Global & Regional Petroleum Products Specification Trends & Outlook: Implication to PETRONAS By Teoh Chew Yew Strategic Research, CSR I am Teoh Chew Yew from Strategic Research and I would like to present to you a topic called Global & regional petroleum products specification trends & outlook and implication to Petronas.

Presentation Objective To share on the followings: Global and regional petroleum products specification trends and outlook The trends and implications to PETRONAS The title is self-explanatory so I don’t have to explain further. As you all know, Malaysia should be implementing Euro 4 and 5 real soon, ever wonder why Malaysia wants to go ahead with this. Is it because we like to copy others? Or we want to be Malaysia BOLEH! We believe there is a good reason behind this.

Presentation Outline Part 1: Drivers toward stricter fuels specification trend 4 Part 2: Malaysia: Transportation fuel market 7 Part 3: Implementation for gasoline & potential sourcing 10 Part 4: Implementation for diesel & potential sourcing 14 As we go along, I will walk you through; the main drivers towards stricter global fuels spec trend and the implementation coverage so far We will then look at Malaysia and its fuel market, mainly on gasoline and diesel covering the drivers for stricter fuel standards as well as supply/demand balance for gasoline and diesel. In Part 3 and 4, I’ll cover the implementation timeline for both gasoline and diesel and potential issue, particularly on the supply side and how to circumvent it In part 5, we are going to take a look at the SECA implementation in the marine sector and its related issues relating to PETRONAS Part 5: SECA implementation in marine sector 19 Key Takeaways 23 DSTREAM RISK/CSR/OCR

Part 1 Drivers toward stricter fuel specification trend Without further ado, lets start by looking at the drivers

Manufacturers / OEMs/ engine specification Stricter environmental standards/awareness are driving moves or compliance towards stricter fuel standards Environmental standards -> 6% reduction of greenhouse gas (GHG) in Europe by 2020 and 43% reduction of GHG emission in US by 2025 Government / Mandate Fuel Standards CAFE, ETS Manufacturers / OEMs/ engine specification Basically, stricter environmental standards/awareness are driving compliance towards higher fuel standards, particularly in developed countries in the West. There are environmental standards target in placed for Europe and US. Europe: 6% reduction of GHG by 2020 US: 43% reduction of GHG emission in US by 2025 In ensuring the targets are met, there are few initiatives being undertake: Government/mandate – use of biofuels/bioethanol , 5-10% in the gasoline /diesel Fuel standards – Move to Euro 5, even to Euro 6 in the longer term post 2025 CAFÉ standards in US – Corporate Average Fuel Economy , with target of 35.5 mpg by 2015 and 54.5 mpg by 2025. ETS = emissions trading scheme (EU) European Union's policy to combat climate change and its key tool for reducing industrial greenhouse gas emissions cost-effectively. It covers more than 11,000 power stations and industrial plants in 31 countries, as well as airlines. The EU ETS works on the 'cap and trade' principle. A 'cap', or limit, is set on the total amount of certain greenhouse gases that can be emitted by the factories, power plants and other installations in the system. In 2020, emissions from sectors covered by the EU ETS will be 21% lower than in 2005. By 2030, the Commission proposes, they would be 43% lower. Manufacturers/ OEMs also producing wider range of energy efficient vehicles Source: SR Analysis SIF/CSR/OCR

Source: FGE, Transportpolicy.net, SR Analysis Developing countries are lagging as compared to developed countries in implementing the standards leading to fragmented market Nationwide Gasoline Sulfur Limits, 2014 Nationwide Diesel Sulfur Limits, 2014 Compared to developed countries, you’ll notice that it is quite colorful in the Asia Pacific region. What this means is there are less initiatives in the developing countries in implementing the standards, which leads to a fragmented market. This is because there are lesser incentives from the government and it will incur cost and CAPEX. However, developing countries will eventually become the same as the developed countries The main reason : mainly depend on drive / incentives from the Government and to move to higher Euro standards will also incur some cost/CAPEX hence depending on the Gov priority whilst doing the budget. Source: FGE, Transportpolicy.net, SR Analysis SIF/CSR/OCR

Part 2 Malaysia: Transportation fuel market Now we look into Malaysia transportation fuel market

Source: FGE, Transportpolicy.net, SR Analysis Domestic implementation of stricter fuel standards is to address environmental targets as well as opportunities to move to higher efficiency Malaysia is adopting an indicator of a voluntary reduction of up to 40% in terms of emissions intensity of GDP (gross domestic product) by the year 2020 compared to 2005 levels Car manufacturers and OEMs are producing wider range of energy efficient vehicles (EEVs) which include hybrids, electric-powered vehicles, flexi fuel vehicles and compact cars that requires higher quality fuels. For Malaysia, domestic implementation of stricter fuel standards is to address environmental targets as well as opportunities to move towards higher efficiency During UN Climate Change Conference in 2009 in Copenhagen (COP15), our PM Datuk Seri Najib mentioned that Malaysia is adopting an indicator of a voluntary reduction of up to 40% in terms of emissions intensity of GDP (gross domestic product) by the year 2020 compared to 2005 levels. At the same time, car manufacturers, OEMs are also producing wider range of energy efficient vehicles (EEVs) , including hybrids, EV and compact cars that inevitably requires higher quality fuels. Source: FGE, Transportpolicy.net, SR Analysis SIF/CSR/OCR

Would domestic supply adequate to fulfill the demand? Malaysia requires import of gasoline for domestic needs Malaysia’s diesel market is in marginal deficit until 2019 Malaysia Gasoline Market Malaysia Diesel Market kbpd Malaysia will need to import on-spec gasoline kbpd Malaysia will need to import small amount of on-spec diesel 100 112 With all the targets and drives for better efficiency, the next question that come to mind is ---- when Malaysia shifted to better fuel spec, Would domestic supply be adequate to fulfil the demand ??? Looking at gasoline supply/demand balance, from now until 2020 Malaysia’s deficit will only decline marginally from 112kbpd to 104kbpd. Hence, we will need to import the on-spec gasoline, or expect RAPID to fill in the gap when it comes on stream. For diesel supply/demand balance, Malaysia’s will have marginal deficit of about 4-5 kbpd. Malaysia will still need to import small amount of on-spec diesel, or expect RAPID to fill in the gap when it comes on stream. Source: FGE, Transportpolicy.net, SR Analysis SIF/CSR/OCR

Part 3 Malaysia: Implementation for gasoline and potential sourcing Ladies and Gentlemen Moving on to Part 3, lets now look at the implementation timeline for gasoline as well as potential sourcing.

Euro standard for Gasoline in Asia Pacific Region Countries that are meeting Euro 4/5 gasoline standard are predominantly developed countries, China, India and Thailand Euro standard for Gasoline in Asia Pacific Region >1000 ppm Euro 2 (500 ppm) Euro 3 (150 ppm) Euro 4 (50 ppm) Euro 5 (10 ppm) Indonesia, Pakistan, Philippines, Vietnam, Bangladesh, Sri Lanka, Malaysia India Australia, China, 13 cities in India, New Zealand, Thailand, Singapore Beijing, Shanghai, Guangdong, Jiangsu Hong Kong, Japan, Taiwan, South Korea 2013 Indonesia, Pakistan, Philippines, Vietnam, Bangladesh, Sri Lanka, Malaysia India Australia, China, 13 cities in India, New Zealand, Thailand, Singapore Beijing, Shanghai, Guangdong, Jiangsu Hong Kong, Japan, Taiwan, South Korea 2014 Pakistan, Bangladesh, Sri Lanka, Vietnam Indonesia, Philippines Australia, China, India, Malaysia (ULG 97), Singapore Beijing, Shanghai, Guangdong, Jiangsu, Tianjin, Hong Kong, Japan, Taiwan, South Korea, China, New Zealand, Thailand 2015 As you can see on the chart here, countries that are meeting Euro 4/5 gasoline standards are predominantly developed countries (Hong Kong, Japan, Taiwan, South Korea, Australia, Singapore, New Zealand), with some provinces in China, major cities in India and also Thailand. For Malaysia, Euro 4M, Gasoline (ULG) U97 : September 2015 Euro 4M, Gasoline (ULG) U95 : October 2018 And beyond 2020, Euro 5, Gasoline (ULG) U97 & U95 : September 2025 Australia Singapore, China, Vietnam Malaysia Pakistan, Bangladesh, Sri Lanka Indonesia, Philippines Japan, Taiwan, South Korea, China, Hong Kong, New Zealand, Thailand, India 2020 SIF/CSR/OCR Source: FGE, Transportpolicy.net, Citigroup, SR Analysis

Source: FGE, WoodMac, SR Analysis Malaysia could tap Euro 4/5 gasoline supply from India, South Korea, Singapore, China, Taiwan and Thailand Petroleum Products Demand-Supply Balance for selected Euro 4/5-Compliant Countries in Asia Major Refinery Addition/Upgrade Paradeep Cuddalore Vadinar Kochi Koyali Major Refinery Addition/Upgrade Fujian Sichuan Jiangsu Jiangxi Guangdong Yunnan Tianjin Major Refinery Addition/Upgrade Hokkaido Aichi Major Refinery Addition/Upgrade Sriracha Bangkok Major Refinery Addition/Upgrade Daesan Incheon Seosan Assuming there is no CAPEX investment in our existing system refineries and RAPID will be fully commissioned by 2018/2019, Malaysia could tap Euro 4/5 gasoline supply from regional surplus market namely India, South Korea, Singapore, China, Taiwan and Thailand. Major Refinery Addition/Upgrade Jurong Unit: kbpd SIF/CSR/OCR Source: FGE, WoodMac, SR Analysis

Malaysia also has the option to tap Euro 4/5 gasoline from the Middle East Potential Exportable Euro 4/5 Gasoline in the Middle East Total: 244 kbpd Qatar : - UAE: 74 kbpd (by 2015) Saudi Arabia: 160 kbpd (by 2015) Looking beyond Asia Pac region, Malaysia also has the option to tap Euro 4/5 gasoline from the Middle East amidst their rapid refining expansion. There will be some export volume available from Saudi Arabia (by 2015 when 400kbpd Yanbu refinery comes on stream), UAE (by 2015 when 417 kbpd ruwais refinery fully commission) and Oman by 2017 when Sohar 60 kbpd refiney come on stream. In total, there will be about 244 kbpd of gasoline volume exportable from the Middle East. Oman: 10 kbpd (by 2017) SIF/CSR/OCR Source: FGE, SR Analysis

Part 4 Malaysia: Implementation for diesel and potential sourcing Ladies and Gentlemen Moving on to Part 4, lets now look at the implementation timeline for diesel as well as potential sourcing.

Euro standard for Diesel in Asia Pacific Region Countries that are meeting Euro 4/5 diesel standard are predominantly developed countries Euro standard for Diesel in Asia Pacific Region >1000 ppm Euro 2 (500 ppm) Euro 3 (350 ppm) Euro 4 (50 ppm) Euro 5 (10 ppm) Brunei, Pakistan, Vietnam, Sri Lanka, Malaysia China, India Philippines, Bangladesh 13 cities in India, Thailand Beijing, Shanghai, Hong Kong, Japan, Taiwan, South Korea, Australia, New Zealand, Singapore Indonesia, 2013 Brunei, Pakistan, Vietnam, Sri Lanka,, Malaysia India, Philippines, Bangladesh China, 13 cities in India, Thailand Beijing, Shanghai, Hong Kong, Japan, Taiwan, South Korea, Australia, New Zealand, Singapore Indonesia, 2014 China, India Beijing, Shanghai, Tianjin, Guangdong, Hong Kong, Japan, Taiwan, South Korea, Australia, New Zealand, Singapore, Thailand Bangladesh Brunei, Pakistan, Vietnam , Sri Lanka, Indonesia, Malaysia Philippines 2015 As you can see on the chart here, countries that are meeting Euro 4/5 gasoline standards are predominantly developed countries (Hong Kong, Japan, Taiwan, South Korea, Australia, Singapore, New Zealand), China, major cities in India and also Thailand. For Malaysia, Euro 5 Diesel : September 2020 2020 China, Hong Kong, Japan, Taiwan, South Korea, Australia, New Zealand, Singapore, Thailand, China, India, Malaysia (E5 Diesel) Bangladesh, Philippines, Pakistan, Indonesia Brunei, Sri Lanka, Vietnam, India SIF/CSR/OCR Source: FGE, Transportpolicy.net, Citigroup, SR Analysis

Source: FGE, WoodMac, SR Analysis Malaysia could tap Euro 4/5 diesel supply from India, South Korea, Singapore, China, Taiwan, Thailand and Japan Petroleum Products Demand-Supply Balance for selected Euro 4/5-Compliant Countries in Asia Major Refinery Addition/Upgrade Paradeep Cuddalore Vadinar Kochi Koyali Major Refinery Addition/Upgrade Fujian Sichuan Jiangsu Jiangxi Guangdong Yunnan Tianjin Major Refinery Addition/Upgrade Hokkaido Aichi Major Refinery Addition/Upgrade Sriracha Bangkok Major Refinery Addition/Upgrade Daesan Incheon Seosan Again, Assuming there is no CAPEX investment in our existing system refineries and RAPID will be fully commissioned by 2018/2019, Malaysia could tap Euro 4/5 diesel supply from regional surplus market namely India, South Korea, Singapore, China, Taiwan, Thailand and Japan. Major Refinery Addition/Upgrade Jurong Unit: kbpd Source: FGE, WoodMac, SR Analysis SIF/CSR/OCR

Malaysia also has the option to tap Euro 4/5 diesel from the Middle East Potential Exportable Euro 4/5 Diesel in Middle East Total: 482 kbpd Qatar: 24 kbpd (by 2016) UAE: 143 kbpd (by 2015) Saudi Arabia: 280 kbpd (by 2015) Looking beyond Asia Pac region, Malaysia also has the option to tap Euro 4/5 diesel from the Middle East amidst their rapid refining expansion. There will be some export volume available from Saudi Arabia (by 2015 when 400kbpd Yanbu refinery comes on stream), UAE (by 2015 when 417 kbpd ruwais refinery fully commission) and Oman by 2017 when Sohar 60 kbpd refiney come on stream. In total, there will be about 574 kbpd of diesel volume exportable from the Middle East. Oman: 35 kbpd (by 2017) SIF/CSR/OCR Source: FGE, SR Analysis

Import bill is expected to rise when sourcing for EURO 4/5 compliance fuel Based on the average premium, additional cost of about US$77 mil pa to import diesel… Price Premium of Gasoil 0.005%S to Gasoil 0.05%S US$ per bbl PETRONAS may incur higher cost in sourcing for on-spec diesel Avg. 2012 – Sep 2014: US$1.0 per bbl I have highlighted earlier potential source of supply to fill in the gap of supply deficit. Another important element would be the pricing element. Dependency over imports volume for higher spec gasoline and diesel may lead to higher import bills for Malaysia. For diesel, based on the average premium of US$1 per bbl and 2014 demand, another US$77 mil pa additional cost to import diesel assuming we import 100% of diesel demand pre RAPID. (Our Melaka refinery have some ULSD volume that currently being exported around 30 kbpd and timeline for Euro 5 diesel is in 2020.) For gasoline, currently the price assessment done by the Platts based on RON number instead of the sulphur content, hence cant really make comparison between euro 2 and euro 4 spec. SIF/CSR/OCR Source: Platts, SR Analysis

Part 5 SECA implementation in marine sector Ladies and Gentlemen Moving on to the final part, on SECA implementation in marine sector

Tighter global marine policy will lead to adoption of better quality fuels such as LSFO and marine diesel Current bunker market of 4 mil bpd of fuel oil, 84% of which high-sulphur fuel, will be at risk as the market shifts towards lower sulphur fuels Emission Control Area (ECA) implementation target for marine vessels - This shift will affect refineries, petroleum prices, supply-demand balance, trade flows and shipping sector Japan: Proposed Mediterranean: Part or all by 2018 Caribbean Sea Hong Kong (0.5%S in 2015) SECA is a sulphur emission control area regulated by IMO. The tighter global marine policy will lead to adoption of better quality fuels such as LSFO and MDO. Current bunker market of 4 mil bpd FO, 84% of which is high sulfur (3,3 mbpd) will be at risk as the market shifts towards low sulfur fuels. Present ECA area in North America, and Europe is with 1% cap . This to be reduced to 0.1%s in 2015. Current global cap stands at 3.5%s, and according to the IMO timeline, this will be tightened to 0.5% by 2020 or 2025, subject to review outcome in 2018. There are also mulling on expanding ECA area to other major shipping points such as Panama canal, Singapore, Australia, Hong Kong and Japan. Annex VI: Prevention of air pollution by ships (Emission Control Areas) Baltic Sea (SOx) 26 Sept 1997 19 May 2005 19 May 2006 North Sea (SOx) 22 Jul 2005 22 Nov 2006 22 Nov 2007 ​ North American (SOx, and NOx and PM) ​26 Mar 2010 ​1 Aug 2011 ​1 Aug 2012 ​ United States Caribbean Sea ECA (SOx, NOx and PM) ​26 Jul 2011 ​1 Jan 2013 ​1 Jan 2014 Singapore: Proposed Present ECA area with 1%S cap and to be reduced to 0.1%S in 2015 Likely ECA Australia: Proposed Current Global Cap – 3.5%S will be tightened further to 0.5% S by 2020 or 2025 depending on review outcome SIF/CSR/OCR Sources: IMO, SR Analysis

Residual fuel demand to be impacted more following wider implementation of stricter IMO standards in 2020 Bunker supply/demand balance with IMO Global Cap in 2020 Bunker supply/demand balance with IMO Global Cap in 2025 Capacity of secondary units of a percentage of crude distillation in early IMO implementation (2020) and later (2025) Surplus Surplus Deficit Deficit With SECA implementation, global cap of 0.5% by either 2020 or 2025, residual fuel demand to be impacted more following wider implementation. The global diesel deficit will increase substantially and this will also result in a substantial global surplus of fuel oil. And in the long term, residual (HSFO) spread to weaken, but distillate (MDO) spread will strengthen. Refining upgrades to sufficiently meet higher demand for distillates will lead to upgrading activities by 2020 In the long term, residual (HSFO) spread will weaken, but distillate (MDO) spread will strengthen Source: WoodMackenzie, SR Analysis SIF/CSR/OCR

SECA implementation will lead to higher cost for refiners and players in shipping sector Based on the average premium, potential additional cost for bunker demand in Malaysia may range up to US$170 mil pa Price Premium of Diesel to Fuel Oil Gasoil-fuel oil differentials will stimulate investments in fuel oil upgrading by refiners and in development of new technology UUS$ per bbl PETRONAS’ shipping outfit may incur higher cost for bunker Avg. 2012 – Sep 2014: US$24.3/bbl High bunker prices will drive efficiency gains and incentivise ship owners to look at other alternatives, such as LNG and potentially LPG So what would be the impact on pricing? SECA implementation will lead to higher cost for refiners and players in shipping sector. Based on the average diesel premium to FO and Malaysia bunker demand of about 14 kbpd, potential additional cost for bunker may range up to US$170 mil pa. The situation may further exacerbate if global cap SECA of 0.5% implement in 2020 , same timeline for our Euro5 diesel. The premium may be even higher. (Mention the implications as you click) High premium of distillates versus fuel oil will stimulate uptakes of scrubbers in certain areas, allowing some fuel oil to be burnt while meeting emissions standards Source: Platts, SR Analysis SIF/CSR/OCR

Cost of secondary units such as desulphurisation is high Rule of thumb: Refinery, per 100 kbpd ~$4-4.5 billion Cost of secondary units such as desulphurisation is high Global refining investment : $280 billion by 2018 Asia Pacific refining investment : $100 billion by 2018 $100-500 million for desulphurisation unit $50-100 million per power plant $50-500 million equipment cost China refining investment : $60 billion by 2018 Whiting refinery upgrade (hydro-treating) 500ppm to 15ppm ~$300-400 million Note: All currency in US dollar SIF/CSR/OCR

Key Takeaways Existing domestic refineries in Malaysia have limited capacity and the supply is insufficient to meet the demand of new fuel standards. (assuming RAPID could close the gap when it comes on stream post 2018) In the interim, Malaysia could tap for Euro 4/5-compliant gasoline and diesel supplies from India, South Korea, Singapore, China, Taiwan, Thailand and Japan. Malaysia could also potentially tap the fuel supplies from Saudi Arabia, UAE, Qatar and Oman. In conclusion, these are the key takeaways from my presentation Existing domestic refineries in Malaysia have limited capacity and the supply is insufficient to meet the demand of new fuel standards. (assuming RAPID could close the gap when it comes on stream 2018/2019) In the interim, Malaysia could tap for Euro 4/5-compliant gasoline and diesel supplies from India, South Korea, Singapore, China, Taiwan, Thailand and Japan. Malaysia could also potentially tap the fuel supplies from Saudi Arabia, UAE, Qatar and Oman. SECA implementation worldwide will lead to tougher operating environment for refiners and operators in freight service. Higher quality fuels are required which incurred higher cost for both parties. Note: From 2012-2035, usd1.5 trillion will be used for global refining investment. Out of which usd280 billion needed for investment on existing projects i.e. upgrades & maintenance (about usd12 billion pa in 23 yrs period). It is expensive to upgrade refineries. SECA implementation worldwide will lead to tougher operating environment for refiners and operators in freight service. Higher quality fuels are required which incurred higher cost for both parties. Source: SR Analysis SIF/CSR/OCR

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Key Messages In general, existing domestic refineries in Malaysia have limited capacity of producing gasoline and diesel that comply to the new fuel standards: Euro 4M, Gasoline (ULG) U97 : September 2015 Euro 4M, Gasoline (ULG) U95 : October 2018 Euro 5, Gasoline (ULG) U97 & U95 : September 2025 Euro 5 Diesel : September 2020 Even with RAPID slated to come on stream in 2019, the specific volume for on-spec gasoline and diesel has yet to be finalised. There are a pool of countries in East of Suez with surpluses of gasoline and diesel of which Malaysia could potentially tap for supply. Asia Pacific: India, South Korea, Singapore, China, Taiwan, Thailand and Japan Middle East: Saudi Arabia, UAE, Qatar and Oman

Existing and planned Emission Control Area (ECA) ... which is exacerbated by tightening emission standards for bunker sector and possible expansions of ECA... Existing and planned Emission Control Area (ECA) Mexico/Panama: Possible by 2018 Mediterranean: Part or all by 2018 Australia: Likely Singapore: Hong Kong: Japan: Present ECA Likely ECA Global Cap 4.5% Baltic and North Sea SOx ECA 1.5% All SECA 1.0% Global Cap 3.5% All ECA 0.1% Review Global Cap 0.5% Global Cap 0.5%? Possible delay Timeline for bunker specification changes SKG02_2/CSP/WR Source: FGE, SR Analysis

Import bill is expected to rise when sourcing for EURO 4/5 compliance fuel Based on the average premium, additional cost of about US$150 mil pa for gasoline… … and another US$77 mil pa additional cost to import diesel Price Premium Euro 4/5 Gasoline RON 95 to Euro 2/3 Gasoline RON 95 Price Premium of Gasoil 0.005%S to Gasoil 0.05%S US$ per bbl US$ per bbl PETRONAS may incur higher cost in sourcing for on-spec diesel PETRONAS may incur higher cost in sourcing for on-spec gasoline Avg. 2012 – Sep 2014: US$1.0 per bbl Avg. 2012 – Sep 2014: US$1.9 per bbl I have highlighted earlier potential source of supply to fill in the gap of supply deficit. Another important element would be the pricing element. Dependency over imports volume for higher spec gasoline and diesel may lead to higher import bills for Malaysia. For gasoline, based on the average premium of US$1.9 per bbl and 2014 demand, estimated additional cost of about US$150 mil pa assuming we import 100% of gasoline demand pre RAPID. And for diesel, based on the average premium of US$1 per bbl and 2014 demand, another US$77 mil pa additional cost to import diesel assuming we import 100% of diesel demand pre RAPID. However, it is less critical for diesel as our Melaka refinery d have some ULSD volume that currently being exported around 30 kbpd and timeline for Euro 5 diesel is in 2020. DSTREAM RISK/CSR/OCR Source: Platts, SR Analysis