Feedstock that is rich in paraffins is better used as a petrochemical feedstock as it cracks easily. Olefins do not occur naturally in crude oils but are produced by refining processes and are present in other feedstock like naphthas and gasolines. Naphthenes and aromatics have higher octane numbers and are more suitable for refineries.
The product yields are used to calculate the gross refining margin. This is calculated by multiplying the product yields with the prevailing product prices and subtracting the cost of crude oil used. Some of the popular local product benchmarks are listed in Table 1.4. Calculating refining margins is essential to maintain the profitability of the refining operation, as refineries have flexibility in terms of choosing the optimum crude oil grade to use, changing the operation of the refinery to produce different fractions of products, blending, and the storage of products.
TABLE 1.4 Selected local product benchmarks
Natural Gas
Natural gas is another fossil fuel, which is naturally found along with crude oil or coal and is formed in a similar manner (i.e., the exertion of high pressure and temperature over millions of years, by geological processes, on the remains of plants and animals). The main constituent of natural gas is methane (CH4). Natural gas, when produced along with crude oil, is called associated gas. When crude oil is found in small quantities along with primarily natural gas, it is called condensate. Natural gas can also be extracted from coal reservoirs (known as coalbed methane), and landfill gas and biogas also contain high quantities of methane. Natural gas usually occurs with impurities such as water vapor, carbon dioxide, mercury, nitrogen, and hydrogen sulfide, as well as other gases such as ethane, propane, butane, and heavier hydrocarbons, which when liquefied are called natural gas liquids (NGLs). These impurities need to be removed before natural gas can be transported.
Natural gas is transported through pipelines or is liquefied to transport using liquefied natural gas (LNG) carriers. In this case, regasification facilities are required at the terminal where LNG is transported to. Since the heating use of natural gas is seasonal, gas needs to be stored for the winter season. Natural gas is “injected” into underground facilities like depleted gas reservoirs, salt caverns, and aquifers or stored within pipelines or as LNG.
Natural gas is the cleanest-burning hydrocarbon and is increasingly being used for electricity generation. It is used for heating and cooking and as feedstock for chemical manufacturing. It is also used as fuel for vehicles, which run on either compressed or liquid natural gas, and it can further be converted to other fuels using gas-to-liquid processes. Ethane is used for manufacturing plastics, while propane and butane are used as LPG. Heavier NGLs consist of gasoline, naphtha, and kerosene fractions and can be blended with crude oils.
Natural gas markets are much more localized than other energy markets and multiple pricing methods prevail globally; this has allowed only a few benchmark prices to attract sufficient market liquidity. The benchmarks that have gained popularity include Henry Hub Natural Gas in the USA, the National Balancing Point (NBP) in the UK, and Zeebrugge and TTF (Title Transfer Facility) in Continental Europe.
Coal
Coal is a black or dark-brown combustible sedimentary rock that is formed by the carbonization of vegetation and is composed primarily of carbon, along with varying proportions of hydrogen, nitrogen, sulfur, and oxygen. It generally occurs in rock strata, in layers called coal beds or coal seams. There are various grades of coal, classified based on the amount of time spent under intense heat and pressure, which affects their chemical properties. Lower-rank coals such as peat, lignite, and sub-bituminous coals have lower amounts of carbon by weight and are more volatile. Higher-rank coals include anthracite and bituminous coal, which have higher carbon and, thus, higher heat content.
Anthracite coal is primarily used for heating. Bituminous coal can be divided into two types – thermal or “steam coal” and metallurgical or “coking coal.” Steam coal is mainly used for power generation and as an energy source for cement production, while coking coal is used to produce coke, which acts as a reducing agent in the production of pig iron and subsequently, steel. Lignite and sub-bituminous coals are mainly used for power generation. Coal can be converted into liquids to use as alternate fuels for transport, cooking, power generation, and in the chemicals industry. Coal can also be converted to syngas, a mixture of carbon monoxide and hydrogen gas, and subsequently used to produce electricity or other transport fuels.
Global coal markets can be split into two major regions – the Pacific basin and the Atlantic basin. The major benchmarks for thermal coal are based on delivery at ports where coal is exported from or imported to, and include Newcastle coal (Australia), API4 coal (Richards Bay, South Africa), and API2 coal (Amsterdam Rotterdam Antwerp, ARA). Further, local coal markets like the USA have their own benchmarks.
PRICE DRIVERS IN ENERGY MARKETS
Prices in physical markets are influenced by a myriad of factors. As in most markets, supply and demand play a major role in price determination. Commodity prices are also generally linked to economic performance, with growing economies consuming more commodities, and thus raising prices. Commodity prices are also influenced by events affecting the supply chain of the product, from producers and refiners to distributors and consumers.
As a number of energy commodities are considered strategic assets and their production is concentrated in the hands of a few countries, which are largely emerging economies that can be prone to instability, there is a geopolitical aspect to price determination as well. As commodities get increasingly financialized, with major financial players like banks and hedge funds trading in these markets, commodity prices have also become linked to other asset prices.
Let us examine some of these factors briefly, using the oil markets as an example.
Geopolitical Risks
Oil prices are particularly vulnerable to events such as war, internal strife, or terrorist attacks, especially in the sensitive Middle East region. For example, oil prices spiked in the wake of the Gulf War and the Iraq War of 2003, as well as during the “Arab spring” rebellions across a number of countries in North Africa and the Middle East. In such environments, oil prices trade at a premium to prices implied by supply/demand balance, and this is sometimes dubbed the “fear premium.” In contrast, resource nationalism, in the form of higher royalties or outright nationalization of assets, has been decreasing in recent years and many national oil companies are opening up to collaboration with global oil companies due to the scarcity of capital and technological know-how needed to exploit new reserves.
The Geopolitical Chessboard – The Petrodollar System and Rising China
Earlier in this chapter we discussed the strategic role played by energy resources and touched on how the pricing of this commodity can impact the destiny of large nations. The fact that more than 60 % of the global production of oil moves on maritime routes makes naval power integral to securing the supply of oil and thereby shaping the world's geopolitical chessboard. By far, the USA is the mightiest naval power in the world and has been successful in providing protection to major oil producers and securing the maritime routes, thereby deserving the privileges of the petrodollar system. Other rising powers, like China, have also relied on US-led maritime route security to secure the energy imports required to build an industrial complex and accelerate their economic growth. However, it is only recently that these nations have begun viewing these energy maritime routes as the source of vulnerability that they are and have taken steps to address these weaknesses and reduce their exposure to the petrodollar system.
The Strait of Hormuz, the Strait of Malacca, the Suez Canal, Bab El Mandab, the Danish Straits, the Bosporus and, to a lesser extent, the Panama Straits are the major oil chokepoints, representing
