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Edited Transcript of 010950.KS earnings conference call or presentation 31-Jan-20 1:00am GMT

Q4 2019 S-Oil Corp Earnings Call (English, Korean)

Seoul Feb 10, 2020 (Thomson StreetEvents) -- Edited Transcript of S-Oil Corp earnings conference call or presentation Friday, January 31, 2020 at 1:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Young-Il Cho

S-Oil Corporation - Executive VP & CFO

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Conference Call Participants

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* Dong Jin Kang

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

* Hyunryul Cho

Samsung Securities Co. Ltd., Research Division - Analyst

* Oscar Yee

Citigroup Inc, Research Division - Director

* Rui Hua Ong

JP Morgan Chase & Co, Research Division - 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 will begin the conference of the fiscal year 2019 fourth quarter earnings resulted by S-Oil. This conference will start with a presentation followed by a divisional Q&A session. (Operator Instructions)

Now we will begin the presentation of the fiscal year 2019 fourth quarter earnings resulted by S-oil.

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Unidentified Company Representative, [2]

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Good morning, everyone. Welcome to S-Oil's fourth quarter of 2019 earnings conference call.

I would like to thank you all for joining us today. I am [Cho Yun Yeoh], 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. Gwang-cheol and other IR team members are with me here today.

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

The company's fourth quarter earnings decreased amid challenging business environment. Refining margin sharp dropped due to supply increase from commercial operation of regional new refineries and the plunge of HSFO margins ahead of implementation of IMO's new sulfur regulation.

Moreover, start-up of new large-scale PX plant in China and trade tensions between [these 2], put downward pressure on PX Naphtha spread. Despite the aforementioned hardships, the company managed to generate profit by optimized operation of our RUC and ODC facilities.

Looking ahead to 2020, refining margin is expected to improve on the back of demand growth, driven by IMO 2020 and the recovery of global economy, which outpaces the annual supply increase.

On the petrochemical side, PX spread is likely to remain bearish by the operation of sizable new competitors in China. However, the pressure will be gradually [reserved] by the end of the year due to production cost by -- on [prominent] PX players as well as assured Chinese PX downstream positions.

PO spread will be continuously healthy, supported by a gradual recovery of demand. Whereas PP spread is likely to stay subdued owing to supply [drop]. [Decent] level of low base risk spread will be maintained as the demand for high quality product is expected to rise on account of more stringent emission regulations.

Now we are ready to take the challenges as opportunities. Although the worst situation have passed, [conflict] around the global economy, such as trade disputes and geopolitically have not cleared yet.

Year 2020 will be still challenging with uncertainty. However, we are all geared up to proactively respond to market challenges in order to capture opportunities like IMO 2020 through full utilization of our resources and capabilities.

The company will increase operational flexibility of upgrading plants through maximizing the operation of the sulfurizing unit to take full advantage of IMO benefits.

With these kinds of strenuous efforts, we believe that the company can achieve fruitful outcome in 2020, exceeding last year's performance.

Looking further ahead, (inaudible) feature of sustainable growth and be ready for beyond (inaudible).

The Phase II petrochemical project is on the feasibility strategy to attain our final investment decision in 2025. So our product is going to include the TC2C technology, which will increase our [crude oil] chemical conversion ratio innovatively.

Again, thank you all for joining us today and keeping interest in our company.

I would like to conclude my presentation here. From now on, Mr. Cho will take you through presentation on the fourth quarter financial results and 2020 business outlook.

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Young-Il Cho, S-Oil Corporation - Executive VP & CFO [3]

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Thank you, [Mr. Yeoh], and welcome all of you to today's conference call. Before I get started, I want to draw your attention to our cautionary statement. The company's 2019 first quarter and full year financial results are provisional, and thus, the results are subject to change according to independent auditor's review. Also, during the course of this conference call, we will make forward-looking statement that is based on our current expectations, assumptions, estimates and projections. We caution you not to place undue reliance on any forward-looking statements, which may involve risks and uncertainties.

Now I will start with financial results on Slide 4.

We delivered a KRW 6.5 trillion in revenue in the first quarter, representing around 4% quarter-over-quarter growth. Sales (inaudible) was flat, while volume increased 4.6%.

Operating income was KRW 39 billion, decreased by KRW 192 billion from the third quarter. (inaudible) refining margin dropped by over $4 per barrel. Registering almost 0, lowest quarterly level in the past decade. Also, cash spread was decreased further. On top of that due to the planned maintenance of #1 RFCC on [October] we could not reduce the (inaudible) of high sulfur fuel oil, or HSFO in short, to a minimum level. The estimated opportunity loss from the maintenance was about KRW 40 billion. Meanwhile, inventory related gain from crude price rise, KRW 46 billion, was mostly [powered] by negative impact from won strength.

Under the operating income line, won strength recorded FX gain of KRW 102 billion on net liabilities we had. As a result, fourth quarter pretax income was KRW 104 billion of gain, improving by KRW 30 billion quarter-on-quarter in spite of a contraction of operating income.

Moving on to our next slide, our financial status. Our year-end cash was about KRW 0.6 trillion, decreased by about KRW 0.2 trillion during the year. Whereas borrowing balance did not change it meaningfully. And thus net debt balance increased to KRW 5.8 trillion, while net debt-to-equity ratio rose to 89%. Annual profitability deteriorated year-on-year. ROE and ROC recorded a 1.3% and 2.4%, respectively. EBITDA was around KRW 0.7 trillion.

Now turning to the fourth quarter performance by business segment on Slide 6. Sales revenue in the refining business increased by 4% quarter-on-quarter, while its operating income [turned] to lowest, recording KRW 80 billion of loss. This decline in Singapore refining margin mostly related to loss. Meanwhile, inventory related gain in refining business is estimated at about KRW 40 billion, but most of that was offset by a negative impact of won strength.

Petrochemical sectors' operating income decreased to KRW 20 billion from KRW 79 billion in the previous quarter. It was because the (inaudible) price of all petrochemical products from PX to PO throughout quarter-on-quarter. On the other hand, our business sector remarkably expanded its earnings posting KRW 98 billion of operating income with 24% OP margin ratio.

Plunge of HSFO price contributed to the big jump in the operating income but only [tested] demand for high-quality products. Coming to the capital expenditure and refinery operations.

Last year, the company carried out CapEx of KRW 648 billion, 82% of total budget. Out of that, KRW 79 billion was used for brand acquisition in Onsan Plant in order to secure a site for future potential projects. Whereas KRW 383 billion was spent on upgrading and maintenance of the plant. Looking at 2020 CapEx budget. The total amount is KRW 653 billion, almost equal to the last year's CapEx execution.

Most of our budget is allocated to upgrade and maintenance. In comparison with last year, maintenance budget decreased, reflecting year-on-year reduction in turnaround plans. While our [credit and implementing] budget increased to enhance value creation and sustainability of the company.

As for maintenance plan, the scalable 2020 turnaround will decrease meaningfully compared to last year. Our unit subject to turnaround work this year are limited to the smaller procedure; #2 RFCC, PP&PO plant and Group II base oil plant.

Based on the preliminary schedule, most of the turnaround will be in second half.

Before turning to the next slide, let's look at utilization rate in the fourth quarter.

All the major facilities other than #1 RFCC and PP plant were operated at around 95% or higher. #1 RFCC corporation was started in October for planned maintenance, while PP plant was run at reduced level due to low economics.

Meanwhile, through the optimal and stable operation of RUC and ODC, the company could avoid bigger loss in refining business.

[And to the end of] this year, the company is endeavoring to increase the production of very low sulfur fuel oil or VLSFO, in short, to capitalize on current VLSFO margin trends.

Next, let me explain post quarter market environment on our 2020 annual outlook by each business at slide 8.

Singapore operating margin sharply dropped to almost 0 on average in the fourth quarter. Demand was weaker than expected caused by slow down of regional economy activities and the continued trade conflict between U.S. and China as well as warm winter, especially, HSFO demand shrank back and (inaudible) territory due to preparation for IMO 2020.

On the other hand, new plants in the region (inaudible) increase the supply pressure in the market. However, we think refining margin will rebound this year.

Globally, market supply/demand balance would improve. Demand growth will likely recover to above 1.2 million barrels per day from less than 1 million in last year, whereas net CapEx dilution would be at 1 million barrels per day.

Together with kick-in of IMO 2020, easy retention in the global economies from traded deal of G2 and North America would support more growth than last year and outpace supply increase from the expected net capacity addition.

Moving on to petrochemical sectors. In the last quarter, PX spread over naphtha declined further to $242 per ton from recent startup of new large-scale PX plant in the region and [flourishing] demand in (inaudible) sector.

Benzene spread also became narrow as new PX plant increased the benzene supply and arbitrage opportunities for U.S. export decreased quarter-on-quarter.

Looking ahead into 2020, PX's spread will not improve as a continuous addition of new PX plant is expected to keep supply pressure. Plus, such a pressure would gradually ease later this year by new PTA capacity coming onstream and more operational reduction by uneconomical players.

Benzene spread would improve slightly as the demand from downstream would be steadily lower.

Turning to Olefin market in next slide. In the fourth quarter, PP spread continued to slide affected by protracted trade dispute between U.S. and China, which curbed demand and increase of supply from new plants.

Fuel spread also dropped due to delayed recovery of downstream sectors and higher feedstock price (inaudible) steady supply from stable operation our PO plants in the region.

This year, PP spread is forecast to remain pressured, mainly due to larger capacity addition in spite of demand recovery on moderated trade tension between U.S. and China.

Fuel spreads will remain stable because of gradual recovery in downstream demand, despite continued capacity increase. Lastly, turning to Lube Base Oil market at Slide 11.

In the last quarter, Lube Base spreads surged as HSFO price declined deeply, while product prices were relatively flat quarter-on-quarter.

This year, the spread could keep solid as a demand for high-quality product is expected to steadily grow, thanks to strict emission regulation amid new capacity addition lessening in the region.

With that, I'd like to conclude my prepared presentation. Thank you for listening. Now we would be happy 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 Baek Young-chan 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 from KB Securities, and I have 3 questions to pose. First is about the inventory gains and the FX impact in the fourth quarter, I would like to have more details into that. My second question is about the diesel crack. And this quarter, we're seeing a deep plunge in the diesel crack. What is your overall outlook on the diesel crack for this year? And the third question is, what was your sales portion of HSFO in 2019, excluding asphalt? And what will it be for this year?

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Young-Il Cho, S-Oil Corporation - Executive VP & CFO [3]

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[Interpreted] Yes. So thank you for your question and your attention. On your first question, as was explained in the presentation just before, the inventory impact in the fourth quarter of last year was KRW 46 billion, and its impact on the operating income due to the FX fluctuation was minus KRW 36 billion.

And as for your second question on the diesel crack, and as you know, the crack has not been very good since the end of last year, and it dropped further in this month. I think this is because of the fact that the IMO 2020 is not fully materialized yet. However, we expect this IMO impact to start to materialize from March this year. And I think that will bring up the diesel crack in the coming months, and also the fact that there is an outlook of recovery in the global economy, I think, and this is my expectation that the diesel crack will be far -- much better than last year.

And to your third question about our company's portion of HSFO. As you know, we had a sizable T&I in the first half of 2019, we have the turnaround for the RUC/ODC and a number of the upgrading facilities. And as a result of that, up to third quarter last year, our sales volume of HSFO was about 30,000 bd.

In fourth quarter last year, the volume has been lower to 20,000 bd, but we cannot fully cut it down because of the #1 RFCC turnaround in October. But starting from December last year, we have significantly lowered the production, both production and sales of HSFO. And so far, we're -- and at the moment, we're not selling and producing HSFO.

So as I explained to you in the previous conference call, we don't have any sales planned for HSFO this year because we will be blending the entire volume to produce VLSFO.

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Operator [4]

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The following question is by [David Singh] from JP Morgan.

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Rui Hua Ong, JP Morgan Chase & Co, Research Division - Analyst [5]

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I think -- this is Parsley Ong from JPMorgan. Now I have 2 questions. Firstly, is on your debt, it is pretty high. So can you remind me what are your plans over the next 2 years regarding debt? Do you have a target net debt-to-equity ratio you hope to achieve?

And secondly, could you give me a status update on your crude to chemicals project. Is this still going to go ahead? And if so, when do you expect to FID and also obtain the bank loan?

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Young-Il Cho, S-Oil Corporation - Executive VP & CFO [6]

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[Interpreted] To answer your question, I know fully about the market's concern on our borrowings, which has obviously went up after the RUC/ODC project. But as we also mentioned in our presentation, our CapEx over the next 2 or 3 years, will be limited to about KRW 600 billion per year. And we also plan to taper down on our borrowing size over the next 2 or 3 years in order to make sure that our debt-to-equity ratio stays below 100%, and our target is to further lower it to about 80% before we launch the Phase II investment project.

And about your second question on our Phase II investment project, our target for the final investment decision is 2021. And towards that, we are in the middle of performing the feasibility study. And at the same time, we're also looking into a various number of financing plans and options.

Excuse me, for not being able to go into all those little details. However, we are fully looking into all the available financing options, and I would like to tell you that we are not facing any constraints as far as our financing options and the project execution is concerned.

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Operator [7]

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The following question is by [Kyoung Jae from Hanwha Securities].

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Unidentified Analyst, [8]

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[Interpreted] I have 3 questions. I'm from [Hanwha] Securities. You just mentioned that the company will have less T&I this year. Does that mean that the product sales volume will go up compared to 2019? And if so, how much?

Second, I would like to know the RUC's contribution to the fuel business and petrochemical business in terms of sales and operating income.

And third is, as we're now seeing an increase in the OSP, is there any plan by S-Oil to lower its crude import from Saudi Arabia? And I will also like to know the share of Arab Light, Medium and Heavy.

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Young-Il Cho, S-Oil Corporation - Executive VP & CFO [9]

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[Interpreted] Yes. Thank you for your question. First, about the -- our impact on sales volume this year because of less T&I compared to 2019. Well, basically, the sales volume is linked to the crude processing capacity. So although there will not be a significant difference in terms of our CDU operation in 2020 versus 2019, we expect the sales volume in the fuel business to go up around 20,000 to 30,000 bd. Whereas in the petrochemical and olefins oil business, we expect to see a more significant increase in the sales volume because of less T&I.

Because of the CDU capacity or the CDU operation rate, there will be a slight increase in our sales volume. But I think the most -- what should draw attention from the market is the fact that we have less C&I for our upgrading facilities, which means that this will contribute to higher operating income for the company because most of our operating income is a contribution from our -- from operating our upgrading facilities.

Yes, to your second question about our RUC's contribution to sales and operating income of the company's fuel and petrochemicals business in the fourth quarter of last year. I think this is a question that we get every quarter and a question -- and also, I get to answer this on every quarter. But again, we don't break down our performance in terms of sales and operating income by process unit. However, as you know, from the third quarter last year, the HSFO frac has tumbled to minus $20 and HSFO is the feedstock for the RUC, whereas the final product from the RUC, which is gasoline and propylene saw a very high crack of -- a little more than $10, which meant that there was a very wide spread between the feedstock and the final product. A spread that was as much as what we had expected when we had planned for this project. So in that sense, I believe its contribution to the company's overall operating income was quite sizable.

To your third question about our import portion of Saudi crude and its breakdown into Arab Light and Arab Medium and Heavy, while our -- when we first built our plant, we configured and built it in a way to make sure that the yield is maximized from Saudi crude. So at the moment, we are sourcing about 90% of our crude requirement from Saudi Arabia and the remaining 10% is light crude for the condensate splitter or the CFU, of which we source it from various regions around the world and some of it from the United States. And out of that 90% of Saudi crude, I think, it is equally split into Arab Light and Arab Medium.

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Operator [10]

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The following question is by Oscar Yee from Citi Group.

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Oscar Yee, Citigroup Inc, Research Division - Director [11]

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I just have one question. Given the current strong [reactable] crack, obviously, your refinery probably is optimizing to maximize the yield. Could I ask how much VLSFO can you produce the maximum basis right now, or maybe in January how much are you producing? And with that, what sort of production is being affected, for example, like gasoline, have you reduced gasoline yield to compensate to make more VLSFO?

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Young-Il Cho, S-Oil Corporation - Executive VP & CFO [12]

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[Interpreted] Yes, to answer your question about the VLSFO production. Yes, we are trying to increase the production of VLSFO. And at the moment, we are blending most of the HSFO and LSFO, and sell it as VLSFO, which this month amounted to about 27,000 bd, and since we are having a lower operation rate of the RFCC, #1 RFCC, that means less gasoline, and we're using to feed to further produce VLSFO, which amounts to about 8,000 bd. So to sum up, it's about 35,000 bd for VLSFO.

And about our production adjustment of the other products, well, I think we have to compare and analyze economics of all different products, including VLSFO and gasoline, and based on that we will make a flexible adjustment of our production in the refinery.

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Operator [13]

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The following question is by Kang Dong Jin from Hyundai Motors Securities.

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Dong Jin Kang, HMC Investment Securities Co., Ltd., Research Division - Analyst [14]

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[Interpreted] Well, as the VLCCs, many of the VLCCs have converted their fuel to LSFO, which has increased the bunker store charge. I think, it's just my guess that the freight has had a pressure and an impact on the company's operating expense. I would like to know if there has been an impact on the operating expense. And if so, how much?

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Young-Il Cho, S-Oil Corporation - Executive VP & CFO [15]

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[Interpreted] Yes because of the increase in the VLSFO price and also the United States sanctions on transporting the Iranian crude oil from Q4 last year, the overall bunker cost went up, and that has negatively impacted the freight. So I don't have the number in full details, but I think, its impact on our operating expense in the Q4 last year was about KRW 30 billion. However, I think, this is far much outweighed by the fact -- by the VLSFO's contribution to the company's operating income. So this is not a high level for the company, something that we can fully tolerate.

And as for the United States sanctions on the Iranian crude oil, this has not had much impact on the company either because 70% of our charter income is from long-term chartering.

And although the freight had spiked up from October last year, as the market's uncertainty has been substantially removed, the freight has come back -- has come down quite substantially. And as we expect the demand for VLCC to go down when the winter is behind, we expect to see a further decline in the freight in the following months.

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Operator [16]

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

The following question is by Oscar Yee from Citigroup.

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Oscar Yee, Citigroup Inc, Research Division - Director [17]

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Sorry, I just had a follow-up question. I remember last year, you brought forward the maintenance of the new RFCC #2 project. But I ask why actually do you have to shut down again this year for the turnaround for the #2 RFCC?

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Young-Il Cho, S-Oil Corporation - Executive VP & CFO [18]

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[Interpreted] Yes. About the T&I of the company's #2 RFCC in 2019 and 2020. If I'm right, I think I shared this with you the other time. In fact, our plan -- our original plan was to do a full scale, a major T&I of the #2 RFCC this year after a couple of years of operation of this new facility. However, we wanted to maximize the benefits of the IMO 2020. So we decided to shorten the period for T&I for this year and split it between 2019 and 2020. So I hope my answer clarifies some of the misunderstanding.

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Operator [19]

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The following question is by Cho Hyunryul from Samsung Securities.

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Hyunryul Cho, Samsung Securities Co. Ltd., Research Division - Analyst [20]

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[Interpreted] I have 2 questions. You said that the T&I in 2020 will be less than 2019. But if you look at some of the cost items of the CapEx for this year, some of the cost items are pretty much the same as last year. So does that mean that there will be a change in the yield of the facilities for this year after the T&I?

My second question is about the diesel spread, you have an outlook that the diesel spread will pick up from March this year. And this is based on the fact that they compared to the demand the capacity increase will be less, and as a result of that, the inventory of the diesel will go down. However, some of the reports that I have looked at shows that some of the diesel capacity will increase in the market. So I would like to have a clarification on this as well.

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Young-Il Cho, S-Oil Corporation - Executive VP & CFO [21]

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[Interpreted] Yes, our budget for the T&I for 2020 versus 2019 is smaller. Last year, our budget was about KRW 200 billion. This year, it's about half of that. However, our budget for the upgrading and maintenance is slightly higher. We increased the budget for the upgrading, renovation and revamping, a part of which is carried over from last year because we were not able to fully execute them.

Yes, on our basis for having a good outlook on the diesel spread while we set the margin in the fuel market to go overall because of the better market fundamentals. In 2019, we saw a net capacity increase of 1.3 million bd, mostly coming from China and the Middle East. In 2020, the net capacity increase will slightly go down to about 1 million bd.

And as for demand, the demand for the fuel products, including diesel, was of short of what we had expected, particularly towards the end of the year in November and December, which was about 1 million bd. However, in 2020, we expect the demand growth for fuel products to go up compared to 2019, and our forecast is about 1.2 million bd.

So based on this forecast, we expect the margin for all the fuel products, including diesel, to go up. And speaking of diesel, there is a very strong bunkering demand for diesel because of the IMO 2020. But as you know, we are in the transitional phase of the IMO 2020, still so far in the market. And as a result of that, we are seeing a very intensive demand for VLSFO. However, I believe this market supply of the VLSFO will be quite limited.

As for our company, although, we are trying to boost the production of VLSFO by adjusting the RFCC operation, we still have some limits because we need to maintain a certain production level of gasoline and propylene. So the concept of lowering the RFCC yield in order to increase the volume of the VLSFO itself is not a fully valid concept. And because of this, I don't think the VLSFO supply will fully meet the high demand for the product.

So over the next 2 or 3 months, I believe the inventory will go down, this will put the VLSFO in shortage, and this will naturally shift demand for diesel starting from March and so forth and onwards.

I think the time is up. Looks like we don't have any further questions. Again, I would like to thank you so much for your deep attention and interest, and I hope to get back to you in the next quarter with better performance results.

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Operator [22]

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This concludes the fiscal year 2019 fourth quarter earnings resulted by S-Oil. Thanks for the participation.

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