By Geoffrey Cann
If in these challenging times you’re able to acquire a struggling competitor, digital innovations are a compelling means to capture value.
A Refinery Purchase
Irving Oil, operator of Canada’s largest oil refinery by volume, has purchased North Atlantic Refining Limited (NARL), a refinery and fuels business in Newfoundland. NARL has the distinction of being one of the early casualties of the oil market chaos, and was shut down in March.
First, a little bit about the buyer. Irving Oil’s refinery in Saint John is a large, 320,000 barrel per day processor and a very sophisticated plant. It can ingest just about any crude available on the market, the bulk of which arrive by international crude carriers that unload at Canaport, an ice-free year round floating mono buoy connected to an on-shore tank farm on the Bay of Fundy.
Irving Oil has been in the news for some time trying to solve the continental pricing dilemma. Tidal crude is priced with reference to Brent, whereas US Gulf Coast refineries purchase crude that is priced with reference to the continental benchmark, West Texas Intermediate. Since North America has too much oil for continental demand, WTI trades below Brent. This difference in price between Brent and WTI is a disadvantage for North America’s coastal refineries who buy Brent and sell refined product into North America. Their production competes with gasoline and other products whose costs are based on WTI.
This explains why Irving Oil has been putting Alberta oil on rail and sending it east, by supporting pipeline development to the East coast, and most recently, by obtaining permission to move Alberta crude from Vancouver harbour by ship through the Panama Canal to the refinery.
NARL, on the other hand, is a smaller facility, located in Newfoundland in Come-by-Chance bay. With a capacity of 130,000 barrels per day, it is geared for mid-grade and light crude oil. The plant fuel is oil, rather than lower cost natural gas, giving it a higher operating cost. Of note, the plant has the ability to produce a super clean refined product that is in high demand in Europe, which is convenient since the plant is just 6 days sail by ship (Rotterdam, 15 knots), a permanent shipping advantage (8 days from Saint John and 14 days from Houston). The plant has historically produced a high proportion of resid or tar, which has largely a local market. That helps explain why Newfoundland has such high quality road surfaces, and why the famous Targa road race is held there.
In a move, Irving Oil has expanded its operations by 40%. And an economical 40%. To build a new greenfield refinery, based on costs experienced elsewhere, takes between $60,000 and $80,000 per barrel of capacity. Brand new, NARL is a capital spend of $7-10 billion dollars. Few boards, in the face of an uncertain future for oil and gas, would sign up for that layout, and indeed, Canada’s last refinery (other than the bitumen processors in Alberta), was built 30 years ago. In fact, the top 10 largest refineries in the world were all commissioned before 2012, and designed before then, predating the digital age.
The industrial logic of the acquisition includes the opportunity to dominate the East Coast Canada refining sector, rationalize the overlapping business footprint (Irving Oil has a presence in NL already), and debottleneck the refinery in NL (it needs a coker, the construction of which Irving Oil has experience). The refinery has a permanent geographical advantage in its proximity to the European market, the zoning needed to operate (and possibly expand), and the potential to access east coast crudes from the NL offshore (which would likely also require some investment).
However, where is the digital opportunity?
Making Money In Refining
As I outlined in my book, about 60 percent of the gap between theoretical value and actual value in refining stems from decisions made in managing the feedstock against the demand (and this is an enormous analytics problem).
Second are the improvement gains from plant operations, which include optimal energy usage, blending inputs to create optimal feedstocks, blending outputs to precisely match demand at the lowest cost, maximizing the use of expensive assets with spare capacity such as jetties and tanks, and improving the reliability of operating assets. About 30 percent of the theoretical value of refinery economics is bled away in these operational areas, and much of that value could be captured by better data and better decision-making.
Last are the improvement gains from decisions taken that do not directly involve hydrocarbons, including the level of critical spares inventories, people management, and minor repairs and maintenance. About 10 percent of the theoretical value of a refining operation is lost through poor decisions outside the actual hydrocarbon value chain.
Since these two plants are unlikely to ever be connected by pipeline, the way to take advantage of this larger refining complex is to leverage it through digital. That’s how the supermajors do it — Exxon has several refineries across North America but they’re not directly connected either.
The physical advantage from having multiple plants (and tanks, jetties, customers, markets, supply routes), is the additional optionality that creates in running the business. Oil companies everywhere seek to create as much optionality as possible in their businesses because of the improved economics that optionality creates. For example, hurricanes in the Gulf sometimes create demand pull for diesel from the East Coast refiners, and having a greater capacity to supply that demand can create extraordinary value. Climate change suggests that the Gulf area will have more and frequent weather disruptions over time.
The Digital Opportunity
By leveraging modern digital tools, the combined organization can capture the kinds of benefits that multi-refinery operators get access to. Here’s a snapshot of what I mean.
OPTIMISE REFINERY FEEDSTOCKS.
The Irving Oil refinery can process the same crudes as NARL but not the other way round. There may be an opportunity for Irving Oil, with its purchasing relationships, to source crude on behalf of NARL, and there may even be the odd opportunity to transship, but there are a lot of variables here — tank capacity, jetty capacity, vessel charter, safety concerns, processing slate, plant utilization, energy costs. This is a super big analytic problem, but with purchase volumes in the 2m bbl range and by lightering, the quantities may justify the effort.
Some of the output from the NARL plant, specifically the high volume of resid, could be shipped to the Irving facility for further refining, allowing the Irving refinery to improve its utilization rates. Such a play means the Irving plant would source slightly lighter crude which would be blended with the resid to create a heavier product suited to the refinery.
To pull this off, the two plants need something like a combined linear program (LP). Running such a beast requires enormous computing power, which is ideal for cloud computing. US refineries now run their LPs using cloud services, which lets them run multiple versions of the LP in parallel.
The very clean product from the NL plant may be more economical with more blending opportunities to match the broader or different demand in the market. Decision making about blending is very complicated because of the complexity of matching the economic opportunity from a blended product with the costs of blending with a plant that is a sail away, and matching to customer demand, and market pricing. Tankage, customer demand, availability, product quality, vessel size and availability, and many other variables, drive this analysis.
CAPTURE SPECIALTY FUELS.
Some fuel grades, such as aviation fuel for navies, are specialty orders (they need to withstand salt contamination and high moisture). Such orders can be lucrative, but complex to take on. With the larger plant facility, specialty orders can be more easily captured, but only if production is moved around to make room for the specialty order (again, involving tanks and refining capacity).
Another use case for heavy-duty analytics.
ALIGN TURN AROUNDS AND SHUTDOWNS.
There should be room to align turn arounds and shutdowns. Some competitors in oil and gas purposefully watch for cranes and scaffolding at their rivals’ facilities, which can signal an impending event. They then gear up to try to steal customers, block access to services, and otherwise make it difficult for the turnaround to proceed economically. Similarly, by aligning events, refineries can reduce the level of market disruption, secure customers, and lower costs, provided the turnaround events are properly planned and coordinated.
HIGH GRADE THE SUPPLIERS.
The creation of a larger company also creates the opportunity to high grade supplier services, and serves as an attractant to suppliers who would normally focus on larger companies. By leveraging innovations such as IronSight, local suppliers can create new digital experiences for their customers. Suppliers will need to step up and modernize, sell out to suppliers who can bring the digital chops, or change industries.
DEPLOY ARTIFICIAL INTELLIGENCE SOLUTIONS.
There are ample example use cases of applying artificial intelligence (AI) and machine learning (ML) solutions in oil and gas. AI and ML work better with more data, the new combined business is 40% larger, and presumably 40% richer in data terms. Pump optimization, facilities inspection, and asset reliability prediction lend themselves to this technology. Even access to useful shared engineering content is valuable. Woodside Petroleum has loaded 3 decades of engineering content into IBM Watson to save 40% of engineering time spent searching for documents.
Beyond these big ideas, there are a number of other innovations in place in the industry that could be leveraged:
- rationalized and redundant control rooms
- blockchain solutions such as BlockLabs to manage new transactional processes between the plants
- virtual asset supervision, such as Osperity’s visual analytics tools
- shared virtual inventory to cut down on redundant spare parts
- robotic process tools to carry out repetitive reporting and analysis, such as mass balancing
Yes, there is compelling industrial logic to expanding your refinery complex if the conditions warrant. And digital tools are how to capture as much of the value available as possible.
Check out my book, ‘Bits, Bytes, and Barrels: The Digital Transformation of Oil and Gas’, available on Amazon and other on-line bookshops.
Take Digital Oil and Gas, the one-day on-line digital oil and gas awareness course.