From time to time we are going to invite external authors as a contributor to our blog. The following is a post by Tamas Pletser, CFA, ING Oil and Gas Sector Analyst.

Looking on the performance of the EMEA refining sector in the last five years, there is one stock, Turkey’s Tupras, which outstands from the crowd by having 51% positive yield (price appreciation plus dividend in own currency) since end-2007 vs. the sector peers that had negative performances during this period. Tupras turned out not only to be resisting the crisis, but even yielding positive results in these difficult times. In this post I am looking at the ingredients of this success.

Stock price performance of European and EMEA refiners

Sources: Blooomberg, ING

Tupras has a special position within the ailing EMEA refining sector. First, it operates in Turkey, the country, which some consider to be the China of Europe and which country grew at an astonishing rate in the last ten years boosting also the refined product consumption.

Second, it is the sole refining company supplying Turkey. Tupras operates two larger refineries in the Western and North West part of the country close to large cities like Istanbul and Izmir, supplying the neighbouring densely populated areas, while Kirikkale in adjacent to Ankara has a role to supply the capital and the middle of the country besides producing petrochemical feedstock. The Batman refinery in the South East part of Turkey populated by Kurdish people is processing the locally produced heavy oil.

Third, Tupras has a dominant position in logistics: it holds majority of ports, storages and other logistics facilities within the Turkish borders. Interestingly the country acts rather like an island from the logistic point of view. It has only few ports deep enough to allow facilitating larger vessels – Tupras is present at all these strategic points. This dominant position is visible in the pricing of fuel products: the company is rather a price-setter in Turkey than a price-taker like its EMEA peers who cannot price above the benchmark European prices. Tupras owns 40% of OPET, the second largest fuel retail chain in the country with approx. 16% market share by volumes.

GDP growth Turkey

Sources: ING, BP Statistics Review

Flexible and efficient operation

Flexible and price sensitive crude oil procurement, and a daily optimization of imports and own production are also supporting the success of the company. The company receives crude oil from all parts of the world, typically medium and heavy blends and medium and heavy in relation to sulphur content. Middle East and Russian suppliers are especially like to deliver to Tupras due to its geographical closeness, as they do not need to ship their crude to Rotterdam or Genova, so the tanker vessels could have quicker refill. In the last few years, Iran had become the main supplier of crude oil to Turkey squeezing out the Russian oil firms. The price for Iranian crude was highly favourable: the discount of Iranian Heavy to Brent was in the range of 5-10 USD/bbl between 2009 and 2011 giving high cost advantage to the Turkish company.

The picture has changed this year due to the sanctions against Iran. Tupras is replacing the diminishing Iranian crude supply mainly from Saudi, Libyan and Iraqi sources. Thanks to its flexible supply position, Tupras is less threatened by the drying out of the Druzhba pipeline system unlike its Polish or Hungarian peers, while the company is making its suppliers competing for the positions and it is searching always for the cheapest input. Besides supply, this kind of a flexible approach can be seen at its fuel product trading activity: Tupras is optimizing its own process and trading day by day, which comes together sometimes with lower own capacity utilization and higher import volumes. This optimization does not necessary mean lower operating earnings, the company simply calculates whether to sell domestically from import or from own process is the more profitable option at a given moment. The Turkish market – similar to Europe – is short of high quality diesel and jet and long of fuel oil and gasoline.

The importance of a supporting family…

The success of Tupras is also highly contributable to the fact that the controlling 51% stake is held by the Koc family, one of the largest family-based holdings of Turkey. ,. The Koc family is now run by the third generation after the founder Mr. Verbi Koc started to accumulate wealth in 20s and 30s and established the holding company in 1963. The Koc Group is present in Turkish energy (LPG trading and retail, refining, fuel retail and power generation), banking (Yapi Kredit), electronics and white goods (Arcelik, Beko) or even in car manufacturing (Ford Otosan, Türk Traktör).

In Turkey, there is a particular relationship between the politics and dozen of wealthy families (Koc, Cukurova, Sabani etc.) running the largest businesses in the country. The essence of the silent agreement is that the families do not intervene directly into the politics, while the government ensures a liberal market regulation, supporting free competition, basically allowing these businesses to thrive. Foreign investors enter this lucrative marketplace with some 75mn inhabitants usually jointly with a local partner. The politics expect some social role from these conglomerates: in Turkey many hospitals, elderly homes are sponsored by the wealthy families. Maintaining the reputation of Koc family is especially important– one of the key beneficiaries are the minority shareholders who invested into the shares of Koc Group stocks. The family pays attention to treat the minority shareholders fairly and to render them the proper part of the earned profit.

It is not a coincidence that these families are not considered to be oligarchs like their Russian counterparts who lavish their quickly accumulated wealth from the country abroad usually on luxury goods.

…and a supporting government

There is also a kind of a silent agreement in refining between Koc and government. On one part, Tupras could set the prices some 3-5% above the Mediterranean benchmarks domestically, so in small extent, the government allows monopolistic prices. In exchange the company has to supply the entire country with fuels and has to operate the Batman refinery, which processes the 30-40,000 barrels per day domestic heavy crude oil production. The untold part of the deal that Koc does not intervene into the politics and the part of the earnings the group spends on the previously mentioned social and artistic purposes. Coincidentally Tupras had only once a conflict with EMRA, the energy regulator body representing the Turkish state in the last few years. At the end of 2010, the company was levied a huge tax fine of 605 million Turkish liras (approx. 350 million USA dollars) on a ridiculous basis (Tupras did not pay VAT after the usage of intermediary fuel oil for years). This fine concurred with some public statements made by Koc family members supporting their friendly peer, the Cukurova group, who at that time had direct conflict with the government. This might be simply a coincidence. Eventually Tupras bargained down the fine to around 150 million liras, which was paid into the Turkish budget.

From investors’ point of view the relatively large distance between local politics and Tupras is positive as the decisions are made mainly on commercial and economic basis, not on political one, while Koc as a private shareholder intends to achieve the highest efficiency within the group. From analytical point of view this is a very important – experience is that energy is considered as a strategic industry all over and politicians tend to influence the decisions everywhere with certain extent. The greater distant to politics is desirable, which allows shareholders’ value creation to prevail the most as the key purpose. Importantly there are no major disputes over the heritage or other topics within the Koc family (you might think about the story of Mittal brothers in India), the two older brothers are steering the ship in harmony. Koc has an undisputable role in the Turkish energy, and their star is likely to shine in the future. Nevertheless, the Azeri Socar Group and its Turkish counterpart, Turcas (belonging to Aksoy family) are building a new refinery in Western Turkey by 2015, but the growing Turkish economy could fare two refining companies.