SK Innovation Follows Asian Trail Into US Shale

BMI View : SK Innovation is the next major Asian corporation seeking to push deeper into the US, to take advantage of its unconventional boom to supplement its income. Not only would US upstream revenue help support falling income from its core downstream business in South Korea, SK's investment into the US could also support US production, that could in turn lead to growing ethane exports from the US into the international markets, to the benefit of SK's petrochemical operations.

SK Innovation is the next major Asian corporation seeking to expand its footprint in the US' unconventional space. President Koo Ja-young reportedly stated the firm's goal to expand its shale gas business in the US. South Korea's largest refiner not only intends to expand its upstream involvement in the US, but also to turn its US unit, SK E&P, into a 'global hub' for 'unconventional energy business'.

US Fortunes

Upstream Holding Up The Rest
SK Innovation - Operating Profits From Selected Quarters (KRWbn)

SK Innovation Follows Asian Trail Into US Shale

BMI View : SK Innovation is the next major Asian corporation seeking to push deeper into the US, to take advantage of its unconventional boom to supplement its income. Not only would US upstream revenue help support falling income from its core downstream business in South Korea, SK's investment into the US could also support US production, that could in turn lead to growing ethane exports from the US into the international markets, to the benefit of SK's petrochemical operations.

SK Innovation is the next major Asian corporation seeking to expand its footprint in the US' unconventional space. President Koo Ja-young reportedly stated the firm's goal to expand its shale gas business in the US. South Korea's largest refiner not only intends to expand its upstream involvement in the US, but also to turn its US unit, SK E&P, into a 'global hub' for 'unconventional energy business'.

US Fortunes

SK follows the footsteps of other Asian players in expanding their positions in the US upstream segment. Chubu Electric is eyeing the acquisition of more shale gas assets, while Sumitomo Corporation and GAIL India could also jointly target unconventional purchases in the US.

Their interest in the US is mainly linked to their future dependence on the US market for liquefied natural gas (LNG), which prices will mainly be linked to the US Henry Hub gas index. A stake in US shale gas assets could allow them to either support US gas production and control prices at the wellhead so as to minimise the end-user price of LNG, or to profit from high wellhead prices as a hedge against high end-user LNG price.

Unlike these firms, SK does not have positions in LNG imports. Nonetheless, a stronger position in the US market can help it support its profits in the face of persistently weak domestic refining margins in its primary business. With crude oil prices having hovered above USD100/bbl for the past three years, and growing downstream competition in the global market and limited demand restricting upward price movements in refined products, refining margins in crude import-dependent South Korea have been squeezed. In Q2 2014, SK Innovation reported a loss of KRW23bn (USD22mn) from a profit of KRW267bn (USD258mn) in Q2 2013. SK Innovation attributed this to high crude oil prices, poorer demand and oversupply that hit margins for petrochemicals, aromatics and diesel in particular. In contrast, its upstream unit produced KRW112.7bn for the firm in Q2 2014.

Upstream Holding Up The Rest
SK Innovation - Operating Profits From Selected Quarters (KRWbn)

Our expectations for global crude oil prices to remain above USD90/bbl up to 2018 and for expanding downstream capacity especially in developing markets in Asia suggests that margins will continue to be squeezed for import dependent refiners such as SK Innovation. However, the US market could be on a different trajectory, as the easing of pipeline bottlenecks and liberalisation of condensate and gas exports promise to improve both oil and gas prices and revenues of upstream producers. This provides a good hedge for SK Innovation.

Narrowing Brent-WTI Spread Good For US Upstream Revenues
Brent & WTI - Oil Price Forecast (USD/bbl)

Long-Term Benefits For Downstream Operations

The benefits of SK's involvement in the US upstream could also be felt in its petrochemical operations in South Korea. The firm's ambition in the US matches a call by South Korea's commerce ministry in July 2013 to develop shale resources in the US, not only to lower the cost of the country's LNG imports, but also for possible use in the petrochemical sector ( see 'Gas Price Movements Present Risk To Shale Bet', July 19 2013). Cheaper ethane and other condensates imported from the US - facilitated by a free trade agreement between US and South Korea - could replace the more expensive oil-based naphtha for petrochemical operations, thereby lowering operating costs to revive the sector's fortunes.

We have already pointed out that Asian markets could be the long-term beneficiaries of growing ethane exports from the US on the back of rising production from the Marcellus and Eagle Ford shale formations ( see 'Ethane Exports Set For Growth', July 21). We also noted that South Korea, in particular, could be the mystery buyer of six newbuild gas carriers - most likely Very Large Ethane Carriers (VLEC) - from Samsung Heavy Industries (SHI), which will be ready by 2016.

Therefore, SK Innovation also has an interest to develop upstream assets and export the ethane by-product to South Korea for its own consumption. Other petrochemical producers in South Korea could also employ SK's strategy by entering the US' unconventional upstream segment. In addition to Japanese utilities, this will see more non-traditional investors take positions in the US upstream.

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