Lecture Notes 1: Structure of the Oil and Gas Industry PDF

Lecture Notes 1: Structure of the Oil and Gas Industry Dr. Jonathan Atuquaye Quaye Department of Petroleum Engineering College of Engineering KNUST, Kumasi. Email: [email protected]  Structure of the Oil and Gas Industry  In this lecture, the structure of the oil and gas industry i...

Lecture Notes 1: Structure of the Oil and Gas Industry Dr. Jonathan Atuquaye Quaye Department of Petroleum Engineering College of Engineering KNUST, Kumasi. Email: [email protected]  Structure of the Oil and Gas Industry  In this lecture, the structure of the oil and gas industry is analyzed, showing the oil and gas industry moving from exploration and  development through production, transportation to crude oil refining and processing, then marketing. Historical reviews of the involved  market structures and pricing mechanisms are provided to show how prices are arrived at in this complex industry.  The main stages in oil are exploration and development, production, refining, transportation, and marketing. Structure of the Oil and Gas Industry Petroleum industry stages from exploration to marketing.  Structure of the Oil and Gas Industry  Exploration and Development  Exploration for oil and gas begins with several kinds of geological and geophysical surveys.  Seismic surveys have turned out to be the most useful.  However, exploration and reservoir development remain a challenging stage in the petroleum industry in terms of economics and technology.  This stage requires more integrated seismic programs, advanced data analysis systems, and sophisticated operational techniques.  Structure of the Oil and Gas Industry  Examples of new technologies in exploration and production (E&P) are 3-D and 4-D seismic imaging, basin modeling, remote sensing integration,  and slim-hole drilling. These technical improvements are aimed at reducing the costs of E&P and increasing efficiency with less  environmental impact. Drilling a test well is the necessary next step, to ensure the presence of oil.  Drilling is a very expensive operation. The table gives the capital and exploration expenditures by major oil companies in 1980, 1985, 1990, 1995, 2000, 2005, and 2010.  Structure of the Oil and Gas Industry OPEC Annual Statistical Bulletin, Vienna, 2012 (based on oil companies’ annual reports).  Structure of the Oil and Gas Industry Note: BP and Amoco merged to create BP Amoco in December 1995 (name changed to BP in 2002).  Exxon and Mobil merged to create ExxonMobil in November 1999. Total/Fina and Elf Agvitane merged to TotalFina Elf in February 2000 (name changed to Total in May 2003). Chevron and Texaco merged to Chevron Texaco in October 2001 (name changed to Chevron in May 2005).  Structure of the Oil and Gas Industry  The cost of exploration and production by major oil companies has increased over the last three decades by more than 400 percent.  This is due mainly to expansion of the oil exploration and production activities beyond the traditional areas to new regions such as Africa and  Asia Pacific. In addition to the monopolistic nature of the oil industry, capital and exploration expenditure has increased as a result of the high  price of new technologies and the shortage of skilled human resources.  Structure of the Oil and Gas Industry  Its cost per well drilled was estimated to be $2 million in 2006, while the cost in  Western Europe is almost 10 times higher because of offshore drilling. One of the reasons drilling is expensive is that in addition to drilling a  test well, more confirmation wells have to be drilled near the discovery well to confirm the amount of oil present.  Structure of the Oil and Gas Industry  From a market structure point of view, oil prices are directly related to the cost of exploration and development.  However, rising oil prices since the 1970s stimulated more investment in exploration, even in relatively high-cost areas such as the North Sea and Alaska.  The number of wells has increased by 30 percent over the period 1980 to 2010. However, as oil prices decline, the total number of exploratory well completions begins to fall. (why?)  Structure of the Oil and Gas Industry  Production  It is hard to separate production from exploration and development from the operating point of view as well as from the point of view of cost  structure. Normally for new fields, oil comes to the surface by natural drilling force as long as the well’s surface pressure is less than the  pressure in the reservoir. The source of this self-driving force is water or gas that is contained in the reservoir, or both.  However, this natural flow will decline as the well gets older and cumulative production increases.  Structure of the Oil and Gas Industry  Thus, secondary recovery methods such as water and gas injections and late tertiary recovery are applied.  The main objective is to maximize utilization of the oil reservoir. More advanced techniques have been applied in planning oil extraction, such  as 3-D visualization modeling. Enhanced oil recovery (EOR) has become a challenging task in order to increase oil recovery rate and reduce trapped hydrocarbons in the reservoir. Structure of the Oil and Gas Industry Typical oil and gas production.  Structure of the Oil and Gas Industry  The production process starts from the well head to metering, storage, and export through gathering,  separation, and gas compression, including several facilities in addition to the utility systems of providing water, air, and energy.  Oil pricing should, in principle, be determined by the relationship of oil supply and demand.  Given the curve of demand, the supply curve will be drawn based on production cost.  The exploration and development stage is part of the overall production operation in the oil industry.  Structure of the Oil and Gas Industry  Thus, production has large fixed costs (FCs), which are mainly the costs of exploration and development, and variable costs (VCs), which are mainly  operating costs. In the oil industry, variable costs tend to be much lower than fixed costs.  This would imply that long-run average total cost (LATC; average cost per unit of output over the long run) declines with increasing production.  This characterizes “natural monopoly” industries, and is true for the giant oil fields such as those of the Middle East.  Structure of the Oil and Gas Industry  In the oil industry, cost structure alone does not determine market structure.  Market size and government policies are important. There are also a number of small fields that tend to have higher operating costs and cause  LATC to rise. Given the demand, and assuming perfect competition, a simple model of the world oil market in the short run can be presented  when the world oil supply is drawn as the upper part of a marginal cost curve above the Average Variable Cost (AVC), as shown in the next figure.  Structure of the Oil and Gas Industry  The intersection of this supply curve with the demand curve will give the equilibrium market oil price (P) and quantity (Q). Structure of the Oil and Gas Industry A static model of the world oil market.  Structure of the Oil and Gas Industry  Refining  Refining is a series of physical and chemical processes that convert crude oil into many finished oil products.  The number of operating refineries in different parts of the world has increased in total from 646 in 1989 to 700 in 2008 refineries located in  120 countries over the last decade. The oil industry, including refining, used to be controlled by the major oil companies.  This structure, however, has changed since the 1970s when oil-producing countries took over most oil operations except refining, which is still  Structure of the Oil and Gas Industry  Generally under the oil companies’ control or as joint ventures with national oil companies.  Most of the world refineries operate on average at about 85 percent of refined capacity.  This may sound high, but in fact indicates a problem of excess capacity, which has tended to prevent oil producers from increasing their refining  capacities or building new refineries.  Structure of the Oil and Gas Industry Distribution of refining capacity by region (million barrels/day) as of the end of 2011.  Structure of the Oil and Gas Industry  During the 1980s and 1990s, the excess capacity was clearly high; a result of the drop in world oil demand to less than 55 million barrels per day in the mid-1980s.  This caused some refineries to close, but with recent growth in oil demand, capacity utilization increased and ultimately the refining margin improved.