Supply and Demand Planning for Crude Oil Procurement in Refineries

The upstream petroleum supply chain is inefficient and uneconomical because of the independence of the four complex and fragmented functions which comprise it. Crude oil exploration, trading, transportation, and refining are functions which may be integrated through unified decision-making facilitated by timely information exchange. This exchange has been problematic because the four business units with their disparate activities have not been able to capture and appropriately structure the required information. How can business executives in the oil industry assemble all of the required information to achieve system-wide optimization? To remove the silos which impede system-wide optimization, there is need to analyze people, systems and issues in the upstream section of the petroleum supply chain; as a background to understanding the current challenges faced in achieving integration. Hence, the use of secondary and primary data sources was used for this research. The secondary includes the review of relevant literature while the primary data were from two sources. The first came from an on-site interview with the heads of business units of a case study, a company which is a major player in the industry. The second is from telephone interviews with industry experts which include software providers, consultants and other major players in the industry. The findings are that on-time information exchange will maximize shareholders' value and improve process efficiency in the supply chain. This process efficiency makes the upstream supply chain more responsive to possible changes in the environment that affects its operation. This will allow supply chain managers to achieve both a reduction in the variability in price of end product will be obtained while achieving stable profit margins. This research concludes by advocating that the use of information systems that accurately support data exchange among the functions in the supply chain in a timely, coordinated fashion with minimal distortion is required to ensure consistency in optimal decision making. To achieve this, change management is necessary because it requires a shift to a holistic approach in making decisions. Finally, areas recommended for future research are stated. Advisor: Dr. Lawrence Lapide (Research Director, MIT CTL) ACKNOWLEDGEMENTS I dedicate this dissertation to God for his continuous guidance and faithfulness This dissertation is the product of the help and the encouragement of many people. I am indebted to many of you but space allows me to mention only a few of the contributors by name. I would begin by thanking my family for their prayers, encouragement and support all through the years. Special thanks, to the MLOG program director Dr. Chris Caplice for his support in various ways during the course of my studies at MIT and for his effort in ensuring that this chosen case study was used for this research. I owe gratitude to the representatives of ExxonMobil, Shell, BP, Accenture, UPS Consulting, SAP, AMR Research and Aspen Technologies for the time taken from their busy schedules to discuss my research work and to those who also shared some draft of their academic papers. Their very useful advice on and valuable contributions helped to shape the structure of this thesis. The research in this field would not have been possible without the expert guidance of my esteemed supervisor, Dr Larry Lapide, who was always available (most times at a moment's notice) through out the research process. Dr. Lapide painstakingly read the drafts of each chapter of my thesis, generously sharing his insights, opinions and candid advise that added immense value to this research. Most importantly Dr. Lapide was instrumental in reaching out to industry experts. His suggestion on pertinent references gave me priceless insight into the research topic. Finally, I would like to thank all my buddies the members of the MLOG class of 2006 for sharing a part of their lives with me. Finally, to all those too numerous to mention that made this year in Cambridge a wonderful living and learning experience, thank you from the bottom of my heart. Beatrice Nne Nnadili obtained a Bachelor of Science in Accounting at the University of Uyo in Nigeria. Before obtaining a Masters in Business Administration at the Lancaster University Management School in the UK, she had worked for two years in Nigeria's oil and gas industry. TABLE OF CONTENTS ABSTRACT .................................................................................................................................................. 2 ACKNOWLEDGEMENTS ......................................................................................................................... 4 BIOGRAPHICAL NOTE ............................................................................................................................ 6 TABLE OF CONTENTS ............................................................................................................................. 7 ............................................................ 1 OBJECTIVE. SCOPE AND METHODOLOGY OF STUDY 10 1 . 1 BACKGROUND ............................................................................................................................... 11 1.2 RESEARCH METHODOLOGY ....................................................................................................... 14 1.3 STRUCTURE OF THIS THESIS .................................................................................................... 16 2 LITERATURE REVIEW ....................................................................................................................... 18 2.1 INDUSTRY OVERVIEW ............................................................................................................... 18 2.1. 1 Lessons from the Porters Five Forces Model ............................................................................ 26 2.2 UPSTREAM SUPPLY CHAIN ACTIVITIES ................................................................................... 27 2.2.1 Crude Oil Exploration and production ...................................................................................... 27 2.2.2 Crude Oil Trading ...................................................................................................................... 28 2.2.3 Crude Oil Transportation .......................................................................................................... 29 2.2.4 Crude Oil Refining ............................................................................................................... 30 2.3 CRUDE OIL PROCUREMENT ....................................................................................................... 32 2.4 SUPPLY CHAIN MODELING ........................................................................................................ 33 2.4.1 Linear Programming ................................................................................................................ 34 2.4.2 Stochastic Programming and Robust Optimization Methods .................................................... 36 2.4.3 Heuristic Methods ...................................................................................................................... 36 2.4.4 Simulation based Methods ........................................................................................................ 37 2.4.5 Limitations ................................................................................................................................. 37 .................................... 2.5 UPSTREAM INTEGRATION CHALLENGES AND OPPORTUNITIES 38 3 INDUSTRY EXPERTS' PERSPECTIVE ............................................................................................. 42 3.1 LEADERSHIP ................................................................................................................................... 42 3.2 INFORMATION TECHNOLOGY .................................................................................................. 44 3.3 PEOPLE ........................................................................................................................................... 45 ............................................................................................................... 3.4 INDUSTRY STANDARDS 47 3.5 3 PL COLLABORATION ................................................................................................................ 47 3.6 MODELLING APPROACH .............................................................................................................. 48 4 CASE STUDY .......................................................................................................................................... 50 4.1 UPSTREAM FUNCTIONS .............................................................................................................. 50 4.1. 1 Crude Oil Trading: .................................................................................................................. 50 4.1.2 Price Modelling ........................................................................................................................ 51 4.1.3 Demand Modelling ................................................................................................................ 51 4.1.4 Refinery Optimization .............................................................................................................. 51 4.1.5 Transportation Planning ......................................................................................................... 52 4.1.6 Crude Oil Marketing .................................................................................................................. 53 4.2 EXTERNAL FUNCTIONS ............................................................................................................. 53 ..................................................................................................................... 4.2.1 Commodity Market 53 ................................................................................................................................ 4.2.2 Competitors 54 ...................................................................................................................................... 4.2.3 Carriers 54 ........................................................................................................ 4.3 AREAS FOR IMPROVEMENT 56 5 FINDINGS ............................................................................................................................................... 61 .............................................. 5.1 CHALLENGES AND THREATS OF UPSTREAM INTEGRATION 61 ........................................................................................................................ 5.1. 1 Incentive Scheme 62 ............................................................................................................. 5.1.2 Information Technology 63 .......................................................................................................................... 5.1.3 Employee Skills 63 .......................................................................................................................... 5.1.4 Investment Cost 64 ................................................................................................................. 5.1.5 Change Management 65 ....................................................................................... 5.1.6 Industry Standards and Collaboration 66 5.2 BENEFITS FROM UPSTREAM INTEGRATION ........................................................................... 66 5.2.1 Operating Cost ........................................................................................................................... 67 ......................................................................................................................... 5.2.2 Asset Utilization 67 .......................................................................................................... 5.2.3 Customer Responsiveness 68 6 RECOMMENDATIONS FOR FUTURE RESEARCH ....................................................................... 69 BIBLIOGRAPHY AND REFERENCES ................................................................................................. 70 APPENDIX ................................................................................................................................................. 73 LIST OF FIGURES Figure 1 PESTLE factors affecting the petroleum supply chain ...................................... 13 Figure 2 PESTLE effects on crude oil prices . (1947 2004) ........................................... 13 Figure 3 Oil Producing regions in the World ................................................................... 20 Figure 4 Porter's five forces affecting the upstream section of the oil supply chain ........ 21 Figure 5 Major Players in Global Refining and their Regional Market Share ................. 22 Figure 6 Retail Gasoline Pump Price Margins ................................................................. 23 Figure 7 U.S. Oil Refinery & Capacity ........................................................................... 24 Figure 8 US Refinery Capacity & Demand ...................................................................... 25 Figure 9 Effects of Porters Five Forces on the Upstream Petroleum Supply Chain ......... 26 Figure 10 Feedstock inflow to the refinery ..................................................................... 27 ................................................................ Figure 1 1 The Geography of transport systems 29 ............................................................................... Figure 12 Crude oil Refining Process 31 Figure 13 Integrating Strategic and Tactical Decision Making ....................................... 43 Figure 14 Structure of Case Study Upstream Functions ................................................... 55 Figure 15 Information Exchanged and Silos existing in Case Study ............................... 56 Figure 16 Proposed Information Exchange Network for Case Study ............................... 60 Figure 17 Case Study Structure of Information Flows in Upstream activities ................. 73 1 OBJECTIVE, SCOPE AND METHODOLOGY OF STUDY This is an exploratory study of the on-going tension between centralization and decentralization of information networks within the oil industry. The effect of this tension on the efficiency of information shared within the organization is examined to understand how companies in the oil sector respond to the internal forces that shape the integration, behaviour, strategy and structure of their supply chain. The first objective of this work is to gain an industry-wide view of the upstream section of the petroleum supply chain. Secondly, an elaborate case study was conducted on one of the major players in the industry. This was done to understand current practices of information exchanged within a company and to explore how such practices affect upstream integration. This research explores opportunities for upstream integration in the petroleum industry and the gains that could be derived from effective and timely exchange of information among its functions. Present business support systems are unable to capture information fiom various functions in the upstream section and present it in a structured manner that will aid unified decision-making. This shortcoming makes assembling all the data required for decision-making a difficult task for managers. Given this situation, the major motivator for this thesis is a need for a new paradigm for the integration of processes and functions using decision support systems capable of gathering dispersed information required for effective planning of crude oil procurement in refineries.