NATREF IN DURBAN

1. NATREF IN DURBAN NATREF IN DURBAN

2. History • Economic boom in SA post World War 2 resulted in petroleum demand reaching about 210 000 bbls per day in the early 1960’s. • By 1966 five refineries in operation in South Africa and a recently completed refined products pipeline to Sasolburg was nearing saturation (see appendix 1). • In 1966 a crude line was commissioned for strategic crude oil storage at Kendal in present day Mpumalanga (SATS). • In 1966 SA Government took decision for establishment of a new refinery to cater for growth - but where? • Total was at the time considering investment in a refinery in South Africa with Mobil. • Total felt that an inland refinery would disadvantage them compared with a refinery at the coast (appendix 2). NATREF IN DURBAN

3. History • TSA and Sasol approached SAR/SARH and Department of Commerce and Industry for assurances that investment in a refinery would not disadvantage Total relative to a coastal refinery. • These assurances, provided by Government, paved the way for the construction of Natref with NIOC, Total, and Sasol as shareholders (appendix 3). • The location of Natref was to be in the Free State near Sasolburg because of (among others) • Strategic concerns • Located near the heart of highest demand for fuels • Refined products line capacity close to saturation • Existing infrastructure supported investment • Business opportunity for upgrading of crude oil to saleable fuels NATREF IN DURBAN

4. Natref in Durban principle • Government assurances were primarily given around transport economics. • This gave rise to the principle of Natref as if it were located in Durban from a transport perspective. This would then not disadvantage Natref relative to a Durban refiner. • This means that the total cost of transport of crude oil and the transfer of refined product from Natref to a depot would be equivalent to transport of the same product from Durban to the depot after adjustment for yield. • The creation and subsequent management of the tariff structure between crude and refined product has generally been in line with Government assurances provided at the time of the negotiations for the establishment of a new refinery and the “Natref in Durban principle” (appendix 4). NATREF IN DURBAN

5. Total South Africa today • Since democratic elections in 1994 several milestones have been reached or are in process of being attained: • Publication of the White Paper in 1998 • The BEE Charter in 2000 • The change towards better methods of petroleum product pricing • The start of a framework towards the provision of Cleaner fuels • Total recently completed the opportunity related to the BEE Charter in providing 25% of its shareholding to a BEE Consortium, TOSACO. • TOSACO through its stake in Total South Africa now has a direct interest across the entire downstream petroleum value chain including crude oil refining and Natref in particular. NATREF IN DURBAN

6. Natref – Long Term Strategic Positioning? • Natref could be considered a strategic refinery due to, amongst others, its inland location and as a primary, reliable supplier of jet fuel to JIA. This has been proved over many years. • There is nothing more in the way of capital expenditure or otherwise that Natref can do to minimise any threat to its transport economics. • Any such threat to its transport economics has the potential to seriously damage its long term viability. • For coastal refiners this is not the case, as adverse changes to the tariff structure would ultimately be carried by the consumer in both regulated and deregulated environments. This is because they have direct control over the management of these costs. NATREF IN DURBAN

7. Natref – Long Term Strategic Positioning? • This is not the case for Natref which is dependent on a third party owner / operator for the supply of its feedstock. This third party (currently Petronet) can charge tariffs out of proportion to those charges ultimately recoverable from the customer putting Natref at a transport disadvantage relative to a Durban refiner. • Thus firm arrangements on an appropriate tariff structure by Petronet can be viewed as crucial for maintaining the medium to long term viability of Natref. • Without assurances future investments can be compromised and the medium to long term viability of Natref can be questioned. NATREF IN DURBAN

8. Natref – Pipeline Bill Implications • It is recognised that some form of regulation of the pipeline industry in South Africa is required. Unfortunately the current Pipeline Bill does not provide sufficient security for Natref. • An unintended consequence of the Bill could render Natref economically unviable with a negative effect on the regional economy, employment, consumers, reduced income to the Natref shareholders and subsequent loss of tax revenues to the state. NATREF IN DURBAN

9. Natref – Pipeline Bill Suggestions • It is suggested that the Pipeline Bill creates a reasonable tariff differential between crude oil and refined product so that any existing or future inland refinery would not be disadvantaged relative to a coastal refiner from a transport cost perspective. This would require changes to Sections 21 and 33. • It is further suggested that the Bill provides that should State- owned entities dispose of pipeline assets, these assets are first offered to affected parties who would also have pre-emptive right over such issues. NATREF IN DURBAN

10. Natref – Pipeline Bill Suggestions • It is recommended that Clause 21 be amended to read: 21. Licensees may not discriminate between customers or classes of customers regarding access, tariffs, prices, conditions or service except for objectively justifiable and identifiable grounds, which grounds may include the geographic location of a refinery. • It is recommended that Clause 33(1)f be amended to read: (f) the methodology to be followed by the Authority in setting and approving tariffs, price regulation principles and applicable procedures, provided that this shall include a mechanism to ensure that there is no discrimination in transport charges between an inland refinery and a coastal refinery, with the effect that such refineries are charged the same amount for the transport of an equivalent amount of petroleum (taking into account the actual yield of crude oil to petroleum products) to the same destination. NATREF IN DURBAN

11. APPENDICES NATREF IN DURBAN

12. 1. South African Refining History • 1954 - Commissioning of Sasol 1 in Sasolburg. • 1965 - Refined product line from Durban to Sasolburg commissioned. • 1966 - Crude line had already been commissioned for strategic storage at Kendal in present day Mpumalanga. The coal mines would, at its peak, hold about 118 million barrels of oil. • By 1966 the following refineries were in operation: • Satmar (1934 in Boksburg) - Satmar(Anglo-Vaal) • Enref (1954 in Durban) - Mobil (Engen) • Sapref (1963 in Durban) - Shell & BP • Calref (1966 in Cape Town) - Caltex NATREF IN DURBAN

13. 2. Total concerns about inland refinery • Total was keen to invest in a refinery and had discussions with Mobil to set up refinery at the coast. • Total felt that location of Natref would disadvantage them compared to a coastal refinery for numerous reasons: • Additional pipeline cost for crude to the inland refinery and then transport cost of product from this refinery to the end destination. • An inland refinery could not benefit from export opportunities which were available at the coast. • There was no bunker market inland to absorb fuel oil production. • The only way to accommodate fuel oil production was either through crude selection or through a complex refinery processing scheme – either option being very expensive. • Accordingly TSA required an undertaking from Government that it would not be disadvantaged vis-à-vis a coastal refiner should it invest in Natref. NATREF IN DURBAN

14. 3. Assurances – from Government • Internal SAR memo dated 24/04/1967 from GM  • negotiation mandate: • “that in principle the tariff for crude oil shall be determined so that transport income for crude oil from the coast to Natref and of refined product from Natref to destination must be the same as if refined product was transported directly from the Coast” • further confirms that discussions with Sasol & Total must be advanced in this manner. • Internal SAR memo dated 26/05/1967 from GM  • confirms that negotiations on transport cost for crude oil and refined product has been settled in accordance with negotiation mandate set out in memo dated 24/04/1967. • Letter from MD of Total to Secretary of Commerce & Industry dated 03/07/1967  • TSA notes the agreed principle and that government will ensure that inland refinery will not at any time be placed at a disadvantage as regards transport cost in relation to a refinery at the coast NATREF IN DURBAN

15. 3. Assurances – from Government • Letter from Assistant GM of Sasol to SAR dated 17/01/1975 • affirms agreement reached in 1967 and that SAR would not lose or gain(same for Natref) because Natref not situated at the coast. • also confirms government assurance that Natref would not be worse off than refinery at the coast. NATREF IN DURBAN

16. 4. Tariffs - history • 1967 - 1981 • SATS principle was that their income would remain the same as if Natref product was dispatched from the coast. To ensure this a crude tariff was defined and a six monthly reconciliation made. Adjustments to the crude tariff would be made accordingly. This was the start of the Natref in Durban principle. • 1981 – 1987 • Above difficult to manage and changed to Natref paying Natref to Depot leg and full Durban to Depot transport cost recovered from SATS. No crude tariff charged. • 1987 – 1991 • Following the de Villiers report that SATS decentralise and become more focused, Petronet created. Crude oil tariffs re-introduced with differentiated tariffs by pipe or rail. Strong resistance from Natref partners to this as it compromised the Natref in Durban principle and exposed Natref to transport diseconomies. NATREF IN DURBAN

17. 4. Tariffs - history • Post 1991 • Agreement was reached with Petronet on a direct linkage between crude oil white oil tariffs. This linkage governed by the yield of white product. • The history of white oil / crude oil tariff structure has thus been more or less in the spirit of assurances previously made by Government or its agencies. • Based on the 1991 agreement the expansion of Natref in the early 90’s was approved. NATREF IN DURBAN

18. 5. Natref Characteristics • Complex refinery with high capital and operating costs. • However this is offset by having a very high refined product yield compared to a coastal refinery (~89% compared to ~ 70% for a coastal refinery). • The high “white oil” yield means the production of fuel oil is relatively low and the costs associated with railing this fuel oil back to Durban are minimised. • Even though the refinery is expensive to operate, the high “white oil” yield makes it cost competitive compared to its Coastal neighbours. • Natref is unable to dispose of undesirable products in the local or export market due to its location. Thus all projects (for example, Clean Fuels) are geared to making the refinery self reliant. • Natref cannot take advantage of opportunities offered in the export market because of its inland location. NATREF IN DURBAN

19. 5. Natref Characteristics • Inland refineries by their very nature are always under threat by coastal companies because of transport economics. • Coastal companies can always recover the cost of transport from their clients in both regulated and deregulated markets – this is not the case for inland refineries who have to pay for the cost of crude and then the cost of moving product to the market. NATREF IN DURBAN

20. 6. Natref Investments • R1.4 billion investment in Natref over the years • intent to increase white product yield from original 79% to ~ 89% (to date) • achieved through advanced “bottom of the barrel” processing and state of the art “distillate hydrocracking” unit • These processes steadily increased petrol & diesel yield from black products • Further the processes allowed for the purchase of heavier crude oils from which Natref could produce more petrol and diesel than a normal refinery increasing the profitability of the refinery through lower feedstock cost with higher end product margins NATREF IN DURBAN

21. 6. Natref Investments • The result is that more refined product transported from Natref to end destinations than before. NATREF IN DURBAN

22. 7. Result of Transport situation • The period through to 1979 can be considered a time when Natref was truly neutral from a transport perspective neither making nor losing money. • The commissioning of Sasol 2 & 3, coupled with penalties imposed by SATS on rail backs from Natref seriously compromised Natref’s transport economic position to the extent that Sasol considered reducing production in 1986. • The period between 1987 and 1991 resulted in numerous interactions with SATS at senior managerial level where both Total and Sasol expressed extreme dissatisfaction to the tariff structure. This culminated in the linked structure from 1991. NATREF IN DURBAN

23. 8. Rail back Economics • Rail backs towards the coast are costly in that the revenue earned for the white oil tariff to destination is often less than that for the total transport expense to supply product. For example (2003 / 2004 prices). Coalbrook (Natref) White oil transport Natref to Depot = R25.85 Crude tariff to Natref = R68.00 Equivalent white oil at Natref yield = R68 / 0.89 = R76.40 Kroonstad Durban to Kroonstad = R99.02 Durban Total cost of product passing via Natref; =Equivalent cost of transport of crude oil as white product plus Cost of transport of white product from Natref to Kroonstad = R76.40 + R25.85 = R102.25 Recovery is Durban to Kroonstad rate at R99.02 Net loss = R3.23 NATREF IN DURBAN

24.        VREDE  NATREF IN DURBAN