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Edited Transcript of 010950.KS earnings conference call or presentation 24-Jul-19 1:00am GMT

Q2 2019 S-Oil Corp Earnings Call (English, Korean)

Seoul Aug 1, 2019 (Thomson StreetEvents) -- Edited Transcript of S-Oil Corp earnings conference call or presentation Wednesday, July 24, 2019 at 1:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Gwang-cheol Ko

S-Oil Corporation - Head of IR

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Conference Call Participants

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* Anna Park

Macquarie Research - Analyst

* Dong Jin Kang

HMC Investment Securities Co., Ltd., Research Division - Analyst

* Jae Kyoung Song

Hanwha Investment & Securities Co., Ltd., Research Division - Analyst

* Oscar Yee

Citigroup Inc, Research Division - Director

* Yeon-ju Park

Mirae Asset Daewoo Securities Co., Ltd., Research Division - Research Analyst

* Young-chan Baek

KB Securities Co., Ltd., Research Division - Analyst

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Presentation

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Operator [1]

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Good morning and good evening. First of all, thank you all for joining this conference call. And now we'll begin the conference of the fiscal year 2019 second quarter earnings results by S-Oil. (Operator Instructions)

Now we shall commence the presentation on the fiscal year 2019 second quarter earnings results by S-Oil.

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Unidentified Company Representative, [2]

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Good morning, everyone. Welcome to S-Oil's Second Quarter of 2019 Earnings Conference Call. I would like to thank you all for joining us today.

I am [Cho Yung Go], the Treasurer of S-Oil Corporation. I am glad to be here today to communicate with you through the earnings conference call. Your continuous support will be highly appreciated. IR team leader, Mr. Ko Gwang-cheol, and other IR team members are with me here.

Before Mr. Ko presents our second quarter's financial results, I would like to start with a brief review on business environment and our performance.

The second quarter was another challenging period for the company. Due to a slow economic growth caused by global trade disputes, regional demand has been subdued, which led to further deterioration of refining margin as well as the sharp decline of PX spread during the second quarter.

Under the unfavorable market conditions, the company had 1-month planned turnaround and inspection of RUC and 3 months offline of #2 PX. As a result, the company recorded an operating loss of KRW 90 billion in the second quarter. However, we have a positive outlook for the third quarter, especially in the refining business.

For the coming months, in consideration of a solid demand growth for driving season and the inventory buildup in preparation of IMO 2020, the refining margin is expected to bottom out and improve further.

On the petrochemical side, PX spread is likely to stay weakened by new large PX plants in China. However, benzene spread would recover to some extent due to strong downstream demand of the U.S. Moreover, PP&PO spreads are likely to show gradual improvement with progress of trade talks between G2. Lube base oil spread is expected to maintain at current level for the time being.

The company successfully completed the plant maintenance on major units, including RUC and #2 PX. After RUC's 1-month long planned maintenance work until mid-May, the RUC/ODC is in its normal operation. In the second half, the RUC/ODC is expected to contribute to the company's profit improvement, amid the recovery of gasoline and olefin products margin.

Furthermore, as the maintenance work for the #2 PX has been finished, it will generate a meaningful profit from the third quarter and beyond. Given that the company's planned major maintenances were already completed and IMO 2020 impact is underway, the company will operate the major production facilities at a maximum rate to take full advantage of the favorable market condition.

Again, thank you all for joining us today and keeping interest in our company. From now on, Mr. Ko will take you through presentation on the second quarter financial results and third quarter's business outlook.

Mr. Ko, please.

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Gwang-cheol Ko, S-Oil Corporation - Head of IR [3]

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Thank you, Mr. Cho, and welcome, everyone. Before starting, I need to draw your attention to our cautionary statement.

The company's 2019 second quarter financial results are provisional and thus the results are subject to change according to independent auditor's review. Also during today's presentation, we will make forward-looking statement that refer to our current expectations, assumptions, estimates and projections. We caution you not to place undue reliance on any forward-looking statement, which may involve risks and uncertainties.

Now I will start with financial results on Slide 4. Sales revenue increased about 15% quarter-on-quarter on sales volume uplift and higher sales prices. Average selling prices went up 5.5% as crude prices was higher quarter-on-quarter on average. Sales volume increased 9% quarter-on-quarter due to the completion of maintenance of crude oil distillation unit in early April. However, operating income shrank by KRW 361 billion quarter-on-quarter, posting KRW 90 billion of loss.

Growth in the Singapore refining margin put pressure down the company's earnings fundamentals, while crude price fluctuation in the second quarter reduced the inventory-related gain to KRW 2 billion. In addition, sharply narrowed PX spread deteriorated the operating income, together with #2 PX plant maintenance throughout the quarter.

Below operating income line, the company suffered KRW 67 billion of FX loss on net dollar liabilities as won currency depreciated against the U.S. dollar and paid net interest of KRW 42 billion. Consequently, second quarter operating income recorded KRW 195 billion of loss, decreasing by KRW 353 billion quarter-on-quarter.

Moving onto next slide, the financial status. At the end of second quarter, cash balance was about KRW 1.1 trillion, decreased by KRW 100 billion quarter-on-quarter. Meanwhile, cash balance increased by about KRW 900 billion during the quarter. The company newly issued KRW 400 billion of corporate debenture in June saw the refinancing of maturing bonds this year and increased the short-term returns borrowings for the increased working capital up to the end of the plant maintenance.

Net debt balance increased to about KRW 6.1 trillion, while net debt-to-equity ratio rose to 95%. Second quarter (inaudible) further down ROE and ROCE to minus 1% and 0.7%, respectively. Total debt average interest rate was 2.7% per annum.

Now turning to the performance by business segment on Slide 6. Sales revenue in refining business increased 23% quarter-on-quarter, while its operating income turned to loss, recording minus KRW 136 billion due to very low Singapore refining margin and reduction of inventory-related growth.

Also, petrochemical sector's operating income largely contracted to KRW 4 billion, and sales revenue decreased about 8% quarter-on-quarter due to the maintenance of #2 PX throughout the quarter, while PX spread dropped sharply.

On the other hand, lube business sector saw a modest recovery in earnings, KRW 41 billion of operating income, with 12% OP margin ratio. The improved performance resulted from normalizing the operation of hydrocracker FH unit after planned maintenance.

Turning to the capital expenditure and refinery operations. For the first half, the company's CapEx execution was KRW 249 billion, 30% of annual budget. Most of the CapEx was executed for planned maintenance across the refinery and minor construction. First half depreciation was KRW 275 billion. Throughout the second quarter, the company's olefin refinery was busy with plant-wide maintenance works. All of the maintenance works except for #2 PX were done in second quarter as scheduled. Meanwhile, #2 PX plant maintenance work was recently completed, around 1 month earlier than planned.

As of now, #2 PX plant is under setup, and it will start to produce (inaudible) from August. The remaining planned maintenance for this year is on #1 RFCC. The work will start from mid-September and take 1 month.

Looking at second quarter utilization rate, CDU returned to full operation and lube base oil plant rose to 95%, whereas the running rate of secondary unit from RFCC to PX to PP&PO unit dropped quarter-on-quarter. As of now, except for #2 PX, all the units, including RUC and ODC are operating normally.

Next, let me explain second quarter market environment along with third quarter outlook by each business at Slide 8.

Singapore refining margin further declined quarter-on-quarter, recording $1 per barrel on average. Seasonal demand was weak on the slowdown of Asian economies due to continued trade conflict of G2 and lower seasonality in the region. However, in the third quarter, refining margin will likely rebound. Demand will improve, thanks to driving season and inventory buildup for components modern fuel oil ahead of IMO 2020, while new capacity addition will be limited.

Moving to petrochemical sectors. PX spread over naphtha considerably dropped quarter-on-quarter, pressured by the concern of supply increase from a big new PX plant commencing operations. Benzene spread is likely to rebound due to decrease of NGL supply from PX players. Some PX players cut operating rate from June due to poor margins.

In the third quarter, PX spread will continue to be under downward pressure as supply from a new PX plant in China will deteriorate supply-demand balance for the time being. Benzene spread will move up further, driven by strong downstream demand in U.S. But the extent of recovery would be limited by ample supply and sluggish demand in Asia.

Looking at olefin market in next slide. PP&PO spread continue to decline due to lingering trade disputes between U.S. and China which hurt downstream demand.

In the third quarter, PP&PO spread would improve as expectation for the resumption of negotiation between G2 could lead to demand recovery in the olefin downstream chains.

Lastly, turning to lube base oil market at Slide 11. Lube base oil spread moved down due to supply from new capacities in the region in spite of healthy demand for high-quality products. In the third quarter, the spread will be at current level as global demand is expected to remain stagnant.

Before closing my part, I'd like to share the outlook for IMO 2020 effects, which is detailed in Appendix 3. As you know, the main impact of IMO 2020 on the market is to switch demand for modern fuel oil from HSFO to compliant fuel oils, including low sulphur fuel oil and diesel. The company believes diesel prices are likely to expand from Q4 on stock building for diesel in advance.

Market has already started to move towards stock building. Since May, low sulphur fuel oil premium [over] high sulphur fuel oil had a spike-up because stock building for low sulphur fuel oil took place. This increased inventory buildup will spill over into middle distillates in Q4 as low sulphur fuel oil supply is not enough to meet the shipping sector's demand for IMO 2020 compared to pure oil.

With that, I'd like to conclude my prepared presentation. Thank you for listening. Now we are ready to take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question will be given by Young-chan Baek from KB Securities.

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Young-chan Baek, KB Securities Co., Ltd., Research Division - Analyst [2]

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[Interpreted] I am Young-chan from KB Securities and I have 3 questions to you. First about the FX. We know that the FX went up in Q2 and that must have a positive impact on the operating income. Could you tell me how much of a positive impact the FX increase has on the company's operating income in the Q2? Second question has to do with the petrochemical business. I think because of the narrow spread, the operating income in the petrochemical business was more than the -- was bigger than what I thought -- was less than what I -- what the market had expected. And there must be several factors behind this, which may include the #2 PX maintenance and other factors. So could you please break that into one by one and tell us about these -- each of these factors? And third has to do with the lube base oil business. The spread in the second quarter was narrower than the first quarter. However, the operating margin in the lube base oil business was higher in Q2 at 12% versus 7.5% in Q1. Could you elaborate on this?

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Unidentified Company Representative, [3]

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[Interpreted] Okay. Thank you for your questions, and let me recap your questions. First is the impact of the FX on the operating income in Q2. Second is why we have seen a drop in the operating income in the petrochemical business. And third is why the lube base oil business has ended the third quarter with a higher operating income despite the fact that the margin was not much of different compared to the second quarter.

To answer your first question about the positive impact of FX on the operating income, it was -- it totals about KRW 90 billion in Q2 because of the fact that the average FX went up in Q2 versus the first quarter. So when we make the estimation, we rely on the average FX at the end of March, which is the end of the first quarter, and we also rely on the average of FX at the end of June. And if you compare these 2 periods, the FX went up by KRW 46, which is why we had a positive impact on the operating income.

To your second question about why we have seen a drop in the operating income in the petrochemical business. First reason is, obviously, we have seen a drop in the PX spread. And second is the fact that we had a turnaround of T&I in the #2 PX unit, which cost about KRW 40 billion in the opportunity loss.

And finally, to your third question about the lube base oil, Young, we had a higher operating income in Q2 compared to Q1 because most of the turnaround had an impact in March. And the portion of the turnaround was quite small in April and which is why that resulted in a higher operating income in the lube base oil business in Q2.

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Young-chan Baek, KB Securities Co., Ltd., Research Division - Analyst [4]

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[Interpreted] I know that the run rate of the PP&PO unit in Q2 was lower in Q1. And how much does that translate into the opportunity loss?

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Unidentified Company Representative, [5]

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[Interpreted] Please excuse me that I cannot -- we do not separately calculate the opportunity cost by the turnaround in the PP&PO. We only look at the overall impact that T&I has on our petrochemical performance. So we do not have a breakdown for that.

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Operator [6]

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The following question is by Yeon-ju Park from Mirae Asset Daewoo.

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Yeon-ju Park, Mirae Asset Daewoo Securities Co., Ltd., Research Division - Research Analyst [7]

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[Interpreted] I am Park Yeon-ju from Mirae Asset Securities. First, on the impact of the IMO 2020. Could you share with me how your customers and clients are responding to this new sulphur regulation enforced from the early part of next year? And I know that there are many players who are building their stocks and -- to be ready for the IMO 2020. And for S-Oil, how much are you building up the stocks for the IMO 2020 versus the amount that you are required to do so?

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Unidentified Company Representative, [8]

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[Interpreted] Yes, to answer your first question, most of our customers are in the shipping industry as it relates to the IMO 2020. And I think they all have a different position depending on where they stand in the market. For some of the big tankers, we're seeing some of them investing in the scrubber -- mounting the scrubber so that they can continue to use the HSFO. But for our customers, a majority of them are not really moving towards the investment into the scrubber, which I believe will eventually lead them to rely more on LSFO or blending the diesel for the marine fuel consumption.

To your second question, with regard to our stock building in compliance with the IMO 2020. As you know, we're running our refinery 100%. So we are not on stockpiling or further producing diesel only for the purpose of IMO 2020. However, if the market turns in a more favorable direction and the diesel margin gets better, then there is a possibility for the company to use slurry in order to produce more LSFO through blending.

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Yeon-ju Park, Mirae Asset Daewoo Securities Co., Ltd., Research Division - Research Analyst [9]

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[Interpreted] Let me clarify your question about the customers' stock building. I think they are building their stocks. And do you -- can you estimate how much of they're building their stocks versus the amount that they're required to do so?

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Unidentified Company Representative, [10]

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[Interpreted] We are not fully informed about it because we do not -- they do not share those kind of information or -- their information with the company.

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Operator [11]

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The following question is by Oscar Yee from Citigroup.

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Oscar Yee, Citigroup Inc, Research Division - Director [12]

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First question is regarding your balance sheet. Obviously, the net debt has gone up a lot further. Could you provide some sort of guidance in terms of dividend payout? Because I believe, given there's another plan for you to potentially [use] the cracker, does it mean that you will look to reduce your dividend payout compared to your previous guidance?

Secondly is based on the recent news report, the CapEx for your new project has been significantly revised up from KRW 5 trillion to KRW 7 trillion. Could I ask why would that be the case? And also, how do you plan to fund it if you decide to go ahead with the FID? And my final question is could you provide some sort of indication about what is the latest sort of like PP&PO utilization as of July?

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Unidentified Company Representative, [13]

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[Interpreted] To answer all of your 3 questions. First of all, as you know, we have seen an increase in our net debt-to-equity ratio as is presented in the financial statement. But -- and as we also know that we have a plan to invest as was presented and covered in the news report. But we expect the final investment decision to be out in 2021, which means we still have some time needed. And most of the CapEx will be executed after the FID. So that will come in around 2023 and 2024. So I don't think this new investment plan will have an impact on the company's dividend policy.

Second is -- have to do with our FC&D investment, why the investment size has gone up and what are our financing plans? This is only a rough estimation, but we have seen a slight increase in our investment size because of the fact that there has been a change in the FX. And also, we are going to integrate Saudi Aramco's new technology called TC2C into our FC&D investment projects, which is why we have seen an increase in our investment size. However, the exact estimation will be out only when we get the FID. And that is when we are going to set our financing plan for this new project. But hopefully, because we expect to see a much improved operating income from 2020 and onwards, we'll be able to secure a thicker internal cash reserve over the last 2 or 3 years, which will be very helpful for the company's investment project. However, we will also look into the financing plan within the scope where we are financially capable and also within the scope where we can continue to protect our financial structure and keep it in a stable and a healthy mode. But again, we still have time until the FID, so we will keep a close eye and monitor the overall business environment and the financing market.

Finally, to your third question, our utilization rate of our PP&PO plant in July was 90% and 100%, respectively.

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Oscar Yee, Citigroup Inc, Research Division - Director [14]

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Could I just follow up on your FID? So are you expecting the FID to be 2021 instead of your earlier guidance of 2020?

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Unidentified Company Representative, [15]

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[Interpreted] Well, as I said, we are going to integrate the TC2C technology into our FC&D project, which requires a new feasibility study for the TC2C only, which is why we have made some time adjustments for the FID.

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Operator [16]

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The following question is by Anna Park from Macquarie.

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Anna Park, Macquarie Research - Analyst [17]

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[Interpreted] Okay, I have 2 questions. First is could you tell us how much of one-off costs from maintenance in Q2 had an impact on the company's operating income? And second is what is S-Oil's target debt-to-equity ratio?

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Unidentified Company Representative, [18]

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[Interpreted] To answer your questions. First, the opportunity loss caused by the maintenance in Q2 to our operating income was about KRW 100 billion. And our target debt-to-equity ratio -- in fact, our optimal target is in the band between 80% to 100%.

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Operator [19]

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The following question is by Jae Song Kyoung from Hanwha Financial Investments.

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Jae Kyoung Song, Hanwha Investment & Securities Co., Ltd., Research Division - Analyst [20]

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[Interpreted] I have 2 questions. First is, we have seen a big increase in refining margin lately and also a very big increase in the Bunker-C oil margin. Do you think this has to do with the market fundamentals or the supply and demand? If so, why?

And number two is, as we see a deep increase in the Bunker-C margin, is this affecting -- positively affecting your profitability estimation for RUC/ODC?

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Unidentified Company Representative, [21]

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[Interpreted] Yes, to answer your first question about the Bunker-C price. As you know, the crack with the Dubai has risen significantly to $7 to $8 in July, and it is slightly dropped to $5 level. Both has to do with the supply and demand. In the demand side, we are seeing some firm demand coming from the power plants in the Middle East and Asian region, but we believe the supply side is playing a bigger role in why we're seeing a big increase in the Bunker-C price. As you know, in Q2, there have been some T&Is in some of the refineries which caused the Bunker-C supply to be limited. And we've also seen the successful restart-up of RCC in the Middle East, which has tightened the supply for the Bunker-C. And as we all know, we are seeing a rising and escalating geopolitical tension in the Strait of Hormuz, which is causing the demand for Bunker-C in the Middle East to be replaced to the demand for Bunker-C in Singapore, which is causing the Bunker-C demand in Singapore to come down. So all in all, given -- in light of all these market conditions and the factors, we expect this HSFO to stay strong for the time being. However, through the end of the third quarter, we expect the demand for the Bunker-C in the power plant sector will go down, and we'll see some adjustments in the HSFO stock building before the IMO 2020.

To your second question about the profitability of RUC/ODC. In the first half of the year, the Bunker-C price, the price of Bunker-C, which is the feedstock for RUC/ODC, was high. So obviously, the profitability should not have met our expectations. And the case is still holding true since the Bunker-C price -- if the Bunker-C price continues to stay above the Dubai benchmark price. However, we expect the Bunker-C price to go down, thanks to the impact from the IMO 2020. And that will hopefully widen the spread between our feedstock, Bunker-C and the gasoline PP&PO. So although it's been a tough first half of the year for the company, we expect things to get better and turnaround from Q4. And from 2020, we expect the profitability from the RUC/ODC to meet our target expectations.

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Operator [22]

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Currently, there are no participants with questions. (Operator Instructions) The following question is by Dong Jin Kang from Hyundai Motor Securities.

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Dong Jin Kang, HMC Investment Securities Co., Ltd., Research Division - Analyst [23]

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[Interpreted] Yes. You mentioned about the escalating geopolitical tension around the Strait of Hormuz, which is causing the demand for Bunker-C in the Middle East to be replaced to that in Singapore. So if this continues and, because of the IMO 2020, if diesel demand goes -- picks up, do you think this will have a favorable impact on the refineries in Asia?

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Unidentified Company Representative, [24]

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[Interpreted] Yes. As you know, the crisis around the Strait of Hormuz is lingering. And if the IMO 2020 increases the demand for diesel for bunkering, then that will obviously replace more bunkering demand from the Middle East to Singapore, which are the first and the second largest bunkering ports in the world. So that itself could be a positive factor. However, we still have a question mark on how much of -- a question mark on whether the political tensions around the Strait of Hormuz will have a positive impact on the global economy and the demand for fuel products. In fact, we believe that this geopolitical tension could work in a negative way in terms of the global economy and the demand for fuel products. So we'll have to watch how things develop.

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Operator [25]

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The following question is by Anna Park from Macquarie Securities.

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Anna Park, Macquarie Research - Analyst [26]

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[Interpreted] What is your outlook on Saudi Arabia's OSP?

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Unidentified Company Representative, [27]

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[Interpreted] Yes. Yes, so we have seen a slight decrease in the Saudi OSP for August [loading] compared to July. However, all in all, the Saudi OSP has been staying at a higher level compared to 2018 fundamentally because of the tightening crude supply from the Middle East, which is what leads us to believe that OSP will remain at a relatively high level. However, I think this will be challenged in the longer term, especially after the IMO 2020 because this new sulphur regulation will place higher demand for the sweet and light crude from Europe and the United States compared to that from the Middle East.

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Operator [28]

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Currently, there are no participants with questions. (Operator Instructions)

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Unidentified Company Representative, [29]

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[Interpreted] If there are no further inquiries, please allow us to wrap up today's earnings release. And if you have any further questions, please contact S-Oil's IR team and they'll get back to you, or we can hopefully have a chance to have a face-to-face meeting in the future. Hope to see you in the next Q3 earnings release. Thank you.

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Operator [30]

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This concludes the Fiscal Year 2019 Second Quarter Earnings Results by S-Oil. Thank you for your participation.

[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]