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Sunil Goriah

Basic Principles of Petroleum 7

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Basic Principles of Petroleum 7
Marketing Petroleum Products
Introduction
Welcome to the final module of Basic Principles of Petroleum
Program, Module 7: Marketing Petroleum Products.
Prerequisites
There are no prerequisites for this module.
Objectives
In this module you will learn: What the three marketing sectors of petroleum are, which
forces control the nature of the petroleum market, where the major producers and
major consumers are located, how crude oil is traded, how the supply and demand of
petroleum is stabilized and how refined petroleum products are marketed.

Petroleum’s Three Market Sectors

The marketing of petroleum products can be divided into three sectors: Marketing
crude oil, wholesale marketing of the bulk refinery products and retail marketing of the
finished products. The markets for crude oil deal in very large quantities. Several
hundred thousand barrels of oil frequently constitute a single transaction. 42 US gallons
or 35 Imperial gallons equals 1 barrel of oil, the standard by which crude oil is traded.
Thousands of transactions are conducted daily. The markets for refined products are
smaller, and for retail marketing smaller still, down to the 10 or 20 gallons of gasoline
purchased at a gas station.

Petroleum Market Forces

Before considering each of these market sectors, let’s look at the market forces that
drive petroleum products. Marketing petroleum products is all about supply and
demand on the one hand and price on the other, price being the controlling mechanism
between supply and demand. If the demand in any one sector exceeds the supply, the
price goes up. If supply exceeds demand, the price goes down. Marketers in each sector
try to maintain a supply that does not exceed market demand, while ensuring that there
is still a sufficient supply to meet the demand. Producers hold stocks of crude oil.
Refined products are held at refineries, terminals, distribution points, and at retail
outlets.

The Supply of Crude Oil

The supply of crude oil is limited by: The physical ability of major producers to draw
sufficient quantities of crude oil from their reservoirs, the availability of transportation at
any one time and the capacity of refiners to process the incoming crude oil. These
factors tie directly into the availability, or supply, of refined products.

Demand for Petroleum Products

Supply is directly related to demand, and demand is related to the needs of the major
consuming areas. For the products in greatest demand, gasoline, aviation fuels, diesel
and lubricating oils, demand remains more or less constant throughout any one year.
The demand for fuel oils and natural gas used for heating is seasonal, especially during
the winter in the northern hemisphere, where the majority of major consumers are
located

Location of Major Producers and Major Consumers

To further understand the effects of supply and demand, we have to consider the
geographical location of the major oil producers and major oil consumers. Essentially,
the major producing areas are the Middle East and North America, including Mexico
and Canada. The major consuming areas are North America, Europe, and Asia,
principally Japan and China.

The Global Imbalance in the Production and Consumption of

Petroleum
Besides this geographical dislocation of markets, there is a vast imbalance between the
major producing areas of the world and the major consuming areas. The primary
producer of crude oil, the Middle East, consumes little of the oil it produces and is
geographically removed from consuming areas. Each day, the Middle East produces
about 22 million barrels of crude oil but only consumes about 1 million barrels. The
major consuming areas produce insufficient, little or no crude oil themselves. Even
North America, which consumes 23 million barrels of crude oil a day, only produces 11
million barrels a day. Western Europe produces 6 million barrels and consumes 12
million barrels every day. Asia and the Far East produce 7 million barrels a day and
consume 20 million barrels a day.

The Separation of Markets

Thus supply, where the crude oil is produced, is largely separated from the sources of
demand. The markets of the producers of crude oil have to be linked to the markets of
the consumers. This poses particular problems in that the crude oil has to be
transported from its source to its consumers. Therefore, the availability of transportation
is a critical factor in the buying and selling of crude oil. The link between producers of
crude oil and consumers is made by trading crude oil and refined products at three
principal financial centers world wide: New York, London and Singapore.

Crude Oil Trading

Trading in crude oil and refined products is by far the largest part of the world’s fiscal
trade, exceeding all other forms of financial transaction by a wide margin. Worldwide,
some 68 million barrels of oil are traded daily. The market for petroleum products is
consequently very large, and marketing those products is a very big business. Crude oil
and bulk refined products are traded three different ways: By contract, an agreement
between seller and buyer for medium to long-term usage of fixed quantities. By spot
pricing, the buying and selling of set quantities at a particular time, such as the purchase
of a single ocean tanker load. And by futures, a series of financial instruments that are
usually based upon the expected price of a certain quantity of crude oil or finished
products, fixed at a set point of time in the future. The first two price mechanisms
comprise physical trading and the last is a purely paper transaction since no actual
delivery of product takes place.
The trade of paper products is based upon pricing differentials, which calculate the
variance between the price now and what it is expected to be in one or two month’s
time. If the price is higher for future stocks than the present price, the market is said to
be in contango. If the price for futures is lower than the present price, then the market is
backwardated. Futures and related financial instruments were developed in an attempt
to stabilize supply and demand over the long term.

Stabilizing Supply and Demand

Producers and refiners both maintain stocks and inventories. Producer and consumer
governments also hold strategic stocks to guard against excesses in supply or demand.
Overstock pushes prices down, understock pushes prices up. Seasonal variations, as
we’ve already noted, affect price, as do regional variations. Country and local taxes are
also used to control demand. The price of the product at the outlet plays a significant
part of keeping demand in line with supply. For example, in the face of a shortfall in
supply the price of natural gas, heating oils and gasoline may rise steeply to restrict
demand. An important mechanism in the attempt to stabilize the oil market is the
coordination and oversight of OPEC, the Organization of Petroleum Exporting Countries.
OPEC was formed in 1960 by most of the major producing countries in order to assist
them in matching production with expected demand. OPEC’s principle concern is to
prevent the unpredictable and potentially damaging effects of unregulated competition
among its member countries. OPEC attempts to keep supply stable by setting quotas
that are based on the amount of oil produced by each country. Usually, potential
production is slightly underestimated to prevent oversupply and to allow producing
countries to respond to increases in demand if they occur.

Marketing Refined Petroleum Products

Marketing refined products from the refinery or terminal requires the signing of medium
to long-term contracts with large industrial users. Generally, such users have: Either their
own storage facilities to be filled regularly by road or rail tanker, or the product or
feedstock piped to them directly from the refinery or nearby terminal. The demand for
bulk refined products mainly consists of: Petrochemical feedstocks for industries making
chemicals, plastics and pharmaceuticals, heating oils for industrial plants and diesel and
heavy fuel oil for electrical power plants, ships and standby electrical generators, and the
like. Fleet transportation users, such as trucking companies, airlines and shipping
operators, require gasoline, diesel, jet fuel, lubricating oils and bunker fuel delivered
from a terminal. The marketing effort is constantly improving the efficiency of the
product stream.

Fleet users continually strive for better prices and contract conditions. In the retail
sector, marketers concern themselves with maximizing the number of retail outlets. If
outlets are owned by refiners, then sole sourcing captures wholesalers and retailers
through networks such as gas stations, service centers and commercial outlets. Entire
chains of networked retail outlets are constantly monitored through the frequent
collection of data on sales and revenue, and of which products move best. In addition,
marketers of finished products are constantly identifying and analyzing the completion,
marketing trends and opportunities. Lastly, marketing strategies for finished products
absorb the short term and long term effects of: Constantly changing country, regional
and local legislation and regulations that affect the finished products and health, safety
and environmental issues.

Summary
Objectives
In this module you have learned: What the three marketing sectors of petroleum are,
which forces control the nature of the petroleum market, where the major producers
and major consumers are located, how crude oil is traded, how the supply and demand
of petroleum is stabilized and how refined petroleum products are marketed.

Review
In this module you learned how the markets for crude oil, bulk refinery products and
finished products differ. You saw that price and supply and demand are intimately
connected. You were taught how the supply and demand of petroleum can be
stabilized. Finally, you learned how finished petroleum products are marketed globally.