By: Nana Amoasi VII, IES According to the Congressional Research Service (CRS), measures of economic performance in the refining industry usually begin with the gross margin, referred to as crack spread. The gross refining margin is a simple, first approach to refinery profitability. It is computed as the total revenues from product sales minus the cost of the largest single input in refinery operations, crude oil. For McKinsey, it is the difference between the value of the refined products produced and the cost of the crude oil and other feedstock used to produce them. The other inputs, which are used also, generate costs, which leads to the net margin. The net margin is therefore the gross margin minus petroleum product marketing costs, internal energy costs and other operating costs. Refining margins are thus dependent on input crude oil cost, product slate, and prices of refined products. In this sense, the refining margin is an indicator of the overall profitability of a company’s refining operations. The Canadian Energy Research Institute suggest that refineries must therefore find the sweet spot against a backdrop of changing environmental regulation, changing demand patterns and increased global competition among refiners in order to be profitable. Since refineries have little or no influence over the price of their input or their output, they must rely on operational efficiency for their competitive edge. Efficiency is measured by the ratio of output to inputs, and increases through constant innovation, upgrading and optimization to produce more outputs from fewer inputs—in other words, the refinery’s capacity to maximize gross margin. Examples of operational efficiency includes but not limited to selecting the right crude type to fulfill anticipated product demand, increasing the amount and value of product processed from the crude. Efficiency can also be achieved by reducing production down-time, developing valuable by-products or production inputs out of materials that are typically discarded, operating at a high utilization rate when margins are high and, conversely, reducing production and buying product from third parties when margins are low. In brief, key factors such as crude type, refining capacity, capacity utilization rates, and complexity (configuration) have been identified as ultimately influencing the profitability of refineries, aside supply, demand, location et cetera. Crude Type There are many different kinds of crude oil. Crude oil can be of lighter or heavier density, as well as having a higher or lower sulfur content. Heavy grades with higher Sulphur content (termed as sour crudes) have a higher proportion of heavier hydrocarbons composed of longer carbon chains, and are cheaper and increasingly plentiful, but more expensive to refine since they require significant investments and have higher processing costs. The lighter crude grades (sweet crudes) require less upgrading at the refinery because they have a lower sulfur content. The density of the crude oil is important because, in general, a lighter crude oil input yields a lighter product mix. A lighter product mix is important because lighter products are generally in higher demand, and yield higher prices for the refiner. The crude oil market compensates for differences in the quality between light and heavy crude oils by a price differential, the light-heavy price spread. At any given time, the actual, specific spread value for any set of crude oils is also influenced by relative availability on the world market as well as the location of the oil. However, this light-heavy spread does not fully compensate for the lower cost of refining lighter crude. Since the cost of crude oil is a refinery’s largest input cost, processing cheaper heavy crude into higher-value lighter products usually improves profit margins, if the refinery has the configuration to do that. The choice a particular grade of crude may not necessarily be anchored on the cost, because each crude grade yields a different array of refined products, each of which has a different price that also varies by region. Refining Capacity This refers to the given capacity of total crude charge input, which a refinery is built to handle before the crude is converted into other consumable products. The facility size does matter, as it creates an opportunity to spread fixed costs (e.g. maintenance, labour, insurance, administration, currency depreciation) over many barrels. Facilities with larger refining capacity (size) are more efficient, better able to withstand cyclical swings in business activity and spreads fixed costs over a larger number of produced barrels. The global refinery capacity for crude oil has been steadily increasing since 1970. As of 2019, the total global refining capacity for crude oil was some 101.3 million barrels per day (bpd). The United States had the world’s largest oil refinery capacity as of 2019, at 18.97 million barrels per day. The U.S. have consistently maintained the largest oil refinery capacity of any nation worldwide. Aside the United State, most refineries in the Middle East, Canada, Asia, and Europe are typically large in size, ranging from 100,000 bpd to 1.2 million bpd, and capable of producing high quality products at much lesser prices, relative to the refining capacities recorded in sub-Saharan Africa (SSA) which ranges between 10,000 bpd and 210,000 bpd. Utilization Rate Utilization rates shows the extent to which the installed refining capacity is used to refine crude oil. It is the relationship between the actual output produced with the installed refining capacity, and the potential output, which could be produced with it, if capacity was fully utilized. Compared to refineries in Asia, Middle East, Europe, Canada, the United States, and the North Africa that recorded a utilization rate of between 73 percent and 91 percent in 2017, SSA overall capacity utilization rate averaged 49.5 percent; down from 54.2 percent in 2016 due to erratic and unpredictable operations. Whereas refinery operation rates remain higher in Eastern and Southern Africa (ESA) and North Africa (NA), West and Central Africa (WCA) generally experienced much lower operation rates. Cote d’Ivoire, Chad, Niger, Gabon, Angola, Cameroun, and Congo refineries operated between 56 percent and 88 percent in 2017. The three State refineries in Nigeria utilized just between 14 percent and 24 percent of capacity; with Ghana operating under 2 percent of capacity, as found by CITAC Africa in 2018. Higher refining capacity utilization rates are necessary because they results in higher production of refined products over a given period, and directly influences the revenues of refining segments. Since the refinery business involves high fixed costs, higher capacity utilization rates remains a key factor that drives profitability. Generally, a sustained 95 percent utilization rate is considered optimal as rates above that drives costs to rise due to process bottlenecks. Too high a utilization rate however increase potential system unreliability due to stress, damage, and difficulty in scheduling down time for maintenance, repairs, and investment activities. A rate below 9 percent suggests either that some units are down for planned or unplanned repairs or that production was reduced following a drop in profit margins or demand. Complexity A simple refinery (“topping” refinery) is essentially limited to basic crude oil distillation; for separating the crude oils into refined products, but not meant to modify its natural yield patterns. A hydro-skimming refinery is also quite simple, and is mostly limited to processing light sweet crude into gasoline, and not heavy oil. It allows for meeting Sulphur specifications, but unable to modify the natural yield patterns of the crudes. By contrast, a complex refinery entails expensive secondary upgrading units such as catalytic crackers, hydro-crackers and fluid cokers to modify and improve the natural yield patterns of crudes. These refineries are configured to process a wider range of crude oil types, treat residual oils and converts them to lighter products, process bitumen from oil sands, adjust to changing markets and local fuel specifications, have a high capacity to crack and coke crude ‘bottoms’ into high-value products, and removes Sulphur to meet environmental requirements. The complexity influences the input cost, the unit output, and the revenue stream; thus impacting the profitability of a refinery, as a highly-complexed refinery is associated with lower costs than a low-complexity refinery because it can process cheaper crude oil. Additionally, highly complex facilities produces more of light fuels such as Naphtha, Jet fuel, Gasoline, and gases which are more expensive than heavier fuels. In other words, complex and flexible refineries generates cost savings by taking advantages of the price differences between heavy and light crude oils, and more valuable light products. And a refinery’s capability to adjust its product yields to meet changes in demand has a huge impact on its profitability. The most advantageous market position for a complex refinery that has invested in the capability to produce a light product mix from a heavy crude input is a large price spread between light and heavy crude and a similarly large spread between light and heavy products. In that environment, similar to that observed in 2005, a refiner can buy heavy crude to minimize direct input costs and sell a light product mix at relatively high prices to enhance the gross margin per barrel. Most U.S. refineries, just like the most recent refineries elsewhere (Asia, Middle East, South America) are already conversion or deep conversion refineries. However, this is not the case for existing refineries in SSA, which are mostly topping, and hydro-skimming types. Written by Paa Kwasi Anamua Sakyi (aka Nana Amoasi VII), Institute for Energy Security (IES) ©2020 Email: [email protected] The writer has over 23 years of experience in the technical and management areas of Oil and Gas Management, Banking and Finance, and Mechanical Engineering; working in both the Gold Mining and Oil sector. He is currently working as an Oil Trader, Consultant, and Policy Analyst in the global energy sector. He serves as a resource to many global energy research firms, including Argus Media and CNBC Africa