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Petroleum Industry Overview

23 August 2010

When I was writing a post on the difference between the price of gasoline in Canada and the US, I realized that it would be nice to include a little background on the petroleum industry. Here’s my quick crash course…

My interest in the oil industry developed from the several work terms I had in the oil industry – informal and formal training, lunchtime conversations, and presentations by senior leaders. The lunchtime conversations were probably my favourite. Over the course of a year I worked as a research assistant in a lubricant group, a pricing analyst in a lubricant group, and refining and supply analyst.

Overall, there are 5 steps required to convert crude oil to gasoline at the pump:

  1. Extract crude oil
  2. Transport crude oil to a refinery
  3. Refine crude oil into gasoline
  4. Transport gasoline to a fuel terminal
  5. Distribute gasoline to retail stations

A single company may be involved in the entire process. It is possible for a company like ExxonMobil to extract crude oil, transport that same crude oil to its refinery in Texas to make gasoline. Then distribute the same gasoline to its Exxon and Mobil gas stations. In reality, this is not the case. It’s too expensive. This is a more possible situation: crude oil extracted by ExxonMobil is sold to a BP refinery. BP may then choose to sell some of its refinery product to a Safeway gas station.

The important message to take away is the petroleum industry is a value chain – the products moving between each step are very fluid between companies (pun intended). If you disturb crude oil production (step 1), it has an impact on the refinery (step 3), fuel terminal (step 4), and retail station (step 5). If you disturb step 5, you only disturb step 5.

What does this actually mean? Customers who boycott BP, Arco, and Safeway gas stations (step 5) will have little impact on BP’s operations in steps 1-4 (maybe its PR will be affected). Let me explain. The demand for gasoline doesn’t really change much in a city. If people decide they no longer wish to buy gasoline from BP because of the Deepwater Horizon accident, they will have to buy it from Shell or Mobil. When Shell runs out of gasoline, they will have to buy gasoline from BP’s fuel terminal at a wholesale rate. No matter what customers do, they will have to indirectly buy BP gasoline at one point.

There are three important numbers to consider when talking about profit / margin for oil companies:

  • Upstream margin: 45 cents / L
  • Refinery margin at fuel terminal: 16.2 cents / L
  • Retail margin: 7 cents / L

Most of the profit from oil companies is in the upstream industry (66% based on May 2010 prices), but the margin from gas stations only accounts for 10%. Sure, BP may lose some money if you choose not to buy at their retail stations, but it isn’t a significant problem.

In reality, integrated oil companies like ExxonMobil, BP, Imperial Oil and Suncor consist of two companies operating under one umbrella, and the petroleum industry is often divided into an upstream and downstream Sector to reflect these differences. The following tables expands on the five step process I outlined in the introduction.

Upstream

 

Step 1 – Extract Crude Oil

The first step in the process is crude extraction. The conventional method has been to pump conventional oil from wells in places like Texas and Saudi Arabia. Demand for crude oil has increased drastically over the past 50 years, which has enabled other alternatives like offshore platforms and the oil sands operations in Fort McMurray

Hibernia offshore platform
Hibernia offshore platform suncor oil sands

Margin: 45 CAD cents / L (based on a retail 97.3 CAD cents / L)

The profit margin at this step is determined by the cost of production and the market value for crude. WTI is the benchmark for crude in North America, but nobody actually buys WTI crude in Canada. The market value of crude in Canada is usually dictated by the cost of crude at certain hub locations, plus transportation costs from step 2.

Integrated Oil Companies:

Integrated oil companies like Imperial Oil, Suncor, and ExxonMobil have interests in all types of oil extraction. Their geography range is large, covering coast-to-coast, if not the entire world.

Imperial Oil

Husky Energy logo

ExxonMobil logo

ExxonMobil logo

Shell logo
BP logo

Independent Crude Producers:

Independent crude producers are only involved in the first step of the value chain. They extract crude oil, and sell it to an integrated or independent refinery. They do not refine or sell gasoline. Independent crude producers may or may not have interests in crude production worldwide: Nexen has interest in oil sands operations in Fort McMurray and offshore production in the North Sea. Syncrude is an example of a company that is only involved in oil sands operations.

Canadian Natural Resources logo
Syncrude logo
Nexen logo

 

Downstream

 

Step 2 – Transport Crude Oil to Refinery

When the downstream industry purchases crude oil from the upstream producers, they are required to transport the crude oil from the production site to their refineries. Crude oil originating from offshore production is pumped into oil tankers, received at a port, and transported via pipeline to the refinery – this is common practice for refineries in Ontario and Quebec. However, refineries in Alberta simply transport crude oil via pipeline.

crude tanker
Crude pipeline

Refinery Costs

The cost of transporting crude oil is a refinery cost. Companies are required to pay tolls fees to shipping companies or pipeline companies.

Companies:


Enbridge and TransCanada are two national companies that have large pipeline networks in Canada. Their pipeline networks can transport crude oil or gasoline. Enbridge’s liquid pipeline network may allow Albertan crude oil to flow into Ontario and Quebec refineries. However this is not common, as it is still cheaper to receive crude oil from offshore production. This may change in the future as offshore production dwindles and oil sands play a greater role in Canada.

Enbridge Logo
TransCanada logo

 

Step 3 – Refine Crude Oil

Once crude oil has arrived at the refinery, it is stored in local tanks until it is ready to be fed into the refinery. Refineries often have at least a month’s worth of supply.

Refineries may adjust their process to produce more or less amounts of gasoline and diesel. They adjust their process to maximize profits. For example, let’s say a refinery typically makes 50 litres of gasoline and 50 litres of diesel a day. Diesel demand has been higher recently, so let’s say diesel currently sells for 90 cents / L, while gasoline sells for 85 c / L. This refinery would be interested in making more diesel as it sell at a higher price (assuming the costs to make it are the same). It can adjust its refinery to produce 70 litres of diesel and 30 litres of gasoline.

refinery
refinery

Refinery Costs

At this stage in the process, refineries have incurred costs in crude oil, crude oil transportation, and the actual refining.

Integrated Oil Companies:

Integrated refineries are not obligated to buy crude from their upstream counterparts. In fact, a Suncor refinery may actually buy crude oil from Imperial Oil. The same is true for American companies. ExxonMobil has several refineries on the Gulf Coast that may purchase crude from BP and Shell.

Imperial Oil

Husky Energy Logo

Suncor Logo

ExxonMobil logo

Shell logo
BP logo

Independent Refineries:

Independents have no upstream assets which means they are required to buy crude oil from integrated or independent producers. They are in the business of refining crude oil into gasoline, diesel, and sometimes asphalt. These independent companies can sell gasoline on the wholesale market (step 4), or they can sell it out their own retail station (step 5). Irving Oil has Canada’s largest refinery in Canada, and operates a large retail network in Atlantic Canada. On the otherhand, North Atlantic Refining Company operates a small refinery and does not sell gasoline at retail stations.

Co-op Logo
Irving Oil Logo
North Atlantic Oil logo

 

Step 4 – Transport Gasoline to Fuel Terminal

Nobody buys gasoline at a refinery, so they are required to transport their products to a bulk fuel terminal. Typically a refinery will tranport its gasoline and diesel to various hub terminals in a region – these are called the rack. A Montreal refinery may pipeline gasoline to a fuel terminal in Kingston, Toronto, and London as their are major hubs. Large volume customers may purchase gasoline or diesel for cheaper wholesale rates. Based on prices in May 2010, the savings amounts to 7 cents / L plus GST.

Petro-Canada publishes their wholesale rack prices
on their website.

A fuel terminal may be owned and operated by a single integrated or independent company, joint companies, or another company that deals with energy storage (Kinder Morgan).

 


Crude Pipeline

Gasoline Fuel Terminal

Margin: 16.2 CAD cents / L (based on a retail 97.3 CAD cents / L)

The margin is determined by what the market price of gasoline is at the closest hub in the area and the loca conditions. The major hub for Toronto is New York Harbour, while Vancouver’s price is determined by the Los Angeles market.

Integrated Oil Companies:

Imperial Oil

Husky Energy logo

Suncor Logo

ExxonMobile logo

Shell logo
BP logo

Independent Wholesalers:


Co-op logo
Irving Oil Logo

North Atlantic Refining logo

 

Step 5 – Distribute Gasoline to Retail Stations

The final step is the distributing gasoline from the fuel terminals to the retail stations. This is by the the most visible step in the entire process to the public.
Canadian Tire Gas Station
Shell Gas Station
Esso Gas Station

Margin: 7 CAD cents / L (based on a retail 97.3 CAD cents / L)

The 7 cents margin is not profit. Retail stations have costs such as wages, electricity, land taxes, etc.

Integrated Oil Companies:

Imperial Oil

Husky Logo

Petro-Canada logo

ExxonMobil logo

Shell logo
BP logo

Independent Retailers Producers:

As mentioned earlier, an independnet company like Irving Oil is involved in the oil industry from steps 2-5. It buys crude oil, and sell gasoline at the retail pump. However, Canadian Tire and Safeway are examples of indepenent retail stations that have no involvement from steps 1-4. They simply show up at step 5, buy gasoline at a wholesale rate, and slap on a retail margin. Often times these companies have supply arrangements with an integrated oil company. Canadian Tire purchases gasoline from Imperial Oil, while Safeway from BP.

Why are these companies in the business of selling gasoline that would otherwise be sold by an integrated company? Gasoline is essentially the same from one pump to another. But they can use their brand or convenience to convince people to pull into their station. If you have shopped at Canadian Tire you will notice they often give you coupons at their gas bar. On the other hand, if you are buying your groceries at Safeway, why not fill up at a gas station in the same parking lot?

Canadian Tire Logo
Irving Logo
Safeway logo

Summary

Anyone that has filled a gas tank at Petro-Canada has probably seen this interesting pie graph showing the cost breakdown of gasoline.

When I was a kid I used to look at it and automatically associate the crude slice with Saudi Arabia – which is inaccurate as Saudi crude doesn’t flow into Canada. I think this graph can be misleading, but that is also dependent on where you are located in Canada. This pie chart essentially shows the margins for the downstream industry, and not the upstream industry.

If you are in Montreal, it is very likely that your crude oil is coming from the North Sea or Northern Africa (Algeria). In this case, crude becomes a cost to the integrated oil company, and the profit for the downstream and the integrated company is equal to 3%. But what about Alberta? The upstream and downstream industry in Alberta is more domestic than international. What does that actually mean? Unlike East Coast refiners, Canadian crude flows into Canadian refineries to make Canadian gasoline. A company like Suncor can pipeline bitumen to its Edmonton refinery, and distribute it to its retail stations. The downstream industry continues to make its 3% profit, while the upstream makes a substantial amount of profit. I don’t know the exact margin, but I have often heard $30 as the breakeven point for a lot of oil sands projects. Therefore, the integrated oil company makes far more than the 3% profit. They just don’t show it on the sticker at the gas pump since its all Upstream money.

When I was working in Sarnia one of the researchers commented that the downstream’s operating budget is roughly equivalent to the upstream’s pizza budget. There is some truth in the joke, as more money has flown into oil sands development. An integrated oil company may be a single entity, but it carries two wallets: a nice leather wallet, and a batman wallet it has had since the 1970’s. It shouldn’t be hard to figure out which wallet belongs to whom.

Comments

comments


2 Comments »

  • Patrick said:

    Very informative. Halfway through I was going to comment about the Petro Pie Chart and then there it was.

    Very disappointed that I went through your entire post without seeing the word “fungible” though. It’s got fun right in there!

  • kcorreia (author) said:

    Do you mean to say gasoline prices are fungible? Or money in general?
    For the most part gasoline prices are transparent since they are based on market values. Only problem is that in Vancouver gasoline stations don’t sell at the same price (which they do in the GTA). So you could pay up to 3 cents more per litre in some cases.