oil e-course

OIL MODULE COURSE NOTES

WHERE IS OIL FOUND?

While petroleum is widely used, reserves of crude oil are spread unevenly around the world. Saudi Arabia holds a fifth of the world’s oil – and more than six times as much as the Asia-Pacific region. Including Iran, Iraq, the United Arab Emirates, Kuwait and other producers, the Middle East holds nearly 60% of the world’s proved reserves.

Reserves determine a country’s production potential, but production is influenced by other factors.

World’s top-10 oil producers, 2009

Million barrels a day

Country Production

Russia 10.032

Saudi Arabia 9.713

US 7.196

Iran 4.216

China 3.790

Canada 3.212

Mexico 2.979

UAE 2.599

Iraq 2.482

Kuwait 2.481

Source: BP

World’s top-10 oil producers, 2008

Million barrels a day

Country Production

Saudi Arabia 10.846

Russia 9.886

US 6.736

Iran 4.325

China 3.795

Canada 3.238

Mexico 3.157

UAE 2.980

Kuwait 2.784

Venezuela 2.566

Source: BP

Saudi Arabia has by far the largest reserves and an estimated production capacity of 12.5 million barrels a day – more than any other country could produce. However, it was not the biggest producer in 2009, because it reduced its output, in line with Opec’s production policy, in order to support crude-oil prices during the recession. Iraq, with the third-largest oil reserves in the world, did not even feature in the top-10 producer nations in 2008 – war, insurgency and prolonged underinvestment preventing it from realizing its potential. However, it reached ninth position in 2009 and is expected to continue to climb the ranks over the next few years. Venezuela, meanwhile, dropped out of the top-10 in 2009 because of persistent underinvestment in its oil fields.

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OIL’S PLACE IN THE ENERGY MIX

Oil accounts for a third of the primary energy the world uses. Oil is used for heating, power generation and as a feedstock for petrochemicals production. But transportation is the main driver of oil demand growth.

World primary energy demand

Oil demand growth may be dampened by a combination of the following factors:

• Improvements in energy efficiency

• Advances in engine technology

• Biofuels

• Electric vehicles

• Synthetic transportation fuels produced from natural gas and coal

• Government efforts to reduce oil usage by making it more expensive to produce carbon

However, no substitute is yet ready to replace oil at scale, and nothing can yet match it for economic value or for energy density. As a result, oil will still be supplying a similar proportion – perhaps 25% – by 2035 even if ambitious environmental policies are put in place.

In addition, because overall energy demand will increase in parallel with the expanding population (see box), the world will continue to consume large volumes of oil for decades. The International Energy Agency (IEA) estimates that oil demand will amount to between 81 million barrels a day and 107.4 million barrels a day in 2035, compared with the present level of about 87 million barrels a day.

Other Renewables: 0.6%

Biomass & Waste: 10%

Coal: 26.5%

Nuclear: 5.9%

Hydro: 2.2%

Oil: 34.1%

Gas: 20.9%

Source: IEA

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OIL’S PLACE IN THE WORLD ECONOMY

Oil consumption and economic strength are inextricably linked. The biggest oil consumer in the world, the US, is also the world’s biggest economy. The countries with the smallest per capita oil consumption are typically the poorest. When the world’s oil supply threatens to become scarcer, its importance quickly becomes evident (see box).

The links between energy and many other aspects of the economy mean oil prices also have a significant effect on inflation. The price of oil dictates the cost of other forms of energy – including natural gas – and the prices of manufactured goods, which need energy to be made, as well as transportation and services.

The world’s population has roughly doubled in the past 50 years to 6.8 billion and it’s expected to reach 9 billion or more by 2050 – a lot more people wanting heat, light and mobility. In addition, in China and India alone, more than 500 million people will move from a rural to an urban way of life in the next two decades, leading to an increase in per capita energy consumption.

Forecasting oil demand Oil demand will grow over the next two decades. Most, if not all of the growth in oil demand, is expected to come from developing nations, such as China and India; oil demand in the rich countries of the Organisation for Economic Co-operation and Development (OECD) has probably peaked.

But there is considerable uncertainty about the rate of growth. The IEA, for example, forecasts demand will amount to between 81 million and 107.4 million barrels a day by 2035; the final outcome will depend on economic growth, and the success governments have in introducing low-carbon energy sources, such as biofuels, renewables and nuclear power, and energy-efficiency policies. However, it is unlikely demand would ever reach the top end. It would be environmentally undesirable because of its high carbon impact, and would be technically difficult to achieve.

In the IEA’s New Policies Scenario, which takes account of broad policy commitments and plans already announced by countries around the world, oil demand (excluding biofuels) will reach 99 million barrels a day by 2035 – 15 million barrels a day higher than in 2009. All of the growth will come from developing countries, with 57% from China alone, mainly because of rising use of transport fuels. Biofuels will reduce the need for oil for transportation, but only slightly.

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WHAT MOVES THE OIL PRICE?

High prices, in theory, result from a shortage of spare capacity. If supply is struggling to keep ahead of demand, even relatively small disruptions to supplies – or fears of disruptions – can result in higher prices. In the short term, oil demand is inelastic – unable to adjust itself quickly to fluctuations in oil prices. Interruptions could be caused by variety of factors, including oil-producing facilities being temporarily closed down for maintenance, sabotage or bad weather.

Conversely, if there is too much spare capacity and the oil system can easily cope with demand, prices fall.

Prices ultimately dictate future supply. Low prices result in less investment, which causes supply growth to slow down and – eventually – for the balance between supply and demand to tighten, pushing up prices again. High prices, meanwhile, stimulate investment, which can lead to excess supply and an eventual slump in prices.

Other factors affect oil prices. Opec argued that the oil-price spike that occurred in mid-2008 was largely the result of speculation in financial markets. Although it is difficult to prove, the theory is compelling and has become widely accepted: with China and India consuming spare oil to fuel the rapid expansion of their economies, some investors thought oil prices would rise indefinitely; they bought oil futures in order to sell them later at a profit, driving up oil prices in the process – and creating a self-fulfilling prophesy.

In addition, oil prices often rise when the US dollar falls and fall when the dollar strengthens. This happens because a rise in the US dollar on currency markets makes oil more expensive to buy with other currencies; also, buying oil securities has come to be regarded by banks, hedge funds and other investors as a hedge against the falling dollar.

Measuring oil: the barrel.

In 2011, unrest in the Middle East – affecting the production of Libya, an important oil producer – resulted in rapid oil-price inflation. In 2008, oil futures reached almost $150 a barrel, partly as a result of escalating tension between the US and Iran over the latter’s nuclear programme, which gave rise to concerns that Iranian oil sales could be disrupted.

Those events are part of a longer trend. In 1973, Middle Eastern oil producers suspended exports to the countries that supported Israel in the Yom-Kippur War; this prompted a fourfold rise in oil prices and sent the world economy into decline. Similarly, in 1979, the Iranian Revolution led to a drastic drop in exports and a rapid escalation in world oil prices.

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CRUDE-OIL COMPOSITION

Crude oil is mainly made up of chains of carbon and hydrogen atoms, called hydrocarbons; it also contains small amounts of sulphur, nitrogen, oxygen, metals and salts.

In order to become useful, crude oil must be refined into oil products, using a combination of heat, pressure and catalysts.

Oil’s chemical flexibility enables refiners to turn undesirable hydrocarbon combinations into valuable ones. The hydrocarbon compound is the most versatile on the chemical charts – it is able to make an estimated 2.5 million combinations.

TRANSPORTING OIL TO MARKET

At some point on its way to market, oil must pass through a pipeline – to go from the point of production to a consumption centre or to a coastal export point for onward transport by ship. Oil can be transported by pipeline, rail and truck, but most internationally traded crude oil is transported by sea.

Tankers are classified according to their carrying capacity and usually have several separate cargo tanks, enabling them to carry different grades at the same time. Transport costs fluctuate widely, depending on oil supply and demand, and the time of the year, as well as available shipping capacity. Shorter-range product tankers also transport refined petroleum products by sea.

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GRADES OF OIL

Oil varies in quality. Crudes are classified by density, sulphur content and various other measurements established in an analysis called a crude-oil assay.

Lighter, or less dense, crude oils generally contain a greater proportion of higher- value products, such as gasoline – which can be recovered with simple distillation.

When simple distillation is applied to heavier, or denser, crudes, they tend to yield a greater share of lower-value products, such as fuel oil. They generally require additional processing to produce the desired range of products.

A grade – or type – of oil that yields a greater volume of high-value products is usually more expensive than one that yields greater quantities of lower-value products.

The value of a particular crude oil is usually expressed as a premium or discount to a single representative crude oil, a benchmark grade – and reflects the degree of refining that it requires.

Grades are gauged by their specific gravity, according to a scale, calibrated in degrees, developed by the American Petroleum Institute (API). Most values fall between 10° and 70°API gravity. The heavier the oil, the lower the gravity rating; the lighter the oil, the higher the gravity rating (see graphic).

Oil tanker classifications

The carrying capacity of tankers is measured in deadweight tonnes (DWT) – the weight of a ship’s cargo, fuel, stores, passengers and crew, minus the weight of the ship itself.

The biggest tankers are called Ultra Large Crude Carriers, which can carry between 320,000 and 550,000 dwt. They are used for carrying crude oil on long-haul routes from the Persian Gulf to Europe, the US and east Asia, via the Cape of Good Hope or the Strait of Malacca. However, ULCCs are less common than Very Large Crude Carriers (VLCCs), which have a capacity of between 150,000 and 320,000 dwt. Other categories include: Medium Range, Panamax (the maximum size of vessel that can pass through the Panama Canal), Aframax, and Suezmax (the biggest the Suez Canal can accommodate).

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REFINING

Refineries come in many different sizes and configurations, depending on the size of the local market, the types of products needed and the types of feedstocks available for processing.

But they all perform the same basic tasks; distilling crude oil into its various constituent fractions; chemically rearranging low-value configurations of hydorcarbons molecules into high-value combinations to produce a variety of end-products, from hydrocarbon gasoline to Tupperware; and treating those products to meet environmental and other specifications and standards.

Hydrocarbons have a variety of uses, depending on their molecular structure.

For example, molecules used for cooking gas usually have up to four carbons, while gasoline is composed of a longer chain, of up to 12. Lubricants – motor oils, for example – are even longer, with 50 carbons.

Oil containing high levels of sulphur is known as sour crude. Crude with low levels of sulphur is sweet crude. The sourer a crude, the more processing it requires and the less valuable it tends to be.

West Texas Intermediate, the US benchmark, is a premium crude grade. It has a relatively high natural yield of naphtha and gasoline, both of which are desirable, high-value products. Nigeria’s Bonny Light, another premium grade, has a high natural yield of middle distillates. However, almost half of the simple distillation yield from Saudi Arabia’s Arabian Light is a heavy residue that requires further processing.

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FRACTIONAL DISTILLATION

The components of petroleum have different boiling points, so they can be separated by heating the crude and distilling the resulting vapour. First, impurities such as water and salt are removed from the crude. Then it is heated – often by burning fuel oil in a furnace. The vaporised petroleum, heated to about 350°C, is pumped into a fractionating tower or atmospheric pipestill.

As the vapour rises up the tower, it cools down and its components condense back into several distinct liquids, collecting in a series of trays.

The lightest products – liquefied petroleum gas, naphtha and so-called straight-run gasoline – are recovered at the lowest temperatures, collecting near the top of the tower.

Middle distillates – jet fuel, kerosene, diesel and home heating oil – come next. These are followed by the heaviest products, asphalt, lubricants and waxes. Heavy residue from the atmospheric distillation process can also be reprocessed in a vacuum distillation unit, which uses a combination of low pressure and high temperature to make more useful products.

At this stage of the refining process, jet fuel is pretty much ready for use in an aircraft, but most of the products aren’t finished. They are blendstocks or feedstocks for other processes. A combination of further heating, pressure treatment and the use of chemical catalysts break the chemical bonds that link these chains together, reconfiguring them into new combinations to yield a host of desirable products.

A catalytic cracker can handle a number of feedstocks, including heavy gasoil, treated fuel oil and residue from the lubricant treatment plant. Mixing the feedstock with a hot catalyst enables the cracking reaction to take place at a relatively low temperature (about 500°C). The products are then separated in a fractionating column.

Another refining process, reforming, uses heat and pressure in the presence of catalysts to convert naphtha feedstock into higher-octane, gasoline-blending components. The finished products – with marketable octane ratings and specific engine properties – are then stored in tanks on the refinery’s premises, before being loaded onto barges, ships and trucks, or into special pipelines for transportation beyond the refinery gate to market. Sulphur and other unwanted compounds are removed in a hydrotreater.

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OIL PRODUCTSMotor gasoline/petrol: Gasoline is a light hydrocarbon fraction used in internal-combustion engines. It is distilled from crude oil at between 35°C and 215°C. It can include additives such as oxygenates to reduce the amount of carbon monoxide created during combustion, as well as octane enhancers. It can also be mixed with ethanol.

Distillate fuels: This category covers a wide range of products, including diesels for use in car engines, light heating oil and heavy gas-oils, which can be used as a feedstock in petrochemicals plants. Diesel oil is distilled at around 180-380°C. Diesel has overtaken gasoline in the European market: fuel consumption is lower, and the performance of diesel cars is now close to that of gasoline engines.

Jet fuel: Large turbine and turbo jet commercial aeroplanes use kerosene, similar to diesel. This jet fuel needs to satisfy a welter of strict international regulations and usually has a freezing point of lower than -40°C to cope with cold temperatures at high altitude. Aircraft operated by piston engines run on a different fuel – aviation gasoline (avgas). This has a high octane rating and more closely resembles motor gasoline than diesel.

Still gas: Also known as refinery gas, this is a gas, or mixture of gases (methane, ethane and ethylene, for example), produced as a by-product of upgrading heavy petroleum fractions to more valuable, lighter products through distillation, cracking and other methods. It can be used as a refinery fuel or petrochemicals feedstock.

Residual fuel oils: Sometimes known as heavy fuel oils, these are extracted from what is left after the distillate oils and lighter hydrocarbons have been distilled in the refinery. They include oils suitable for powering some types of ships, power plants and heating equipment, as well as for use in various other industrial purposes.

Asphalt and road oil: Also known as bitumen in some regions, asphalt is best known as a road-surfacing material. A sticky semi-solid, it can be found in naturally occurring deposits, but it can also be derived from crude oil, by separation through fractional distillation, usually in a vacuum. It can be made harder by reacting it with oxygen. Road oil is any heavy petroleum oil used as a surface treatment on roads.

Liquefied refinery gas: This is fractionated from refinery or still gases and kept liquid through compression and/or refrigeration. These gases can include ethane, propane, butane, isobutane and their various derivatives.

Petroleum coke: A black solid residue used as a feedstock in coke ovens for the steel industry, for heating, chemicals production and for other purposes. It has high carbon content – around 90-95% – and low ash content, so it burns well. However, it has a high sulphur content, which can create environmental problems. It is obtained by cracking and carbonising petroleum-derived feedstocks, vacuum bottoms (the heavier material produced in vacuum distillation), tar and pitches using processes such as delayed coking and fluid coking.

Liquefied petroleum gas (LPG): LPG is a type of refinery gas, mainly comprising propane. LPG can be used to run vehicles and for domestic cooking and heating in remote areas that lack alternative fuel sources. Or, indeed, firing up your barbecue.

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REFINERY ECONOMICS

Refining is a cyclical business. Gross margins – the value of the products exiting the refinery minus the cost of the crude oil – reflect the sector’s health. In recent years the refining business has spent more time in weak parts of the cycle than strong ones, squeezed by rising operating costs and the need for additional investment to meet higher environmental standards. Aided by sophisticated computer software, refiners aim to run the optimal mix – or slate – of crudes through their refineries.

A refinery’s profitability depends on:

• The type and cost of the crude purchased

• The prevailing price of individual oil products

• The cost of the process that is selected to process the feedstock

• The availability of facilities and technology capable of producing in-demand products

Octane rating

This measures the resistance of fuels such as gasoline to detonation (or knocking) in an engine. The rating is derived from comparisons between a given fuel and a benchmark mixture of iso-octane and heptane. Higher octane ratings are more suitable for higher-performance engines, whose greater compression ratios make the gasoline used more likely to detonate. Gasoline engines work on 95- or 98-octane gasoline.

New flows of crude

Oil from unconventional sources, such as oil sands and oil shale, is becoming more common.

These feedstocks require different refining techniques from those used to process conventional crude oil, adding another layer of cost.

For example, Canada’s oil sands produce bitumen, which must first be upgraded in special units into synthetic oil before it can be refined (synthetic crude oil is called “synthetic”

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DOWNSTREAM: MARKETING AND DISTRIBUTION

Significant infrastructure in the form of roads, ships and products pipelines is required to move end products from the refinery gate to end consumers.

Before being delivered to the customer, however, they are stored in petroleum products depots, intermediary storage centres responsible for supplying a region, from which large volumes of gasoline, diesel and heating oil can be dispensed locally as required.

Road tankers collect fuels – heating oil, gasoline, diesel and aviation fuel – from these depots, delivering them to filling stations, businesses, homes and airlines.

The price of products to end-users are determined by a combination of the crude oil price, industry margin and government taxes.

because it is altered from its naturally occurring state by a chemical process.) The synthetic crude oil can be upgraded – using refinery processes such as distillation, coking, catalytic cracking and hydroprocessing – into a light sweet crude that can be converted into useful petroleum products in a conventional refinery.

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PETROCHEMICALS

More value can be extracted from hydrocarbons by treating petroleum feedstocks in petrochemicals plants to create new products.

The feedstocks – the main ones being naphtha, diesel and butane – are treated in steam crackers, which are usually located in the same place as a refinery. The aim is to break down the molecules under the action of heat to obtain substances such as olefins (a group that includes ethylene and propylene) and aromatics (distinctive smelling chemicals like benzene and toluene).

Storage

Crude oil is not always processed as soon as it arrives at its destination.

Many countries, especially in the developed world, hold strategic stocks of crude oil – in depleted reservoirs, above-ground tanks and tanker ships – and products that allow them to cope with any unexpected shortages of oil.

The level of oil stocks held in different locations around the world (but especially in big markets such as the US and Europe) is an important determinant in the oil price because stored oil serves as a buffer against supply shocks. The higher the stock level, the less the market worries about supply interruptions. The lower the stock level, the more volatile prices tend to become.

Mostly, governments mandate companies to hold minimum volumes of petroleum. Some – including the US, China and Japan – have government-administered emergency oil stocks. The US’ Strategic Petroleum Reserve (SPR), maintained by the Department of Energy, is the world’s biggest, with a capacity of up to 727 million barrels.

IEA countries must hold oil-stock equivalent to 90 days of the previous year’s net imports.

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These in turn provide the foundations for a range of familiar materials, including polyester, vinyl acetate, polystyrene, polyurethane, detergent alcohols, synthetic rubber and many more products.

Petrochemicals production facilities are expensive to build, maintain and run. Like refiners, they must contend with volatility in the prices of the commodities they produce, planning in years when profits are high for times when margins are low.

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BIOFUELS

Biofuels are a growing part of the fuel mix. These can be blended with, or even used instead of, conventional gasoline and diesel.

Many governments, including the EU and the US, have mandated that biofuels account for a minimum percentage of the fuel mix, so oil companies have become adept at acquiring and handling them.

The main biofuels on the market today – so-called first-generation biofuels – are:

• Bioethanol

• Biodiesel

They are made from a variety of raw materials, but are generally derived from crops such as:

• Maize (bioethanol)

• Sugar cane (bioethanol)

• Palm oil (biodiesel)

• Rapeseed (biodiesel)

Limits on biofuels’ market penetration

There are doubts over whether first-generation biofuels make a positive contribution to the environment. In some cases, CO2 savings made by burning biofuels in motor vehicles can be outweighed by the CO2 emitted during the cultivation of the crops, their conversion into fuels and transportation to market. Ethanol has been successful in Brazil, where gasoline has a 25% ethanol blend, but the country has the right climate and enough land to grow large amounts of sugar cane. Few other countries share those natural advantages.

The US, for example, the world’s biggest ethanol producer, uses maize (corn) to produce ethanol, but this is eight times less efficient as a biofuel crop than sugar cane. Ethanol also has a lower energy density than gasoline – about a third less. Biodiesel compares more favourably to conventional refinery diesel in terms of energy content, but it’s a living fuel; store it under the wrong conditions and it will go rancid. That adds another layer of complication – and cost. Ethanol or biodiesel tend to cause starting problems in cold weather, too. And ethanol is corrosive, making it hard to transport.

In addition, land used for growing crops for fuels is land that can’t be used for growing crops for food; so biofuels cultivation presents a threat to food production and may cause inflation in food prices.

There’s hope that second-generation biofuels, such as those produced from algae or biomass, will help mitigate these problems by harnessing crops that grow on land that wouldn’t be suitable for food crops and by converting non-edible parts of plants into energy. But it will be many years before these nascent technologies begin to have a big impact on fuel supply.

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