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The Basics Petroleum Economics

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The presentation done under Energy Regulators of East Africa & East Africa Community between 14-18 November 2022. Facilitatotor: Dr. Aloys Rugazia – PowerPoint PPT presentation

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Title: The Basics Petroleum Economics


1
The Basics of Oil Gas Economics
  • Dr Aloys Rugazia (PhD)
  • Email aloys.rugazia_at_afrifalegalconsultants.com

2
Introduction
  • To understand oil economy it is important to
    understand the following basic concepts in the
    energy sector and Market.
  • Energy sources include
  • (i) Solar Energy
  • (ii) Biofuels.
  • (iii) Wind Energy.
  • (iv) Biomass
  • (v) Water and geothermal.

3
  • Solar energy radiant energy emitted by the sun.
  • Solar energy is created by nuclear fusion that
    takes place in the sun. Fusion occurs when
    protons of hydrogen atoms violently collide in
    the suns core and fuse to create a helium atom.
  • Solar energy is constantly flowing away from
    the sun and throughout the solar system. Solar
    energy warms the Earth, causes wind and weather,
    and sustains plant and animal life.

4
  • Solar energy is a renewable resource, and many
    technologies can harvest it directly for use in
    homes, businesses, schools, and hospitals.
    Some solar energy technologies include photovoltai
    c cells and panels, concentrated solar energy,
    and solar architecture.There are different ways
    of capturing solar radiation and converting it
    into usable energy. The methods use either active
    solar energy or passive solar energy.

5
  • Photosynthesis is also responsible for all of
    the fossil fuels on Earth. Scientists estimate
    that about 3 billion years ago, the
    first autotrophs evolved in aquatic
    settings. Sunlight allowed plant life to thrive
    and evolve. After the autotrophs died, they
    decomposed and shifted deeper into the Earth,
    sometimes thousands of meters. This process
    continued for millions of years.Under intense
    pressure and high temperatures, these remains
    became what we know as fossil fuels.
    Microorganisms became petroleum, natural gas, and
    coal.People have developed processes for
    extracting these fossil fuels and using them for
    energy. However, fossil fuels are a nonrenewable
    resource. They take millions of years to form.

6
  • Oil resources are not as extensively distributed
    worldwide as coal, but oil has crucial
    advantages.
  • Fuels produced from oil are more ideal for
    transportation.
  • They are energy-dense, averaging twice the energy
    content of coal, by weight. But more importantly,
    they are liquid rather than solid, allowing the
    development of the internal combustion engine
    that drives transportation today.

7
Different fuels carry different amounts of energy
per unit of weight.  Fossil fuels are more energy
dense than other sources. 
8
  • the British and American navies switched from
    coal to oil prior to World War I, allowing their
    ships to go further than coal-fired German ships
    before refueling.
  • Oil also allowed greater speed at sea and could
    be moved to boilers by pipe instead of manpower,
    both clear advantages.
  • During World War II, the United States produced
    nearly two-thirds of the worlds oil, and its
    steady supply was crucial to the Allied victory.

9
  • Natural gas, a fossil fuel that occurs in gaseous
    form, can be found in underground deposits on its
    own, but is often present underground with oil.
  • Gas produced with oil was often wasted in the
    early days of the oil industry, and an old
    industry saying was that looking for oil and
    finding gas instead was a quick way to get fired.
  • In more recent times, natural gas has become
    valued for its clean, even combustion and its
    usefulness as a feedstock for industrial
    processes.
  • Nonetheless, because it is in a gaseous form, it
    requires specific infrastructure to reach
    customers, and natural gas is still wasted in
    areas where that infrastructure doesnt exist.

10
  • Electricity is not an energy source like coal or
    oil, but a method for delivering and using
    energy.
  • Electricity is very efficient, flexible, clean,
    and quiet at the point of use. Like oil,
    electricitys first use was in lighting, but the
    development of the induction motor allowed
    electricity to be efficiently converted to
    mechanical energy, powering everything from
    industrial processes to household appliances and
    vehicles.
  • the energy system transformed from one in which
    fossil energy was used directly into one in which
    an important portion of fossil fuels are used to
    generate electricity. The proportion used in
    electricity generation varies by fuel.
  • Because oil an energy-dense liquid is so
    fit-for-purpose in transport, little of it goes
    to electricity in contrast, roughly 63 of coal
    produced worldwide is used to generate
    electricity.

11
  • Methods of generating electricity that dont rely
    on fossil fuels, like nuclear and hydroelectric
    generation, are also important parts of the
    system in many areas.
  • However, fossil fuels are still the backbone of
    the electricity system, generating 64 of todays
    global supply.

12
Fossil fuels still dominate global electricity
generation
13
  • Transitions through history has not just been
    about moving away from current solar flows and
    toward fossil fuels. It has also been a constant
    move toward fuels that are more energy-dense and
    convenient to use than the fuels they replaced.
  • Greater energy density means that a smaller
    weight or volume of fuel is needed to do the job.
    Liquid fuels made from oil combine energy density
    with the ability to flow or be moved by pumps, an
    advantage that opened up new technologies,
    especially in transportation. And electricity is
    a very flexible way of consuming energy, useful
    for many applications.

14
  • The advantages of fossil fuels come with a
    devastating downside. We now understand that the
    release of carbon dioxide (CO2) from burning
    fossil fuels is warming our planet faster than
    anything we have seen in the geological record.
  • However, unlike fossil fuels, wind and solar can
    only generate electricity when the wind is
    blowing or the sun is shining. This is an
    engineering challenge, since the power grid
    operates in real time Power is generated and
    consumed simultaneously, with generation varying
    to keep the system in balance.

15
  • Wind turbines and solar photovoltaic (PV) cells
    convert solar energy flows into electricity, in a
    process much more efficient than burning biomass,
    the pre-industrial way of capturing solar energy.
  • Costs for wind and solar PV have been dropping
    rapidly and they are now mainstream,
    cost-effective technologies. Some existing forms
    of generating electricity, mainly nuclear and
    hydroelectricity, also dont result in CO2
    emissions.
  • Combining new renewables with these existing
    sources represents an opportunity to decarbonize
    or eliminate CO2 emissions from the
    electricity sector. Electricity generation is an
    important source of emissions, responsible for
    27 of U.S. greenhouse gas emissions in 2018.
  • However, unlike fossil fuels, wind and solar can
    only generate electricity when the wind is
    blowing or the sun is shining. This is an
    engineering challenge, since the power grid
    operates in real time Power is generated and
    consumed simultaneously, with generation varying
    to keep the system in balance.

16
THE ADVANTAGES OF FOSSIL FUEL OVER OTHER SOURCES
OF ENERGY
  • Industrial processes that need very high heat
    such as the production of steel, cement, and
    glass . The steel blast furnaces operate at about
    1,400 C. These very high temperatures are hard
    to achieve without burning a fuel and are thus
    difficult to power with electricity.
  • Renewable electricity cant solve the emissions
    problem for processes that cant run on
    electricity. For these processes, the world needs
    zero-carbon fuels that mimic the properties of
    fossil fuels energy-dense fuels that can be
    burned.
  • Biofuels also compete for arable land with food
    production and conservation uses, such as for
    recreation or fish and wildlife, which gets more
    challenging as biofuel production increases.
    Fuels made from crop waste or municipal waste can
    be better, in terms of land use and carbon
    emissions, but supply of these wastes is limited
    and the technology needs improvement to be
    cost-effective
  • Another pathway is to convert renewable
    electricity into a combustible fuel. Hydrogen can
    be produced by using renewable electricity to
    split water atoms into their hydrogen and oxygen
    components. The hydrogen could then be burned as
    a zero-carbon fuel, similar to the way natural
    gas is used today.
  • However, when we split water atoms or create
    liquid fuels from scratch, the laws of
    thermodynamics are not in our favor. These
    processes use electricity to, in effect, run the
    combustion process backwards, and thus use large
    amounts of energy. Since these processes would
    use vast amounts of renewable power, they only
    make sense in applications where electricity
    cannot be used directly.

17
Gasoline carries much more energy per unit of
weight than a battery. A gas-powered car with a
12.4-gallon tank carries 77.5 pounds of gasoline
18
  • Carbon capture and storage or use is a final
    possibility for stationary applications like
    heavy industry. Fossil fuels would still be
    burned and create CO2, but it would be captured
    instead of released into the atmosphere.
  • Processes under development envision removing
    CO2 from ambient air. In either case, the
    CO2 would then be injected deep underground or
    used in an industrial process.

19
  • The most common use for captured CO2 today is in
    enhanced oil recovery, where pressurized CO2 is
    injected into an oil reservoir to squeeze out
    more oil.
  • The idea of capturing CO2 and using it to produce
    more fossil fuel seems backwards does that
    really reduce emissions overall?
  • But studies show that the captured CO2 stays in
    the oil reservoir permanently when it is injected
    in this way. And if enough CO2 is injected during
    oil production, it might make up for the
    combustion emissions of the produced oil, or even
    result in overall negative emissions. This wont
    be a panacea for all oil use, but could make oil
    use feasible in those applications, like
    aviation, where it is very hard to replace.

20
  • In addition to the engineering challenges, the
    nature of climate change makes it politically
    challenging to deal with as well.
  • Minimizing the impact of climate change requires
    re-making a multi-trillion-dollar industry that
    lies at the center of the economy and peoples
    lives. 
  • In the wealthy world, current efforts focus on
    reducing the greenhouse gas emissions from our
    energy-intensive lives. But the second part of
    todays energy challenge is providing modern
    energy to the billion people in the developing
    world that dont currently have it. You dont
    hear as much about the second goal in the public
    discourse about climate change, but its crucial
    that developing countries follow a cleaner path
    than the developed world did. The need to provide
    both cleaner energy and more energy for
    developing countries magnifies the challenge, but
    a solution that leaves out the developing world
    is no solution at all.
  • In other words talking of clean oil in Africa is
    like talking about animal rights in the continent.

21
Is Africa ready yet?
22
The Basics of Petroleum Economics in the
Sub-Saharan
  • 6000 years of civilisation, Africa is still
    struggling to light its scantly distributed
    households according to the World Bank as of now
    70 of the Rural population do no have access to
    electricity.
  • Petroleum products are thus used across the
    entire economy in every country.
  • Oil in in particular is used in road transport to
    cater for more than 26 Million cars distributed
    across the continent.

23
  • Adequate and reliable supply of transport
    services of electricity are resultantly essential
    to the economy.
  • Kerosene lights up 70 percent of the households
    that are out of the electricity grid. Kerosene is
    also used in cooking and heating.
  • LPG (Liquified Petroleum Gas) also for cooking
    and heating.
  • Gasoline and diesel for private vehicles as well
    as captive power generation.

24
Oil and Gas What is it?
  • The different between oil and gas is usually
    blurred.
  • Fossil fuels in the liquid state is called oil,
    while those in the gaseous state is called
    natural gas.
  • On the other hand, Liquefied petroleum gas (LPG
    or LP gas) is a fuel gas which contains a
    flammable mixture of hydrocarbon gases,
    specifically propane, propylene, butylene,
    isobutane and n-butane.

25
Oil Prices and the economy
  • Prices users pay for these petroleum products
    have macroeconomic and microeconomic
    consequences.
  • At the macroeconomic level, oil price levels can
    affect the balance of payments
  • gross domestic product (GDP) and,
  • where fuel prices are subsidized, government
    budgets, contingent liabilities, or both.

26
Oil Prices Macro- Economic Level
27
Oil Prices Micro-Economic Level
  • At the microeconomic level, higher oil prices
    lower effective household income in three ways.
  • Households pay more for petroleum products they
    consume directly. Most poor households in
    low-income countries do not own motorized
    vehicles or electricity generators and therefore
    purchase little or no gasoline or diesel many
    people not yet connected to electricity rely on
    kerosene for lighting.
  • Second, higher oil prices increase the prices of
    all other goods that have oil as an intermediate
    input. The most significant among them for the
    poor in many low-income countries is food, on
    which the poor spend a high share of total
    household expendituresoften exceeding 50
    percent. Food prices increase because of higher
    transport costs and higher prices of such inputs
    to agriculture as fertilizers and diesel to
    operate tractors and irrigation pumps.
  • For the urban poor who use public transport,
    higher transport costs also decrease effective
    income.
  • Third, the extent that higher oil prices lower
    GDP growth, household income is reduced.

28
  • Generally, petroleum product prices have
    adversely affected most economies that are not
    large net exporters of oil.
  • Earlier studies showed that the countries most
    vulnerable to oil price shocks are low-income oil
    importing countries, which are disproportionately
    concentrated in Sub-Saharan Africa.

29
Oil Prices Micro-Economic Level
30
Oil Markets in the Sub-Saharan Region
  • All productive sectors of the economy can benefit
    from an efficiently managed downstream petroleum
    sector.
  • High fuel costs increase the operating costs of
    the transport sector, this in a region where
    transport costs are already high for a variety of
    other reasons.
  • In the power sector, a recent publication
    identified more than 30 African countries that
    experience power shortages and regular
    interruptions to service.
  • A common response to the crisis is to resort to
    diesel-based emergency power at least 750
    megawatts of emergency generation are operating
    in Sub- Saharan Africa, which for some countries
    constitute a large proportion of their national
    installed capacity.

31
Market Structure
  • There are two major types of oil markets-
  • Concentrated Market,
  • Unconcentrated Market
  • A standard measure of industrial concentration is
    the Herfindahl-Hirschman index (HHI), which is
    calculated by summing the squared market shares
    of all of the firms in the industry.
  • An industry concentrated if the HHI exceeds
    1,800 it is unconcentrated if the HHI is below
    1,000.

32
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33
Concentration or non concentration of the Market
  • Concentration or non concentration of the market
    answers to the question of fair competition and
    non monopoly of the business
  • Countries with the largest number of operators
    and are the least concentrated.
  • The Niger market is the most concentrated and is
    closely followed by Malawi, Madagascar, Senegal,
    and Botswana.
  • Legislative measures could thus be taken to
    promote open access to the depot capacity in
    Dakar.
  • In countries like Madagascar, Malawi, and South
    Africa, the actual HHIs do not depart
    significantly from the theoretical values
    assuming equal shares by all firms, suggesting
    that the market is fairly evenly shared.

34
Tea Break
35
Oil Pricing
  • As seen earlier the supply chain finally affects
    pricing which the affects the economy.
  • Although, currency is often tied to dollar, what
    is not often said is that oil seems to have
    replaced the role of Gold ( Bretton Woods gold
    standard) in giving value to currency.
  • The explanation for this relationship is based on
    two well-known premises. A barrel of oil is
    priced in U.S. dollars across the world. When the
    U.S. dollar is strong, you need fewer U.S.
    dollars to buy a barrel of oil. When the U.S.
    dollar is weak, the price of oil is higher in
    dollar terms.

36
Us Dollar relationship with Oil
37
  • There is a hidden string that ties currencies to
    crude oil. Price actions in one venue force a
    sympathetic or opposing reaction in the other.
  • This correlation persists for many reasons,
    including resource distribution, the balance of
    trade (BOT), and market psychology.
  • Oil and currencies are inherently related wherein
    price actions in one force a positive or negative
    reaction in the other in countries with
    significant reserves.
  • Countries that buy crude oil and those that
    produce it exchange USD in a system called the
    petrodollar system.
  • The USD has benefited from crude oils
    precipitous decline since the energy sector is a
    significant contributor to U.S. GDP.
  • The U.S. shifted from being a net importer to a
    net exporter of energy in 2020 and was the
    largest global producer in 2021.
  • Countries that depend heavily on crude exports
    experience more economic damage than those with
    more diverse resources.

38
Net Importers of oil
39
Factors Affecting Oil Pricing
  • Crude Oil Price
  • Crude oil prices are determined by global supply
    and demand. Economic growth is one of the biggest
    factors affecting petroleum productand therefore
    crude oildemand.
  • Growing economies increase demand for energy in
    general and especially for transporting goods and
    materials from producers to consumers. The
    worlds transportation sector is almost totally
    dependent on petroleum products such as gasoline
    and diesel fuel.
  • Many countries also rely heavily on petroleum
    fuels for heating, cooking, or generating
    electricity. Petroleum products made from crude
    oil and other hydrocarbon liquids account for
    about a third of total world energy consumption.

40
  • The Organization of the Petroleum Exporting
    Countries (OPEC) can have a significant influence
    on oil prices by setting production targets for
    its members. OPEC includes countries with some of
    the world's largest oil reserves. At the
    beginning of 2020, OPEC members controlled about
    71 of total world proved crude oil reserves
    (plus lease condensate), and they accounted for
    36 of total world crude oil production in 2020.
  • OPEC attempts to manage oil production of its
    member countries by setting crude oil production
    targets, or quotas, for its members. Compliance
    of OPEC members with OPEC quotas is mixed because
    production decisions are ultimately in the hands
    of the individual members.

41
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42
Crude Oil Pricing ctd
  • In general, the main factors determining OPEC's
    effectiveness in influencing oil prices include
  • The extent to which OPEC members actually comply
    with production quotas.
  • The ability or willingness of consumers to reduce
    petroleum consumption
  • The competitiveness of non-OPEC producers when
    oil prices change
  • The efficiency of OPEC producers to supply oil
    compared with non-OPEC producers
  • The difference between oil market demand and
    supply from non-OPEC sources is often referred to
    as the call on OPEC because OPEC members maintain
    the world's entire spare crude oil production
    capacity.
  • Saudi Arabia, the largest OPEC oil producer and
    one of the world's largest oil exporters,
    historically has had the largest share of the
    world's spare oil production capacity.
  • Developing and maintaining idle spare production
    capacity is generally not cost-effective for
    international oil companies (IOC) because the IOC
    business model maximizes revenue by producing oil
    as long as the price of selling the oil is higher
    than the cost of supplying an additional barrel
    of oil to market. OPEC spare capacity provides an
    indicator of the world oil market's ability to
    respond to real and potential disruptions in
    world oil supplies.

43
Causes of world crude oil prices and supply
disruptions
  • Geopolitical events and severe weather that
    disrupt the supply of crude oil and petroleum
    products to market can affect crude oil and
    petroleum product prices. These events may create
    uncertainty about future supply or demand, which
    can lead to higher volatility in prices.
  • Most of the crude oil reserves in the world are
    located in regions that have been prone to
    political upheaval or in regions that have had
    oil production disruptions because of political
    events. Several major oil price shocks have
    occurred at the same time that political events
    caused supply disruptions, most notably the Arab
    Oil Embargo in 197374, the Iranian revolution,
    the Iran-Iraq war in the 1980s, and the Persian
    Gulf War in 199091. In recent years, conflicts
    and political events in the Middle East, the
    Persian Gulf, Libya, and Venezuela have
    contributed to world oil supply disruptions and
    increases in oil prices.

44
  • Given the history of oil supply disruptions
    caused by political events, market participants
    constantly assess the possibility of future
    disruptions. In addition to the size and duration
    of a potential disruption, market participants
    also consider the availability of crude oil
    stocks and the ability of other producers to
    offset a potential supply loss. When spare
    capacity and inventories are low, a potential
    supply disruption may have a greater impact on
    prices than might be expected if only current
    demand and supply were considered.
  • Weather also plays a significant role in the
    supply of crude oil. Hurricanes in the Gulf of
    Mexico can affect oil production and refinery
    operations in the Gulf region. As a result, U.S.
    petroleum product prices may increase sharply as
    supplies from the Gulf to other regions drop.
    Severe cold weather can also strain product
    markets as producers attempt to supply enough
    product, such as heating oil, to consumers in a
    short amount of time. This seasonal demand can
    also result in higher prices.
  • Other events such as refinery outages or pipeline
    problems can also restrict the flow of crude oil
    and petroleum products to market. These events
    can lead to a temporary supply disruption that
    could increase prices.
  • The influence of any of these factors on crude
    oil prices tends to be relatively short lived.
    Once the supply disruption subsides, oil and
    product supply chains adjust, and prices usually
    return to their previous levels.

45
Factors Affecting Pricing in the Downstream
  • Apart from a price of a petroleum product on the
    world market, a number of factors affect end-user
    prices net of tax.
  • Some are under the control of the government to
    varying degrees others are outside the control
    of the government and, in some situations,
    outside the control of any actor in the country.
  • Market size is an important determinant and
    affects end-user prices through various channels.
    Large markets can enjoy economies of scale in
    procurement and supply infrastructure, and
    accommodate enough large actors to create healthy
    and effective competition

46
Market Size algorithm
47
Economy of Scale
  • Economies of scale are particularly important for
    refining. Product demand has been increasingly
    moving away from fuel oil (heavy fuel oil, marine
    fuel (MFO), bunker fuel, furnence oil gas oil
    heating oils, diesel fuel etc) to gasoline,
    kerosene, and diesel, requiring cracking of
    residual fuel oil to white products. At the same
    time, fuel specifications are being tightened
    progressively, in particular requiring so-called
    sulfur-free gasoline and diesel in developed
    countries.
  • Producing white products meeting tight fuel
    specifications requires processing units that
    enjoy large economies of scale.
  • As a basic rule of thumb, a refinery needs to
    have a processing capacity of at least 100,000
    barrels a day (or 5 million tonnes a year) to be
    economic in a liberalized market.
  • This is because it is disproportionately
    expensive to install small cracking units, small
    refineries tend to be hydroskimming
    refinerieshydroskimming refineries have no
    ability to convert residual fuel oil to white
    products and have only the units that raise the
    octane.

48
  • If domestic demand for petroleum products is
    small and much less than the production capacity
    of an economic-scale refinery, as in many
    countries in Sub-Saharan Africa, then a refiner
    is faced with two options build a
    sub-economic-scale refinery to serve primarily
    the domestic market, or build an economic-scale
    refinery and export some or even the bulk of the
    products.
  • A sub-economic-scale refinery is unlikely to be
    able to compete with product imports from large
    and efficiently run refineries. A world-scale
    export refinery can take advantage of economies
    of scale, but will face full international
    competition.
  • If a refinery is processing domestic crude oil,
    it has a potential cost advantage because it does
    not incur the cost of shipping crude or refined
    products. Similarly, a refinery may have access
    to relatively low-cost crude oil if, for example,
    it is a transit country for a crude oil pipeline.
  • However, such cost advantage can be easily offset
    by higher refining costs if the refinery is small.

49
Competition
  • It is not easy to have effective competition in a
    small market, again
  • because of economies of scale in establishing and
    managing supply
  • assets and in fuel procurement. A large market
    can accommodate several actors, all enjoying
    requisite economies of scale, but a small market
  • not necessarily so. This is particularly true for
    product import, refining,
  • and wholesale. The larger the marine tanker
    carrying petroleum products, the lower is the
    unit cost of shipping. This requires two
    conditions first, the volume to be purchased be
    sufficiently large to fill an
  • economic-size tanker, and second, the port be
    capable of handling large
  • tankers. Some small markets have used joint bulk
    import with varying
  • degrees of success. Refining and pipeline
    transport effectively become
  • natural monopolies in small markets. Provided
    minimal scale requirements are metthe requisite
    scale economy is not achieved in many
  • markets in the regionand infrastructure is well
    maintained for longdistance transport over land,
    pipelines offer the lowest-cost option, followed
    by rail, and then road. But pipelines, like
    refineries, require
  • large upfront investment, regular maintenance,
    and a reliable source
  • of power.
  • International experience points to the importance
    of establishing
  • fair, healthy, and transparent competition in the
    downstream petroleum
  • sector. An effective and well-regulated
    competitive market imposes
  • relentless pressure on participants to improve
    efficiency andequally

50
  • importantlyto share the gains with customers. A
    competitive market also reduces opportunities for
    corruption and provides a sound basis for
    attracting new private investment without
    creating contingent liabilities for government. A
    monopoly supplier by definition is not competing,
    although small markets may have natural
    monopolies. Where effective competition is not
    possible, economic regulation is needed.
    Protection provided to domestic refineries
    through import tariffs increases government
    revenue in the short run but, by increasing
    petroleum product prices throughout the economy,
    could hurt economic growth and lower long-term
    government revenue.

51
THE END !
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