The opportunity for Middle Eastern and African export refineries to the year 2002

The opportunity for Middle Eastern and African export refineries to the year 2002

Gilbert Jenkins IN 1988, MIDDLE EASTERN and African oil producers exported 812 million tonnes of oil; crude accounted for 692 mt and products for 120 mt. Seventy-four per cent of this oil was exported to OECD countries.

When examining the export opportunities for Middle Eastern and African refineries in the early part of the next century, we must be aware that, in looking at the pattern of oil marketing which will emerge, there will be developments or shocks which we do not anticipate. The high prices of 1973/74 and the late 1970s and the low ones of 1986 were not expected. Throughout most of the 1970s and 1980s, the accepted forecast was that oil prices would increase in real terms during this period. Such a forecast was incorrect. So were the associated forecasts regard- ing the development of non-oil energy sources.

Whatever the pattern of events in the 1990s and early next century, the successful marketeers will be those who have credibility as secure suppliers and sell oil at the going market price. A supplier who exploits his market share for temporary gain is likely to lose market share later. Subsequently, he may be forced to cut prices and sell a larger proportion than he would like on the spot market, so as to keep his production level.

It is, therefore, instructive to look at an example of planning by a major oil company over some decades. This we shall do by taking British Petroleum as an example, before examining some of the key issues for oil exporters in detail.

A case study in strategic planning When we are forecasting and planning a decade ahead, we have no reason to

have great confidence in what forecasters term ‘standard world surprise free forecasts’. During the course of a decade, we have every reason to expect at least one surprise which will have a major impact on the marketing of crude oil and oil products. In 1956, 1967 and 1971, the price of oil products in Western Europe rose substantially, due to an increase in the price of ocean freight, and not crude oil. In 1974 and in 1979, the substantial increases in the price of crude were surprises. The increase in the importance of oil product spot markets in the 1960s and oil futures markets during the 1980s were not forecast a decade earlier.

The author is an independent energy consultant from Sunningdale, Berkshire, England. This paper is based on one presented at the Third Annual APS Conference on ‘Middle East Strategy to the Year 2002’, held at Nicosia, Cyprus, on 3-5 October 1989. The content of this paper wasfinalired before the outbreak of the present tensions in the Middle East.

Winter 1990 493

So, if we are to provide credible forecasts and construct long-term or strategic planning on the basis of current long-term forecasts, we need to be aware of the uncertainties associated with forecasts.

BP in the 1950s and 1960s The position of BP in the 1950s and 1960s was analogous to the position in

which some Middle Eastern and African oil-exporting countries found themselves in the early 1980s.

BP had, as the oil exporters have now, large reserves of crude, adequate in- stalled crude production capacity and profitable crude markets. BP, in the late 1950s, saw the need to become more involved in the downstream sector and to establish a presence in the United States. Without such a presence, BP believed it would never be able to compete on equal terms with the six majors which had a strong base in the US, i.e. Chevron, Exxon, Gulf, Mobil, Shell and Texaco.

BP’s entry to the US BP did not have the funds to buy a significant presence in the US oil indus-

try. Furthermore, a shortage of dollars in the United Kingdom prohibited large US investment.

The decision was taken, therefore - a strategic planning decision - to invest the small amount of dollar money available in oil exploration in the US. It was general knowledge that the only area in the US where large oilfields might be dis- covered was in Alaska. But this was likely to be expensive oil, costing up to $1 per barrel to discover and produce. This option was taken up by BP. The company dis- covered oil there in the 1960s, even though oil prices had been falling throughout this decade, as a result of large discoveries in Africa and in the Middle East. But Alaskan oil was, of course, US oil and was therefore always likely to be protected from the world surplus in some way.

BP’s detailed planning in the late 1960s was based on $ l /b to produce Alaskan oil and $l/b to transport it to the US West Coast, where it would be sold at $3/b, giving $I/b profit. In the event, the price of oil rose well beyond the planned price before Alaskan oil reached the market. But the direction of the planning proved to be fundamentally correct and subsequently BP established itself in the US market.

BP’s build-up downstream Prior to the advances made in the 1960s, much of BP’s marketing was in the

form of joint activities with Shell, the companies being called ‘Shell and BP’ or ‘BP and Shell’. Included in this arrangement was the important UK market, in which the marketing company was owned 60 per cent by Shell and 40 per cent by BP. These joint companies were left in place until the early 1970s.

494 OPEC Review

During the 1960s, BP expanded its refining and marketing activities, especially in Europe, quite aggressively. At this time, all oil industry forecasting was consistently failing to anticipate oil demand: i.e. the forecasts were underestimates and were revised upwards each year. To some extent, this helped those who were aggressive to acquire good market shares.

By the early 1970s, BP had realized that it had built up downstream activities which were not best suited for the later 1970s and the 1980s. There were two major problems. The first was the poor profitability of some of the European downstream operations, and the second was that, downstream, BP had a very ‘black’ barrel, i.e. i t was heavily dependent on sales of residual fuel oil. In one quarter in the early 197Os, BP made a profit o f f I5 million, which consisted of approximately f25m profit from crude oil sales (25 mt at €1 per tonne) set against a loss o f f 10m downstream.

In certain markets, profitability calculations over periods of a year gave excep- tionally poor results. The operating subsidiaries were unprofitable, even if allowed theoretically to purchase crude oil at the tax-paid CCJSI - which was then less than $I/%.

BP’s planning In the late 1960s and early 1970s, BP’s planning placed great reliance on the

use of the BP Group model, with supply costs minimized by the use of linear pro- gramming techniques. In retrospect, this type of planning was of no help to the company. It was later scrapped and power transferred from supply planners to those near the customers. The concept of integrated operations also fell out of favour, with, among other activities, the BP Tanker Company being drastically reduced and its mode of operation changed.

BP’s planning and investment in the immediate post- 1973 period became heavily involved with activities outside the oil industry. But, while the company’s petrochemical operations eventually became profitable and are currently assessed to be of strategic importance to the company, activities such as BP Minerals, BP Coal and the many ‘little acorns’ (i.e. small companies of BP Ventures), were not retained. The BP Tanker Company was scaled down to a fraction of its former size and, of the late 198Os, is of little financial importance to the company. BP’s planning and investment is now concentrated on mainstream oil, gas and petrochemical activities, with a much higher proportion of business and financial planning than in the 1970s and early 1980s. The planning and investment activities of all the oil majors, well publicized through annual reports and chairmen’s statements, will doubt- less be debated by planners in the oil-exporting countries.

At BP’s Annual General Meeting in 1989, Sir Peter Walters said, under the heading ‘Our Strategy’: “We have certainly sharpened the focus of our hydrocarbons-based businesses: and the reason for this is that they offer growth options for the future whilst already being of sufficient size to compete strongly in their sec- tors. As I have said before, the most important requirement of all is to concentrate upon what we are best at, remembering at the same time that market realities have

Winter 1990 495

taught us to avoid excessive reliance upon any single aspect of the oil business.” Sir Peter Walters’ message is an important one for BP, and perhaps is even more important for the oil companies of the Middle East and Africa.

Of the OPEC Members, Venezuela has taken strategic decisions for the development of its high-sulphur Orinoco heavy oil. This Country has decided that a market exists for this oil, which is about four per cent sulphur, by competing with coal in world markets. Kuwait has also demonstrated its aptitude for strategic planning, with its investment in high-quality refining with desulphurization, on which there is likely to be a good return. In general, concentrating on what they are best at, and taking sound strategic decisions, is of vital importance to OPEC Members.

Crude and product demand to the year 20001 In 1988, total world oil consumption was nearly 63 million barrels per day,

of which 50 mb/d was in the non-communist world (NCW). Total world oil consumption constituted about 40 per cent of the energy market.

When forecasting energy and oil demand through to the year 2002, there are major uncertainties. One is the rate of economic expansion, while another is concerned with the price of energy. Taking the US ElA’s quantification of these par- ameters, for every $I/b increase in the world price of oil, US oil demand could fall by 30,000 b/d. For every percentage point of additional growth in US gross national product, petroleum demand can be expected to increase by about 100,000 b/d.2

While a rapid advance in the world’s economy could tighten energy supply and firm up energy prices, a slump could lead to a substantial energy surplus (five mb/d of oil equivalent, or more) and low energy prices. We do not have the ability to predict whether the year 2002, or any other year about a decade ahead, will be associated with ‘average’, slump or boom conditions. But some parts of oil demand forecasts are more reliable than others,3 and planning benefits by taking quantified risks into account.

Oil demand forecasts

forecasts:4 The following oil consumption forzcasts (table 1) are based on US DOE

Table I Oil demand forecasts to the year 2000

mhld

us Western Europe

Total NCW Japan

1988 2000 Base

16.4 12.5 4.8

49.8

18.6 12.4 4.7

54.9

2000 Range

17.8 to 19.5 11.1 to 14.1 4.2 to 5.3

50.7 to 59.7

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The ranges quoted are those estimated by the DOE. If there is a relatively abun- dant supply of oil near the year 2000, the upper limits may be extended, but much of this additional demand would be for residual fuel oil in the power-generating sector.

The DOE’S total oil forecasts are backed by sector analyses, which are included in table 2:

Table 2 Oil demand forecasts to the year 2000

quadrillion Btu

us W. Europe Japan Total OECD Industrial 8.9 to 9.6 7.0 to 8.9 3.2 to 4. I 20.7 to 24.4 Transponation 2 1.8 to 23.4 9.6 to 12.1 2.5 to 3.2 37.6 to 42.8 Residentialkommercial 2.4 to 2.5 4.7 to 5.9 1.5 to 1.9 9.0 to 10.9 Electric urilities 2.0 to 3.1 1.7 to 2.2 1.2 to 1.5 5.3 to 7.2

Total 35.1 to 38.7 23.1 to 29.1 8.4 to 10.7 72.6 to 85.4

In the OECD region at present, transportation fuels constitute 50 per cent of total oil consumption, and this percentage is likely to increase slowly to near 55 per cent in the year 2000.

Outside the OECD region, demand for transportation fuels will also increase steadily. Additionally, a factor contributing to the increased use of kerosene is that of substitution for wood and non-commercial fuels. For example, in India, kerosene/ gas oil consumption is forecast to increase from 27.3 mt in 1987 to 61.8 mt in 2000 (Weekly Petroleum Argus, 14 August 1989, p.3).

Oil product consumption for the total NCW is included in table 3.

Table 3 Oil product consumption forecast, NCW, 2002

rnt

1978 OECD

1988

Gasolines 571.8 568.1 Middle distillates 580.5 579.4 Fuel oils 495.7 266.2 Total 1,973.6 1,714.5

Rest NCW Gasolines Middle distillates Fuel oils Total

Total NCW Gasolines Middle distillates Fuel oils Total

81.8 166.1 162.5 476.5

120.4 253.9 180.0 659.1

653.6 688.5 746.6 833.3 658.2 446.2

2,450.1 2,373.6

2002

700 650 250

1.900

200 400 200 900

900 1050 450

2,800

Source of I978 and 1988 data: E P Statistical Review of World Ener.gy. July 1989. Note: the totals include other products.

Winter 1990 497

One of the main features of table 3 is the forecast increase in distillates in the NCW, from about 65 per cent now to about 70 per cent in the year 2002.

Refinery developments In line with the product demand forecasts, refining developments could be in

line with those shown in table 4. The key feature is that a substantial increase in Middle Eastern and African oil producers' capacity is forecast.

Table 4 Refinery capacity developments, 1978-2002

mt pa

Middle East African majors' Other Africa Western Europe Far East CPEs2 North America Latin America Total world

1978 I78 32 50

1.038 494 73 I 983 414

3.92 1

Middle East, African majors -Refineries mhld 4.2 - Crude oil production mhld 28 Refining as % of crude oil production I5

1988

230 85 1 56

690 502 872 896 370

3.699

6.4 19.5

33

2002

500

50 700 600

I ,OOo 900 400

4.150

I 0.03 25

40

Note: I n both North America and Western Europe, refinery capacity peaked in 1980, at

Source of 1978 and 1988 data, Petrole 88, CPDP Paris. I . Algeria, Egypt, SP Libyan AJ and Nigeria. 2. USSR, China and Eastern Europe. 3. The figure of ten mbld could be too high. It will be too high, unless OPEC Member

Countries see the opportunities available and invest in refineries with substantial yield profit and desulphurization capacity. M y opinion i s that there are excellent opportunities for OPEC Members to obtain good market shares by taking strategic decisions now and investing in refineries. Those who do will obtain better rewards than those who continue to sell high-sulphur crude oil.

slightly above the 1978 level.

Trade forecasts Oil product import levels are included in table 5. The key feature of this

table are the large increases postulated for naphtha, motor gasoline and kerosene. As a consequence of the postulated increase in imports, there could be a sub-

stantial increase in oil trade through the Suez Canal (table 6). But these forecasts are completely dependent on the competitive pricing of Suez Canal dues.

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Crude oil Imports Exports Naphtha Refinery output Imports Gasoline Refinery output Imports Kerosene Refinery output imports Gas oil Refinery output Imports Heavy fuel oil Refinery output Imports Total products Refinery output Imports Exports Consumption

Table 5 OECD crude and product imports, 1985-2002

mt

1985 1986 1987 1988

816 909 924 966 156 167 172 175

44 46 45 46 36 39 43 44

449 466 478 49 1 42 46 50 37

121 127 126 132 9 14 18 21

37 1 392 383 40 I 83 94 92 88

232 233 229 228 87 90 84 82

1.439 I SO2 1.510 1.560 300 33 1 335 33 I 181 203 202 205

1,443 1.483 I SO6 I .547

Source of historic data: Quarterly Oil Statistics and Energy Balances. IEAIOECD. Paris.

Table 6 Suez Canal petroleum traffic, 1978-2002

mt

South-North Crude oil Products

traftic

North-South traftic Crude oil Products

1978 1986 1988 2002+

21.0 65.4 35.0 100 7.4 26.8 22.1 200

0.6 3.2 2.8 - 4.2 9.6 13.1 -

*The numbers for 2002 are potential volumes and made on the assumption that canal dues are set at a competitive level. Othenvise, shipments well be made using pipelines and large tankers on the Cape route. Source of 1978,1986 and 1988 data: Petrole 88, CPDP Paris.

Crude and product quality requirements While the many forecasts of oil demand near the year 2000 will differ in de-

tail, we can expect agreement on the barrel becoming progressively whiter, together with a requirement for less sulphur in the marketed barrel. We shall examine the quaiity requirements for the various oil products in turn.

Winter 1990 499

Motor gasolines Legislation to limit exhaust emissions from cars will be relatively wide-

spread in OECD countries. The majority of cars around the year 2000 will require high-quality, lead-free motor gasoline. The leaded grade of gasoline is likely to be a grade equivalent to the present low lead grade, i.e. 0.15g PbAitre; but there is no reason why the grade should not be 0.05g Pbhitre, or even a little lower.

The average quality of motor gasoline in OECD countries could, therefore, be about 95 research octane number clear, i.e. lead free. Furthermore, restrictions on the volatility of motor gasolines could mean that the average butane content is about five per cent.

The proportion of oxygenates in motor gasoline will be dependent on motor gasoline prices through the 1990s. Relatively high motor gasoline prices will encourage investment in plants to produce oxygenates. High-quality, lead-free motor gasolines are also dependent on good supplies of isopentane and isohexanes, al- kylates and aromatics; toluene, xylenes and higher boiling aromatics, which are in the gasoline range.

Motor gasoline demand and quality has been forecast precisely within a five- year period, and this good forecasting record is likely to continue. Although the temporary very high demand for residual fuel oil can lead to low motor gasoline price^,^ prices should be sufficiently firm through the 1990s to allow the quality of motor gasoline to increase steadily and meet market requirements.

Jet kerosene The present quality of jet kerosene is adequate for the 1990s. The stated po-

sition of a leading airline, British Airways, is that, while some improvements in the aromatics content and freezing points of jet kerosenes are always desirable, such improvements do not merit any increase in price for a superior quality fuel.

Adequate quality jet kerosene can be obtained by distillation alone from most crude oils, although the yield varies considerably from one crude to another. The hydrocracking process provides high-quality jet kerosene, but the other cracking processes do not.

Gas oils Several improvements in the quality of gas oils will be sought through the

1990s. The average sulphur content will be lower, reduced pour points will be required for some applications and, for road diesel fuels, an improved cetane number is desirable. It is not yet apparent how road vehicle diesel engines, with exhaust gas recirculation systems fitted to minimize pollution, will benefit by improved quality diesel fuels.

500 OPEC Review

Some of the improved quality sought in gas oil diesel fuels is already being obtained by the use of hydrocarbons, which could be blended equally well into kerosenes, thus effectively putting pressure on the supply of kerosene.

Residual fuel oils Although there have long been grumbles about the use of cracked compo-

nents to blend residual fuel oils, as well as about the high ash content, these quality clauses are likely to remain of minor importance. It is the sulphur content of residual fuel oil which will become an even more important quality parameter than it is now. High-sulphur fuel oil puts three times the quantity of sulphur dioxide into the atmosphere, compared with low-sulphur fuel oil. While a rapid increase in sulphur dioxide emissions and the consequent increase in acid rain has been tolerated, and even encouraged, in some countries over the last three decades, in future we can expect additional legislation to limit sulphur dioxide emission in some places.

What is also encouraging now is that the use of certain types of burner can limit the emissions of nitrogen oxides, but i t is too soon to ascertain whether the nitrogen content of fossil fuels will become an important parameter.

Petroleum coke Petroleum coke falls into two main qualities: high-sulphur (3-8 per cent sul-

phur) petcoke, which competes with low-grade coal, and premium grades of petcoke, some of which are specially manufactured. These premium petcokes have various industrial uses, such as aluminium smelting and the electric arc steel- making process. These premium grades have low sulphur contents, which ideally would be below one per cent sulphur.

All high-sulphur petcoke should he directed to the cement industry, where the sulphur is trapped in the cement and not released to the atmosphere. While the qualities of premium grade petcokes are likely to remain unchanged through the 1990s, it would be sensible if an international specification for high-sulphur petcoke were agreed and the use of this coke limited to the cement industry.

Lubricating oils The two major uses for lubricating oil basestocks are for the manufacture of

crankcase oils for motor gasoline and diesel engines. At present, these oils are sold mainly under brand names, with sales highly dependent upon advertising expendi- ture. During the 1990s, the quantities of these oils sold as commodities should increase. The European market, post- 1992, should help standardize the grades. Consequently specifications, such as those issued by the US SAE, could come into widespread use and be much more widely recognized by the consumer.

Winter 1990 50 1

Crude oil quality While it is not possible to significantly change the quality of the crude pro-

duced from a specified reservoir, it is nevertheless possible to choose which crudes should be produced and the rate at which they are produced.

Naive crude oil production forecasts assume that crude oil quality over the next five years or so will be that calculated from present production levels and qualities. When there is a need to replace OECD-produced crude oil in the world slate, because of depleted OECD reserves, it is assumed that the shortfall will be met by high-sulphur crude produced in the Middle East. These naive production forecasts are sometimes accompanied by forecasts of a rapidly rising sulphur content of the crude oil slates imported into OECD countries from the mid-1990s.6

The conrrary view, which is in some ways less credible than the naive forecast, is based on a number of assumptions:

(i) OECD crude oil production will hold at its present levels through the 1990s, and the average quality will remain similar to the p r e ~ e n t . ~

(ii) If it is necessary for Middle East crude oil producers to concentrate on producing lower-sulphur crudes to obtain adequate market shares, then these crudes will be produced. With the sulphur premium likely to widen through the 1990s, there will be an additional economic incentive to produce such crudes.

(iii) With increasing environmental concern, the refiners in OECD countries will be under increasing economic pressure to process lower-sulphur crudes.

(iv) As it becomes less economically attractive to process high-sulphur crudes in OECD refineries, it will become more attractive to refine these high- sulphur crudes in the Middle East. Cheap natural gas is a considerable help. Fur- thermore, it will be easier to obtain favourable term contracts for the sale of high- quality distillates and low-sulphur residual fuel oil than to obtain contracts for high-sulphur fuel oil (and high-sulphur crudes).

We conclude, therefore, that the quality of crude oil in international trade may not change significantly during the 1990s.

Refining high-sulphur crudes While in general it is not expected that the refining systems in OECD coun-

tries will be adapted to handling high-sulphur crudes and producing no high- sulphur fuel oil, some refiners in the consuming countries have invested in refining technology to handle high-sulphur heavy crudes. Phillips Petroleum is an example. Phillips’ refineries in the US can utilize about 80 per cent of their total crude oil refining capacity to process high-sulphur crudes.

502 OPEC Review

Table 7 Phillips’ US operations, 1988

thousand bid 9% volume

Crude oil processed NGLs processed

30 1 200

Petroleum products sold in US Automotive gasoline 275 Aviation fuels 36 Distillates I00 LPG 95 Other products 34

Total US sales 540

60 40

51 7

19 17 6

100

The Phillips operation is exceptional, however, because of the large proportion of NGLs processed.

Crude and product price structures The price of crude will be determined by the world’s primary energy bal-

ance; the greater the surplus of energy, the lower the price of crude. In the short term, the supply and demand for crude will set the price, and we have accepted that there can be considerable volatility in the price.

For any price of crude, its location will determine the fob price to the pro- ducer. The cost of freight for moving Middle East crude to North-West European and US markets could be $0.5/b or $5/b. While, at present, there is a possibility of high spot market freight rates emerging in the 199Os, there is always the potential to overbuild tankers with freight rates for long-haul crude being near $l/b over the long term. But, in the short term, there will be continued volatility with spot market freight rates as well as with the fob price level.

Refining margins and the price difference between high- and low-sulphur residual fuel oil also have a major influence on crude prices. It is possible that low- sulphur fuel oil will establish an equilibrium price as high as $7/b above the price of high-sulphur fuel oil. This would equate to about a $2/b price difference between a low- and a high-sulphur crude.

Although there has been a decade of relative reduction in refinery capacity in OECD countries, there will always be the temptation to overbuild conversion capacity: crackers and cokers. As we move through the 1990s, there are likely to be periods of volatility with respect to the price of distillates relative to fuel oil, and hence volatility in the gravity premium on crudes.

Winter 1990 503

Possible crude oil prices Many current published forecasts show crude oil prices increasing steadily in

real terms. While such forecasts may have their uses, they may not be the best forecasts on which to develop long-term plans. Furthermore, their credibility is not necessarily high, when they can change with different assumptions by as much as $lO/b (for example, see the Harvard forecasts published in the Financial Times, 19 July 1989). US DOEEIA world oil price forecasts for the year 2000 show a range of $21.7&35.00/b (1988 US$), with the base case being $28/b.

Whatever the credibility of such forecasts, there are no grounds for considering that oil prices will increase in real terms indefinitely. The reality of the situation is that there will be periods when there is a relative shortage of energy in the world and times when there will be a relative surplus. Energy prices, and particularly oil prices, will shift accordingly. As oil product prices vary, so will the differ- ences between the prices of low-gravity and high-gravity crudes. It is unrealistic, therefore, for a crude oil exporter to plan his future on the grounds of a steady market and ever increasing crude prices.

Possible oil product price structures Whatever the level of the price of crude (and the levels of ocean freight and

refining margins), oil product prices will vary relative to each other. The marginal market prices for some main oil products and for petroleum coke are included in table 8. These prices are illustrative of different types of market. It is sufficient to

Table 8 Marginal market price projections for the year 2000

$/tonne

Premium motor gasoline Light distillate feedstock (paraffinic) Jet kerosene

Present Year 2000 A B C D E

200 220 I70 I Y O 160

150 180 I40 150 140 I80 200 I70 180 160

Gas oil I60 I80 I 60 170 150 Low-sulphur heavy fuel oil I10 I10 I30 110 140 High-sulphur heavy fuel oil 90 90 100 50 50

loo 100

The prices quoted are in 1989 $. with crude oil (Dubai) priced in the Middle East Gulf at I15b and freight from the Middle East to NW Europe and US at flO/tonne.

Case A High distillates demand. Case B High distillates demand and tight refinery capacity. Case C High residual fuel oil demand. Case D High distillates demand. Case E High residual fuel oil demand.

In case E, the high residual fuel oil demand can be met only by low-sulphur fuel oil.

- - Petroleum coke low sulphur (1%) Petroleum coke high sulphur (7%) - - - 10 10

-

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state that, when planning for a decade ahead, it is necessary to take into account all possible price structures and a dynamic market. In table 8, the prices are geared to crude oil prices of about $15/b. A doubling of the price of crude would approximately double all the prices quoted, because the ocean freight and refining contri- butions to the oil product prices are relatively small.

Oil companies and their market shares In the oil industry, a large market share provides economies of scale and an

ability to keep market prices high. There are markets in which monopolies exist, but, in general, oil marketing is carried out under oligopolistic conditions. The major oil companies usually supply the largest customers and, in the retail motor gasoline market, have the best sites. Competition is provided by the independents which, operating with much lower overheads than the majors. can operate prof- itably while selling at lower prices than the majors. Thc majors have long accepted that vertical integration and the scale of operation does not necessarily allow them access to oil products at prices lower than those at which the independents buy.

Around five per cent of Europe's oil products pass through the Rotterdam market, but Rotterdam prices influence the whole of Europe's consumer oil markets. Post-1992, oil product prices in the single European market will still be influenced substantially by Rotterdam, but, as at present, the cheapest prices will be in the centres of high consumption where competition is greatest.

It is unlikely that the large oil companies will readily give up market share anywhere in the world, but nevertheless there will be changes. The advances made by Kuwait and, more recently, Saudi Arabia and Venezuela have shown that it is possible to acquire downstream market share, but these opportunities have not been open to all petroleum-exporting countries. We shall consider how the market share may change on a product basis.

Liquefied petroleum gas With LPG, there are two separate consumer markets. The large bulk con-

sumers are those who use LPG for electricity generation and petrochemical feedstocks. With the bulk markets, there is an unlimited opportunity for oil producers to acquire a large market share. The restrictions are limitations of supplies and the ability to negotiate contracts.

The key point with contracts, applicable to all crude and product contracts, is that both the buyer and the seller ideally require suitable term contracts and the price should be the going market price. When a contracted price becomes unfair to either party, the contract ceases to be satisfactory and opportunities will be taken to break it. Hence, LPG for electricity generation must be competitive on a calorific value basis, while, for ethylene cracker feedstock, its need to be priced competi-

Winter 1990 505

tively against light distillate feedstock (or naphtha). It is for use as petrochemical feedstock that the future of large bulk LPG supplies lies.

The fragmented markets for LPG, small bulk and cylinder supplies are seasonal and involve a high service element. These markets are not attractive to the petroleum-exporting countries and the market shares of those serving the markets at present are unlikely to diminish.

Motor gasoline Motor gasoline is likely to become more of a commodity through the 1990s.

although the oil companies will continue to reinforce their brand names. The market shares of the majors will probably be maintained. Nearly all the best sites are in the hands of the majors, who should continue to invest heavily. The ‘network pu- rification’ of the 1980s has given the majors good-quality retail networks. Their market shares are likely to increase gradually through the 1990s, as a result of this quality. But, in the US and Europe, the largest oil companies have probably taken as large a retail market share as they sensibly can without risking government in- terference.

The majors will continue to supply independents with motor gasoline from their own refineries at prices linked to the spot market. This course of action will be preferred by the majors to that of forcing more trade through the spot markets.

While the acquisition of a small market share through the purchase of low- quality chains of retail sites is likely to remain unattractive for the oil-exporting countries, there will be possibilities for them to become more involved with independent storage and in futures markets. The acquisition of independent storage is a way of obtaining market share, especially if the storage is aggressively managed. The greater the volume of activity on the oil futures markets (eg NYMEX and IPE), the larger will be the volumes of oil that are likely to be physically delivered as a result of futures trading activities.9

Therefore the acquisition of independent storage, involvement in the spot and futures markets and sales of high-quality motor gasoline and components to the majors will provide the best export opportunities.

Jet kerosene A substantial proportion of jet kerosene is sold to the largest airlines. What is

of more importance, however, is that very large volumes of this product are lifted at the world’s largest airports. Although the airlines have taken progressively more interest in the oil market tlirough the 1980s, the majors’ position in the aviation sector is just as strong now as it was ten or 20 years ago.

Jet kerosene pricing is relatively transparent in the US, but not in the rest of the world. As sales of jet kerosene rise as a proportion of the barrel, its pricing should become more transparent. There will be opportunities for the major airlines,

SO6 OPEC Review

such as British Airways, to obtain term contracts for kerosene delivered in cargo lots to North-West Europe, for example. As oil imports rise generally in the US, jet kerosene imported into New York Harbour is an obvious opportunity, as is the fast- growing Pacific market.

Gas oil Sales of gas oil to ultimate consumers is one of the least attractive options for

oil-exporting countries. The acquisition of independent storage is again an opportunity to obtain market share, with low pour point, low-sulphur, good-quality gas oils being those most easy to place in the market through the 1990s.

Residual fuel oil The market for residual fuel oil may be considered as composed of two sec-

tors: the electricity-generating sector and the rest. The non-electricity-generating sector has become smaller in Europe over the last decade and the profitability of sales of heavy fuel oil has increased. Sales of fuel oil in this fragmented market have, therefore, become more attractive to oil companies currently operating in Europe and the US, and they will obviously protect their market shares.

The market for heavy fuel oil for electricity generation through the 1990s will be substantial worldwide. In OECD countries and elsewhere, much lower sulphur contents will be required. Limits of three per cent weight sulphur will be re- placed by one per cent weight or less. It is with low-sulphur residual fuel oil sales to the electricity-generation sector that oil-exporting countries will have the opportunity to take appreciable market shares. Those companies at present supplying this market will defend it, but will be aware of its lower profitability and of their limited capability to supply very large quantities of low-sulphur residual fuel oil.

Market shares in year 2000 TO suggest market shares for a decade ahead is not forecasting, but speculat-

ing. Nevertheless it is useful, for the purposes of debate, to consider what they might be and an example is given in table 9. The present OPEC downstream share is based on the Organization’s refinery capacity; the estimate for the year 2002 is based on the need for OPEC’s Member Countries to improve the security of their market shares. It is not postulated that the current market leaders, Exxon and Shell, will give way. Indeed, their present great strengths and dedication to the oil market suggest that they will increase their market shares.

The opportunities for export refineries Let us assume that there are two reasons for an oil-producing country to have

an export refinery. The first is concerned with maintaining its share of the world’s oil market and the second is to add value to its crude oil. But having a refinery is

Winter 1990 507

Table 9 NCW* oil market shares, 1989 and 2002

70

1989 U pstream Downstream

Exxun 4 9 Shell 4 I 1 KPC 3 Saudi Arabian companies 12 - OPEC 45 10 Non-OPEC 55 90

-

2002 Upstream Downstream

5 12 5 12 4 5

16 10 55 30** 45 70

analogous to having ii tanker fleet to sell crude (.if: I f the tankers are not of the right size and bought at a good price and if the fleet is not well managed. selling crude cifwill not be as profitable as selling itfoh.

A refinery built in a poor location with poorly chosen plant acquired expen- sively is likely to run at a loss on any type of crude. But it is possible to have a refinery (or a petrochemical complex) which is a leader rather than a laggard and will be a good investment in nearly all market conditions.

The need to refine high-sulphur crude oil Taking into account the level of oil product demand, the quality of the prod-

ucts, the possible price structures and the commentary on market shares, we can focus on the opportunities.

First, the better the quality of crude, the easier it will be to market it and to do so at a good price. Consequently, high-sulphur heavy crudes will have relatively poor prices in international trade and will be attractive for producers to refine themselves. As successful export refineries do now, these crudes will be subjected to considerable cracking and desulphurization. Concentration of the sulphur in a high-sulphur petroleum coke with the production of high-quality, low-sulphur distillates is an obvious way to refine high-sulphur crude as in the 1990s. but it will always be necessary to optimize a refinery's operation from week to week in the light of the market opportunities.

Dynamics While i t is possible to look at equilibrium or long-term prices, as we move

through the 1990s into the next century, the oil market will be dynamic in terms of crude and product prices, and the volumes of products required will also vary in an

508 OPEC Review

unpredictable manner with unexpected changes in the primary energy balance (coal-miners’ strikes, shortfalls of hydropower, exceptional seasonal conditions, etc).

Meeting pollution targets may also contribute to unexpected demand for oil products. Consider the pollution targets set by the Italian Government:

Table 10 Italian pollution targets set in 1989

thousand tonnes emissions

Sulphur dioxide Lead

1987

2,100 6.60

2000

530 0.29

To meet the sulphur dioxide emissions target, it is planned to increase gas consumption from 32.5 mt of oil equivalent in 1987 to 42 mtoe in 1995 and 50 mtoe in 2000. Any shortfall in natural gas supplies will require low-sulphur fuel oil in larger quantities than the shortfall of gas if pollution targets are to be met. Even if Italy were to import only low-sulphur crude oil, there is a probability that, in the 1990s, it would become an importer of low-sulphur fuel oils in quantities which cannot be forecast with any sensible degree of certainty.

But, whatever the uncertainty associated with European oil imports, there is much more uncertainty associated with the level and type of oil imports to the US. By the end of the century, the US could be importing five mbld or 15 mb/d of oil. A forecast of 15 mb/d has little credibility now. It would have much more credibility if imports reached 10 or 12 mb/d.

Marketing Any export refinery which is not backed by strong marketing will be at a dis-

advantage. As the majors found out in the 1970s, it is not beneficial to tie marketing exclusively to owned refineries. Much profitable marketing can be done using ‘back-to-back’ deals which involve no risk. Alternatively, oil product trading, with use made of oil futures markets when appropriate, can involve considerable risk. The export refineries which become active in this area will need people with proven oil-trading records as operators. The major exporting refineries will undoubtedly have strong marketing teams in the 1990s. The solution for export refineries in some small oil-exporting countries could well be in the form of joint ventures, with the parties bringing the necessary marketing, trading and financial skills.

A general point on planning is that all the major oil companies now have organizations that are adapted to the oil business in the 1990s. Even though much forecasting methodology and the precision of forecasts is relatively unchanged,

Winter 1990 509

compared with recent decades, planning is more efficient. The flow of information through companies is better with, as far as possible, only information on what action is taken or could be taken being transmitted. Finally, the concept of profit centres and individuals being made profit-conscious is progressing, but, in this respect, it is doubtful whether large corporations can ever be as profit-conscious as small businesses.

Undoubtedly, as the Middle Eastern and African oil companies plan and establish their downstream markets in the 1990s, they will watch the actions of the major oil companies carefully. As the majors adapt to the changing environment, so too will the most successful companies of the oil-exporting countries.

Another way of acquiring market share is to replace brokers and traders, including the Japanese trading houses, with direct marketing. Skilful oil product marketing departments are an asset, in that they can secure market share without wrecking prices.

Development of oil-trading practices Oil markets have always been volatile. The control of the pricing of crude by

the major oil companies unt i l 1973 helped reduce the volatility; but, while the foh price was stable for long periods, the cost of freight could treble the price of oil to a European refiner when the spot freight market rose to its peaks.

Since 1974, a volatile crude pricefoh has become an accepted fact. The substantial growth of oil futures markets during the 1980s, along with options and for- wards markets, has brought a new dimension to oil trading. Finance houses, the ‘Wall Street Refiners’, have become active in the oil markets. Although at first the oil majors did nothing to encourage the oil futures markets, they were eventually forced to join or otherwise lose an interest in part of the oil business.

The present situation is that oil majors trade in oil futures markets (and cur- rency markets) around the clock. A major may have 100 people engaged in the financial oil trade, of which nearly half will be active traders. Organizations other than major oil companies have also recently formed strong oil-trading entities, as have Statoil and the NNPC.

Statoil Statoil in the US has a team of eight traders selling crude, refined products

and LNG to US customers. Statoil started its US operation in 1987, it sold three mt of crude in 1988 and it is aiming to sell ten rnt of crude and one rnt of products in 1990. Exports from Statoil’s Mongstad refinery will be targeted at the US market.

The Nigerian National Petroleum Corporation (NNPC) In 1988, the NNPC formed two joint companies with Chevron: Hyson, based

in Lagos, which will buy Nigerian crude and refine and sell oil products; and

5 10 OPEC Review

Calson, based in Bermuda, which aims at becoming a strong international oil- trading company. Additionally, the NNPC could acquire refining and marketing in- terests in France and elsewhere in Europe. Through these activities and others, the NNPC will acquire and develop international oil-trading expertise.

Through the 1990s, all the crude oil producers will develop activities aimed at securing adequate market shares and obtaining a good price for their oil. The shape and size of the oil-trading organizations at the end of the 1990s will depend on their profitability through the decade. An office or trading organization which loses money is unlikely to survive.

Opportunities for the export of specialties While we have concentrated in this paper on the main oil products, there will

be opportunities for export refiners to obtain profitable sales of specialities. New technology could make the export of some light products, including base petro- chemicals, attractive, such as isobutane, toluene and xylenes and the oxygenated gasoline additions. Lubricants, including synthetic ones, also provide possibilities for increasing trade substantially.

At the bottom of the barrel, the export of carbon black feedstocks (CBF) and petroleum cokes could provide major opportunities for the low-sulphur grades. In 1988, the US exported more than six mb of CBF at an average price of $15.67/b. Low-sulphur (about one per cent) CBF is likely to command a premium of about $2/b over three per cent sulphur material. US exports of green petcoke in 1988 to- talled 13.5111 short tons (stn) at $30 per stn, while 3.3m stns of calcined coke were exported at $99/stn. High-sulphur petroleum coke will be sold at distress prices to cement manufacturers (sulphur is trapped during cement manufacture), while low- sulphur petcoke may be expected to obtain increasingly good prices.

Conclusion In considering the opportunities for Middle Eastern and for African oil prod-

ucts exports into the next century, we have demonstrated that the future can be a good one. We drew some comparisons with BP’s position some years ago. We did not mention Gulf Oil, one of the original Seven Sisters, which no longer exists as a separate oil company. The contrast in the fortunes of BP and Gulf Oil illustrates well the degree to which the future can be influenced by those now managing the oil companies of the Middle Eastern and African oil-exporting countries.

Winter 1990 511

Foot notes

I .

2 .

3.

4 .

5.

6.

7.

8.

9.

An independent referee commented on this section: “The section on crude and product demand to the year 2002 draws its conclusion based on a DOE forecast and its sec- toral analysis. The only conclusion I can see relevant to the subject of the paper is that there could be a large increase in the volume of imported products across the barrel, and particularly so for light products. This conclusion is evident from the past pattern of imports and this lengthy section may not be necessary, except perhaps tables 3# 4 and 5 which could appear in an annex.” My reply is that there is a need, in a paper in which strategic planning is the essence, to have a sound analysis and understanding of the present position and the forecasts based on ‘standard world surprise-firee’ methods (developmental planning methods).

US EIA, Short-term energy outlook, April 1989, p . 20 (sensitivity analysis).

The uncertainties in oil-product forecasting to the year 2000. Gilbert Jenkins, OPEC Review. Summer 1988, Vol. X U , no. 2 , pp. 145-164.

US EiA International Energy Outlook 1989, Projections to 2000.

When heavy fuel oil prices are relatively high. compared with crude oi!, motor gasoline prices are relatively low, and sice versa. There is extensive analysis available to support this contention.

The whole history of forecasting crude oif production and qualiv is riddled with er- rors. M y contention is that progressively more effort will be put into the production of low-sulphur crudes in both the OECD and OPEC areas (consider the new finds in Saudi Arabia).

I n a strategic planning paper, it is acceptable to take the view that OPEC crude production could remain at its present level throughout the I9903 (Shell shares this view).

The new, large oil and gas discoveries in OPEC Countries have development and production costs well below $1Slb, as does new coal in Australia.

OPEC’s involvement in the energy futures markets will occur as a resirlt of ventures such as Samarec and rhe need by companies. such as those of Kuwait. to trade in these markets to stay in business.

512 OPEC Review

Documents

The opportunity for Middle Eastern and African export refineries to the year 2002