Oil & Gas

From exploration to distribution

Week 1 V03 Actors & Challenges
Arash Farnoosh

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IFPEN - IFP School 2015 / TOTAL SA 2015 / IFP Training 2015

The oil & natural gas chain

First lets look at the industry itself. The industry consists of two principal sectors: upstream
& downstream. Upstream includes the exploration & production of natural resources, while
downstream deals with the transformation of these resources into petroleum products and
their distribution to the final consumers.
Due to economies of scale, this industry encourages the concentration. In simple words, it
fosters the emergence of vertically integrated companies involved in the whole energy
chain. These are some of the largest privately-owned companies in the world, you probably
know the most famous ones such as EXXON MOBIL, BP, TOTAL and SHELL. However, there
are also many companies that focus only on one side of the business, whether upstream or
downstream. These are called independent companies. In the upstream, companies such
as APACHE or TULLOW concentrate their activities only in exploration & production. While
companies such as VALERO, RELIANCE or SUNOCO focus the larger part of their activities on
the downstream side of the business. In parallel, there are also service companies that
provide technical and engineering assistance to oil companies.
Another usual distinction is made between International and National entities, what we call
IOCs and NOCs. IOCs, as previously mentioned are privately owned companies; while NOCs
operate on the behalf of their home government. Yet, it doesnt mean that they cannot
operate beyond their national frontiers.

Challenges in the upstream sector

Now, lets focus on the upstream side. We observe a significant increase of the investment
made in E&P activities. This is mainly due to the fact that the companies, whether national
or international have to sustain their hydrocarbons production. In only 5 years, investment
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IFPEN - IFP School 2015 / TOTAL SA 2015 / IFP Training 2015

costs in E&P have risen by close to 60%. And 2015 should see a new rise in E&P investment
of 5%.
The whole purpose of the upstream activities is to maximize the oil rent, which is the
difference between crude oil price and the technical cost. The technical cost is the sum of
the exploration, development and production costs. Depending on the nature of the
reservoir, it can vary between 20 and 80 dollars per barrel. This cost must be carefully
controlled to maintain the profitability of the business. Using more new technologies,
optimizing cost management and the standardization of equipment and processes, are very
helpful actions towards total cost reduction.

Following E&P activities, crude oil or natural gas is available in its primary form./ Thereafter,
it has to be brought to refineries so as to be processed and transformed into products
adapted to the final consumer needs.
As oil is liquid, it can be transported simply by using the adequate means such as barges, oil
pipelines, trains or trucks. But in the case of natural gas, it is a little bit more complex:
because, for example, you have to use compressors to increase the pressure of the natural
gas inside the pipe so as to reach the final consumers.
The development of liquefied natural gas technology has made the transport of this
commodity more flexible. However, this technology does not decrease considerably the
transportation costs, except for very long distances.

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IFPEN - IFP School 2015 / TOTAL SA 2015 / IFP Training 2015

Economic features of refining

Now that the hydrocarbons have been transported up to the gate of the refinery, lets follow
our journey along the oil & gas chain by going through the details of the downstream side of
the business.
Thanks to various chemical processes, that will be detailed in the following sessions, the
crude is transformed into many products ready for consumption, such as diesel oil and
gasoline which constitute respectively around 30 and 25% of the products. But of course,
there are many other of them, such as jet fuel, naphtha and fuel oil.
The most important economic element to be considered in the refining industry is the socalled refining margin. It is important to distinguish between gross and net margins. The
gross margin is simply equal to the value of the products coming out of the refinery, minus
the cost of crude oil. If you also subtract the variable costs of production from this value,
then you will get the net margin. That is what triggers the profitability of the refining
business.

You can have different margins for different locations, as refining costs diverge from one
region to the other. For example, in the markets where the refiners have access to a lower
cost of crude or lower operational expenses, the margins could become higher.
This is easily observable by looking at the regional evolution of the refining capacities in the
last 30 years. Indeed, since 1980, capacities in China have been multiplied by 7, India by 8
and the Middle East has more than doubled over the same period, whereas they have
decreased by 30% in the European Union and by 27% in Japan.
But remember that the strong growth of demand has also been a decisive factor behind this
shift towards emerging countries.
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IFPEN - IFP School 2015 / TOTAL SA 2015 / IFP Training 2015

Dont forget that not all hydrocarbons will go through refineries. There is also another
significant portion of oil or natural gas that is processed through petrochemical units, in
which we produce day-to-day final products such as plastic bottles, clothes or packaging
materials. Petrochemicals occupy a leading position today in the hydrocarbon industry, but
an even greater one in the history of material progress in the last century. In this MOOC,
there will be one session dedicated entirely to the technical aspects of this industry.
For the time being, just bear in mind that from a strictly economic point of view, the
profitability of petrochemicals is very similar to that of the refining sector. Again we are
talking about the margin, which is the difference between the value of the outgoing product
and the cost of the ingoing feedstock. The higher the margin, the better the coverage of the
costs, and consequently the higher the profitability.

Distribution
We have made the distinction between the upstream and the downstream side of the oil &
natural gas business. But they are two sides of the same coin and their linkage is very strong.
For instance, lets look at the price history of both crude oil and gasoline in the US market
between 2000 and 2014. As you see, both prices follow the same trend and are highly
correlated during the whole period. What makes the difference between the two prices are
the refining gross margin, the marketing & distribution costs, and, of course, taxes
determined by the local regulator where the final product is actually sold.

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IFPEN - IFP School 2015 / TOTAL SA 2015 / IFP Training 2015

This graph highlights very well the impact of the refining and distribution costs, but, above
all, the impact of taxes on the retail price of oil products eventually paid by the final
consumers in different countries. In general, the final consumer price in producing countries
is lower than in other places. However, in some producing countries, such as Norway, due
to the high taxes implemented by the government, the retail price on gasoline and diesel are
among the highest in the world.

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IFPEN - IFP School 2015 / TOTAL SA 2015 / IFP Training 2015

Conclusion
During this session, we have seen that the oil & gas industry is facing both technical and
economic challenges at each stage of the business. In the case of upstream for example, we
saw how both technical innovation and the crude oil price are decisive factors in going
further and further in exploration & production. Similarly, the downstream side of the
business has to walk along the learning curve in order to improve the processes and reduce
costs in transforming the primary commodity into final products with high added-values.
Last, but not the least, this industry is more and more challenged by environmental and
corporate social responsibility issues. Environment is becoming the major topic in the energy
world. The oil & gas industry has to grasp this challenge by proposing the most efficient and
environmentally-friendly ways of production and processes in every step of the chain from
the well to the wheel.

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IFPEN - IFP School 2015 / TOTAL SA 2015 / IFP Training 2015