Refining

This section focuses on refining, the complex series of processes that manufactures finished petroleum products out of crude oil and other hydrocarbons.   While refining began as simple distillation, refiners must use more sophisticated additional processes and equipment in order to produce the mix of products that the market demands.  Generally, this latter effort minimizes the production of heavier, lower value products (for example, residual fuel oil) in favor of lighter, higher value products (for example, gasoline). 

Simple Distillation

The core refining process is simple distillation, illustrated in a stylized fashion at the right.   Because crude oil is made up of a mixture of hydrocarbons, this first and basic refining process is aimed at separating the crude oil into its "fractions," the broad categories of its component hydrocarbons.  Crude oil is heated and put into a still -- a distillation column -- and different products boil off and can be recovered at different temperatures.  The lighter products -- liquid petroleum gases (LPG),  naphtha, and so-called "straight run" gasoline -- are recovered at the lowest temperatures.  Middle distillates -- jet fuel, kerosene, distillates (such as home heating oil and diesel fuel) -- come next.  Finally, the heaviest products (residuum or residual fuel oil) are recovered, sometimes at temperatures over 1000 degrees F.   The simplest refineries stop at this point.  Most in the United States, however, reprocess the heavier fractions into lighter products to maximize the output of the most desirable products, as shown schematically in the illustration, and as discussed below.

Downstream Processing

Additional processing follows crude distillation, "downstream" (or closer to the refinery gate and the consumer) of the distillation process.   Downstream processing is grouped together in this discussion, but encompasses a variety of highly complex units designed for very different upgrading processes.  Some change the molecular structure of the input with chemical reactions, some in the presence of a catalyst, some with thermal reactions. 

In general, these processes are designed to take heavy, low-valued feedstock -- often itself the output from an earlier process -- and change it into lighter, higher-valued output.  A catalytic cracker, for instance, uses the gasoil (heavy distillate) output from crude distillation as its feedstock and produces additional finished distillates (heating oil and diesel) and gasoline.  Sulfur removal is accomplished in a hydrotreater.  A reforming unit produces higher octane components for gasoline from lower octane feedstock that was recovered in the distillation process.   A coker uses the heaviest output of distillation, the residue or residuum, to produce a lighter feedstock for further processing, as well as petroleum coke. 

As noted above and in the section on demand, U.S. demand is centered on light products, such as gasoline.  As shown in the graph, refiners in the United States more closly match the mix of products demand by using downstream processing to move from the natural yield of products from simple distillation, illustrated earlier, to the U.S. demand slate, illustrated here.  After simple distillation alone, the output from a crude oil like Arab Light would be about 20 percent of lightest, gasoline-like products, and about 50 percent of the heaviest, the residuum.  After further processing in the most sophisticated refinery, however, the finished product output is about 60 percent gasoline, and 5 percent residuum.  

Crude Oil Quality

The physical characteristics of crude oils differ.  Crude oil with a similar mix of physical and chemical characteristics, usually produced from a given reservoir, field or sometimes even a region, constitutes a crude oil "stream."   Most simply, crude oils are classified by their density and sulfur content.  Less dense (or "lighter") crudes generally have a higher share of light hydrocarbons -- higher value products -- that can be recovered with simple distillation.  The denser ("heavier") crude oils produce a greater share of lower-valued products with simple distillation and require additional processing to produce the desired range of products.  Some crude oils also have a higher sulfur content, an undesirable characteristic with respect to both processing and product quality.  For pricing purposes, crude oils of similar quality are often compared to a single representative crude oil, a "benchmark," of the quality class. 

The quality of the crude oil dictates the level of processing and re-processing necessary to achieve the optimal mix of product output.   Hence, price and price differentials between crude oils also reflect the relative ease of refining.   A premium crude oil like West Texas Intermediate, the U.S. benchmark, has a relatively high natural yield of desirable naphtha and straight-run gasoline (see graph).  Another premium crude oil, Nigeria's Bonny Light, has a high natural yield of middle distillates.  By contrast, almost half of the simple distillation yield from Saudi Arabia's Arabian Light, the historical benchmark crude, is a heavy residue ("residuum") that must be reprocessed or sold at a discount to crude oil.  Even West Texas Intermediate and Bonny Light have a yield of about one-third residuum after the simple distillation process. 

In addition to gravity and sulfur content, the type of hydrocarbon molecules and other natural characteristics may affect the cost of processing or restrict a crude oil's suitability for specific uses.  The presence of heavy metals, contaminants for the processing and for the finished product, is one example.  The molecular structure of a crude oil also dictates whether a crude stream can be used for the manufacture of specialty products, such as lubricating oils or of petrochemical feedstocks. 

Refiners therefore strive to run the optimal mix (or "slate") of crudes through their refineries, depending on the refinery's equipment, the desired output mix, and the relative price of available crudes.  In recent years, refiners have confronted two opposite forces -- consumers' and government mandates that increasingly required light products of higher quality (the most difficult to produce) and crude oil supply that was increasingly heavier, with higher sulfur content (the most difficult to refine).

Other Refinery Inputs

In addition to crude oil that runs through a simple distillation, a variety of other specialized inputs, usually to downstream units, enhance the refiner's capability to make the desired mix of products.  Among these products might be unfinished (partly refined) oil, or imported residual fuel oil used as input to a vacuum distillation unit.  The supply pattern for "reformulated gasoline" or RFG, the mandated low-pollution product first required in 1995, includes an important share of blending components that are classified as refinery inputs.  These blending components include oxygenates but consist mainly of products that could be classified as finished gasoline in other jurisdictions or products that require little additional blending to be classified as finished gasoline.  While they are counted as "refinery inputs," they are brought to saleable specifications in terminals and blending facilities, not in conventional refineries.

U.S. Refining Capacity

U.S. refining capacity, as measured by daily processing capacity of crude oil distillation units alone, has appeared relatively stable in recent years, at about 16 million barrels per day of operable capacity (graph).  While the level is a reduction from the capacity of twenty years ago, the first refineries that were shut down as demand fell in the early 1980's were those that had little downstream processing capability.  Limited to simple distillation, these small facilities were only economically viable while receiving subsidies under the Federal price control system that ended in 1981.  Some additional refineries were shut down in the late 1980's and during the 1990's, always, of course, those at the least profitable end of a company's asset portfolio.  At the same time, refiners improved the efficiency of the crude oil distillation units that remained in service by "debottlenecking" to improve the flow and to match capacity among different units and by turning more and more to computer control of the processing.    Furthermore, following government mandates for environmentally more benign products as well as commercial economics, refiners enhanced their upgrading (downstream processing) capacity.  As a result, the capacity of the downstream units ceased to be the constraining factor on the amount of crude oil processed (or "run") through the crude oil distillation system.  Thus crude oil inputs to refineries ("runs") have continued to rise, and along with them -- given the stability of crude oil distillation capacity -- capacity "utilization" rose throughout much of the 1990's (again, see graph).  Utilization -- the share of capacity filled with crude oil -- reached truly record levels in the last half of the decade, nominally exceeding 100 percent for brief periods.  

As with most aspects of the U.S. oil industry, the Gulf Coast is by far the leader in refinery capacity, with more than twice the  crude oil distillation capacity as any other United States region.   (The difference is even greater for downstream processing capacity, because the Gulf Coast has the highest concentration of sophisticated facilities in the world.)   As discussed in the section on Trade, the Gulf Coast is the nation's leading supplier in refined products as in crude oil.  It ships refined product to both the East Coast (supplying more than half of that region's needs for light products like gasoline, heating oil, diesel, and jet fuel) and to the Midwest (supplying more than 20 percent of the region's light product consumption.) 

There are seasonal patterns in refinery input.  In the United States, refinery runs mirror the overall demand for products -- lower in the colder months and higher in the warmer months.  In addition, as they move out of the gasoline season in the early autumn and then as they move into the next gasoline season in the late winter, refiners routinely perform maintenance.  The duration and depth of the cutback in refining activity during each maintenance season is affected by a variety of factors, including the relative strength of the market for refined products.   Therefore, when stocks are high and demand slack, the refinery maintenance season is likely to be longer and deeper.  Refinery activity will also respond to the market's need (and hence relative prices) for product, with changes in the level of crude oil throughput as well as emphasis on one product over another. 

World Refining Capacity

Broadly speaking, refining developed in consuming areas, because it was cheaper to move crude oil than to move product.  Furthermore, the proximity to consuming markets made it easier to respond to weather-induced spikes in demand or to gauge seasonal shifts.  Thus, while the Mideast is the largest producing region, the bulk of refining takes place in the United States, Europe or Asia. 

There have historically been a few exceptions, concentrations of refining capacity that were not proximate to consuming markets.  A refining center in the Caribbean, for instance, supplied heavy fuel oil to the U.S. East Coast where it was used for power, heat, and electric generation.  As the demand for this heavy fuel oil, or residual fuel oil, waned, so did those dedicated refineries.  While the Caribbean refineries, as well as refineries in the Middle East and in Singapore, were built for product export, they are the exception.  As such, most refineries meet their "local" demand first, with exports providing a temporary flow for balancing supply and demand.  (See the section on Trade.)  

The largest concentration of refining capacity is in North America (in fact, the United States), accounting for about one-quarter of the crude oil distillation capacity worldwide, as shown in the graph, and as discussed more fully below.  Asia and Europe follow as refining centers.  As also shown in the graph, North America (again, the United States) has by far the largest concentration of downstream capacity -- the processing units necessary to maximize output of gasoline.  The gasoline emphasis of course mirrors the demand barrel and hence refinery output in the different regions, since no other global region uses as much of its oil in the form of gasoline as North America does.

Refinery Profitability and Industry Structure

In general, refining has been significantly less profitable than other industry segments during the 1990's, as shown in the accompanying graph.  Gross refinery margins -- the difference between the cost of the input and the price of the output -- have been squeezed at the same time that operating costs and the need for additional investment to meet environmental mandates has grown, thus reducing the net margin even further.  In addition, much of the investment made during the 1980's was designed to take advantage of the differential between the dwindling supply of higher quality crude oils and the growing supply of heavier and higher sulfur crudes.  When that differential narrowed, however, the financial return on those investments declined.  Refining margins peaked in the late 1980's. 

During the 1990's the role of independent refiners (those without significant production) has grown substantially, largely as the result of refinery purchases from integrated companies (the "majors") seeking to streamline and realign their positions.  Furthermore, the independent refiners, like the majors, are in a period of consolidation; the mergers and acquisitions are having a significant impact on refinery ownership (although not overall refined product supply).