Oil 101 - Introduction to Supply and Trading
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Oil 101 - A Free Introduction to Oil and Gas Introduction to Supply, Trading, Transportation This Supply, Trading, and Transportation (S&T) overview includes discussions on What is S&T, what are some of the major risks associated with trading, and some historical perspective on the evolution of S&T. The complete S&T Module includes lessons on crude oil and products supply fundamentals, derivative contracts and exchanges, as well as key business drivers in physical trading and financial hedging. Natural gas trading is beyond our scope though it has a similar commercial function, closely tied to the utility and power consumer market. What is Supply and Trading? To help answer that question, let’s look briefly at how Chevron defines S&T on their website. “Chevron Supply and Trading (S&T) provides a critical link between the market and Chevron's upstream, downstream and chemicals companies. S&T provides commercial support to Chevron's crude oil and natural gas production operations as well as to the company's refining and marketing network.”
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Oil 101 - Introduction to Supply and Trading
- 1. EKTINTERACTIVE.COM INTRODUCTION TO SUPPLY & TRADING OIL 101
- 2. EKTINTERACTIVE.COM This Intro to Supply & Trading overview includes: What is S&T Major Trade Risks Historical Perspective S U P P L Y & T R A D I N G
- 3. EKTINTERACTIVE.COM Complete Supply &Trading Module includes: Crude Oil and Product Supply Fundamentals Derivative Contracts and Exchanges Drivers in PhysicalTrading and Financial Hedging Learn More
- 4. EKTINTERACTIVE.COM What is Supply and Trading?
- 5. EKTINTERACTIVE.COM Chevron Defines S&T “Chevron Supply and Trading (S&T) provides a critical link between the market and Chevron's upstream, downstream and chemicals companies. S&T provides commercial support to Chevron's crude oil and natural gas production operations as well as to the company's refining and marketing network.”
- 6. EKTINTERACTIVE.COM Focus On Downstream As Chevron noted, S&T supports many operations within an integrated company.
- 7. EKTINTERACTIVE.COM In Europe, a major oil company may have to manage over 25 different supply networks across the continent. S&T in Europe
- 8. EKTINTERACTIVE.COM Major US Hubs In the US, many S&T functions are organized by the major geographic refining and supply centers, including: • US Gulf Coast • East Coast and New York harbor • West Coast and Alaska • The Midcontinent – Chicago Market
- 9. EKTINTERACTIVE.COM The Role of Logistics Hubs To understand the importance of crude oil and product transport, one must understand the role of logistics hubs.
- 10. EKTINTERACTIVE.COM Gateways of Regional Supply Logistics hubs serve as gateways for regional supply of crude and products. Hubs are at the core of oil markets’ efficiency, providing an ability to quickly respond to changes in supply and demand.
- 11. EKTINTERACTIVE.COM Risk Management in Crude Oil and Product Trading
- 12. EKTINTERACTIVE.COM Transactions in any commodity market come with a variety of risks. The most common risks addressed in crude and products trading are as follows...
- 13. EKTINTERACTIVE.COM Market Risk The risk that a change in market dynamics, especially price, will change the financial position of an oil company or trader.
- 14. EKTINTERACTIVE.COM Basis Risk The risk that the differential between prices of the same commodity in different markets – for example, due to differences in delivery location or delivery time – will affect the financial position of the oil company or trader.
- 15. EKTINTERACTIVE.COM Credit Risk The risk that a counterparty will not perform in accordance with the contract terms, either by failing to deliver the agreed upon commodity or to pay the agreed upon price.
- 16. EKTINTERACTIVE.COM Operational Risk The risk that losses will be incurred due to errors or inadequacies in the multiple systems or processes needed to structure, price, trade and manage physical positions within the Commercial organization.
- 17. EKTINTERACTIVE.COM Liquidity Risk The risk that there is no available counterparty to accept an offsetting position. Then the organization may be saddled with assets or commitments – physical or financial – that it had not intended to keep.
- 18. EKTINTERACTIVE.COM Join now for access to free eBooks, members only forums, and a growing body of digital learning content. Free eBooks include: History of Oil Upstream Fundamentals Midstream Fundamentals Downstream Fundamentals Business Processes/Risk Management Industry Trends Learn More!
- 19. EKTINTERACTIVE.COM Major “Physical” Risks Three major risk factors considered associated with the physical commodity drive decision-making in managing supply & trading of crude oil and products. Volume Ratability Time Price Volatility
- 20. EKTINTERACTIVE.COM Volume Ratability Neither crude oil nor refined products travel through the supply system at a ratable, steady-state speed.
- 21. EKTINTERACTIVE.COM Refineries do not process crude oil at the same rate that the crude arrives. Crude pipelines do not carry crude at the same rate at which crude oil is produced. Product pipeline and marine shipments are not easily matched to demand patterns. Consumers do not use gasoline (or any product) at the same rate at which refineries make it.
- 22. EKTINTERACTIVE.COM Effect Of Time Supply network distances can be enormous, causing time lags in decision making and exposure to market fluctuation.
- 23. EKTINTERACTIVE.COM Crude and products arriving from the Middle East to the US or Europe have already traveled thousands of miles and maybe ship thousands more by pipeline once cargo lands. A Global Supply Chain
- 24. EKTINTERACTIVE.COM Volatility Studies show that oil, natural gas and electricity prices are the most volatile commodity prices.
- 26. EKTINTERACTIVE.COM History of Supply & Trading in Crude and Products Volatility and trading have always been an integral part of the oil business.
- 27. EKTINTERACTIVE.COM Rockefeller’s ‘Cooperation’ JD Rockefeller realized that control of supply was the key to success in the business. His initial focus was “cooperation” (later named monopoly) between refining, transportation and marketing.
- 28. EKTINTERACTIVE.COM A Global Industry Managing supply logistics was also a global challenge from the early days of the industry.
- 29. EKTINTERACTIVE.COM Marcus Samuel – The Shell Oil Company In 1878 the son of a London businessman who traded seashells, named Marcus Samuel, discovered the oil export business.
- 30. EKTINTERACTIVE.COM S&T – Critical To Downstream To this day efficient supply movements of crude and products continue to be the heart of the downstream.
- 31. EKTINTERACTIVE.COM The First Petroleum “Paper” Exchanges By the end of the 19th century, New York hosted a Petroleum Exchange for crude oil futures contracts to allow hedging of supplies.
- 32. EKTINTERACTIVE.COM Financial Hedging Hedging allowed traders to match a paper contract with their physical barrels to offset market and basis risk.
- 33. EKTINTERACTIVE.COM Era Of Instability Another exchange was started in California in the 1930s.
- 34. EKTINTERACTIVE.COM Birth Of The NYMEX In 1978, the New York Mercantile Exchange (NYMEX) launched a heating oil futures contract, followed by a crude oil contract in 1983, which is now one of the most actively traded physical futures contracts in the world.
- 35. EKTINTERACTIVE.COM 24/7 Global Marketplace Crude and products hedging has now matured – with a complex variety of 24/7 global exchanges, brokers, futures contracts and options.
- 36. EKTINTERACTIVE.COM Complex Global Supply Chain Daily decisions of thousands of participants to: • Move crude oils from production to processing • Refine crude into a variety of products for the marketplace • Transport refined products from refineries to consumers
- 37. EKTINTERACTIVE.COM There’s More? This Intro to Supply & Trading material was taken from our free Oil 101: Introduction to Oil & Gas course.
- 38. EKTINTERACTIVE.COM EKT Interactive staff have provided oil and gas training since 1986. Visit us at www.ektinteractive.com to learn more. Who are we?
Editor's Notes
- Hi, and welcome to Oil 101, the podcast. My name is Doug Stetzer and I’m content and community manager for EKT Interactive. Today we will continue drilling deeper into Downstream functions by covering Supply, Trading, and Transportation, often known simply as supply and trading, S&T or the Commercial operation. We’ll be sure to put the links to the Downstream Overview and Introduction to Refining in the program notes. If you want more information about our free Oil 101 “Microbes to Markets” content be sure to visit www.ektinteractive.com.
- This Supply, Trading, and Transportation (S&T) overview includes discussions on What is S&T, what are some of the major risks associated with trading, and some historical perspective on the evolution of S&T.
- The complete S&T module includes lessons on crude oil and product supply fundamentals, derivative contracts and exchanges, as well as key business drivers in physical trading and financial hedging. Natural gas trading is beyond our scope though it has similar commercial function and is closely tied to the utility and power consumer market.
- To help answer that question let’s look briefly at how Chevron defined S&T on their website.
- “Chevron Supply and Trading (S&T) provides a critical link between the market and Chevron's upstream, downstream and chemicals companies. S&T provides commercial support to Chevron's crude oil and natural gas production operations as well as to the company's refining and marketing network.”
- As Chevron noted S&T supports many operations within an integrated company. However, we will focus on downstream S&T decisions that are focused on the supply and logistics network that bring the crude to and take products away from a specific refinery.
- In Europe, a major oil company may have to manage over 25 different supply networks across the continent. Each of these supply networks has a different set of cost drivers that needs to be clearly understood to make the correct day-to-day commercial decisions.
- In the US, many S&T functions are organized by the major geographic refining and supply centers, including: US Gulf Coast East Coast and New York harbor West Coast and Alaska The Midcontinent – Chicago market In major trading houses, namely those without refineries, S&T functions are organized around either bulk terminal assets, pricing points like Cushing in Oklahoma, major pipeline connections or marine supply points.
- To understand the importance of crude oil and product transport, one must understand the role of logistics hubs.
- Logistics hubs serve as gateways for regional supply of crude and products. Hubs are at the core of oil markets’ efficiency, providing an ability to quickly respond to changes in supply and demand. We get into this concept of logistic hub more in the full S&T module.
- Now let’s get into a brief discussion of risk.
- Transactions in any commodity market come with a variety of risks. The most common risks addressed in crude and products trading are as follows...
- First is market risk. The risk that a change in market dynamics, especially price, will change the financial position of an oil company or trader.
- The risk that the differential between prices of the same commodity in different markets – for example, due to differences in delivery location or delivery time – will affect the financial position of the oil company or trader.
- The risk that a counterparty will not perform in accordance with the contract terms, either by failing to deliver the agreed upon commodity or to pay the agreed upon price.
- The risk that losses will be incurred due to errors or inadequacies in the multiple systems or processes needed to structure, price, trade and manage physical positions within the Commercial organization.
- The risk that there is no available counterparty to accept an offsetting position. Then the organization may be saddled with assets or commitments – physical or financial – that it had not intended to keep.
- This episode is brought to you by EKT Interactive’s Oil 101 - a free Introduction to Oil and gas. Our Oil 101 materials are available at www.EKTInteractive.com. Within this free, members-only content area you’ll find eBooks on oil and gas industry fundamentals, relevant articles on key oil and gas topics, and a growing body of digital learning content. Claim your free membership and join the Oil 101 learning community at www.ektinteractive.com today.
- Three major risk factors considered associated with the physical commodity drive decision-making in managing supply & trading of crude oil and products: These risk factors are: Volume ratability Time Price volatility
- Neither crude oil nor refined products travel through the supply system at a ratable, steady-state speed.
- Refineries do not process crude oil at the same rate that the crude arrives. The crude pipelines do not carry crude at the same rate at which crude oil is produced. Nor are product pipeline and marine shipments easily matched to demand patterns. Finally, consumers do not use gasoline (or any product) at the same rate at which refineries make it and you can see how this gets complicated.
- Next is timing. Supply network distances can be enormous, causing time lags in decision making and exposure to market fluctuation.
- Crude and products arriving from the Middle East to the US or Europe have already traveled thousands of miles and maybe ship thousands more by pipeline once cargo lands. For example, a cargo of middle east crude oil takes 23 days to get to Japan and 40 days to get to the US Gulf coast. A pipeline move from the major US gulf coast refineries to the New York Harbor can take 14 days. A lot can happen during these lag times.
- Finally of all commodities whether wheat, sugar, orange juice, gold, copper, platinum or whatever - studies show that oil, natural gas and electricity prices are the most volatile commodity prices. There daily prices are tracked on the Intercontinental Exchange (ICE) or New York Mercantile Exchange (NYMEX) which is now apart of the SME and other global trading exchanges. Numerous industry hedging tools are used to dampen the impact of pipe fluctuation or help mitigate these risk.
- So let’s step back and discuss some relevant history in supply and trading.
- Volatility and trading have always been an integral part of the oil business. In 1859 crude oil was selling for $20 per barrel and two years later for only $0.52 per barrel. Speculators would buy huge quantities of crude after an especially successful wildcat well had made the prices drop, stored in tanks, and wait for the price to rise again.
- JD Rockefeller realized that control of supply was the key to success in the business. His initial focus was “cooperation” (later named monopoly) between refining, transportation and marketing. By 1879, Standard Oil controlled 95% of oil refining in the US. He also purchased plants, warehouses, tanker cars and wagon fleets to make his company totally integrated and self-sufficient.
- Managing supply logistics was also a global challenge from the early days of the industry.
- The rapidly growing emerging economies are now adopting the best of western refining technologies to meet growing demand for their transportation fuels. He extended it to a huge developing market for kerosene for lighting in Japan. He ultimately had one of the first tankers built to move Russian kerosene through the Suez Canal to Asian markets. In the process Shell Oil Company was created. Internationally, Standard Oil competed fiercely with Shell in the 1890’s to also sell its blue kerosene tins, using Singapore as a distribution hub.
- To this day efficient supply movements of crude and products continue to be the heart of the downstream.
- By the end of the 19th century, New York hosted a Petroleum Exchange for crude oil futures contracts to allow hedging of supplies.
- Hedging allowed traders to match a paper contract with their physical barrels to offset market and basis risk.
- Another exchange was started in California in the 1930s. A new era of price instability was initiated with the 1973 Arab oil embargo, and the subsequent nationalization of significant crude oil reserves.
- In 1978, the New York Mercantile Exchange (NYMEX) launched a heating oil futures contract, followed by a crude oil contract in 1983, which is now one of the most actively traded physical futures contracts in the world.
- Crude and products hedging has now matured – with a complex variety of 24/7 global exchanges, brokers, futures contracts and options. They help stabilize the global pricing structure and are considered to be a reliable index for less visible markets for the sell of physical barrels of both crude oil and petroleum products.
- To the outsider the global supply chain is transparent and orderly. The global supply chain is comprised of constant movement and adjustments by the daily decisions of thousands of participants to: Move crude oils from where they are produced to where they are processed Refine crude into a variety of products for the marketplace Transport refined products from refineries to where they are consumed.
- Thanks for listening, and we hope you’ve learned a few things about the supply, trading, and transportation function of downstream oil and gas.
- Be sure to share this as you see fit, and review us on itunes if you have a chance. Your feedback really helps us improve as we move forward. If you want more information about our Oil 101 “Microbes to Markets” content go to www.ektinteractive.com and register to access our free content library. OK. See you next time.