,957 10,966 Wcap (3,424) (4,294) (1,369) (2,831) (1,501) Other Operating cash flow 27,227 33,968 41,204 48,091 54,869 Interest (1,053) (1,195) (1,146) (1,237) (3,089) Dividends (5,360) (6,138) (7,044) (7,282) (9,243) Tax (6,040) (9,037) (9,493) (11,096) (12,219) Capex (16,108) (25,086) (29,167) (24,367) (33,358) Trading Cash flow (813) (7,069) (5,394) 4,569 (537) FCF before financing 5,181 122 2,844 12,998 9,943 Acquisition / disposals 0 0 0 0 1 Other 192 0 0 0 0 Change in Net Debt -1,813 -8,100 -5,548 4,407 -700 Source: Company reports and J.P. Morgan estimates. FY10 FY11E 190,669 199,667 3.5% 4.7% (45) (52) FY10 FY11E FY12E 224,768 12.6% (54) FY12E FY13E 249,864 11.2% (55) FY13E FY14E 274,852 10.0% (58) FY14E
3.6 7.60 74.50 813.6% (9,776) FY10 1.7 6.7 8.5 1.7 14.8% 11.7 2.7% 0.0 58.5
3.0 2.7 3.3 3.3 7.07 7.20 7.60 7.60 92.80 100.00 100.00 102.00 926.0% 1084.0% 1098.5% 1098.5% 6,216 5,460 4,000 1,262 FY11E 1.5 5.7 7.1 1.5 16.3% 9.0 -0.7% 0.2 29.2 FY12E 1.5 5.3 6.7 1.4 15.3% 8.2 0.7% 0.3 27.9 FY13E 1.3 4.3 5.3 1.2 17.1% 6.5 6.2% 0.2 35.7 FY14E 1.3 3.9 4.8 1.1 17.0% 5.8 4.4% 0.2 36.7
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200

JP Morgan - Global Downstream - Global Refining - A Long and Painful Sunset For Many

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JP Morgan - Global Downstream - Global Refining - A Long and Painful Sunset For Many

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Global Equity Research

European Oil & Gas Fred Lucas

(44-20) 7155 6131 fred.lucas@jpmorgan.com J.P. Morgan Securities Ltd.

Asian Oil & Gas Brynjar Eirik Bustnes, CFA

Indian Oil & Gas Pradeep Mirchandani, CFA

LatAm Oil & Gas Caio M Carvalhal

South African Oil & Gas Alex Comer

For Specialist Sales advice, please contact Hamish W Clegg

Fred Lucas (44-20) 7155 6131 fred.lucas@jpmorgan.com

Global Equity Research 08 September 2011

Fred Lucas (44-20) 7155 6131 fred.lucas@jpmorgan.com

Global Equity Research 08 September 2011

Fred Lucas (44-20) 7155 6131 fred.lucas@jpmorgan.com

Global Equity Research 08 September 2011

Stock specific summary

OECD 9 focus names

We estimate BP Downstream is worth $59bn, 2012E EV/EBITDA 6.5x

BP is a prime candidate to spinoff its downstream business

Fred Lucas (44-20) 7155 6131 fred.lucas@jpmorgan.com

Global Equity Research 08 September 2011

RD Shell downstream performance ranks it third equal alongside TOTAL

We would like to see more refinery and network divestments

We estimate RD Shell Downstream is worth $68bn, 2012E EV/EBITDA 7.7x

ENI downstream performance ranks 5th weak operational performace

Small downstream exposure is positive

Agressive divestment of downstream assets is not on managements agenda

We estimate ENI Downstream is worth 1.9bn, 2012E EV/EBITDA 3.8x

Fred Lucas (44-20) 7155 6131 fred.lucas@jpmorgan.com

Global Equity Research 08 September 2011

Refining capacity will grow 25%+ CAGR 2010-13

We estimate Essar Downstream is worth $5.3bn, 2013E EV/EBITDA 3.8x

Galp ranked at the bottom performance ought to improve

Investment in refining complexity should be a plus for the margins

We estimate Galp's Downstream is worth 3.2bn, 2012E EV/EBITDA 5.1x

Fred Lucas (44-20) 7155 6131 fred.lucas@jpmorgan.com

Global Equity Research 08 September 2011

OMV ranks low challenging outlook

Downstream exposure has grown, backed by acquisitions

We estimate OMV Downstream is worth 4bn, 2012E EV/EBITDA 4.9x

Repsol ranks sixth big downstream footprint

Earnings exposure to European refining will remain high

We estimate Repsol Downstream is worth 11.5bn, 2012E EV/EBITDA 4.2x

Fred Lucas (44-20) 7155 6131 fred.lucas@jpmorgan.com

Global Equity Research 08 September 2011

Statoil downstream ranks first very good operational performance

Limited investor focus on the company's downstream business

We estimate Statoil's Downstream is worth Nkr24bn, 2012E EV/EBITDA 3.7x

TOTAL downstream performance ranks 3th delivered healthy return on capital

Ongoing divestment will be a plus for overall performance

We estimate TOTAL's Downstream is worth 18.6bn, 2012E EV/EBITDA 5.9x

Fred Lucas (44-20) 7155 6131 fred.lucas@jpmorgan.com

Global Equity Research 08 September 2011

Table 1: Downstream earnings exposure of OECD names

Non-OECD 5 focus names

Fred Lucas (44-20) 7155 6131 fred.lucas@jpmorgan.com

Global Equity Research 08 September 2011

Fred Lucas (44-20) 7155 6131 fred.lucas@jpmorgan.com

Global Equity Research 08 September 2011

Fred Lucas (44-20) 7155 6131 fred.lucas@jpmorgan.com

Global Equity Research 08 September 2011

Global theme refining capacity surplus

Fred Lucas (44-20) 7155 6131 fred.lucas@jpmorgan.com