The Future of HRC

PROSPECTS AND RISKS FOR 2017/2018

As part of our strategic priorities moving forward, HRC is focused on implementing several key projects and opportunities to build a sustainable future. These initiatives are key to allow the refinery to continue operations and deliver products against the evolving product quality specifications demanded by the Malaysian market whilst respecting local regulations. At the same time, our Company will leverage on SHPC’s resources to capitalise on its technological expertise in operating as an independent refiner and experienced operator producing Euro 6 compliant products as required in the China domestic market.

ASSETS AND PROJECTS

- Euro 4M Mogas Project

This is a crucial project to ensure the going-concern of our Company and sustainability of the business to meet the industry’s future requirements. Our project team is developing the Basic Engineering Design and Front End Engineering Design (FEED) work with a reputable contractor and licensor with support from SHPC to ensure that the product specification is compliant to Euro 4M mogas specifications upon its planned implementation in October 2018. Following our approval process, the Final Investment Decision (FID) for the project will be presented to the Board in 2nd quarter of 2017. Thereafter, the projects and technology teams will focus on project execution, targeting to complete the construction during the second half of 2018. To minimise downtime outside the Turnaround period, both the equipment tie-ins and completion are targeted during Major Turnaround 2018 (TA2018).

RISK: If the refinery is not able to produce Euro IV compliant products by the regulatory deadline, then our customer will import their product requirements, which are Euro 4M compliant. These imports cannot be co-mingled with the products that the refinery is able to produce now as they are Euro 2 compliant. Through the Product Offtake Agreement (POA), our customer can contractually use our facilities to throughput their products. This means that the operations and financial performance of HRC would be significantly impacted during the period in which we are unable to produce Euro 4M products post the compliance date. Management and SHPC’s current perspective is that we are confident that the project is on track and our refinery is able to meet the regulatory timeline by leveraging on SHPC’s technical resources and guidance. Management is reviewing the project progress weekly to ensure challenges and hurdles are effectively dealt with to protect the project schedule.

Major Turnaround 2018 (TA2018)

The major turnaround in 2018 is driven by legislative requirements of the Malaysia Department of Occupational Safety and Health (DOSH). HRC subscribes to the DOSH Statutory Safety Inspection (SSI) programme which is a structured integrity inspection and assurance programme. Part of the requirement is establishing a baseline of equipment inspection status, which requires all equipment to be opened in 2018. A full inspection of the equipment during TA2018 will thus enable us to renew our license to operate as issued by DOSH. With this inspection, our refinery is in a good position to negotiate a four-year turnaround cycle post-2018 with DOSH. During the turnaround, maintenance work will be executed to ensure the integrity and reliability of operation of all equipment. The scope is established based on previous inspections, our technical advisor’s experience and issues we observed during the current plant operation. Scope definition, preparation, resourcing of materials is an important 2017 deliverable. A significant investment for equipment renewal that will take place in TA2018 is the replacement of the internals and top dome of the catalyst regenerator of the Long Residue Catalytic Cracker Unit (LRCCU). The life of these internals is 18 years and replacement is due in 2018, as confirmed during the inspections in the previous turnaround in 2015.

RISK: Planning and execution is crucial to a successful and timely Turnaround. Any unexpected incident or emergent scope arising during the event could result in an extended shutdown resulting in a financial impact. The project team which has been assigned to this crucial project comes with extensive experience in HRC’s previous turnarounds and operates within the well established governance framework. Moreover the regenerator top dome project is executed in partnership with contractors that have experience with the manufacturing and installation in similar units elsewhere. The manufacturing of the new dome is not schedule critical.

Additionally, the Turnaround is crucial as it is the only opportunity to modify equipment for safety, efficiency, reliability, increased capacity or for economic reasons. Several future projects which will be tied-in into the plant during TA2018, are also being developed in 2017.

Opportunistic Tie-ins during TA2018

TA2018 provides a timely opportunity to install facilities that will allow future modifications to the process during normal operation of the refinery between 2018-2022. By installing tie-ins during TA2018, we avoid the need for costly refinery shutdowns in 2019 or 2020 to connect new equipment required to meet thecompliance due dates. These compliance driven projects include meeting the Department of Environment’s (DOE) environmental compliances for Clean Air by 2019 and to prepare for the planned investment to comply with the new Euro 5 gasoil specifications in 2020.

- CAR Compliance:

Clean Air Regulation (CAR) is mandated for compliance in 2019 by the Department of Environment (DOE). HRC is currently undertaking front end studies to assess changes required to meet the CAR requirements. We plan to use TA2018 as the opportunity to execute tie-ins, whilst the project is targetted to complete before the 2019 compliance date. This is subject to FID approval by the Board OF Directors.

- Euro 5 Gasoil Project:

DOE is mandating Euro 5 gasoil specifications by 1 September 2020. Since our next TA is only planned for 2022, we need to undertake project tie-ins during the upcoming TA2018 window. Front end studies and licensor selection are now in progress to enable the timely identification of tie-in points.

RISK: Our resources are being stretched to deliver several large projects at the same time. The Board has sanctioned for HRC to engage external subject matter experts where necessary to ensure that the initial identification and implementation for tie-ins are executed to the intended specifications and in a timely manner.

COMMERCIAL AND COST

We actively seek new opportunities to grow our business and realise new supply and procurement opportunities as well as hedge management.

-Business Improvement Tactics.

- Diversification of crude oil and feedstock supply

HRC continues to leverage on its present strengths to source for different crudes, blending components and feedstock to obtain the lowest cost of sales whilst safeguarding our production and yield levels. We are able to do so by leveraging on our long term relationship with Shell International Eastern Trading Company (SIETCO) as well as exploring new opportunities with market traders and through SHPC to widen our crude diversification and optimisation efforts.

- Energy efficiency improvement

Several relatively low cost energy improvement opportunities have been identified through an expert team in 2016. HRC plans to start implementation of these opportunities in 2017 to reduce energy costs and reduce the energy footprint of the refinery. More capital intensive projects to reduce energy consumption have been parked for the moment to ensure the delivery of the major projects described previously.

- Procurement and Cost reduction

SHPC opens up an opportunity for HRC to enhance cost and procurement optimisation through their knowledge of the Chinese market and through new partnerships. HRC will refresh our sourcing and contracting strategies to ensure that we can capture reductions in material costs such as catalysts whilst maintaining the integrity and performance of our assets.

- Trade opportunities

With the transition, HRC is also exploring trade opportunities in China leveraging on SHPC’s in-depth knowledge of the domestic requirements and opportunities in China. Whilst HRC continues to provide a secure supply of main fuels to the Malaysian market, we are exploring outlets for intermediary products. Import and export are also driven by the local product specifications which may help us to meet local regulations without excessive capital investment and cash requirements. Thus, we are exploring potential business with alternative clients for products without impacting our deliverables within the POA. In doing so we expect to be in a good position to utilise the taxation benefits for products imported into China from Malaysia.

Managing Market Driven Risks

As an independent refiner, HRC is cognisant of refining margins and foreign exchange (FX) risks that could hamper our financial performance. The potential to hedge and limit the risk exposures arising from these market movements could result in a more consistent financial performance.

Oil related Commodities/Margin Performance

This risk consists of two distinct market movements as defined below:

– Margins Performance

The spread between the products which we sell and the feedstock which we purchase determines the refining margins. As the pricing of both our sales and purchases is influenced by a wide variety of market forces, HRC is exploring the use of hedging to protect its refining margins against extreme movements where possible. Hedging however can also limit the gains if the market becomes volatile beyond expectations. Hence the management is guided by subject matter experts whilst also targeting to secure HRC’s operating cash requirements.

– Stockholding Gains/Losses

Oil price movements impact financial performance because HRC holds on average 30 to 40 days of inventories. Whilst this may also be hedged to limit stockholding impact, the management will work with subject matter experts to determine the levels of hedging, keeping in mind that HRC can capture potential gains from oil price increase from current levels. However, as current market analysts expect experiencing lower oil prices for longer period, this exposure needs to be ascertained at every instance based on available market information.

- Foreign Exchange Exposures

This market driven risk arises because of HRC’s different settlement currencies. Although our sales and purchases are USD based as these values are linked to commodity pricing published by platforms such as Platts, our sales are settled using the translated equivalent of Malaysian Ringgit (MYR or RM) in compliance with local regulations for settlements between resident companies. Triggered by the refinancing of the loan to be entirely USD based financing, our Company has changed its functional currency to USD in line with our accounting policy effective 1 January 2017. This change ensures that our financial reporting reflects our Company’s underlying transactions in accordance with the Malaysian Financial Reporting Standards (MFRS). With hedging comes a certain level of risk which needs to be balanced with the benefits. Management is cognisant of the exposures and are liaising closely with market consultants to derive and execute suitable hedges for the refinery based on our projected sales and production volumes and taking into account market information as well as our cash requirements. Management will continue to manage foreign exchange exposure risks as guided by the governance policies agreed by the Board of Directors.