Global Oil Company

By : Abhishek Birmaan Manulal K Pallavi Rajesh Agarwal

Some facts about Oil Industry

Total US Imports 11,108,000 barrel per day Average Price for a barrel $109.53 Average acquisition cost for a barrel Saudi Arabia alone produces 21.9% of total production Total production per day 5.4 million barrels
Source : api.org/news1

Oil Industry Terminology

Gasoline Light oil and heavy oil LNG AND LPG Barrel Gallon OPEC Upstream/Midstream/Downstream

Oil Industry Terminology

Gasoline
Mixture of lighter liquid hydrocarbons used chiefly as a fuel for internal-combustion engines.

Heavy Oil
Long chain of Hydrogen and carbon atoms

Light oil
Small chain of Hydrogen and carbon atoms

 Liquefied Natural Gas (LNG) Primarily compressed methane Liquefied Petroleum Gas (LPG) Pressure or refrigeration liquefies lighter hydrocarbons, such as propane, butane, pentane, and mixtures of these gases Petroleum Generic name for hydrocarbons, including crude oil, natural gas and their products. BBL Barrel of oil, a volume of 42 U.S. gallons (0.16 m3)

 Gallon The imperial (UK) gallon was legally defined as 4.54609 L The US liquid gallon is legally defined as 231 cubic inches, and is equal to exactly 3.785411784 L The US dry gallon is 2150.42 cubic inches, it is equal to exactly 268.8025 cubic inches or 4.40488377086 L.

 OPEC
Organisation with 12 members countries founded in the year 1960

Upstream operation
Exploration and production

Midstream operation
Gathering, field processing transportation and storage

Downstream operation
Refining and marketing

Value Chain

Exploration, drilling, and production of crude oil

Transportation and trading of crude oil to refineries

Refining of crude oil Storage of crude oil Distribution and marketing

Upstream

Midstream

Downstream

EXPLORATION: Using technology to find new resources DRILLING Bringing oil to the surface using natural and artificial methods Drill a hole to obtain crude oil and natural gas from under the earth's surface. Engineers make this hole using a rotary drilling rig. The rotary drilling rig uses a drill bit to cut through the earth and create a hole. As the hole gets deeper, pipe is added to the drill bit to allow it to dig further. The pipe is connected to an engine that turns the drill bit to cut the hole. The rotary rig operates the same as a hand-held electric drill. The electric drill has a motor that turns the drill bit and sufficient weight must be applied to keep the drill in contact with the bottom of the hole.

Production
Completing the Well Installing casing pipe in the well. The production casing runs to the bottom of the hole or stops just above the production zone.

Tubing and Packers After cementing the production casing, the completion crew runs a final string of pipe called the tubing. The well fluids flow from the reservoir to the surface through the tubing. A packer is a ring made of metal and rubber that fits around the tubing. It provides a secure seal between everything above and below where it is set. It keeps well fluids and pressure away from the casing above it. Subsurface Safety Valve The valve remains open as long as fluid flow is normal. When the valve senses something amiss with the surface equipment of the well, it closes, preventing the flow of fluids.

Production(Continued)
Starting the Flow Before oil production can begin the drilling mud must be removed from inside the casing. Salt water is pumped into the tubing to remove this mud. Sometimes after starting the flow the well does produce at a fast enough rate. In this situation, flow from the reservoir may be increased by stimulation. Stimulation is one of several processes that enlarge or create channels in the reservoir rock so that the oil and gas can move through it and into the well.

Fracturing
Hydraulic fracturing is a technique used to allow natural gas and crude oil to move more freely from the rock pores where it is trapped to a producing well so it can be brought to the surface at higher rates. Specially engineered fluids are pumped at high pressure and rate into the reservoir interval to be treated, causing a vertical fracture to open. The wings of the fracture extend away from the wellbore in opposing directions according to the natural stresses within the formation. Proppant, such as grains of sand of a particular size, is mixed with the treatment fluid to keep the fracture open when the treatment is complete.

Transportation
Moving oil to refineries and consumers with tankers, trucks and pipelines

Crude oil tankers are used to transport crude oil from fields in the Middle East, North Sea, Africa, and Latin America to refineries around the world. Product tankers carry refined products from refineries to terminals. Tankers range in size from the small vessels used to transport refined products to huge crude carriers. Tanker sizes are expressed in terms of deadweight (dwt) or cargo tons. The smallest tankers are General Purpose which range from 10 to 25,000 tons. These tankers are used to transport refined products. The Large Range and Very Large Crude Carriers (VLCC) are employed in international crude oil trade.

Refining
Converting crude oil into finished products Refineries are composed of many different operating units that are used to separate fractions, improve the quality of the fractions and increase the production of higher-valued products like gasoline, jet fuel, diesel oil and home heating oil. The basic refining operations are described in the following sections. It is done through : Crude oil distillation Vacuum Gas Distillation Catalytic reforming Catalytic cracking

Marketing
Distributing and selling refined products Refined products are moved to markets using pipelines, tankers and tank trucks. Pipelines are the lowest cost method. Once the products reach their destination, which is usually a supply terminal, they are distributed to gasoline stations, airports and homes by tanker trucks. Companies mix their additive packages into gasoline at these facilities.

Risks Across value Chain

Exploration Design Technology Environmental Political HR Risk Production Process related Resource related Environmental Labor Issue Refining and marketing Risk Construction Regulatory Licensing Financial Delay Decommissioning Transportation Pipeline breakdown Weather risk

Sales Related Demand Risk Supply Risk Product risk Price Risk

International Vs Domestic Operation

Legal/Regulatory Risk Currency Related Transportation Employee Related issues Quality Resource nationalty

Strategic

Financial

Operational

Event Extra ordinary

Project Related

Reserve Depletion Reserve Replacement Development Acquisition Geological Risk Change in Demand

Interest Rate Currency Capital Intensity Foreign Exchange Funding Asset Liquidity Financial Governance and Policies Cash Management Price related Commodity Accounting Capital Structure

Fluctuating production Poor performance of worker Transportation Poor performance of supplier Accidental leak out Fire Explosion Pipeline breakdown Human Skills New Technology

Terrorism & Criminal Natural Calamities Weather risk Global Economic Slowdown Resource Nationality Geopolitical Developments

Site selection Construction delay Designing

HIGH FREQUENCY HIGH IMPACT

Fire and explosion Accidental leak out Site selection Capital intensity Funding Commodity pricing

HIGH FREQUENCY LOW IMPACT

Price related risk, Transportation, Fluctuating Production Poor performance of workers Poor performance of supplier Weather risk Competition for reserves Currency risk Foreign exchange risk Geopolitical Developments

LOW FREQUENCY HIGH IMPACT

Natural calamities Terrorism and criminal Global economic slowdown Demand Change

RISK MAP

LOW FREQUENCY LOW IMPACT

Resource nationality Construction delay

Pipeline breakdown Reserve Replacement, Government Policies Acquisition, Design Geological risks, Government Policies

PRESENT 10 MAJOR SOURCE OF RISK

Financial Risks (Case specific)

Interest rate Risk
Financed billions of dollars for its project financing and its hundreds of subsidiaries needed capital for their daily activities for which each one raise money from their respective local market and manage insurance premium etc.

Risk at decentralized treasury

Each operating unit had different treasury department of its own to manage cash management, Forex exposure and short term borrowing needs. They had to operate within specified guidelines and had little freedom.

 Forex Risk
It varied with operations of each operations. In exploration it had exposure in local currency but in international trading it had exposure in US dollar and again during retail sales it again had exposure to local currency.

Cash Management
Each unit was engaged in more activity than needed if done in Pooled basis. Could not obtain best prices for their deals because both their trading volume and credit rating were lower than parent company

RISK-DERISKING STEPS TAKEN

Decentralization

Centralization

Earlier
Each subsidiary has its own finance division Loans in one dept are not offset by another department Decentralized Forex trading Decentralized cash management

Now
A central treasury department A single loan portfolio handling all demands Central Forex trading Centralized cash management

Obstacles to Centralization
1. Divergence of operations
1. It was present in end to end operations through hundreds of subsidiaries. (you write here ) Presence in more than 100 countries each having different culture, ideology and thinking.

2. Capital barriers and withholding tax issues

1. 1.

3. Geographical diversification 4. Poor IT Infrastructure

At Present. Centralized treasury Group is created to provide financial risk management service across the group This is divided into two phases

Phase 1 Phase 2

Centralized cash manag. & short term borrowing

Internal bank for the business

Central treasury net borrowing at lower rate

Central treasury borrowing of Forex risk

Core capability established with Euro conversion and significant Vol Discount

De Risking steps Across Value Chain

Advance use of computers, operation risk model to provide enhanced risk capability. Simulation Models were used to help configure the operations. Marker risk measures like VaR has been incorporated and used extensively. Price insurance from the liquid market

Operations Risk ( Case Specific)

 Transportation Risk
The company was present in end to end solutions and hence had huge transport network of pipelines and tanker (road and sea) services.

Storage Risk
While transporting from one place to another the oil was stored at several places and there were safety measures that were strictly followed at each storage unit

Processing Risk
The risks associated at different stages of processing of crude oil.

 Manage huge volume of daily trade

Global Oil Corp. transfers about 5 million barrels of crude oil through the chain to finished petroleum products

Optimal utilization of other resources

Global Oil had considerable resources other the oil resources like refineries, tanker fleets, storage facilities and pipelines etc. which were to be managed effectively and optimal utilization of these resources was also required

Operation Risk Mitigation Technique

 Creation of Oil Trading Centre

It was created to support the core business. In this the corp. used external markets to manage its portfolio of exposure from flow of oil. It was responsible for managing all risks related to movement (whether oil was sourced from inside or outside) taking advantage of aggregate traded physical volume. Due to aggregate treatment of oil the risk is managed on a portfolio basis.

Measurement of oil Price risk on three dimensions Outright Price risk

To mitigate this when a physical quantity of a product is bought, the company sells the equivalent quantity of futures. When a product is sold to the ultimate customer on a fixed price basis, it buy back the futures sold earlier to close the hedge

Exposure to main Market Price differentials

To avoid this a contract for difference is done between two parties. In this the difference between the current price and the contract price is paid by either the buyer or seller depending upon whether the price is currently more or less than the contract price

Backwardation Risk
Backwardation is the name for the condition that the market quotes a lower price for a more distant delivery date, and a higher price for a nearby delivery date.

Mitigating the financial risk using Derivative

FRAMEWORK FOR FINANCIAL RISK

RISK MANAGEMENT FLOW

VARIOUS FINANCIAL RISK

PRICE RISK: FORWARD ,FUTURE,OPTIONS EXCHANGE RATE RISK: FORWARD EXCHANGE CONTRACT, SWAP INTEREST RATE RISK: INTEREST RATE SWAP

Forward Contracts
A forward contract is an agreement between two parties (counterparties) for the delivery of a physical asset (e.g., oil or gold) at a certain time in the future for a certain price that is fixed at the inception of the contract. Forward contracts can be customized to accommodate any commodity, in any quantity, for delivery at any point in the future, at any place.
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Counterparties: Buyers and Seller Asset/Commodity: Crude oil Delivery/Payment Time: 6 weeks Priced Fixed: $75 Buyer: ABC (long position) Seller: Global oil company (short position) Trading Volume: 1000 barrel
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Future Contracts
Futures contracts are highly uniform and wellspecified commitments for a carefully described good (quantity and quality of the good) to be delivered at a certain time and place (acceptable delivery date) and in a certain manner (method for closing the contract).

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Forward versus future

Obligations without a clearinghouse
Buyer Seller

Obligations with a clearinghouse Clearinghouse

Buyer

Seller

Chapter 1

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Forward Versus Futures

COMPARISON
Trade on organized exchanges Use standardized contract terms Use associate clearinghouses to guarantee contract fulfillment Require margin payments and daily settlements Close easily Regulated by identifiable agencies Any quantity Any product

FORWARD
No No No No No No Yes Yes

FUTURES
Yes Yes Yes Yes Yes Yes No No
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Management of IR risk: forward rate agreement

A forward rate agreement (FRA) is an interbank-traded contract to buy or sell interest rate payments on a notional principal. Maturities of the contracts are typically 1, 3, 6, 9 and 12 months.

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 Example: GOC buys an FRA that locks in the first interest payment (due at the end of year 1) at 5% p.a.
If LIBOR rises above 5% at the end of year 1,GOC receives a payment for the differential interest rates, If LIBOR falls below 5% at the end of year 1, GOC makes a payment for the differential interest rates.

A series of FRAs is an interest rate swap.

Management of IR risk: interest rate swaps

Swaps are contractual agreements to exchange or swap a series of cash flows. These cash flows are most commonly the interest payments associated with debt service.
interest rate swap: Exchange fixed interest rate payments for the floating interest rate payments. currency swap: Exchange currencies of debt service obligation (e.g. from SF loan to $ loan). interest rate and currency swap: A single swap may combine elements of both.
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IR risk: Why interest rate swaps?

Suppose ABC Inc holding a floating-rate debt conclude that interest rates are about to rise. The finance manager of ABC may wish to pay fixed and to receive floating interest payments. If XYZ concludes that interest rates will fall. Then XYZ may wish to pay floating and to receive fixed interest payments on their fixed-rate debt. There is an incentive for the two parties to enter into an interest rate swap. Interest rate swap exploits a mispricing in two markets.
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FORWARD EXCHANGE CONTRACT

A FEC is a binding agreement between two parties in which one currency is sold or bought against another currency at an agreed forward exchange rate for settlement on a specified date (beyond two (2) business days) in the future.

EXAMPLE:
An Australian Importer needs to pay USD100,000 in 3 months time for goods bought overseas. The importer can buy the USD in 3 months time but then it cannot budget the right amount of AUD because the exchange rate in 3 months time is unknown. Assume current AUD/USD spot exchange rate is 0.6500.

 If the AUD/USD exchange rate went up (the AUD appreciates), You will need less AUD when it comes time to pay for the USD. Assume the exchange rate rises to 0.6600, then the importer will pay AUD 151,515.15. If the AUS/USD exchange rate goes down (AUD depreciates), You would pay more AUD. Assume for this example that the rate falls to 0.6200, then the Importer would pay AUD161,290.32.

 The importer can eliminate its exposure to exchange rate risks by entering into a FEC. A Financial Intermediary, could offer the Importer a FEC guaranteeing the exchange rate to be used in 3 months time for their purchase of USD100,000 against AUD. This guaranteed future exchange rate valid for the AUD USD is called the Forward Exchange Rate. Again, assume the current spot exchange rate is 0.6500. The 3-month forward margin is -USD0.0130, which when applied to the current spot exchange rate, results in a 3month forward exchange rate of 0.6370. In 3 months time You will buy from Travelex the USD100,000 at the forward exchange rate of 0.6370 and You will pay AUD 156,985.87

Effect of all the strategies of Risk Mitigation

Currently managing its oil product flow on centralized basis . Trading companies sophistication and ability to coordinate activity is highest today. Implementation of some new risk measures like VaR and are being used extensively. The models of risk are extended to cover their core business risk Simulation models are introduced to help configure the operations in real time.

Enterprise wide Risk Management

Adopting an organised approach to aggregate political , legal and general public about the need for consistant energy policy. Investing time and resources to understand the environment related risk. Company need to strengthen alliances and partnerships with NOCs Management of cost reduction programme and better communication across the company

 Balance between new development opportunity and worsening fiscal downs. Performing enterprise risk assessment to asses exposure across all segment. Adopting a flexible shorter lead time structure which allow peak supply during excessive demand period

Thank You