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A look at refining-I - Views on News from Equitymaster

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A look at refining-I

Feb 26, 2008

The refining process
The refining process consists of three major processes:

  1. Distillation- It is also known as atmospheric distillation or hydro skimming. Crude oil is separated by boiling under high heat in the distillation unit and recovered as hydrocarbon fractions. The lowest boiling fractions (LPG, naphtha) exit through the top. Medium boiling fractions (kerosene, aviation fuels, diesel oil, heating oil) are drawn from the middle. Higher boiling fractions (vacuum gasoil) are drawn from the bottom.
  2. Conversion- Vacuum gasoil is converted into selected petroleum products through cracking. Itís a process that breaks or cracks larger and heavier hydrocarbon molecules into lighter and smaller molecules. The most important conversion units are the fluid catalytic cracking (FCC) unit and the hydrocracker unit. The former increases the gasoline yield of the refinery, while the latter increases the yields of middle distillates.

  3. Treatment- Products from both the distillation and conversion processes are treated to remove impurities, like sulphur, and are processed to meet product specifications like octane and vapour pressure.

Types of refineries
Refineries are classified into simple and complex.

  1. Simple refineries: They carry out only the first process, i.e. distillation.
  2. Complex refineries: They carry out all the three processes, i.e. distillation, conversion and treatment. The configuration of complex refineries is oriented either towards catalytic cracking or hydrocracking. Refinery complexity refers to a refineryís ability to process heavy (density) and sour (sulphur content) crudes. It is measured by the Nelson Complexity Index.

Refining margins
Oil refining is primarily a margin-based business. The following factors affect the refining margins:

  1. Demand for refined petroleum products.
  2. Supply of crude oils. (Crude oil typically accounts for 90% to 95% of the total cost of refining)

  3. Light-heavy spread & configuration: The supply of heavy & sour crude and demand for lighter products has resulted in an increased light heavy spread, measured as the price difference between Arab Light and Arab Heavy. This spread favors the operation of complex refineries instead of simple ones. Hence, existing simple refineries will either be phased out or upgraded. In the mean time, there is likely to be a global shortage of complex refining capacity.

  4. Capacity of refineries.

  5. Utilisation rates of refineries.

  6. Operating expenses. (They are relatively fixed)

  7. Location: The location influences a refineryís ability to access feedstock, distribute its products efficiently and choose transportation between tanker vessels, pipelines, rail or tank trucks. Due to their flexibility and lower logistics costs, coastal refineries typically have a competitive advantage over the oil refineries located inland. In some cases, oil refiners situated in areas of high petroleum product consumption enjoy a comparative advantage with respect to satisfying the local demand.

  8. Environmental regulations:Stricter specifications have led to an increased demand for lighter refined products.

  9. Crude-mix. The mix of crude grades have changed over the years, with an increase in the availability of heavy and sour crudes relative to light and sweet varieties.

We shall continue with the series on the refining segment of the energy sector in the next article.

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