Boycott BP! Boycott BP! Boycott BP! (and hurt small businesses instead)

The execs at Goldman-Sachs must be the only people in America hoping that oil will keep pouring from the BP Macondo well off Louisiana indefinitely. After all, up until April 2010, the billionaires on Wall Street were the most detested people in the country for the lavish bonuses they gave themselves just a year after contributing heavily to the destruction of the US economy, not to mention unemployment approaching 10%.

All that’s changed now: the most hated company in the USA is now BP. Big Oil (or as they call it in Texas, “the awl bidness”) has never been a public favorite. Maybe it’s because few (if any) other industries post the price of their products on every street corner; a product that most people buy as regularly as any heroin addict buys that nickel bag. Maybe it’s that so many people are just a little ashamed of their gasoline addiction… Or maybe it’s just that so many people don’t really understand the oil business.

That last is probably why almost every time an oil company incurs public ire, somebody decides it’s time to boycott their brand of gasoline. The cries of “Boycott!” rang out in 1989 after the Exxon Valdez ran aground in Prince WIlliam Sound, Alaska. When gasoline prices topped $4.00 per gallon in 2008, the same folks suggested that we all “boycott big oil." Presumably everyone would buy gas from “little oil” – whoever that is - instead.

Oil Industry Basics: Refineries and Refining

Basics of the Petroleum Industry V: A Simple Look at Refineries and Refining Costs...

If you’ve been following along, you’ve learned some basics about where oil comes from, how large accumulations of oil form, and how oil companies find those accumulations. Last time out, we looked at the economic realities of the oil business; how companies need to factor in not only the costs of finding new oil (finding costs), but also of getting it out of the ground (producing costs), and getting it to market (transportation costs). That’s only part one of the process, though, because there is almost no use for oil in its raw state. Crude oil, oil that’s just as it comes out of the ground, is highly variable in both chemistry and composition; but almost every use for petroleum products requires that the product fall within a narrow range of compositions. You think “Oil is just oil”? Well, no: oil is composed of lots of things, which is one reason why it’s proven so versatile over the last century or so.

Crude oil is made up mostly of two elements: hydrogen and carbon, which is why we call oil a hydrocarbon. Those two elements can combine in a great many different physical arrangements, and each of those arrangements forms a different kind of hydrocarbon molecule. You may be familiar with some of these molecules already; molecules with names like methane, propane, butane, and octane. Hydrocarbons have unusual physical properties that allow complex molecules to join with other complex molecules to form  even more complex hydrocarbons. There are hundreds of different molecules in nature, and even more among the vast number of man-made molecules that we lump together under the term "plastics." Crude oil also contains other elements in different amounts; among them oxygen, nitrogen, sulphur, and trace amounts of many metals.

Produced crudes are composed of many slightly different hydrocarbons, mixed together in different proportions. How much of which hydrocarbons are present in a given crude oil is a result of many variables. Among them are things like the original source material that was “cooked” into crude oil, the length of time the oil spent in the cooking pot, how high the temperature was, and the chemistry of the water with which the crude oil was mixed in its reservoir. If the field from which the crude comes is fairly shallow, bacteria can also have consumed some of the lighter hydrocarbon molecules over the millennia, leaving behind oil made heavier by the process of biodegredation.

Hydrocarbons are usually separated into light and heavy classes. The higher the ratio of hydrogen atoms to carbon atoms gets in a given molecule, the lighter the hydrocarbon. Methane (a gas), is the simplest and lightest hydrocarbon: it has four hydrogen atoms and one carbon atom. Heavy hydrocarbons are those with a low ratio of hydrogen to carbon atoms. Heavy hydrocarbons include the asphaltenes, which have only about 1.2 hydrogen atoms for every carbon atom. Crude oils are also classified as light or heavy, depending in part on which hydrocarbon molecules are most common. When we hear reports about the price per barrel of oil, the price quoted is usually for the best-quality oils: so-called light, sweet crude. Light hydrocarbon molecules tend to produce more energy than heavy hydrocarbons when they’re burned, and since the majority of crude oil is turned into jet fuel, gasoline, diesel, and heating oil; light crude tends to be in high demand. “Sweet,” by the way, means that the crude contains less than 0.5% sulfur – sour oil, which has more sulfur (usually in the form of hydrogen sulfide) needs more processing steps to make fuel.

The process of turning crude oil into the many different petroleum products used in our society is called refining. Refineries are industrial sites where many different processes are used to separate out individual hydrocarbons or groups of hydrocarbons. The world’s largest refinery, Paranaguá, is operated by the Venezuelan national oil company Petreleos de Venezuala, S. A. (Pedevesa). Actually a complex of three refineries, Paraguaná can process almost a million (940 thousand) barrels of crude per day (a barrel is 42 US gallons, about 1.6 cubic meters). The largest refinery in the USA is ExxonMobil’s complex in Baytown, Texas, which has a maximum capacity of 570 thousand barrels/day. Refineries usually cover large land areas, often several square miles. Most refineries are in or near areas where oil is produced, although many near the Gulf Coast of the United States process crude oil shipped in tankers from overseas. Refinery complexes are notable for their enormous, tangled masses of pipes of many sizes that come together to create towers and other strange arrays; for having few buildings for their large footprint; and for often having an open flame, or “flare,” atop one or several towers. In addition to separating out the various hydrocarbons, refineries also remove other impurities from the oil.

Many processes are used to separate the different hydrocarbon molecules from each other. An atmospheric distillation unit simply allows molecules of gas (methane, for instance) to bubble out of the oil; the gaseous portions are siphoned off at this point. Some of the gas may be flared (burned), but this product is commonly piped elsewhere in the refinery complex to be used as fuel for later steps. The liquid portion continues into giant furnaces, where batches of crude are heated. Different liquid hydrocarbons boil at different temperatures, which allows them to be separated from one another by fractional distillation: the boiling crude feeds into tall distillation columns, and light hydrocarbons like butane and propane reach the very top of the column and leave by piping there. The hydrocarbons in gasoline leave the tower lower down; followed by kerosene (principal component of aviation fuel), diesel, and heating oil. The processing is much more complex than this, of course, and even the simplest refining will involve multiple stages of fractional distillation.

Leftover heavy hydrocarbons are also processed further. The lightest remaining fraction can be turned into lubricating oil, such as that in your car’s crankcase, but most of the remaining portion of the crude oil consists of heavy molecules – those with small amounts of hydrogen, which burn poorly and aren’t suitable for fuel. Some of what remains is only suitable for making asphalt and paraffin, but a modern refinery is like a meat-packing plant that “uses everything but the squeal.” Better living through chemistry means that refineries employ several different techniques to “crack” a single heavy hydrocarbon molecule into two or more lighter molecules. These processes require more time and more energy than the first, simple distillation process, and most also require the use of catalysts – substances that speed up chemical reactions. The cracking process can turn heavy hydrocarbons into gasoline or kerosene, even propane. For those crude oils that don’t have large amounts of the lighter hydrocarbons, hydrocracking and catalytic cracking are important in producing the light fractions that can be used to make fuels. Cracking heavy hydrocarbons to make gasoline requires more time and energy than distillation, and also requires the introduction of catalysts. All three factors add to the expense of refining heavy crudes, which explains why light crude has a higher price on the commodities market.

In addition to passing through multiple separation processes and perhaps cracking as well, every drop of crude that enters a refinery also passes through several steps intended to remove metallic and non-metallic impurities. These may be as simple as salt, which comes from water mixed in with the produced oil. Sulfur is a common contaminant, one that must be removed for clean-burning fuels – US refineries generate tens of thousands of tons of sulfur every day. Metal impurities such as nickel, iron, and copper are also removed, though in much smaller quantities than sulfur.

In what seems like a violation of the law of conservation of mass, a forty-two-gallon barrel of oil usually yields fuels, lubricants, and other hydrocarbons that add up to a little less than forty-three gallons of product. The “excess” is a result of the cracking process, which transforms dense molecules into light, less dense hydrocarbons. Even though refineries seem to put out more than they take in, in truth efining crude oil into gasoline is an expensive process, in part because of the large capital investment needed to build a refinery. Energy costs are also substantial, though at least a portion of the energy is generated through combustion of “waste” gases at most sites. Additives such as catalysts are also part of the costs, as is labor and maintenance of tens of thousands of pipes, vessels, towers, and other containers that must be carefully monitored. All told, crude oil’s visit to a refinery adds anywhere from twenty to thirty cents to the price of a gallon of gasoline in the US, according to the United States Energy Information Agency.

This is number five of a series of minilectures on the oil industry:

1) Where Does Oil Come From?
2) Where Do Oil Companies Find Oil?
3) How Do Oil Companies Find Oil?
4) The Economics of Petroleum Exploration and Production
5) Refining  <== You are here.  Future installments include:
6) The Economics of Big Oil
7) The Future of Oil

The Economics of The Oil Industry

Basics of the Petroleum Industry IV: It costs a lot to produce oil

OK, so far, we’ve talked about how oil forms, how it accumulates in fields, and how scientists look for new oil fields. Everything we’ve looked at so far has been about science or technology, and how the nerdy guys and gals who work for oil companies use their high-tech toys to help find new fields. At one time, oil companies were the world’s leading users of technology; and they’re still close to the top. We’re talking about more than numbers of computers and amounts of memory and data storage; we’re also talking about software. One high-end software program widely used by large oil companies has a list price of a quarter of a million dollars – for every one-seat license – and the big multinationals have paid for hundreds of licenses and training so their staff can run these highly complex programs. And computers, software, and training are just a tiny part of the cost of finding new oil…

This time, let’s take a look at the economics of the petroleum industry. That gallon of gasoline you burned on your way to work this morning has had a long journey. Let’s ignore for now the minor miracle that had to happen for oil to accumulate in the first place and concentrate on what it costs along the way to get that stuff out of the ground and into your gas tank.

Step 1: Finding the oil

The business calls this “finding costs,” the expense of searching for oil fields. It might seem simpler to just take a drill and go out and stick a new hole in the ground every couple of miles, but the cost of doing that would be astronomical – not to mention that you might miss the good stuff (and you’d never be certain that you hadn’t stopped drilling a foot or two too soon). So companies work hard to reduce risk so they only have to drill one – or maybe two or three – exploration wells to find out if a prospective site has oil or not. To do this, highly-trained geoscientists make educated guesses about the area using data from nearby wells; and they also use seismic surveys. Now we’re talking about money: a seismic survey of an area will cost hundreds of thousands to several million dollars depending on the size of the survey and the difficulty of getting the data. Those billions of digital records must be processed and reprocessed with highly technical software, and then they’re loaded into high-end computers running expensive software. All that to just look for a prospective location…

We’ll skip the details and cut to the chase: an oil company has determined that there is a sufficient probability of a sufficient amount of oil that they’re willing to take the risk and drill. Before they can do that, however, they have to get permission to drill in the form of a lease. Companies pay for the right to lease land, either from individuals or governments, and also promise to pay part of the profits from any oil that’s produced from that property. Those payments are called royalties, and range from 10% of the sale price of oil up to more than half the proceeds in some foreign countries. The company must also pay to prepare the site if it’s on land, and usually pay for a permit to drill. The up-front investment to drill a well – including salaries for the exploration department – can be, shall we say, “substantial.” Exploration budgets for large companies are typically on the order of hundreds of millions to billions of dollars. Companies spend millions of dollars just picking a place to drill – and then the real money comes into play. Drilling a shallow well on land, perhaps 2500 feet deep, costs on the order of $75-100,000. Offshore exploration costs are far higher, and increase rapidly as the well gets deeper. A recent discovery in 4000 feet of water in the Gulf of Mexico is estimated to have cost a quarter of a billion dollars to drill!

Obviously, if oil sells for $50 per barrel and it costs $55 per barrel just to find it, the company is not going to make any money – that’s one reason why company projections of changing oil prices have to be taken into account just like company guesses at the size of the oilfield.

Step 2: Producing the oil

Let’s say you drilled yourself a gusher. Whoopee! But except for what returned to the surface from that one well, everything else is still deep underground. The physics of fluids like oil and water just don’t allow you to pump all the oil out of one hole, so you need to drill more wells to produce what’s down there. If you’re on land, you could just drive the drill rig to another spot and poke another hole, but if you’re in water, you will have to build an offshore platform and drill several wells to out at an angle. Each of those wells also costs a bundle, and the offshore platform could easily cost hundreds of millions of dollars. That’s all before you pump a single drop of oil into a tanker. If you’re on land, you still need to move the oil from all the individual wells (sometimes hundreds or even thousands of them) to central collection points so that the oil can be piped or trucked to market. There is a lot of money tied up in all the infrastructure, maintaining it, and the personnel needed to keep it operating. That’s a big part of “producing” or “lifting costs.”

But wait, there’s more: there’s also water produced along with the oil, more and more of it as the field ages. The water has to be separated from the oil and disposed of – usually by pumping it back into the reservoir, since it can’t just be poured out on the ground or dumped in a river because it’s salty. More expense…

Remember that we learned some time ago that oil doesn’t collect in underground streams and lakes, but is stored in the tiny pore spaces between grains of rock? That has an important side effect: most of the oil would rather stay clinging to its grains of sand than flow to a well. Companies use all sort of tricks to break that hold: pumping in lots of water, pumping in natural gas, even pumping in carbon dioxide in an effort to”re-energize” the oil and get it moving. Guess what: more expense! and there’s one truth that every oil company scientist and engineer knows: you can never get all the oil out of a field – you’re lucky when you can get half of it.

Step 3: Moving the oil to market

Though it’s not as expensive as finding or producing the oil, getting it to market also has its associated costs. You can’t drive a couple of tank trucks up to a field that produced hundreds of thousands of barrels of oil per day; that would eat up all your profits. So when a company finds a new field, transportation costs are another factor. Building a pipeline big enough to transport that volume of product costs hundreds of thousands of dollars for every mile of pipe. If you can’t get the oil to a refinery or a terminal to sell it, then producing it does you no good!

The bottom line:

Every drop of oil that a company like Shell or Conoco-Phillips sells has all of those costs, and more, associated with it. Just finding oil can cost a bundle, and that’s only the beginning: getting it out of the ground costs even more, and a company is still not done paying to produce oil until it finally reaches a buyer. It is possible – in fact happens frequently – to strike oil but determine that there isn’t enough in the reservoir or it’s not of good enough quality to pay for pumping it out of the ground. When this happens, the find is called “uneconomic.” Obviously, if prices increase faster than producing costs and transportation costs, a find can become economic sometime later.

A company will not drill a well unless they believe that there is enough oil at the site to pay back every one of the costs and have some left over for profit – without profit, they can’t drill the next well. This explains the so-called “obscene profits” that oil companies rake in when the price of oil hits $140 per barrel. Their experts forecast that they would make a reasonable profit at a price of $50 or $70 per barrel, and when the market started paying more, the extra dollars become pure profit. This is no different from a farmer who plants soybeans expecting to make $7 per bushel; except that if he gets $10 instead, no one talks about his “obscene profits.” Oil companies and farmers have the same downside as every commodity producer, because they don’t control the prices – their buyers do. So if our hypothetical farmer got paid $6 per bushel instead of the $7 he was expecting, he has a bad year, and the same with oil companies: if they’ve forecast $50 oil and the price drops to $35 (as it did in December, 2008) then they’re losing money.

So there you have it. That gallon of gasoline you bought today did not simply run out of the ground into a handy gas pump, it’s had a arduous journey from the reservoir to the pump – a journey that had costs at every step along the way.

This is the fourth of a series of minilectures on the petroleum industry from the ground up

1) Where Does Oil Come From?
2) Where Do Oil Companies Find Oil?
3) How Do Oil Companies Find Oil?
4) The Economics of Petroleum Exploration and Production <== You are here.  Future installments include:
5) Refining
6) The Economics of Big Oil
7) The Future of Oil