The Trading and Price Discovery of Oil Products

Abstract

While crude oil is one of the biggest markets in the world the consumer has little interest in the raw material that comes out of the ground. It is the refined products that can be extracted from the crude oil that the end-user wants to know about. This chapter explains which hydrocarbons are mixed up inside a barrel of crude oil and how the refining process separates, treats and upgrades the composite to extract the usable products needed. It looks at whole crude properties and what these mean for handling and transporting the oil. It defines the different types of refinery processes, from primary distillation to reforming right through to cracking and coking. It describes the range of products that result from refining crude oil and the use to which each product is put.

1 Introduction

It may seem obvious to say that crude oil is, by-and-large,¹ only useful because of the products that can be extracted from it by the refining process. But the knowledge silos that exist in the oil industry often mean that the upstream industry does not know what is happening downstream at the refining end of the supply chain, let alone what retailers are up to at the consumer end.

Fortunately, although historically many crude oil traders were completely divorced from what their refined product trading colleagues were doing, today the division between crude and products trading is less like separate knowledge silos and more like two sides of a louvre door. There is still a division, but more exchange of knowledge and information between the two disciplines.

It is the purpose of this chapter to examine:

• 1. what is crude oil and the range of different types of crude oil that exist;

• 2. the most common types of refinery processes;

• 3. the quality and quantity of different products that can be extracted from crude by refining;

• 4. the purpose to which those refined products are put by the consumer; and

• 5. the inter-relationship between crude oil and refined product prices.

2 Some Very Basic Carbon Chemistry

Crude oil as it comes out of the ground is a complex mixture of hydrocarbons, which as the name suggests are compounds containing, among other things, carbon and hydrogen atoms and some of which contain oxygen. This differentiates them from the carbohydrates, which all contain oxygen atoms, that are more familiar outside the oil industry.

For those who did not pay attention at school, or for whom school is a dim and distant memory, an atom is made up of a positively charged nucleus surrounded by negatively charged electrons. The number of positive charges in the nucleus determines how many electrons are needed to stabilise, or neutralise, the atom. The atom will tend to gain or lose electrons in order to neutralise the charge of its nucleus.

The valence of an element is related to its ability to combine with hydrogen (‘H’), which has a valence of 1, to achieve neutrality. Hydrogen is an atom containing a single positively charged proton in the nucleus orbited by a single negatively charged electron. This electron is available for sharing with other atoms to form compounds.

For example, one oxygen atom combines with two hydrogen atoms to form water and, since the valence of each hydrogen is 1, the valence of oxygen can thus be deduced to be 2. An atom of carbon (‘C’) is capable of combining with up to four other atoms, that is, it has a valence number of 4.

So, one familiar basic hydrocarbon molecule is CH₄, that is, methane. This represents one C, with a valence of 4, combined with 4 H, each with a valence of 1.

But carbon atoms can combine not only with atoms of other elements, like hydrogen, but with other carbon atoms. This means that carbon atoms can form chains and rings onto which other atoms can be attached. Carbon compounds are classified according to how the carbon atoms are arranged and what other groups of atoms are attached.

2.1 PONA

‘PONA’ indicates how these carbon chains or rings are organised in crude oil. It stands for Paraffins, Olefins, Naphthenes and Aromatics. These four types of hydrocarbons will sum to 100%, so the lower the paraffin content, the higher the naphthenes and aromatics. Olefins are not found in crude oil for reasons explained later.

Paraffins, also known as alkanes, are straight (‘normal’) or branch (‘iso-’) chained hydrocarbons ‘saturated’ with hydrogen. In other words, the valence number of 4 of the carbon has been neutralised by the attachment of sufficient 1 valence hydrogen atoms to use up all the valence of the carbon.

Paraffinic material is used in the petrochemical industry for making ethylene and propylene, which are the building blocks to make polythene and polypropylene. Paraffins occur in all crude oils, especially in so-called paraffinic crude in the lightest distilled fractions.

By referring to alkanes, or paraffins, as ‘saturated’ we mean that there are no double or triple bonds between the carbon atoms, that is, the valency is ‘neutralised’ because each 4 valency carbon atom is attached to four other atoms.

Olefins, also known as alkenes, are unsaturated and are made up of hydrocarbons containing carbon double bonds. When there are insufficient hydrogen or other atoms available, the 4 valency of carbon atom is ‘unsatisfied’. The carbon will attempt to acquire a spare electron from another carbon atom. The carbon atoms are depicted as sharing the available short supply of electrons amongst themselves and forming double bonds.

Olefins tend not to occur naturally in hydrocarbons because the double bonds are highly reactive and the olefins are quickly converted to more complex molecules where all the carbon’s appetite for electrons is satisfied.

However, when large carbon molecules are broken up in the refining process, such as in a catalytic or FCC cracker as explained below, olefins tend to be more prevalent, that is, carbon to carbon bonds are broken and valency needs to be satisfied by saturation with hydrogen. If there is insufficient hydrogen available double bonds or even less stable triple carbon bonds (‘alkynes’) will form. For this same reason olefins tend to poison catalysts in catalytic crackers because they are so reactive and build up a residue of molecules on the catalyst surface.

Naphthenes, also known as cyclo-paraffins or C-alkanes, are saturated cyclical chains of more than 4 carbon atoms, such as cyclopentane or cyclohexane, the latter depicted below.

Unsaturated cyclo-alkenes also exist such as cyclopentadiene, depicted below.

That is, cyclopentadiene = C₅H₆

A key specification in the distilled product, naphtha, is its paraffin content compared with olefins, naphthenes and aromatics (‘PONA’), as mentioned above. These four types of hydrocarbons will sum to 100%, so the lower the paraffin content, the higher the naphthenes and aromatics. This will dictate if the naphtha is naphthenic and will go on to a reformer to produce gasoline or is paraffinic and will be used as a petrochemical feedstock.

Aromatics are cyclical unsaturated molecules such as benzene, toluene and xylene.

The simplest aromatic, benzene, is depicted below, represented simply as a carbon ring with a cloud of electrons in the middle shared amongst the six carbons.

Aromatics differ from cyclo-alkenes in that they have an uninterrupted cyclic electron cloud. N+A ring structures are typically used in gasoline production and aromatics are used in making polystyrene, paint, solvents and so on. Right, enough chemistry.

3 The Crude Oil Assay

There are two different kinds of crude oil assay that are used in the oil industry:

• 1. the PVT assay; and

• 2. the refining assay.

PVT stands for pressure, volume and temperature and is an analysis of how the crude oil will flow in the reservoir and the well from which the oil is produced. This is upstream data used by reservoir engineers. Frequently oil field project managers will present their oil traders with a PVT assay and expect the trader to come back with an estimate of the value of their particular crude oil in the market.

Unfortunately, consumers in the market are not interested in the reservoir characteristics of crude oil. They are interested in what type and quantity of oil products can be extracted from the crude by refining. So, in order to value a particular type of crude oil, the trader needs to see a refining assay. This can only be obtained from a sample of the crude that is produced from the well, which is then sent to a laboratory to simulate passing it through various refinery processes of increasing complexity.

The resulting refining assay is usually provided in tabular form and contains data concerning:

• The whole crude properties of the unrefined crude, which give important information about how the crude oil should be handled, stored and transported;

• A True Boiling Point (‘TBP’) distillation curve, which plots the cumulative volume and weight of the crude oil that has boiled off at increasing temperatures;

• A basic PONA breakdown, as described above, of the refined products, usually the lighter ends. The olefin content should be at or close to zero in crude oil. The presence of olefins may mean the crude volume has been bulked out by adding some cracked material that has already been through the refining process. The presence of olefins should be questioned by a buyer;

• The quantity and quality of the different products that are derived from the crude oil are arranged into different temperature ranges or cut-off points, usually just called ‘cut points’. For example, everything that boils off between say 165°C and 235°C might be categorised as kerosene.

4 Whole Crude Properties

4.1 Density

Every assay will contain information about the density of the crude as one of the prime characteristics defining the crude. Density is defined as the mass per unit of volume and may be expressed as kilograms per cubic metre or kilograms per litre. Since the volume of materials change with temperature, density is referenced at an exact temperature, typically 15°C.

Density is often expressed relative to the density of water, that is, the specific gravity, with both substances at the same temperature. Specific gravity is a ratio and is not a particularly user-friendly number. It may be a number such as 0.8536, with the specific gravity of water being 1. So, in the oil industry, we have our own measure of density, namely API gravity.

The higher the API gravity, the lighter the crude. For crude oil the API gravity ranges from less than 10° for some of the very heavy, dense Venezuelan crudes, to up to about 45–50°, which are very light and are often categorised as condensate. The API gravity of water is 10°. Most crude floats on water because the oil is usually lighter or greater than 10° API.

4.2 Sulphur Content

Sulphur is a contaminant, which is present to a greater or lesser extent in all crude oil. The desire to burn ‘cleaner’ fuels means that sulphur compounds need to be removed from the crude before the end products are sold to the consumer. There are different kinds of sulphur compounds of varying corrosiveness and toxicity increasing from disulphides, sulphides, thiols, also known as mercaptans, and, the most toxic, hydrogen sulphide (‘H₂S’). This last compound is strictly limited by pipeline operators usually to less than 10 parts per million (‘ppm’). Beyond 100 ppm it is considered to be potentially fatal.

Mercaptans too can be limited because of their characteristic ‘rotten eggs’ odour, which can be detected down to 0.5 ppm. This makes them useful when added to the gas supply to help detect leaks. But tankers will often reject high mercaptan crudes because the odour is not only unpleasant, but persistent. Some ports will not admit tankers that have carried a high mercaptan crude oil as one of its previous five cargoes.

4.3 Pour Point

As the name suggests the pour point is the temperature below which the oil cannot be poured, or pumped. If the pour point is too high then it may need to be shipped in a tanker with heating coils, depending on the time of year and climate at the destination port. There have been cases when vessels carrying high pour point crude oil have been arrested, for reasons connected to previous voyages, at northern ports in the summer and, by the time the dispute was resolved and the vessel was released in the winter, the oil had solidified and had to be dug out of the tanker.

The pour point is associated with the wax content and the kinematic viscosity of the crude oil. Highly paraffinic crudes may have a high content of complex wax molecules that begin to crystallise at low temperatures, as measured by their ‘cloud point’. But this is not a hard and fast rule as some highly naphthenic crudes, such as some Venezuelan grades, also have high viscosity. The cloud point is the temperature at which these crystals first appear. Kinematic viscosity records the time taken for a given volume of oil to flow a known distance through a pipe at a controlled temperature, subject only to the force of gravity.

4.4 Acid, Salt and Metals

The Total Acid Number (‘TAN’) is the amount of potassium hydroxide in milligrams required to neutralise a gram of crude oil, and it is therefore a measure of the acidity of the whole crude. A TAN of more than 0.3 can present difficulties for refineries that do not have acid-resistant metallurgy and indicates that the refinery may need to blend the crude oil with a low acid grade or avoid that grade altogether.

High salt content can also be corrosive and requires treatment in a desalter before being introduced into the distillation column. Most refineries have such desalters. The presence of metals, such as vanadium and nickel, can cause problems for refineries that use catalysts because the trace metals can deposit on the catalyst surface slowing down the rate of chemical conversion reactions.

An analysis of these whole crude properties gives an initial indication of the type of crude that is being analysed and what type of refinery is most likely to squeeze the last cent of value out of the oil in question.

More detail is contained in the product cuts described by the refining assay. We will return to these after a discussion of the refining process.

5 Refining Processes

Refining processes can be classified into three basic types:

• Separation, which divides the crude oil into different categories of products like LPG, naphtha, kerosene, gas oil and heavy fuel oil. This does not make any changes to the crude at the molecular level. Recombining the products would, in theory, restore the crude oil;

• Treatment, which does not change the yield of individual products, but changes the characteristics of the product to remove contaminants, often sulphur. Treatment may involve blending the products with other material or including additives to enable the product in question to meet the quality specifications that the market, or government regulation, demand; and

• Upgrading/conversion, which changes the yield, breaking down less valuable heavy products into lighter, more valuable products.

5.1 Primary or Atmospheric Distillation

Primary distillation is carried out at atmospheric pressure and is the most common separation process employed in the oil refining sector. It is the starting point of crude oil’s journey towards the refined products that the end-user demands.

The crude oil is heated up in a furnace so that a large proportion is vapourised and the liquid/vapour mixture is introduced into the distillation column. Any liquid that has not been vapourised falls to the bottom of the column. This is known as long residue. The vapour rises up the column where it passes through a number of perforated trays. Each tray contains liquid and, as the vapour bubbles through the liquid, it cools down. Some of the vapour will revert to liquid at this cooler temperature, and can be drawn off from the side of the tray. The lighter components remain as vapour and rise higher to the next tray where the process continues. The lowest tray will extract the heavier fractions and the higher trays will extract progressively lighter fractions. The end result is LPG, naphtha, kerosene, gas oil and long residue. The last of these can be used to make heavy fuel oil, but is more often processed further to generate more of the lighter products needed by the end-user.

Depending on the placement and the temperature of the trays, the refiner can produce a bit more or less naphtha and a bit less or more kerosene, or a bit less kerosene and a bit more gas oil.

Historically, a number of refineries ceased processing the crude at that point. These were referred to as ‘topping’ refineries. Very few simple topping refineries remain and those that do tend to sell their product on to more complex refineries as semi-finished product for treatment and upgrading.

The highest boiling point compounds are not acceptable for upgrading by the cracking process, described below. So, it is necessary to separate further the fractions suitable for upgrading by additional distillation.

The residue produced from primary distillation will disintegrate or crack up into lighter products in an uncontrolled and undesirable manner if it is subjected to higher temperatures. So, to extract the residue without it breaking up, a secondary distillation is carried out on the atmospheric residue, this time under a vacuum. This reduces the boiling points needed to separate the fractions and the vacuum gas oil (‘VGO’) can be separated out and used for selective cracking. The vacuum residue, or short residue, which is left over from this process is a heavy, viscous, tar-like material, which can be used as bitumen or for fuel oil, or which can be upgraded through processes such as coking or long residue hydrocracking. These are explained below.

Separation of products in crude oil by temperature, with or without a vacuum, is not the only separation process. Separation can also be achieved by freeze point and solvency in different chemicals. But primary distillation is the predominant methodology in commercial use.

5.2 Hydrodesulphurisation and Reforming-Hydroskimming

Treatment processes are primarily involved with treating or removing sulphur compounds contained in the products. There are two main techniques:

• 1. Hydrodesulphurisation, in which sulphur is removed, by first converting the sulphur compounds to H₂S, which, as a gas, can be separated easily from liquid products. Elemental sulphur can be recovered from the gas.

• 2. Merox treatment involves converting mercaptans by oxidising them to disulphides, which are sweeter and non-corrosive.

The hydrodesulphurisation process requires supplies of hydrogen gas to stimulate the removal of sulphur contained in the products. This is why hydrodesulphurisation tends to go hand in hand with reforming.

A reformer converts the naphtha from the primary distillation column into gasoline. The naphtha is heated over a platinum catalyst and its octane number is improved. As discussed below octane number is a measure of a fuel’s ability to burn evenly. A number of chemical reactions take place in the reformer and hydrogen is generated as a by-product. This hydrogen can be used in the hydrodesulphurisation process and so the ‘hydroskimming’ refinery was developed, combining reforming with hydrotreating.

The end result of the processes in a hydroskimming refinery is LPG, gasoline, kerosene or aviation turbine oil, gas oil and long residue in broadly the same proportions as seen in primary distillation. There will also be elemental sulphur recovered from the hydrotreater.

5.3 Upgrading/Conversion

The third type of process encountered in oil refineries is upgrading or conversion. These processes are employed to change the yield of products and generally consist of converting the unwanted high boiling point, long chain hydrocarbons to shorter molecules. This is achieved through application of heat and catalysis to ‘crack’ the molecules.

Cracking processes employ a catalyst to promote thermal decomposition of the long hydrocarbon chains. Cracking is an endothermic reaction, that is, it needs the input of heat. It also produces carbon, which can be used to generate heat and re-energise the process. Cracking processes include Fluid Cat Cracking (‘FCC’) and hydrocracking, which also consumes hydrogen to saturate the olefins produced.

5.4 Other Refining Processes

Other upgrading processes include:

• Alkylation—combines light, gaseous hydrocarbons such as propylene, butylene and isobutane to make gasoline components;

• Visbreaking—thermal cracking to produce more middle distillate from residual fuel oil;

• Coking—converts the residual oil from the vacuum distillation column into low molecular weight hydrocarbon gases, naphtha, light and heavy gas oils and petroleum coke;

• Zero Fuel—the continued drive to reduce greenhouse gas emissions has meant that oil refiners have had to employ more upgrading processes to produce proportionally greater yields of clean transportation fuels. Refiners have been required to employ more than one form of cracking and ‘zero fuel oil’ refineries have started to be sought out by refiners. Generally, a coking plant is employed with a cracking unit to completely destroy fuel oil fractions.

After the treating and upgrading process, the products that emerge differ from those that result from primary distillation and hydroskimming: they will comprise more LPG, more gasoline, about the same amount of aviation turbine oil or jet fuel, more ultra-low sulphur diesel (‘ULSD’) or gas oil and much less heavy fuel oil. How much more or less depends on the specific crude or blend of crudes put through the refining system and the nature of that crude, as identified by the refining assay.

As mentioned above, the quantity and quality of the different products that are derived from the crude oil are arranged in the assay into different temperature range cut points. There are no absolute rules about where these cut points should be because there can be considerable overlap in the refining process between the different categories.

	TBP ranges (°C)
Light naphtha	C5a–85
Heavy naphtha	85–165
Kerosene	165–235
Middle distillates	235–350
Vacuum gas oil	350–550
Long residue	350+
Short residue	550+

1. ^aC₅ refers to pentane, which has 5 carbon atoms and 12 hydrogen atoms (C₅H₁₂). The shorter chained hydrocarbons, methane (CH₄), ethane (C₂H₆), propane (C₃H₈) and butane (C₄H₁₀), occur naturally as gases at atmospheric temperature and pressure.

6 Refined Products

When crude oil traders and refined product traders switch disciplines the first and most obvious difference apparent to them is the definition of the quality of what is being bought and sold.

Crude oil traders are used to buying a crude oil identified by its ‘brand name’ alone. This might be something like Bonny Light of the quality available at the time and place of delivery, Nigeria, or Lula of the quality as available at the time and place of delivery, Brazil.

This is particularly problematic when the crude oil is a blended stream of production from a number of different oil fields of varying quality. The quality of the blend can vary, sometimes quite substantially, depending on the production rates of the various contributing fields, for example during maintenance. Certain blended crudes that have a reputation for highly variable quality are sold with price adjustment mechanisms in the sales contracts to compensate the buyer if the quality actually delivered on the day is outside a pre-defined range.

The buyer typically does not have the right to reject the cargo if the quality delivered is not as expected. In such circumstances the refiner may have to subject the cargo to a different type of refinery process or to blend it with some other grade of crude oil or semi-finished product.

In the case of refined products, the buyer is much more specific about the quality of the product that is to be delivered and much less concerned about the crude oil from which it originated. The products have to be fit for the purpose for which they are being purchased and the buyer will reject any cargo that does not meet the specifications contained in the contract.

The refined products, or distillates, that are produced in the refining process can be separated into two categories: the major products that are burned and the specialty products that are not burned. The major products are LPG, gasoline, kerosene/jet fuel, gas oil/diesel and fuel oil. The specialty products are naphtha, bitumen, lube oils, waxes and coke.

6.1 LPG

Liquefied petroleum gases are mixtures of propane and butane. These are used for heating/cooking and as motor fuel, but additionally can be used as chemical plant feedstock or propellant.

Because propane and butane are pure compounds, it is generally only necessary to specify the chemical composition of the mixture to define the requisite quality. Other important qualities specified are the sulphur levels and other hydrocarbon contaminants.

6.2 Naphtha

Naphtha is used either as a precursor for gasoline or for petrochemical manufacturing. It can also be used directly as a solvent. As mentioned above, its chemical composition, that is, its N + 2A, will determine whether it is suitable for reforming into gasoline or whether it should be used as petrochemical feedstock. N + 2A can be calculated as the volume or weight per cent of naphthenes in the naphtha plus twice its volume or weight of aromatics.

The higher N + 2A naphtha the higher the octane of the output when the naphtha is fed through a reformer to produce gasoline. A low N + 2A percentage means that the naphtha is likely to be sold to the petrochemical industry.

Light naphtha, in particular straight-chain pentane and hexane, known as ‘normal’ pentane and hexane, or n-pentane and n-hexane, together with n-butane can be passed through an isomerisation unit to convert them into their branched chain equivalents. These have a higher octane number than their straight-chain incarnations and are used in gasoline blending. Iso-butane provides additional feedstock for an alkylation unit, as described above.

The boiling range of the naphtha is specified in the contract as a key component in determining the yield of the naphtha in a reformer. The sulphur content is also relevant because it is a potentially toxic contaminant.

6.3 Gasoline

As mentioned above, the burning qualities of gasoline are defined by the octane number. This is an index against iso-octane, which is defined to be 100 octane, and heptane, which is defined to be 0 octane. Octane number is a measure of a fuel’s ability to burn smoothly without engine knock. Engine knock is heard when multiple flame locations occur within a piston.

The Reid Vapour Pressure (‘RVP’) of the gasoline is measured in pounds per square inch (‘psi’) and indicates the volatility of the fuel, or the extent to which it vapourises at a given temperature. This is important because the fuel must be capable of vapourising and igniting at low temperatures to ensure that cars start on cold mornings. Sulphur content and chemical composition are also regulated for ever-tightening environmental reasons.

Gasoline blending is the most complex of refinery operations and is often performed at specialist blending terminals. The objective is to source cheap, poor quality components to blend them with more expensive, better quality components in pursuit of the whole being greater than the sum of the parts. Gasoline is a highly seasonal product and the differences between winter and summer specifications are significant, particularly in cold climates.

6.4 Kerosene/Jet Fuel

Kerosene is still used for heating and lighting in many countries. Kerosene and jet fuel are essentially the same product, but jet fuel has more extensive specifications.

The burning characteristic of both these products is defined by the smoke point, measured in millimetres. This is the maximum flame height at which the flame will burn without smoking. Paraffins have a high smoke point, while naphthenes and aromatics have progressively lower flame heights.

For jet fuel, the volatility and freeze point are particularly important because of the low temperature and pressure at high altitudes, as are stability, boiling range and acidity. Jet fuel is the only internationally specified product, because airplanes need to be able to fuel up with confidence at any airport in the world.

Interestingly jet fuel is permitted the highest sulphur content of all transportation fuels. Because it is burned at high altitude it is considered to be less of a threat to humans.

6.5 Gas Oil/Diesel Fuel

Gas oil and diesel fuel are essentially the same product, but diesel fuel has more extensive specifications for use in diesel car engines. Gas oil is most commonly used in agricultural and construction machinery. Marine quality gas oil is increasingly used in the bunker fuel industry as described below.

The burning characteristics of these products are defined by the Cetane Number, or Index. This measures the time between the start of ignition and combustion. The lower the Cetane Number the longer the ignition delay and the less suitable is the fuel for automotive diesel engines.

The cold flow properties are particularly important for diesel fuel and are measured by the Cold Filter Plugging Point (‘CFPP’). It is measured in degrees centigrade and is the lowest temperature at which a given volume of diesel can be drawn through a standard filter in 60 seconds under controlled temperature and pressure conditions. The sulphur levels for both diesel and gas oil are strictly controlled and the boiling range and density are also specified.

6.6 Fuel Oil and Bunkers

Fuel oil is a term used to cover the higher boiling point fuels used in heavy power plants, furnaces and slow speed diesel engines. Density and cold flow properties, as measured by viscosity and pour points, are important specifications for heavy fuels. Metal content and sulphur levels are strictly controlled for environmental reasons because the product is burned often in the proximity of humans.

Bunker fuel used to be the pool into which cracked fuel oil and other low-quality residual fuel could be dumped for burning in engines onboard tankers and other sea-going vessels. Environmental concerns have changed this attitude to bunkers. Consequently, increasingly the bunker pool is taking material from the gas oil pool to provide higher quality marine gas oil.

In 2016 the International Maritime Organisation (‘IMO’) announced a global sulphur cap of 0.5% on marine fuels starting from 1st January 2020, down from 3.5% in one fell swoop. This limit applies outside Sulphur Emissions Control Areas (‘SECAs’). Inside SECAs the limit is even lower at 0.10% sulphur. At the time of writing the list of IMO SECAs is:

• Pacific coasts of North America;

• Atlantic coasts of the United States, Canada and France and the Gulf of Mexico;

• Hawaiian Islands;

• US Caribbean sea;

• The Baltic; and

• The North Sea.

China introduced its own ECAs on 1 January 2019. This is gradually tightening over time.

From 1 March 2020 it is prohibited to even carry non-compliant bunkers unless the ship has exhaust gas cleaning systems, or scrubbers, which can be retrofitted, but which are expensive.

Sulphur is not the only environmental target for bunker fuels. The IMO introduced a mandatory marine fuel consumption data regulation for global shipping from 2019, with a view to make the future fleet more fuel efficient and reducing greenhouse gas emissions from burning bunkers.

6.7 Lubes

Crude oil that is approved for the production of lubricating oil contains a small economic jackpot because it is one of the highest value-added products in the barrel. The additional margin usually accrues to the refiner of lube manufacturer rather than the upstream producer. Because of the use to which lubes are put, viscosity, cold flow properties and wax content are significant specifications.

There are two main types of lubricants: Paraffinic and Naphthenic. Paraffinic lubes are used in situations where there is a significant change in operating temperatures. The Viscosity Index is used to measure the change in the viscosity of the lubricant at different temperatures. Naphthenic lubes are used in situations where temperature will be virtually constant and therefore the absolute viscosity is more relevant.

It takes a long time to get a grade of crude oil approved for lubes production. This is because the lube oil has to be tested to destruction in an engine, which can take over a year in a laboratory.

Lubes are made largely from vacuum gas oil and is subjected to further processing and improvement with chemical additives.

6.8 Bitumen

Bitumen is used in the paving and road industry. The relevant properties are the softening point and penetration, which describe the ability of the material to maintain its integrity with changes in ambient temperature. Since bitumen is not burnt, its sulphur content is not as important as it is for other products.

6.9 Coke

Petroleum coke is a by-product from the thermal destruction of high boiling components of crude oil, such as from a coker, as mentioned above. High-quality coke can be used as electrical anodes for metal electrolysis processes, but typically the product is used for burning in furnaces.

As stated earlier, petroleum products have a significant degree of overlap between their boiling point ranges. For example, heavy naphtha can become part of the gasoline, kerosene or even the gas oil pool. A refiner can choose to eliminate the kerosene yield and instead maximise gasoline and gas oil production. It is important to recognise the overlap of product yields as this can have an impact on determining crude values.

7 Gross Product Worth and the Value of Crude Oil

We said at the outset that crude oil is only useful because of the products that can be extracted from it by the refining process. We have looked at the chemical analysis of crude oil as expressed by an assay. We have looked at different refinery processes and how they are used to extract and treat usable products from the crude oil in the quantities and of the qualities demanded by the market. We have also looked at the applications in which these refined products are employed by end-users.

It is time to look at what all the foregoing means for the value of crude oil. One of the basic tools used for this task is the Gross Product Worth (‘GPW’).

A GPW is established by considering the physical and chemical analysis of the grade of crude oil involved, that is, the assay. The assay can be evaluated in the context of how that particular quality of oil will perform in different types of refineries of varying complexity. This will produce an assessment of the amount and quality of refined products that can be extracted from that grade of crude, if sold to the right refiner.

For example, the crude seller will not get the best price by selling a very high API gravity light crude to a refinery with coking capability. The coker would be much better off buying cheaper, low gravity heavy crude and extracting more valuable light ends from short residual fuel from the vacuum distillation unit, as explained above. Similarly, a refinery with stainless steel metallurgy is not going to maximise its margin by buying low TAN crude. It would be better off buying cheap, high TAN crude that it can run when others cannot.

Taking the assay together with the optimum type of refinery model for the crude in question allows the calculation of the GPW of the crude.

The GPW takes the price of each of the products that can be derived from a specific crude oil in a specific refinery configuration, multiplies the yield of each product by its price and adds these up to give an estimate of the likely value of the crude oil in the market. It is the sum of the quantities of each product multiplied by the prices of each of those products. Obviously, the right product prices have to be used. There is no point trying to value a crude that you are trying to sell to a refinery in Singapore using product prices in Rotterdam.

In reality, the actual traded price in the market may be very different from the GPW, because there is more to the price of crude oil than its quality. For example, the refiner will not just be influenced by the GPW of the crude. It will also take into account the cost of freight to get the oil to its refinery. The refiner may favour a grade of crude oil that gives it a lower GPW, but which is located on its doorstep and gives it a minimal freight cost. The buyer may take into consideration any factors that in its sole opinion it considers relevant. For example, if it buys FOB from a loading terminal where there are persistent delays and where demurrage claims are not settled promptly, or at all, it may mark down the price it will pay for that crude.

The GPW is not an exact proxy for the absolute value of a barrel of crude. But it is a useful tool for assessing the likely market price of a grade of crude oil where there is not much data available on trades, by comparing it with the GPW of a grade of oil where there is active trading and transparent price information. Comparing the GPWs of two different grades of crude oil is the normal starting point for assessing the likely relative price of the two grades of crude oil in the market, that is, the price differential between the two.

8 Leads and Lags in Petroleum Prices

One of the perennial conundrums within the oil trading community is whether refined product prices lead crude oil prices up or down, or whether the opposite is true and crude price movements precede a rise or fall in product prices. There is no single correct answer as both statements can be true at different times.

For example, back in the mid-1980s when OPEC decided to maintain its market share in the face of rising oil production from newcomer producers such as the North Sea, the OPEC producers undertook to guarantee their buyers a positive refining margin, or ‘netback’. With an assured margin, refiners started producing flat out and churned out more refined products that the market needed or wanted. Product prices fell and, to honour the promise of positive refining margins, the OPEC producers had to cut their crude prices. Crude oil prices chased product prices down to less than $10/bbl before OPEC ‘blinked’ in August 1986 and abandoned the netback policy.

As another example, the crude oil price collapse at the end of 2014 makes a classic case study in market economics at work. Crude oil prices, driven up by burgeoning demand for refined products in China, India and other emerging economies, led to a rapid increase in crude oil supply from oil fields that had hitherto been uneconomic, including US oil production from shale. This increased production had a moderating effect on oil crude prices, while the high refined product prices choked off demand and the emerging economies faced a recession. This is ‘Economics 101’.

The old maxim that ‘when China sneezes the rest of the world catches a cold’ seems cruelly prophetic when the impact of the 2020 COVID-19 virus on oil prices is considered. The collapse in demand for refined products as China went into quarantine, followed by the rest of the world, cratered demand for products and would have inevitably dragged crude oil prices down after them, absent any other factors.

But another compounding factor in 2020 was the oil production war led by Saudi Arabia on one side and Russia on the other. The ‘OPEC+’ cooperation pact amongst 24 oil-producing nations to moderate production, which had been in existence since 2017, broke down at a meeting in March 2020 and the floodgates of crude supply were opened, accelerating the race to the bottom of the whole crude and product price complex.

The relationship amongst and between crude oil and refined product prices is heavily influenced by the process of arbitrage. If oil prices are high in one region and low in another, traders will buy the lower priced oil and transport it to the higher priced region up to the point where the cost of freight and the time value of money no longer make it economic to do so.

Similarly, if the price of oil for delivery today is lower than the price of oil for delivery next month, traders will buy oil for delivery now and store it for delivery later when prices are higher. They will do this until the cost of storage and the time value of money no longer make it economic to do so.

Lastly, if the demand for a particular specification or quantity of refined product differs between regions, whether for climatic, seasonal or regulatory reasons, traders will respond by transporting and/or storing and/or blending the oil to iron out the anomalous discrepancy in prices between regions.

Refiners respond to such price anomalies by changing the types of crude oil they put through their refineries, that is, their ‘crude slate’, to meet the quality specifications demanded by end-users up to the point where they no longer have a positive refining margin. At which point the anomaly is likely to have been eliminated by the combination of responses referred to above.