Crude Primer

7/29/2019 Crude Primer

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IntroductionHistory, Characteristics of Crude, Uses of RefinedProducts


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History of Crude Oil

From decay of plants,

planktons and animals after

being compressed and

heated

Found in dome-shaped

geological traps

More viscous bitumen

extracted from oil seeps

Intro Supply & Demand Major players Strategies Price outlook


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Shale vs. Oil Sands



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Main uses of oil in history

Mortar

Waterproofing

Medicinal

Embalming

Adhesive tools

Prehistory - 1949



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In 1859, Edwin Drake drilled America's first commercial oil well inTitusville, Pennsylvania.

In 1870, Standard Oil was founded by John D. Rockefeller with $1million incapital responsible for 90% of US refining capacity

In 1930, Saudi Arabia allowed Standard Oil to begin prospecting for oil

In 1960, OPEC formed

In 1974, oil prices quadrupled in NYSE after an oil embargo was announcedby OPEC members

1850 - Present



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Characteristics of Crude Oil

Density

American Petroleum

Institute scale: 10-70

Lower API = denser,

lower price

Measured by Baume

Hydrometer scale

Sulfur Content

Sweet Crude has less

sulfur than Sour Crude

Cheaper prices of SourCrude due to additional

processes needed to

refine oil

Forms sulfur dioxidewhen combusted



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Density and Sulfur Content



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Density and Sulfur Content - Prices



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Oil Refinery Process

3 Major Refining Processes

Separation

After Dehydrating and Desalting

Conversion

Decomposition (dividing) by thermal and catalytic cracking;

Unification (combining) through alkylation andpolymerization; and

Alteration (rearranging) with isomerization and catalyticreforming

Purification



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Oil Refinery Process - Separation



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Oil Refinery Process -

ConversionPrimary purpose to convert lower value

heavy oil to high valued petrol

Uses Fluidized Catalytic Crackers, Cokers

and Hydrocrackers

Joining carbon chains Catalytic

Reformer and Alkylation



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Oil Refinery Process -

Purification

Removal of impurities, sulfur content and separations of

aromatics and naphthenes

Sulfur causes knocking in aviation fuel and corrosion in

diesel fuel



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Oil Refinery Process - Summary



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Uses



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Supply



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MENA Saudi Arabia, Iran, UAE North America U.S.A Europe Russia & Norway


17%

9%

21%33%

10%

10%

Daily Oil Production-Barrels

Total North America

Total S. & Cent.America

Total Europe & Eurasia

Total Middle East

Total Africa

Total Asia Pacific


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US Canada Mexico South &

Central

America

Europe Former

Soviet

Union

Middle

East

North

Africa

West

Africa

Asia

Pacific

Rest of

World

0

5000

10000

15000

20000

25000

Daily Export Volumes

1,000 barrels per day


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0

10000

20000

30000

40000

50000

60000

70000

80000

90000

0.00

20.00

40.00

60.00

80.00

100.00

120.00

198319851987198919911993199519971999200120032005200720092011

World Oil Production vs Prices

Daily Production Brent Prices Linear (Daily Production)


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Members

Production 43%

Exports 60%

Control the marketto keep prices high

Quota system

Why is it bad? Regional

Instability

Iraq-Iran

Religious conflicts

Strains on supply


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Does it work?


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Demand


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Demand

Need forEnergy

GovernmentRegulations

Geographical

DistributionType

End Use


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26%

7%

22%9%4%

32%

Daily Crude Consumption

Total North America

Total S. & Cent. America

Total Europe & Eurasia

Total Middle East

Total Africa

Total Asia Pacific


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0

10000

20000

30000

40000

50000

60000

70000

80000

90000

100000

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Demand vs Supply

Demand supply


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Factors affecting Demand Biofuel and Electric Vehicles

Directly affects Crude use as

Gasoline

Alternative Sources of Electricity

Generation Affect Crude use as a source of fuel


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The Major Players



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The 7 Sisters

Dominated the global petroleum industry from the mid-1940s to the 1970s



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7 sisters emerged as a result of several mergers



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The new 7 sisters



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NOCs increasing clout in the

global industry



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What makes the success oil

firms?Old seven sisters which shrank to four in theindustry consolidation of the 1990s produce about10 per cent of the worlds oil and gas and hold just 3per cent of reserves. Even so, their integrated status

which means they sell not only oil and gas, but alsogasoline, diesel and petrochemicals push theirrevenues notably higher than those of the newcomers

- The Financial Times



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Importance of being vertically

integrated

Technologicaleconomies

Have longerpaths to flowacross,eventuallymanifestingas

competitiveend-products

Barriers toentry

Results inexcess profits

Raises rivals'costs

restricts theexpansion of

competitors

Security ofsupply

Takes chargeof own E&P

Security ofmarkets

Betterprediction ofthe inputprice

Moreprofitable

investmentdecision



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Vertical Integration

Ways to do so:

Enter new market on its own

e.g. a refiner opening a new retail service station

Acquiring firm that is in the secondary market

e.g. a refiner acquiring an existing service station

Entering into a long-term contract with another firm, underwhich the two firms coordinate certain aspects of their behavior

e.g. a refiner entering into an exclusive dealing contract with a retailer, whoagrees to purchase all of the retailer's gasoline from that refiner



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Introducing..The Independent Oil Traders


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Independent physical oil

traders

Physical traders that are mainly involved in

mid/downstream activities

Trend: more are starting to own upstream assets



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Overall Competitive Landscape

Key buyers: Oil refiners, petrochemical companies,independent traders

Key Suppliers: Oil exploration and production equipmentand services companies

Crude: most actively traded

commodity

Large conglomerates,

highly vertically integrated

EOS is key for successful

entry Highly fluctuating prices

and lack of differentiation

of end- product leads to

high rivalry

Substitutes: alternative

energy. But these involvehigh switching costs

incurred by buyers



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Buyers Power- Moderate

Downstream consumers

insignificant as suppliers

are highly vertically

integrated

Presence of benchmarks

kills buyer power w.r.t

prices

Buyers can switch to better

offers, but most are

restricted by LT contracts

But, Undifferentiated product

Brand loyalty insignificant



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Suppliers Power- Strong

Oil equipment & service

providers

Typically large, huge

bargaining power

But, Supplier power weakened

due to some oil majors

having own services

operations



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A Supplier-Buyer conspiracy?


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Threat of New Entrants- Weak

Complications: possible for

companies to operate in

one or more parts of the

supply chain

Presence of powerful

incumbents investingheavily + Exploration

permits= significant BTE

Usual for incumbents to

buy over small, innovative

firms (e.g. as Exxon did in

2009 when it paid $41bnincluding debt for XTO

Energy)



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Threat of Substitutes- Weak

Differentiated only by

sulfur content and specific

gravity

Petroleum has few

significant substitutes when

it comes to powering

vehicles or for

petrochemicals

With shale development,

threat of alternative fuel

wanes



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Degree of Rivalry - Strong

Diversification downstream

eases competition

But,

Different geographies, but

same business models

High fixed cost, highly

energy and labor intensive

operations:

hard to exit market



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Basis of competition for traders

Ability to unify trading operations and consolidate sources of supply

Better manage and meet customer demand while improving profitmargins

Having well-equipped storage facilities in each region

Ability to manage intricate web of cross-border income tax, valueadded tax (VAT) and customs issues.

Locating strategically

E.g. setting up multiple trading branches in various time zones across theglobe to boost margins with non-stop trading 24 hours a day.

Dynamic supply chain management: to mix and match supplies frommultiple sources, allowing for greater supply chain stability



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Global reach is key

Source: KPMG


North Sea


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Trading StrategiesOptions, Spreads, Arbitrages


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Oil Options

Collars

Buy put Sell call, Long underlying

Capped Swap ( hedging )

Capped floating payments

Multi-Legged Options

Iron Condor, Butterfly etc.



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Oil Options

Collars




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Oil Options

Collars


Capped Swap ( hedging )

Capped floating payments


Iron Condor, Butterfly etc.



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Oil Options


Straddle, Strangle, Iron Condor, Butterfly etc.



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Spreads

Carrying Spreads

Long near-month contract, Short further-month contract

Crude-Product Spreads

3:2:1 Crack Spread


3:2:1 Crack Spread

1 x Heating Oil 3.1*42 per gallon * 42

2 x Gasoline 5*42 per gallon * 42

minus 3 x Crude Oil 95 per barrel

Crack Spread 18.4 per barrel

All numbers for

illustrativepurposes only


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Factors Influencing PricingShort vs. Long Term, WTI-Brent Spread


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Short Term (10-12 months)

Bullish

Chinas expansion, along withemerging nations growth (MIST,BRICS)

Gradual recovery in Europe, reviving

the manufacturing industry

Geo-political risk in the Middle East(Algeria, Iran)

Natural gas, a viable substitute,continues to face significant exportregulations

Gain support from the increase in theequity markets

Bearish

New pipeline capacity lowers the

cost of moving midcontinent

crude oil to the Gulf Coast

refining centers. Worldwide

benchmarks will fall as USrefiners look inwards

Current glut in the markets


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WTI-Brent Spread



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WTI Properties : Sweeter and lighter than Brent,

Why is Brent the global benchmark?

Draws from large pool of resources Benchmark for

Europe, West Africa, Mediterranean

Now South East Asia

Responsiveness to global news

Why does the spread exist?

High inventory build-up at Cushing

Too many entry pipelines, too few exits

Representative of only the North American market

Result? Expect spread to increase with oil inventories at Cushing


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Long Term Present to 2020

Demand

Population and Income

growth

Global GDP Growth

Major consumers like China

Gas and Renewables as

substitutes for oil

Rising Energy Efficiency


Supply

Shale Gas in US, China,

Australia, Brazil

Geopolitical Risk in MENA


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Done by,

Pierre Peh

Yap Rei Horng

Akshat Kukreja

Thank you

Crude Primer

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