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with Clyde Michael Bandy, Chairman and CEO, Chemoil Corporation

06.07.2010 / Energyboardroom

Chemoil experienced an operational loss in the first quarter of 2010 as well as a disappointing profit after tax of US$ 11.5 million for 2009. When will we see Chemoil returning to benefits?

The years 2008 and 2009 were a stressful time for everyone in the industry. The financial crisis itself took some time to ripple through the industry and as one of the largest independent marine fuel suppliers, Chemoil started to see a substantial deterioration in the shipowners’ demand by the second half of 2009. Chemoil has a three-pronged strategy aiming to backward integrate our supply chain (converting expenses to assets), diversifying our product offering to customers and increasing the global footprint of the company. In this class of trade you see multiple companies competing in the space, each of them having a distinct business model. The way Chemoil sees it, is that the winners in the long run will be those companies that can source oil from anywhere, move it to anywhere in the world and be able to distribute it to the end users. We see an increasing dislocation of the supply sources of fuel in the world and the ultimate customer base in the world. Other companies rely on business models that are heavily levered on brokering and trading. Chemoil on the other side believes that investment in infrastructure is going to be essential in the long run. That is why it recently constructed the Helios terminal in Singapore and is currently expanding another terminal in Fujairah. The worldwide fuel oil markets have seen a compression in the relationship between the wholesale and retail margins. This erosion worked its way into Chemoil’s earnings. To protect itself from this erosion, the company spends a lot of effort on increasing the efficiency of asset utilization. Chemoil expects to see significant improvement in this as the company goes forward. Another recent key development is the sale of almost 52% of Chemoil’s shares to Glencore international. Together with the second largest shareholder, Itochu, Chemoil finds itself in a position with two extraordinarily strong parents. Both of them operate in the same business, which is expected to translate into synergies very soon. In the long run, this corporate structure offers a very robust business platform.

In January last year, Chemoil was looking at five to six targets to acquire. Will the Glencore acquisition change Chemoil’s growth strategy?

One of the issues the company faced in the back year and a half was the whole question of ownership. People were not really sure what would happen if the main shareholders, the Chandran family, sold and whether or not this sale would trigger a public general offer. The family’s decision to sell was a personal decision following the unfortunate death of the founder of the company, Bob Chandran, in 2008. The company is still governed by a board of nine people, of which three directors are from Glencore and another two from Itochu. There will however now also be an emphasis on extracting synergies between Chemoil and its partners, of which the company is now already seeing the benefits with the recently approved sale and service agreement giving Chemoil and its partners a lot of optionality around first rights. These synergies will benefit Chemoil’s shareholders and the company’s structure. Lastly, Chemoil managed to survive the economic downturn thanks to a strong balance sheet, good credit lines and a healthy debt-to-equity ratio. In spite of this, the first quarter of 2010 was rather unfortunate due to different elements, including some one-off charges related to the share-option program for the employees. Therefore, these first quarter results should not be viewed as a proper reflection of what is to come in the following months. Chemoil’s major customer base is still the shipping companies and with most of Chemoil’s activity in the East-West container ports, the company now needs to cope with the reduced shipping loads of the container companies in those ports. Fortunately for Chemoil, this trend has lead to as many opportunities as disadvantages. Some of these opportunities consist of a growth in bunker volumes that Chemoil was able to take in thank to its ability to maintain attractive credit terms. The company also selectively reduced some of its arbitrage trading activities because it simply was not as profitable in the past six months as it was before. Rather than a trend, this is a reflection of the nature of the trading community where you back out of markets when conditions turn unfavorable. Going forward, you will see the shipping companies stepping back and rerouting. The ones that have survived are the ones that stabilized their route patterns. Singapore and the major hubs that Chemoil is present in will continue to be major bunker markets. In fact, Singapore in particular has been a real success story with dramatic improvements in the company’s performance in Singapore and a growth in sales volumes of 30 to 40% in the last six to eight months. With these numbers likely to increase further and Chemoil’s position as one of the top ten suppliers in the port, Chemoil is ready to head up the growth curve again provided that the macro-economic conditions do not worsen. For the energy business, the years 2008 and 2009 were remarkable in terms of market volatility, which obviously affects every player in the industry. With my previous experience at Chevron-Texaco, I understand what impact such dramatic movements in the price of crude oil have on the balance sheet. It is unrealistic to think that this market will substantially become more stable, as there will always be a number of destabilizing elements worldwide, from the war in Iraq to the catastrophe with the Deepwater Horizon platform. This instability is an important challenge for a company like Chemoil, while at the same time it can offer opportunities. In fact, the determining factor for Chemoil is not the price of crude oil, but rather the spread between the wholesale and the retail marketplace, as well as the transportation costs. Currently, there is a predominance in supply coming from the former Soviet Union, Eastern block countries and South America. Every single month, you see a lot of Eastern and South American cargo coming in here in Singapore while at the same time a lot of surpluses in Asia are diminishing. Therefore, Chemoil’s strategy of backward integration of the supply chain will be very beneficial in the long run.

One of the things that will help Chemoil substantially is the company’s aggressive diversification in its products offerings towards the customers. This will allow for new flexibilities such as fixed price contracts that will better enable the customers to manage their business. In addition to that, Chemoil continues to improve its expertise in the risk management of its inventories and improvements in the risk process of the company. All of that helps to limit the downside risks of the company.

Talking about risk management, we also see that you recently took some internal measures such as the appointment of a new risk specialist. To what extent are the measures sufficient to face these new challenges?

The risk platforms at Chemoil are approaching the state of the art of the industry, giving the company the maximum flexibility and transparency. Given that Chemoil can have 1 to 5 million barrels of inventory sitting in its tanks at any point in time, this creates a very substantial risk management challenge. Many of its markets are perfectly hedged such as the Gulf Coast of the United States or Rotterdam. Other areas where Chemoil holds substantial amounts of inventory such as Panama and the West Coast of the United States do not have perfect hedges. It is an interesting challenge on a port-by-port basis, although Chemoil has the benefit of being a global company which helps to mitigate risk quite well. The more challenging ports affect the company in two ways: they raise the company’s risk in downmarket situations while increasing rewards in upmarket situations. You have to be careful that you do not manage the risk out of the price to a point that you take away shareholder value. This is the balance everyone in the industry finds challenging to meet.

On a more positive note, the company has also been expanding significantly, in particular in India, New Orleans and Fujairah while we also saw a 6% increase in the bunker segment. What are going to be the next niche and geographical growth markets for Chemoil?

While a lot of people will be saying that the world’s growth comes from Asia, the reality is that Chemoil services shipowners that transport goods from any place in the world to any place in the world. The growth for Chemoil will thus be much more evenly distributed around the world. If for example exports from China and India go up, Chemoil is in the right position to take advantage of this trend both in the home country as well as the locations the cargo is going to. The engine of growth may very well be Asia, but this will manifest itself in growth around the world for Chemoil. The company will thus be able to fuel Chinese ships, European ships and so on, regardless of their location. As long as world trade improves, Chemoil will enjoy a lot of opportunities beyond India and China. The company will see trade in places that are less apparent in current growth projections, with examples of the Americas and Europe. Consistent with its three-pronged strategy that aims to expand Chemoil’s global footprint, the company has focused on supporting the East-West container trades in the big ports during the first 25 years of the company. This strategy has lead to some holes in Chemoil’s platform, being poorly represented in Africa, and the Mediterranean region with Suez. These markets offer new growth opportunities and expansion possibilities for Chemoil.

Being one of the key strengths of the company, how will you keep control of the supply chain as the company grows further?

You can control the supply chain either by owning or leasing assets. Chemoil views asset ownership necessary only if a lack of those assets represent a barrier of entry to the market. When Chemoil came to Singapore in 2006, there was not sufficient capacity to lease facilities which resulted in the construction of the Helios terminal. The good news for Chemoil is that the new growth markets under consideration will require a less aggressive capital budget. Chemoil now owns two or three flagship assets around the world including a major terminal on the West Coast of the United States where tanks are very short and tight and where constructing new tanks remains difficult. Moreover, the company has a major flagship terminal in Singapore, the Middle East as well as further minor terminals around the world. For now, that will be a very good platform for our wholly-owned terminals program. This does not mean that you will or will not see new terminal projects. In Asia for example, Chemoil is partnering with shipping companies and port authorities who are interested in state of the art world class bunker terminals to feed the fuel requirements of those ports. You have seen Chemoil entering in such projects. Mundra in India, for example, is one of the first big private port projects in the country and owned by the Adani Group. The Adani Group found themselves very challenged to convert this port into a world class bunker port for many different reasons. With shipowners coming from all over the world, you need marketing capability worldwide. After two to four years of running their business solely, the Adani Group realized that they would achieve more by bringing in a global player specifically for the bunker business of that terminal. So far, this has been a very successful joint-venture force with the scope of this project expanding all over India. Such synergies imply that it is not always necessary for Chemoil to go out and build or own new infrastructure as Chemoil.

When looking at the new infrastructure and the Helios Terminal in Singapore in particular, how can this terminal become a “terminal of the future”, taking into account the changes in regulatory and environmental requirements currently being pushed through?

First of all, Chemoil expects to see a review of all the regulations related to oil transfers around the world. In Gibraltar for example, the government is already considering a ban on floating storage. Conversely, Chemoil expects to see more and more ports looking at lower cost options of floating storage, ship-to-ship transfers and so on. When you have state-of-the-art land-based terminals, they bring a certain amount of comfort to the local market because first, you can be sure you did everything you can to be environmentally safe and operate safe and second, you are prepared and have the resources at hand to respond when necessary. This is much more difficult when operating floating storage. While in many ways ship-to-ship transfers are the backbone of the maritime industry, it is somewhat unrealistic to think that such activity is not exposed to a certain amount of risk. Chemoil has been at the forefront of environmental awareness, with the Helios Terminal in Singapore as a good example.

If we consider the floating storage options in Singapore, how do you see the future of the country as a hub for the energy industry?

Singapore’s strategic location and business-friendly government is going to be very pro-active in ensuring that Singapore retains its unique foothold. There are many ports in the region that have the capability to challenge Singapore, but I do not see their government or their port authorities being as pro-active as Singapore in making their ports competitive for the next 50 years. You can still see a lot of construction and commitments as well as land reclamation going on. Singapore’s approach to regulatory processes is a very thoughtful one that tends to allow quick response when things go wrong, learn from the experience and choose what is appropriate to go forward. That approach will be very successful for Singapore.

On a more personal note, you arrived in the company under rather dramatic conditions and were soon to face one of history’s worst economic crises. How did you deal with this pressure and are you not afraid that you might become bored when business returns to usual?

It is interesting as I in fact retired at 55 years old after a long career at Chevron-Texaco. I wanted to do a lot of different things in life other than what I had been doing. As a close personal friend, the founder of Chemoil, Bob Chandran, tried to persuade me to do something for his company, a request I was rather resistant to. But when he approached me about taking the company public and asked me to be his lead independent director, it seemed like something where my experience could add some value. At that time no one could of course anticipate that Bob would pass away the following year. When he did so, I felt an obligation to assist Chemoil work through what has been a difficult transition. I do believe Bob did many wonderful things by creating a very talented and experienced senior management team which made it much easier for the company to face the global financial crisis. These people were tested professionals allowing my appointment the ability to focus on refining the strategic direction of the company, rather than arriving at a company to save what is left. Moreover, Bob and I had been working on the strategic vision of Chemoil since 2006 making the transition somewhat easier. The economic downturn certainly brought its own challenges while the sale of the Chandran family stake was certainly not unexciting with at least ten or twelve different companies as potential buyers. Many factors drove the ultimate choice which was not simply based on the takeover price. At this point of time, my objectives for the company are the same as when I took over. One was to stabilize the company in the eyes of the marketplace and show that Chemoil was a sustainable enterprise. The second objective was to work with the Board of Directors and the Chandran family to determine the proper long term ownership structure of Chemoil. These objectives have been reached successfully. The next thing on the horizon will be the transition of leadership over to a leadership team that is mutually agreed upon and very beneficial to the company. Reaching this target will be a great outcome for the shareholders.

If we would come back in five years, where will we see Chemoil?

Chemoil will continue to be one of the top independent fuel suppliers in the world. You will likely see the major oil companies pull continue to pull back from this market place, not because they cannot compete but because they choose not to compete. These players had a lot of small refineries around the world some 25 to 30 years ago, many of which produced fuel oil. Because of this, it made sense to be in the global fuel business. You have to understand that the product Chemoil deals in is not an engineered product. It is not gasoline, diesel or jet. It is what is left over after everyone takes what they want. If you are a major oil company with fuel producing refineries around the world, it is in your interest to invest in marketing and solicit ship-owners to sell your fuel. What we have seen in the last couple of decades however, is the closure of a lot of these small refineries and a merging of a lot of oil companies. Many of these companies do not have a global footprint of heavy oil anymore. Their core focus is finding the oil, drilling, refining and getting it to the gas stations on the streets. Their focus is not to go into a fuel oil business that involves trading fuel oil from one place in the world to another. Every single port that Chemoil is in, operates as a small business with its own management team. Major oil companies generally have a difficult time running such a collection of small businesses. The larger companies can more efficiently use their resources for the purpose of exploration which, if they are successful, generates a higher rate of return. While Chemoil can typically generate a return of 10 to 12% to its shareholders, oil companies may have upstream projects with better returns. In five years from now, you will see the majors continue to retract in this business while the smaller independent companies will continue to grow, with Chemoil being one of them. In doing so, it will remain true to its three-pronged strategy by diversifying its footprint, its products offered to its customers and the backward integration of the supply chain. If you come back in five years, Chemoil will be a much bigger, stronger and more profitable company. Bob Chandran very carefully selected Singapore as the headquarters for Chemoil because he recognized that Asia would be the engine for growth. Today, you see Chemoil in Korea, the Philippines and Singapore. Going forward, the company will gain presence in many more Asian countries with boots on the ground chasing the new emerging ship-owners. Today, Chemoil’s customer base are mainly large container lines but as you go forth, these companies will reach a certain saturation point while a lot of growth will come from the new emerging shipping companies. Chemoil intends to be there to service this customer base. In five years from now, you will thus see Chemoil with a heavily diversified customer base.



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