CEO’s Message

Developments in the global economy

The global crisis started in the final quarter of 2008 and spilled over to all countries in 2009, obliging all nations to take extensive measures and engage in a global war against recession. The USA, where the crisis broke out, joined the large economies of the European Union and Asia to simultaneously initiate urgent measures and gigantic bailout plans in the first quarter of 2009. The monetary equivalent of the monetary policies and measures adopted corresponds to 25% of the total world economic volume of US$ 57 trillion. The measures taken have prevented recession in many countries starting from the second quarter onwards and in the third quarter, various macroeconomic indicators have shown that the worst of the crisis was behind, aiding the recovery of the global economy.

As of May, the collapse of the world economy was averted and economic indicators gradually started rising after hitting bottom, thanks to numerous measures. The world’s prominent central banks cut interest rates, the FED bought government bonds and made giant purchases of securities related to mortgage loans in order to provide liquidity to the economy, banks in the USA passed the stress test and the G-20 nations provided the world financial systems with a total of US$ 1 trillion, of which, US$ 500 billion went to the IMF for aiding countries in trouble. Consequently, in the second and third quarters of the year, many countries, including the USA, Japan, Russia, Germany, France, Canada and Brazil, recorded positive growth rates. From the final quarter onwards, the world’s foremost central banks decelerated the measures of liquidity and support meant to fight the global crisis. The timing of the interest rate rise that will put an end to loose monetary policy will be a determining factor for the global economy’s performance in 2010.

Repercussions of the global crisis on the Turkish economy:

The Turkish economy’s performance during the crisis conditions of 2009 drew a parallel to the performance of foreign economies. At the beginning of the crisis, in the first quarter of 2009, economic contraction accelerated, foreign exchange rates picked up and the unemployment rate peaked. Although the Turkish banking sector could protect itself with its high capital adequacy ratios, the real economy suffered business losses due to the slump in domestic demand and exports. The Turkish economy, which is completely integrated with world markets, began to turn back the tide from the second quarter onwards. The Central Bank’s policy to cut interest rates, various stimulation packages and tax reductions in consumer oriented sectors such as durable white goods and automobiles had a positive impact on the real economy. The timing and momentum of the recovery changed from nation to nation; however, the increased stability of exchange rates starting in the spring and continuing in the latter part of the year, the ongoing low interest rates and the deceleration of the economic slowdown resulted in a drop in both the unemployment rate and the severity of the recession.

Nevertheless, since it will take time for the real economy to regain its strength and enhance its profitability in 2010, the government’s tax income will decrease; also, the stimulation packages implemented in 2009 will take their toll on the public budget, creating imbalances and a relatively high deficit and the real economy will most likely be unable to invest sufficiently, resulting in continued high levels of unemployment. All of these basic problems await solutions during the recovery of the national economy in 2010.

Crude oil prices:

The course of oil prices was significantly affected by the global crisis, as well as by the decisions of oil producers in 2009 and the amount of supply and inventory of oil. In the first quarter, oil prices stayed between US$ 40-50; however, thereafter, oil prices rose steadily, due to factors such as the USA’s year-long low interest rate policy resulting in a low exchange rate for the dollar, OPEC’s decision in the final quarter of 2008 to cut production by 4.2 million barrels, which was implemented without compromise throughout 2009, efforts to raise floating inventories due to low prices and the recovery signals of the world economy starting from the second quarter onwards. As global measures against the crisis gradually decreased towards the year end and since it became obvious that the high levels of physical and floating inventories could not be eliminated easily, the upward trend of oil prices slowed down towards the end of 2009.

Developments in the world refining sector:

In the refining sector, the newly commissioned refineries especially in certain Asian countries have coupled with weak consumption in the USA to create imbalances in the regional product trade in mid-distillate markets. In an environment of global recession, rapidly changing trade balances in countries with weak domestic demand have obliged export oriented refineries with low complexities to cut back on and even totally abandon production. Numerous inefficient refineries that suffered profit losses due to the loss of export markets, especially in developed countries, closed down permanently or temporarily in 2009.

The refinery margins around the Mediterranean in 2009 bottomed out as heavy crude oil types became more expensive relative to lighter types because of the production cutback by OPEC and as demand in mid distillate products decreased. In 2009, the worldwide consumption of petroleum products fell by around 1.3 million barrels and the newly opened refineries increased the world’s production capacity by 2.0 million barrels. Despite the resulting supply surplus of 3.3 million barrels relative to 2008, the refineries that were permanently or temporarily closed down in 2009 had a total capacity of only 1.2 million barrels. The resulting excess in supply brought Mediterranean refinery margins to an average of US$ 1.95 dollar/barrel in 2009.

Following the economic contraction in 2009, the global economy is expected to grow and the world demand for mid-distillate products is expected to rise in 2010. However, since OPEC might ease its cutback decision in order to meet the global oil demand, refinery margins are expected to rise slightly above their level in 2009, despite the new refineries to be opened in 2010. Nevertheless, the demand-oriented, no inventory production strategy based on low capacity utilization that became widespread in the final quarter of 2009 will probably have to be continued into 2010 because a strategy to the contrary would have negative effects on the profitability of the sector unless there appears to be a significant rise in demand.

In a general sense, 2010 is bound to be more favorable for the refining sector compared to 2009. Even so, the currently high physical and floating inventories of mid-distillate products, as well as the prediction that global interest rates could rise due to crisis exit strategies, might result in oscillations in economic growth and refinery margins during the recovery from the crisis.

Developments in the Turkish oil sector:

As in many other countries, the global crisis has taken its toll on petroleum product consumption in Turkey, with fuel product consumption decreasing 7.6% in 2009, a period in which the Turkish economy shrunk by more than 5%.

The products that suffered the largest fall were diesel fuel and fuel oil the products most sensitive to economic growth. The decrease in benzene consumption continued in 2009, with the benzene market shrinking by 2.7% to fall back to 2.9 million m3. Tüpraş adopted a production and sales policy that will minimize the effects of the year long crisis on its financial results and has met 60% of total fuel demand. In a period in which national benzene consumption contracted by 2.7%, Tüpraş increased its benzene sales by 1.9%, bringing its market share to 88%.

While the consumption of rural diesel fuel in Turkey dropped by 9.4%, Tüpraş lowered the maturity on its sales on account and opted for meeting its clients’ need for working capital by importing rural diesel fuel. As a result, Tüpraş’s sales of rural diesel fuel dropped by an additional 10.6%. The overall consumption of low sulphur diesel fuel however, increased 17.3%, with Tüpraş augmenting its sales by 231 thousand tons.

Contrary to the negative course taken by the air transport sector around the world, air transport expanded in Turkey and the sector preserved its strength, and consequently, the national consumption of jet fuel grew 9%. If military jet fuel sales are included, the total jet fuel sales grew 16% over 2008.

Tüpraş in 2009:

In 2009, in the world refinery sector, competition became tougher, prices for heavy crude oil remained high and product profitability fared below last year’s. The global crisis’ repercussions expanded and the world economy plummeted in the first quarter of the year; however, Tüpraş relied on its operational and financial flexibility to adapt to changing conditions. The production and sales optimization policy pursued in 2009 has allowed Tüpraş to figure among those refineries that showed a positive outlook during the crisis.

Tüpraş strives to optimize and diversify its crude oil purchases in order to diversify its petroleum sources, distribute risk in the supply chain and obtain advantages in prices and freight charges. Despite the source limitation related to low crude oil charge and optimum inventory policies, Tüpraş realized purchases of 16 different types of crude oil from 10 different countries in 2009.

The global refinery margins fell to their lowest and the profitability of exported products dropped in 2009  however, Tüpraş preferred to process semi-finished products (operationally more cost efficient relative to crude oil) in upgrading units, applied optimum production and sales policies to meet domestic demand and enhanced white product productivity. If only the processed crude oil is taken into account, the crude oil capacity utilization attained 60.4% if semi finished products in charge are also taken into account, the total capacity utilization rate rises to 69.1%. Pre-planned maintenance activities of the Kırıkkale and Batman refineries were carried out during the first quarter of 2009, when the crisis’ full impact was felt and when demand was relatively weak. Regional demands were met by products transported by land or railroad from other refineries and thus, production and sales were optimized among Tüpraş refineries.

In the years prior to the crisis, black products in excess of domestic demand had been marketed abroad, however, the production of black products was decreased in 2009 since export markets had unfavorable conditions. The share of white products in total production rose from 68.7% in 2008 to 73.6% in 2009. Thanks to this policy, Tüpraş’ gross refinery margin fell only 15% over the previous year, to US$ 9.2 dollar/barrel, whereas the Mediterranean refinery margin fell 65% to US$ 1.95 dollar/barrel.

Despite the negative effects of the global crisis on domestic demand, domestic sales attained 18.2 million tons. In 2009, the profitability of exports fell and the amount of exports was decreased by 46% over 2008 to 3.3 million tons of produce worth US$ 1.8 billion. Thus, Tüpraş’ total sales in 2009 attained 21.5 million tons.

In 2009, in parallel to the negative global outlook in the refining sector, many oil companies posted losses in refining activities. However, during the same period, Tüpraş implemented suitable strategies, became financially stronger and reached its target by posting US$ 522 million in net profits.

In the face of the low margins in the sector, Tüpraş placed greater stress on cost cutting and productivity enhancing projects in order to gain the competitive edge. In order to correctly measure advances in productivity, Tüpraş carried out sector wide comparisons to be able to quantify the initial point reached and rapidly implemented energy saving projects. 80 projects have been chosen from the “Business Perfection Program” organized to enhance the Company’s productivity in its areas of operation. The result has been the creation of US$ 244 million of added value in three years, of which US$ 79 million was realized in 2009.

The Health, Environment and Safety (HES) criteria, which serve to minimize the risks that could be suffered by various parties due to our activities, are constantly enhanced. To this end, a long-term plan has been prepared in order to efficiently implement and monitor Health, Environment and Safety practices, which figure among the top priorities for our company. One of the most crucial technical safety and environment indicators is the accident incidence rate which includes the employees of the contractors. This figure has dropped even below the previously set 2009 target of 3.5 to reach 2.5, the target for 2012. We aim to lower the accident incidence rate further.

As an indicator of our compliance with the Capital Market Board’s (CMB) Corporate Governance Principles, the corporate governance rating was revised upwards from 8.20 to 8.34 out of a possible 10. This was due to our progress in corporate governance, as well as steps taken for the sake of environmental awareness. In August 2009, Tüpraş ranked 2^nd among Turkey’s 50 highest turnover corporations in the “Turkey 2008 AccountAbility Ethic Accountability Evaluation” organized in collaboration with the independent corporate social responsibility and accountability agency, AccountAbility Institute of Social and Ethical Accountability.

Fitch, the international credit rating agency, raised Tüpraş’ foreign currency long term credit rating from “BB” to “BBB-” which constitutes the country ceiling rating and an investable level. This has been a confirmation of our company’s ability to implement correct strategies and take the right steps in a period when the effects of the crisis were still present.

The factors behind Tüpraş’ ability to have its credit rating supersede that of its rivals’ are Tüpraş’ strong operational and financial structure, efficient storage capacity and robust distribution infrastructure which bring it to a leadership position in the Turkish market, its cash structure rising above the refining sector average and its product diversity.

Residuum Upgrading Project:

The Residuum Upgrading Project will transform 4.2 million tons of low value, black products such as fuel oil and atmospheric dip which are consumed less and less in Turkey into approximately 3.5 million tons of more valuable and environmentally friendly white products such as benzene and diesel oil. This project, with a total estimated investment of US$ 1.8 billion, is expected to be completed in 2014 at the İzmit Refinery. This investment is a continuation and culmination of all of Tüpraş’ previous investments. As a result of assessments in 2009, an agreement was signed with the Spanish firm Tecnicas Reunidas for the realization of this project and necessary studies have been initiated.

The completion of this project will make the İzmit Refinery Europe’s most complex refinery and an additional US$ 400 million of EBITDA will be created. The project will contribute to the domestic supply of diesel fuel (of which Turkey is a net importer) and Tüpraş’ competitive advantage and profitability will be augmented.

Our employees have created a vision and broad perspective for Tüpraş’ future that will allow us to maintain our position as a high performance player in the sector and continue to produce for our shareholders as well as for our country.

Yavuz Erkut

General Manager