RIL to use US ethane instead of costly naphtha: Edelweiss

Latha: Just explain to us what this really means, is this a mere diversification and so less risk for the company or is this going to mean actual savings?

A: I don't believe that this is mere diversification. I think this has got potential to add to Reliance Industries’ profitability significantly. Essentially this is global economics of petro chemicals and input sourcing that one needs to intimately understand to appreciate the significance of this move by Reliance Industries. Essentially, the first thing is that simplistically there are two inputs to manufacturing petrochemicals. There is Naphtha and there are gases. Naphtha costs about USD 23/mmbtu, gas it depends on where you source it from.

At the moment in the US it costs roughly about USD 4/mmbtu. So you can imagine the implication of the economics if you can get hold of that cheap gas in the US.

The petrochemical plants within the US are so profitable because of this huge gap, they are pretty much nearly as profitable as the Middle East capacities and the payback periods range barely two-three years maximum. So what Reliance is actually looking to do is partially substitute its petrochemical feed intake from Naphtha to ethane and partially capture this arbitrage of this cheap gas coming from ethane. So these economics indeed work out very significant.

Latha: With this 1.5 million tonne per annum, what is the benefit and by when to the company?

A: Reliance is tied up, by the second half of 2016 is when they should start getting the gas to start with and we estimate that this could potentially increase their profits by as much as Rs 2,000 crore per annum.

This involves very complex global linkages and sourcing facilities so essentially this requires Reliance – they have tied up the sourcing of gas from the US itself which is by far the most critical part of linkage, setting up storage facilities there, liquefaction facilities. I would think that this is one of the first ethane liquefaction facilities in the world and given Reliance’s size of global capacity in petrochemicals, the economics of this and the ability to do this itself is significant.

Following which shipping which Reliance has placed orders for six of the largest ethane liquid carriers in the world and of course receiving facilities here which Reliance itself has got its port in Dahej which will allow them to regasify the liquid ethane which comes here. Reliance has also got two of its crackers which can already take gas as an input, and even the third cracker it had initially set up as a dual feed cracker which essentially they need to make some minor modifications to start receiving the gas in that cracker as well. So it is basically arbitraging Naphtha which is USD 23/mmbtu by the time they land in India, we estimate that the cost will be USD 12/mmbtu. If you do the math it actually works out in excess of Rs 2000 crore per annum.

Latha: Should we assume that this is a bit of a pilot and if this works well, the company could substitute more of its naphtha with shale based ethane?

A: I think that there may be scope to do a little more but I don't really think that this is a pilot. 1.5 million tonne of ethane is one of the largest – actually I would think that they would be one of the largest ethane importers in the world. So on that scale I wouldn’t say that this is really pilot, this is really a significant project in itself basically.

Latha: In your report you have said that RIL's USD 30 billion capex is starting to bear fruit and so we reaffirm a Buy. What are your expectations in terms of this bearing fruit of the capex and what it will do to the EPS say up until FY16-FY17, what are your price targets?

A: This is one of the several things Reliance is doing and of course incrementally the ethane imports. Reliance among several other things its polyester capacities have already started going on-stream. Its organised retail business has already turned around, its US shale business which could partially be the sourcing point of ethane import in the US has already turned rather profitable and is going to make even more money. This is all near term and some of the more significant projects then going on-stream in two-three years time are of course the petrochemical gasification and off gas cracker. Notably, ethane imports have got nothing to do with those two projects so we shouldn’t confuse the two. Those economics work independently and significantly by themselves. Of course we have got Rs 70,000 crore being spent on Reliance Jio.

All these things will progressively have profits kicking in and perhaps it’s wiser to talk about may be a four year time horizon, perhaps even five which could potentially even double Reliance’s profits rather than a two-three year time horizon. For a company of that size and a USD 30 billion plus capex, that by any means is a significant achievement.

Disclosure: Network 18, which publishes moneycontrol.com, is now part of the Reliance Group.