Hengyuan buys Shell Refining Malaysia

The private Chinese refinery company is paying $66m for a 51% stake but the total cost is set to rise to $480m once debt and upgrade requirements are factored in.

Shandong Hengyuan Petrochemical beat out other bidders to purchase a majority stake in Shell’s Malaysian refining unit for a total capital cost of $480 million, marking the first time an independent Chinese refinery has made an international refinery acquisition.

Hengyuan, a Dezhou-based private refinery company, was the winning bidder on Monday in an auction for a 51% stake in publicly traded Shell Refining Co Federation of Malaysia.

The two companies entered into a definitive agreement for Hengyuan to purchase Shell’s stake. Once this is concluded the Chinese refinery will make a mandatory offer for the remaining 49% of shares.

Falling oil prices are generally good for refiners, which buy crude oil, convert it into usable diesel or petrol, and then sell it on. As a result, the collapse of the price of oil from nearly $100 a barrel in 2014 to $29 a barrel at the end of January has been a boon to these companies.

Still, increasingly stringent emission regulations are taking their toll. Shell opted to sell the Malaysia unit after deciding that it would cost too much to upgrade the company’s technology to meet Euro IV pollutant emission standards for fuel and Euro V standards for diesel, which Malaysia is set to implement in 2017.

Hengyuan paid $66 million for Shell’s 51% stake, which represents a huge discount to its RM1.48 billion ($351.58 million) market capitalisation, based on a closing share price on January 29 of RM4.94.

But the total acquisition cost will be much higher since Shell Refining Malaysia has $350 million in debt, a large amount of which falls due this year.

Additionally, the technology upgrade costs are likely to run into the tens of millions of dollars. As a result, Hengyuan looks set to end up paying $480 million to acquire and upgrade the business, according to a senior executive familiar with the transaction.

“It’s a fixer-upper, so to speak,” the executive told FinanceAsia.

He said Hengyuan bid for the company because it wants to build a market presence outside of China, where state-owned operator Sinopec dominates diesel and gasoline refining.

“We’ve already seen in China various widget makers and technology companies going out and buying market share outside of China,” said the executive. “Hengyuan has decided to do the same because it can only grow so much domestically and it has access to capital, so the company said ‘let’s grow abroad if we cannot grow locally’.”

He also noted that Chinese refinery companies have become proficient at upgrading refining technology to new standards for a lot less money than equivalent Korean or Japanese companies would be able to manage.

“Hengyuan knows how to operate a refinery but not in Malaysia, so it will retain everybody [who works there], while it has access to capital and technology to upgrade the refinery’s technology in addition to getting a new market footprint,” the executive said.

Meanwhile, Shell is believed to be happy to sell the asset because it was unwilling to spend the required amounts to upgrade the refinery. “If it hadn’t been able to sell it, Shell was planning to mothball the plant and turn it into a jetty; a fuel import terminal,” the executive added.

Cost and investment

Hengyuan’s decision to buy a heavily indebted refinery in need of upgrade might seem a sign of its desperation to expand.

To make its position even more challenging, Malaysia’s state oil company Petronas is set to bring a huge new oil refinery dubbed Rapid online in 2020, making the country’s refining market a great deal more competitive. However, the executive argued that the deal still made sense for Hengyuan.

“Today Malaysia is short of fuel and capacity [and] has to import it all, so Hengyuan has four to five years to make money, fix the balance sheet, and find synergies,” he said. “Additionally, Chinese companies are producing too much diesel, so companies like this are learning to trade diesel in the region. Plus, even after Rapid comes online there is a theory Malaysia can combine with Singapore to become a major refining hub to the rest of Asia, which has shortfalls.”  

While the consolidation of upstream oil assets will remain difficult in today’s conditions, the possibility exists for further refinery mergers and acquisitions in the coming months, the executive added.

“It’s very hard to conduct M&A in the upstream oil industry because the bid-ask cap is really big. Nobody wants to sell when the forward curve is at $50 [a barrel],” the executive said. “However, refinery margins are healthy, some companies are taking a longer term view, and if [the oil] majors want less [market share] they might wonder, ‘why not sell now?’"

Hengyuan’s offshore acquisition underlines the fact that there are more than just Chinese state-owned enterprises operating in oil and gas in Asia. “Many international majors think there are just three oil and gas companies in Beijing. This deal will open the eyes of the majors and might make them wonder of [the] demand [that] exists for some of their assets,” he said.

While Shell has sold its Malaysian refinery, the company is believed to have no plans to divest its profitable petrol distribution arm in the country. 

Shandong Hengyuan has Citi as a financial adviser, while Shell Refining Co Federation of Malaysia is being advised by Lazard. 

¬ Haymarket Media Limited. All rights reserved.
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