Vietnam’s first oil refinery, the Dung Quat refinery in Quang Ngai Province, was inaugurated in 2009 after some two decades of planning, disagreements, pullouts by investors, delays and much frustration. But once it was launched, it brought serious economic benefits to both the province and the country; industrial gross output in Quang Ngai Province increased by 144.7 percent in 2009, and the share of the oil industry in the province's GDP surged from 36.2 percent in the previous year to 46.3 percent. Today, 90 percent of the province’s income comes from the Dung Quat Economic Zone, where the refinery is located.

It is no surprise that Vietnam now wants more of them, and fast. State-owned oil and gas group PetroVietnam, the owner of Dung Quat, is now planning two more refineries – the $9-billion Nghi Son plant in the central province of Thanh Hoa and a petrochemical complex in southern Vietnam. Petrolimex, the country’s largest fuel distributor, said it is looking for investors to build the Nam Van Phong Refinery in the central province of Khanh Hoa. Also being planned are the $3.2-billion Vung Ro refinery in central Vietnam, a joint project by the UK’s Technostar Management Ltd and Russia’s Telloil, and another $350-million project in the Mekong Delta city of Can Tho, which received an investment licence in 2008. And Thailand’s state oil company PTT has proposed building the mammoth $28.7-billion Nhon Hoi refinery and petrochemical complex in central Binh Dinh Province, which if completed, will become one of the largest refineries in the world. Aside from all of this, the Dung Quat plant aims to raise its capacity from 135,000 barrels per day, which is currently meeting a third of the country’s oil demand, to as much as 240,000 barrels per day.

However, much like Dung Quat before them, the planned refineries face far from a smooth road going forward. Construction of the 200,000-barrels-per-day Nghi Son refinery was originally scheduled to start in the first quarter of 2011, but has been delayed due to difficulties with preparation procedures and its four investors – PetroVietnam, Kuwait Petroleum International, Japan’s Idemitsu Kosan Co, and Mitsui Chemicals – announced only last month that they would proceed with the project in Vietnam after reaching a final investment decision. Construction plans for the Vung Ro refinery were revised in October after a two-year delay, and the investment was raised to twice the original plan. The project in Can Tho has not made any progress since it received an investment licence in 2008, with no commencement date being announced. And in April, PetroVietnam expressed “great concerns” about the Nhon Hoi project, stating that PTT had not properly evaluated availability of stable, long-term crude oil, details of the partners to be involved in this project, and capital arrangements.

Angus Mitchell, partner at DFDL and head of the firm’s oil and gas division, says that while the premise behind establishing refineries is sound, the projects can be extremely challenging. “Though it remains a net exporter of crude oil, Vietnam is a net importer of refined petroleum products,” he says. “This leads to balance of payments issues among others, so Vietnam has joined many nations in putting an expansion of internal refining capacity at the forefront of its development plans. Every government wants to add value to exports and to replace expensive imports.” He adds that on the face of it, the economics should be attractive for investors as well, “but massive capital costs, long project lives, difficult siting and challenging feedstock and output pricing are among the issues that make refineries some of the most demanding projects to push through to financial close.”

Feasibility in question

According to Vietnam’s Ministry of Planning and Investment, the month of May saw $3.4 billion in fresh capital injected into projects currently being implemented, a 14 percent rise compared to the same month last year. The bulk of this came from Idemitsu pouring $2.8 billion into Nghi Son, but it is clear investors want to introduce more capital in order to increase capacity. For example, the Vung Ro refinery was initially planned with an initial capacity of four million tonnes per year, a figure that local officials claim would make the project “inefficient and unprofitable,” and so capacity was doubled, as was the investment to $3.2 billion.

However, the worry is that once all these projects become operational, Vietnam may face a shortage of crude oil. Media have quoted Tran Viet Ngai, chairman of the Vietnam Energy Association, as saying that if the country does not find new oil reserves, current resources, which can provide 14 to 15 million tonnes of crude oil per year, would not be enough for the new refineries. Dung Quat, for example, needs about 6.5 million tonnes of crude oil per year. Similarly, one of the biggest questions is where the crude oil will come from for the Nhon Hoi refinery. Bill Magennis, a Hanoi-based partner at Allens, notes that currently Vietnam imports petroleum products, “and it is always possible to import crude oil to make those petroleum products in Vietnam by way of import replacement. It is simply a matter of getting the right quantity to meet domestic demand, and/or to have a plan for export of product.”

Mitchell at DFDL notes, however, that estimates related to this can be wrong, as evidenced by refineries operating at below capacity in some jurisdictions and at peak capacity in others. “The sponsors and the lenders on the Nghi Son project will have had the greatest incentive to get that refinery’s economics right,” he says, “and (albeit after many hurdles and false starts) their positive FID should be taken as a positive and educated endorsement of refinery economics in Vietnam.” He adds that from the Vietnamese government’s perspective, it makes sense to encourage the development of a number of these projects right now, “in the knowledge that only the ‘fittest will survive’ the natural winnowing process and make it to financial close,” he says. “Presumably, Vietnam would prefer to have an excess of refining capacity that a deficit and will tailor its policies accordingly.”

Refining the risks

Lawyers agree that the most important requirement for investors in these projects is that they be financially capable enough to ensure the smooth arrangement of capital and borrow capital from credit institutions. They especially need to have the right to take initiative in distributing products. “Oil and gas projects are the same as any other projects that require massive capital,” says Magennis. “Such projects require investors to have a sufficiently positive view as to long-term demand for the products, and require providers of large-scale loan finance to have risk abatement measures agreed with the government.” Adds Mitchell of DFDL: “Obtaining financing is the most challenging issue for investors in the capital-intensive segment of Vietnam’s oil and gas space.”

Another issue is currency risk, given that the Vietnamese dong is a highly volatile currency. Mitchell suggests a way to mitigate this. “Though the dong-U.S. dollar exchange rate has remained relatively stable recently, refinery projects – and  their project debt – are long-term prospects, so appropriate derivatives contracts can be a useful tool to mitigate exchange rate fluctuations,” he says. Having offtake priced and paid for in a foreign currency may also allay some concerns. The availability of foreign exchange and non-convertibility of the dong is a related issue that should be addressed through a Vietnamese government guarantee if possible.” Magennis says that the best hedge is to provide for earning foreign currency by way of exports. “In so far as a project is for import substitution, then one needs agreement on availability of dollars,” he says.

Finally, Mitchell adds that getting the government’s buy-in is paramount. “No oil and gas project in Vietnam can proceed without a considerable degree of interaction with Vietnamese governmental authorities; be it PetroVietnam as a contract counterparty in a PSC or as a refinery consortium member, or other governmental authorities granting the countless required project approvals,” he says. “This can lead to delays, costs and associated frustrations, as well as a ceding of more control over a project than might be the case in other jurisdictions.”

Fueling the promise

Despite the risks, however, Mitchell says that Vietnam’s oil and gas industry has much going for it. “[The country] remains home to some relatively unexplored and potentially resource-rich acreage,” he says. “It is located in the heart of a region whose thirst for petroleum will continue relatively unabated for the foreseeable future, despite periodic market downturns.  Those fundamentals merit a look from all oil and gas investors, be they juniors or majors or something in between. However, good local advice – legal, commercial, practical and political – will be more important than in some other jurisdictions.”

 
An appetite for risk, however, is vital. “Perhaps the biggest concern relating to Vietnam’s most prospective oil and gas areas is the Chinese government’s expansive claims in the South China Sea,” adds Mitchell. “Only oil majors that can play the long game and take losses, or juniors whose investor base has an enormous appetite for risk – and commensurate reward – should wade into those waters.”

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