READINGS FOR CRUDE OIL MARKETS AND REFINED PRODUCTS | 24 QUESTIONS

Bradford, T. (2018). The Energy System: Technology, Economics, Markets, and

Policy. Cambridge, MA:
The MIT Press.
Chapter 14. Oil
• Describe the oil value chain: exploration and development, production, refining, shipping, and
marketing
• Recognize the relevant share of oil used in the transport, industrial, power, and petrochemicals
sectors, and how this varies globally and at different levels of economic development

• Recognize the main crude oil producers and consumers, and recognize major trade flows

• Understand the general difference between "resources" and "reserves," and their determination
factors

- Resource
o OIIP – Oil initially in place
o GIIP – gas initially in place
o Technically recoverable resources = first filtering of OIIP; by estimating recovery rate
- Reserves
o Commercially recoverable in known accumulation under defined conditions
o Must be:
 Discovered
 Recoverable using existing technology
 Commercially viable – necessary legal and contractual rights to produce
(political capital) and infrastructure to deliver (physical capital); project
economics /oil price/ company’s profitability will impact the reserve calculation
 Remaining in the ground (and not previously produced)

• Understand the AAPG/SPE/WPC framework: (3P, proven, probably, possible), developed and
undeveloped, etc., and the concept of reserve life

- 1P (P90) - Both proved developed (in production) and proved undeveloped (not yet in
production but proven through acceptable methods of testing)
 - 2P (P50) – proven plus probable (any unproven reserves)
- 3P (P10) – proven plus probable plus possible (additional estimates identified and possibly
recoverable)
- Discovered = P + C
- Reserve-to-production ratio = reserves divided by production per year

• Explain how crude oils are categorized by different properties (such as light or heavy; sweet or sour);
and anticipate how these designations affect refining decisions
- API gravity
o The higher the API gravity, the less dense the liquid is
o Water as a benchmark, has an API gravity of 10
o Light crude oil – API score of >38
o Heavy crude oil – API score of <22
o Extra-heavy / bitumen - <10
- Sulphur
o Between 0% - 3.5%
o Sweet = very low sulfur = <0.5% by weight
- Lighter oils tend to have lesser sulfur, though relationship is not perfect
- Refining process
o Distillation
 Ceparating by using diff boiling temperatures
 Atmospheric distillation (at normal pressures) for lighter distillates
 Vacuum distillation for heavier distillates
o Conversion
 Break heavier hydrocarbon chains into higher value lighter hydrocarbon chains
(upgrading)
 Coking – convert heaviest distillates into gasoline and petrochemicals
 Cracking – convert middle / heavy distillates to lighter hydrocarbons
using either temperature (thermal) or chemical processes (catalytic
cracking)
o Purification and blending (alkylation)
 Remove impurities to produce highest value fuel
 Hydrotreating – remove residual sulfur
 Blending – to meet precise technical specifications
 - Fuel outputs
o Gasoline
o Kerosene
o Diesel
o Fuel oil
- Non-fuel outputs
o Ethane and liquified petroleum gas (LPG)
o Naphtha
 Olefins
 Aromatics
o Other residuals
 Asphalt
 Lubricating oil

• Recognize the diverse conditions for drilling, on-shore, off-shore, deep subsea and in the arctic, and
the different types of drilling and production operations

- Exploration
o Seismic surveys
o Once the conditions are identified, understanding how a large geographic area is to
establish initial estimates of economic potential
o Exploratory wells – initial wells to determine subsurface conditions, test for flow rates /
pressure and product quality
 o Appraisal wells to test and confirm these conditions over a larger area
o Onshore reservoir – easier
o Offshore reservoir require specialized ships and construction of platforms (shallow
water <500 feet deep) or deepwater locations
- Drilling
o Onshore drilling rigs – less capital intensive
 Contain blowout prevents to protect against back pressure
 Previously involves permanent derrick constructions, but modern rigs can be
dis-assembled and moved to another site
 Onshore declines more slowly than offshore fields
o Offshore drilling rigs
 Mobile offshore drilling units (MODUs) are chosen based on the specific
circumstances
 Jack-up rigs – shallow water
 Floating platforms / semi-or fully submersible rigs – deep-water
o Vertical drilling / directional drilling / horizontal drilling
o Hydraulic fracturing – using high-pressure water + chemicals
- Completing a well - steps to convert a drilled well into a producing one
o Includes perforating, or making holes in the well in the oil production zone to allow oil
to flow into the casing
o Insertion of downhole equipment for monitoring or filtering, construction at the
wellhead, including cement plug, casing heads and production tree/ Christmas tree
(separates and handles flow of hydrocarbons)
- Infield drilling – drilling activity among existing wells to extract remaining pockets of oil
- Hubbert’s peak – half of the technically recoverable oil. Beyond this peak, there is no technical
way to increase the production rate, production will diminish over time to zero

• Be familiar with the major types of companies involved in crude oil production, including IOCs,
NOCs, independents, service companies, etc.

- National oil companies – control 75% of world production and 90% of proven oil reserves
- International oil companies – privately held firms with technical expertise, talent, and access to
capital markets
o Supermajors / Big Oil– BP, Chevron, ExxonMobil, Royal Dutch Shell, Total, ConocoPhillips
o Majors
- Wildcatters / independents – small, risk-tolerant, and aggressive; run by engineers; go into
unexplored areas, coax additional oil out of depleted fields
- Oil field services companies – assist with logistical challenges, drilling, well completion, site
management, repair, and maintenance

• Understand the different ways long-haul and short-haul pipelines operate with respect to mixing
volumes and batch runs
 - Run crude oil through lease separator, a device that separates crude oil from gas and water
- Injected into distribution system (mid-stream), which involves pipelines, tankers, barges and rail
transport along with storage facilities
- Cleaning and maintaining pipelines require specialized equipment called pigs, which are
designed to move through the pipeline and remove buildup and clogs, as well as look for
corrosion

• Understand the different types of tanker ships by size and design features

- Tank barges – flat bottomed vessels that are used in shallow water
- Dumb barges – need to be moved with a tugboat
- Oceangoing shipments - tankers are used
o Panama Canal (panama); Suez Canal (Suezmax); Straits of Malacca (Malaccamax)
o Most countries require double hull (double layer hull with a gap in between) which
performs better during spills
• Explain the operational risks associated with crude-by-rail transport and how recent accidents have
prompted new safety requirements

- Rail is typically more expensive than pipelines and not a long-term solution, but a very flexible
and quickly scalable solution to move oil while pipeline infrastructure is established
- A rise in number of accidents has led to regulatory standards – thicker tank walls, additional
safety equipment and enhanced braking systems

• Classify pre-completion, post-completion, and macroeconomic risks and explain their impact on
project development decisions

• Classify and describe the costs and factors associated with the enhancement and ongoing
production of an oil field, with particular focus on primary, secondary, and tertiary recovery methods

Primary recovery – use natural pressure, simple. 5-15%

Secondary recovery – use pumpjack, gas injection of natural gas / carbon dioxide; if rock is more porous,
can use water injection so that oil floats on the top. 35-45%.

Enhanced recovery – use steam injection to heat hydrocarbons and improve fluid liquidity. 5-15%

• Identify important market crudes referenced in global trade, such as WTI, Brent, Dubai, Urals, Tapis,
Saudi Light, Bonny Light, Edmonton Par, Maya and the JCC
• Understand the relative economics associated with the various methods to transport crude oil; for
example: pipeline, rail, tanker, and other methods

See above

Backwardation – most commodities are worth more today than in future, given storage cost, TVM and
uncertainty

Contango – future price > spot price – implicit assumption is that temporary ss and dd have depressed
the spot price but future conditions will result in a tighter supply and demand.

Inkpen, A., & Moffett, M.H. (2011). The Global Oil and Gas Industry:
Management, Strategy and Finance.
Tulsa, OK: PennWell Corp.
Chapter 3. Access, Leasing, and Exploration
• Summarize the process of accessing new reserves and outline the steps involved in developing a
petroleum project
• Explain how key subsurface geological structures affect oil and gas production, e.g., permeability
versus porosity

• Identify the ownership of subsurface mineral and resource rights based on jurisdiction and market
assumptions

See below.

• Compare the fiscal regimes used in international petroleum agreements

• Describe the typical components of a lease agreement and methods used to establish royalty
payments
• Compare and contrast the physical and economic characteristics associated with various reserve
classifications (e.g., proved, developed, undeveloped, P90), including conventional and
unconventional reserves
• Define reserve replacement and reserve life; determine their values given a set of market
assumptions

- Reserves replacement – reporting of reserves added through exploration each year as in-place
replacements for the current year’s production
- Reserves life – number of years company can sustain current production levels with its booked
reserves

• Describe the effect of various field value assumptions on bidding strategies in lease auctions

- 4 questions
o Do bidders value blocks individually or collectively (complimentary / synergy?)
o What is the basis for bidders valuation (private or public info; complementary /
synergy?)
o Should lease rights be sold simultaneously in bundles or sequentially (individually) -f
each block is valued independently then selling blocks siltaenously is not important. If
value of an individual block is dependent on gaining access to associated blocks, then
sequence is important
o Should lease rights be conducted simultaneously? (single bid) or dynamically (allow
rebidding) – static bid will likely generate ‘winners curse’
- Auction methods
o First-price, sealed-bid
o Second-price, sealed bid (corrects winner’s curse)
o English ascending
o Dutch Descending
- Types of sales
o Wildcat – geological and seismic characteristics not well known
o Developmental sale – previously sold and not reoffered
o Drainage sale – sale of tracts in which oil or gas deposits have been found
Chapter 4. Developing Oil and Gas Projects
• Identify and describe the various steps and associated risk elements that may be considered in
taking an upstream project from concept to completion

1. Start with prospect or development opportunity

2. Perform an appraisal and analysis of the opportunity by evaluating risk, economic returns,
project feasibility, competitive challenges
3. If financing available, FID can be made
4. Once FID is made, project handled over to development team, development design is done and
reviewed
5. handled over to execution team: conceptual design is prepared and prepared  moved to
detailed design, construction and actual execution

• Explain and apply the concept of unitization in the creation of joint development zones

- Requires private parties to coordinate reservoir production to minimize surface and production
costs while managing reservoir proessures to maximize recovery
- Treating as a single unit for development purpose; separate licenses and leases merged into
single lease or license
- Most countries allow first for producing parties to create their own unization production plan
and only require compulsory process if voluntary efforts fail
- Cross border unitization based on international unitization agreements
o Unitization is required only after discovery
o Area of unitization is defined by oil reservoir itself
o Participating countries collaborate via international agreement on all production issues
related to optimal development of the field
o All countries maintain sovereign rights
o Each licensee bears proportion of costs and receives proportionate returns based on
participation factor
 - Joint development zone (field is in area subject to disputed sovereignty) – best if a set of
unitizations and JOAs in place before discovery

• Calculate and interpret relative project economics using the following metrics: NPV, IRR, WACC, and
risk-adjusted return

• Classify pre-completion, post-completion, and macroeconomic risks and explain their impact on
project development decisions
• Describe potential risk exposures related to the use of contractors and subcontractors in petroleum
projects

- Environmental impact
- Socioeconomic impact (employment and economic development, demographic changes,
infrastructure individuals, family and community, aboriginal use and culture, heritage and
archaeological resources, other economic sectors
- Safety

• Identify and calculate key elements of cash flow in an oil exploration and development project and
their determinants, including capital investment, wellhead price, gross revenue, and operating
expenditures, as well as simple royalty and tax payments

Chapter 5. Production of Oil and Gas Products

• Explain how specific upstream costs impact an energy company’s earnings, and why production
costs may vary by location

- Depreciation, depletion and amortization not generally considered part of production costs, but
part of overall costs
- Full-cost approach – companies capitalize all exploration costs, including cost of dry holes
- Successful-efforts approach – only capitalize successful exploration costs, expense all dry holes
exploration costs
- Capitalized = transferred to production assets and for accounting purposes called PPE,
subsequently amortized on the basis of boe produced as a % of proved reserves
- Primary cost driver is nature and geography of reservoir itself
- Cash cost = actual cash expenses related to lifting, and does not include non-cash expenses like
depreciation and amortization

• Assess the economic performance of an oil well, including operating profitability, break-even price,
working interest, and tax allocations
LOE = lease operating expenses

Alpha = relative qty of gas to oil; beta = relative qty of condensates to oil

BBEbe = breakeven bbl; NRI = net revenue interest

BBEbe = breakeven bbl

• Classify and describe the costs and factors associated with the production of an oil field, with focus
on primary, secondary, and tertiary recovery methods

- Finding costs
- Lifting costs
- Workload of field (number of wells drilled), workforce productivity, contractors and supply
chains, equipment, power costs and workover planning
- Cost drivers of the various factors of productions
 - Enhanced oil recover (EOR) = secondary recover and tertiary recovery, usually up to 50% only
- Secondary
o Try to maintain pressure / sweep the oil
o Gas injection / waterflooding (
- Tertiary
o Tries to change the chemical conditions of the hydrocarbons to allow greater movement
and fluidity to the well bore
o Thermal recovery, chemical flooding, gas injection – alters the viscosity of the oil or alter
the adhesive tensions
o C02, microbial treatment
- Secondary recovery costs are very expensive, especially for equipment. Justified if oil price is
higher
- Well intervention / well work – additional repair or reinvestment on periodic basis in operating
well
o Could be expensive to restart wells that were shutdown or abandoned
- Workover – pulling and replacing well completion; pulling of the Christmas tree and possibly
wireline and tubing

• Assess the terms and conditions of a partnership management agreement; understand how duties
are shared and disputes are settled between parties involved
•Describe the nature of relationships, incentives, and potential conflicts among various stakeholders
along the oil and gas supply chain

- Reasons for JV conflict

o Technological uncertainty, massive capital expenditure, many partners, government and
non governmental parties with different objectives, different countries, uncertainty over
price, long development and oil field life cycles, difficult environmental conditions

• Identify and assess political risks that impact crude oil production decisions

- Political risk – unexpected impact on operating cashflows as a result of political actions and
events in the host country
- Government will only interfere if benefits outweighs costs
- Key is to create an economic link with host country
- Solutions
o Insurance, strategic alliance, partnering
o Keep low profile, maintain close relationships, anticipate change, avoiding geographical
concentration, being a good corporate citizen, utilizing local suppliers and personnel to
the greatest extent
Kaminski, V. (2013). Energy Markets. London, UK: Risk Books.
Chapter 16. Oil Transportation and Storage
• Identify classes of oil tankers; describe the transport characteristics, e.g., typical route and cargo
specification for each class of tanker

Drewry Shipping Industry Jargon Deadweight tons Routes

Consultant Classification
LR2 ULCC >200,000 Long-haul; from
VLCC >200,000 Middle East to Asia,
Europe, US Gulf
Suezmax 120,000-200,000 From West Africa to
US; from Middle
East to Europe;
within North Sea /
Mediterranean /
Asia
Aframax 80,000 – 120,000 Shorter regional
trades – NW
Europe, Caribbean,
Mediterranean,
Asia
LR1 Panamax 50,000 – 80,000 Take advantage of
port restrictions
within North and
South America
MR2 Handymax 30,000 – 50,000 Regional trade on
MR1 10,000 – 30,000 routes not suitable
for larger vessels

• Describe and apply common types of charter contracts used for crude oil shipments (Incoterms)

- Bareboat charter – equivalent to financial lease; charterer has full control and responsible for all
costs (except finance costs); cost carried on B/S of owner
- Time charter – operating lease / similar to car rental; charterer responsible for voyage costs (e.g.
fuel)
- Spot charter (voyage charter / trip charter) – ship owner responsible for all expense and timely
arrival in loading port
- Contract of affreightment (CoA) – used to move on a regular basis large volumes of commodity
over time, exceeding size of single vessel

• Calculate the cost of transporting a shipment of oil using the Worldscale pricing system
• Explain the relative economics associated with pipeline, rail, tanker, and other transport methods

- Trunk pipelines – connect major production and consumption centres; backbone of system
- Delivering pipelines are shorter and have multiple extensions leading to different locations
- Operate in:
o Batch mode – identify of the products is tracked and same molecules that were injected
into pipe are delivered to customer
 May cause congestion
o Fungible mode – molecules correspond to the same product are comingled and the
customer receives desired product, but not original material
 Tends to be more efficient, as it gives pipeline more flexibility to manage its
operations
- Transmix - Products will necessarily mix to a certain extent during transportation and will have
to be separated via centrifuges; can be reduced by sending only on product over a 6-10 day
cycle
- Rail shipments are used for products such as LPG, gasoline, diesel, and dominate in the case of
heavier products with high viscoscity, such as bitumen, heavy fuel oil, which are not adapted for
pipeline transportation

• Describe how pipeline shipment times and unexpected disruptions in shipments can impact
commodity traders and oil consumers
 - Cushion gas – amount of gas required to provide necessary internal pressurization to extract
working gas
- Tank bottoms – equivalent concept for oil
- A strong contago supports accumulation of inventories and selling forward stored commodities

• Differentiate types of crude oil storage facilities, including above-ground, below-ground, tanker ship
and pipeline; explain how storage level reports are generated

• Discuss the content and use of primary inventory storage reports produced by different agencies
including the EIA, IEA, and the JODI framework
 EIA - US data
- Inventory data for crude and petroleum products
held in storage at:
- Refineries, pipelines, tank farms, bulk terminals
- Crude oil transit by tanker
- Oil in the SPR
IEA - Provided by Japan
- OECD monthly inventory data
JODI - Saudi Arabia and a few other countries
o

Miesner, T.O., & Leffler, W.L. (2006). Oil & Gas Pipelines in Nontechnical
Language. Tulsa, OK:
PennWell Corp.
Chapter 4. Oil Pipeline Operations
• Explain pipeline field operations and central control room processes

- Piped oil is either commingled, or segregated and batched, depending on the costs of
segregation and the specific crude oil’s value in the refining business
- Some refineries are designed to process only specific qualities of crude oil
- Dedicated line moves only one product, e.g. jet fuel going to airports or fuel going to power
plants
- Gasoline comes in at least 3 grades: regular, mid-grade, premium – regulation forces pipeline to
manage different specifications, which increases complexity and cost of operations
- Control operations have been largely concentrated in a central control room
o Operations to keep the fluids flowing in the line
o Maintenance keeps the line and equipment in good operating condition
o Processing equipment should ensure that the crude oil is of sufficient quality to be
merchantable
 Manual process: Gaugers measure and test the oil to see if it meets or exceeds
pipeline’s expectations
 Automatic: oil is measured and tested by lease automatic transfer (LACT or ACT)
units
 ACTs are skid mounted and built to be easily installed and later moved
to an new location as production files
 Measures crude and takes small samples on a set schedule
 Adjusts for temperature
 From time to time a gauger comes by, uses the temperature and tests
for basic sediments and water (BS&W)
  If volumes are larger, mainline pipeline meter is used rather than ACTs
o If product doesn’t meet specs, shipper must correct situation before pipeline accepts
products
o Pipeline may insist on testing the contents of entire tank before accepting any product
from tank
o As they leave pipeline, they are tested again to ensure pipeline has maintained product
quality while in tis custody

• Explain the key aspects of planning and scheduling pipeline operations including the role of
personnel, batching, pressure, and transmix

- Functions of central control room

o Planning and scheduling operations
o Monitoring and controlling the pipeline
o Responding to and correcting abnormal operations
o Maintaining the control equipment
- Batching – different grades of products move end to end in successive batches
o 5 / 7 / 10 days cycle
o Most similar ones are grouped next to each other to minimize contamination and
downgrading
o Butane is buffered with small quantities of condensate to reduce mixing the butane and
the crude – buyers want to receive the quality they pay for

- Scheduler’s role
o Receive nominations from shippers for the next month
o Have to add up all shipper nominations to arrive at a total
o If line is over nominated, bad news goes back to the shippers and they may elect to
reduce their nominations
o If revised nominations still exceed capacity, pipeline institutes a pro-rated delivery plan
o Schedule is then transmitted to pipeline control room operators and shippers
o Schedule is updated to reflect reality as it unfolds, and making adjustments accordingly
o Must consider transit time – the interval from time the oil is put into the line until it
arrives at the destination
o If too much output, scheduler could lock up the line
- Controllers must look ahead and at past records to make provisions for the right product to be
in the line
- Minimizing transmix
 o Volume of mixed fluids / interface material
o If transmix does not meet specs, it goes into a transmix tank and is transported to a re-
processor who separates it into gasoline and diesel
o Gasoline in diesel can result in a very dangerously low flash point
o Diesel in gasoline can result in an end point too high for efficient combustion
o Crude oil is going to be processed in a refinery anyway, so the interace can be more
forgiving
o Pipeline invoice those who input lower quality of crude oil than average and pay those
that put in higher quality of crude oil
- Hydraulic concepts
o Many lines begin with origin pumping stations
o Pumps add energy in the form of pressure
o Intermediate or booster stations to boost the pressure to add back that which was
eating up by friction loss or to push oil up higher elevations
o Hydraulic gradient is the line sloping from the 1,000-psi mark to the tank, and
represents the pressure at any mileage point along the line
 Slope represents the amount of pressure loss per mile

- In the case of an intermediate offtake, Flow rate slows slightly, reducing the friction loss
(see left graph)
- Pressure at intermediate offtake point is much higher than the pressure needed to push
liquid into the tank. Diverting the stream at full pressure could damage the receiving
terminal’s tanks or create an explosive situation. To avoid that, terminal has a control valve
at the offtake point to dissipate the pressure between main line and tank
 - In the case of intermediate injection – oil must have enough pressure from injection pump
to force liquid into the line. That means flow rate downstream of the injection is higher; the
pressure los (and gradient) is therefore steeper on the downstream (opposite of left graph)
- Heavier material has steeper gradient  higher density / viscosity
- Maximum allowable operating pressure (MAOP) – highest pressure allowed at any point along a
pipeline
o Function of pipe, wall thickness, type of material, safety factor

• Identify and explain routine and potential abnormal operations

- If the break occurs close to and downstream of the pump station, friction loss / pressure goes
down, as the pump is pushing through a shorter distance, which means flow rate increases in
 that section. If flow rate upstream of the pump does not increase, the line is danger of being
pulled apart
- If break occurs far from pump station, close to downstream station, the pressure loss at the
pump’s discharge does not drop, as flow is constant. At the pump downstream, the station is
starved as no oil is coming to it. It goes down, on low suction pressure.
- Low suction pressure = major line break

Chapter 10. Investment Decisions

• Explain why pipelines are built, who decides whether pipelines are built, and the economics of the
decision

- Why
o Pipelines are built when they are the most economical means of trapsortation
o Safer, most environmentally friendly
- Who
o Owners
- Economics – Demand-driven (power plant, refinery, chemical plant) or supply-driven (fields
discovered) or market-driven (availability of new commodity)
o Supply-driven cases have lumpy forward profiles – large investments in capacity that
come on stream
o Demand forecasts are smoother
o Volume estimates
o Establish price rates –
 Use location differentials to establish rates (differences between prices of
commodity at the origin/oversuplied and price of material at destination
/undersupplied)
 Cost of service (regulatory term) – entitled to reasonable RoI
 Others include: Cost of alternative transportation, rates on competing pipelines,
shipper or customer negotiations, regulatory schemes

• Explain what motivates buyers and sellers to change ownership of pipelines

- Sellers motivated by
o Managing portfolio of investments – selling to raise cash
o Implementing strategic changes
 Ensure markets and refining efforts, support marketing
 As markets have matured, some infrastructure have become redundant
 Pipelines private from the state
o Managing risk -selling asset with unacceptable risk / reputational risk
- Buyers motivated by
 o Consistent high cashflow
o Cash generation above cost of capital
o Master limited partnerships (MLP)
 Legal entity sold publicly as units of ownership, with GP owning small part and
act as operator; the rest are publicly owned
 Good at managing assets with high cash flow
 Controlling one part of the value chain to complement other parts
 Motivated by tax code

• Determine the sale price for a pipeline and identify the economic methods used to value the
pipeline

- Economic Value
o NPV
o Multiples of current cashflows
- Comparables
- Highest and best use (not normally used) – the current use may not be the most economic use,
so it might be purchased and used in combination of something else or rebuilt over
- Replacement cost
- Book value (little relevant to what the asset is currently worth)

Inkpen, A., & Moffett, M.H. (2011). The Global Oil and Gas Industry:
Management, Strategy and Finance.
Tulsa, OK: PennWell Corp.
Chapter 10. The Market for Crude Oil
• Explain the evolution of crude oil pricing in recent decades due to market and political forces

- Demand for oil is the demand for its derivative products

- Supply
o Massive new field discoveries – pre-1970 period
o Producer collectives restrain quantities - OPEC
o Sudden disruptive man-man forces – Gulf war, Arab-Israeli conflicts, world wars
o Disruptive forces of nature – 2006 hurricane
- Transportation costs
o Price of producer = price of crude refinery – transportation cost
- After 1980s oil price fell due to increase in prices in 1970s leading to lower demand and also the
development of the futures market
- In 19871, Reagan abolished remaining price and allocation controls
• Differentiate between various grades of crude oil based on chemical composition and physical
characteristics that include sulfur content, gravity, and viscosity

• Distinguish between various global benchmark crudes and understand the role of benchmark prices
in the global crude oil market

- OPEC blend – weighted average from its producing members

 o Saharan Blend (Algeria), Girassol (Angola), Oriente (Ecuador), Minas (Indonesia), Iran
Heavy (Iran), Basra Light (Iraq), Kuwait Export, Es Sider (Libya), Bonny Light (Nigeria),
Qatar Marine, BCF 17 (Venezuela)
- Asia – Tapis Malaysia
- Difference in crude prices is also impacted by availability of refining capacity
o Refining margins have been low in the last decade
o Refiners reluctant to invest in ugprades that would allow them to process heavier
crudes
o Clean-dirty spread - Differential between light / sweet crude

• Distinguish between spot, forward, and futures transactions in the crude oil markets

- Futures – standardized contracts traded on exchanges

o Provide info about future expectations
o Transparent, efficient for price discovery
o Can be used to manage risks via hedging
- Contango  Futures price > Spot + Transportation Cost
- Backwardation  Futures price < Spot
- If futures with shorter delivery date > futures with longer deliver dates  expect price to fall,
reduce inventory now
- If futures with longer delivery date > futures with shorter delivery date  expect price to go up,
increase inventory now as long as higher future prices can cover storage costs

• Describe the factors that affect a crude oil futures contract and determine its value given a set of
market assumptions

- See above.
- Brent futures cash settled; WTI futures physically settled
Chapter 12. Refining
• Compare the operational and economic characteristics of independent refiners and integrated oil
companies

- IOCS – integration between refining and upstream activities allows IOCs to minimize short-term
cyclical effects. Done efficiently, this optimization can lead to superior performance relative to
independent refiners.
- Refiners – have greater flexibility and have potential for fast response to market changes.
Absence of upstream or marketing ties creates flexibility and the potential for fast response to
market changes

• Describe steps in the physical refining process and identify the end-products typically produced

- Distillation
- Hydrotreating – hydrogenation process used to remove contaminants, which if not removed can
have detrimental effects, and improve product yields
- Polymerization – accomplished thermally or in the presence of a catalyst
- Alkylation – combines low molecular weight olefins (propylene and butylene) with isobutene in
presence of catalaysts
o Product is alkylate
o Premium blending stock because it has exceptional anti-knock properties and is clean
burning
• Assess the economics of refinery operations including the relationship between the cost of crude oil
and refinery margins; describe the impact of a refinery’s complexity on its optimal product mix and
profit margin

- Seasonality – More gasoline in the summer and more heating oil for winter
- Profitability is affected by
o Refining is a capital-intensive process, circumstances impacting the availability or
allocation of capital to the industry can have a major impact on industry profitability
o Crude oil is the major variable cost in refining
o Operating costs are a small percentage of total costs but controllable by refiners
o Regulatory costs
o Most products consumed are commodities or commodity-like
- Gross margin = W.A. of products produced minus cost of crude oil
- Net margin = Gross margin – operating costs

• Calculate and interpret results of a crack spread given input and output prices

- U.S.: 3-2-1
- Europe: 6-2-3-1 (6 crude, 2 gasoline, 3 diesel, 1 residual fuel)
• Explain crack spread volatility, input and finished product values, technical value, netback value,
netback margin, gross margins, and net refining margins

- Refining value = technical value = revenue from refined products – operating costs
- Refining margin = refining value – crude oil costs
- Trading crack spreads - hedge itself by buying oil futures and selling gasoline and heating oil
futures
- “sell the crack” – buy crude and sell gasoline and heating oil futures
- “buy the crack” – sell crude and buy gasoline and heating oil futures
- Netback price – pricing which ties the prices of crude oil to the prices of refined products
adjusted for transportation and processing costs back to the source, ensuring guaranteed profit
margin.

• Identify and describe the factors affecting refining economics, including location, technology,
environmental mandates, capacity utilization, scheduling, and refinery complexity/efficiency

- Technology and managerial capabilities – increase productivity and utilization etc

- Environmental mandates
- Capacity utilization - >90% on average; 95% considered full capacity; above 95% may result in
bottle necks / increase costs
- Refinery scheduling – planning and scheduling
- Refining complexity and efficiency – given price differentials for lower quality crudes, refiners
had a strong incentive to increase imports of sour / high-acid crudes. As more refineries are
upgraded to handle heavy crude, differentials are decreasing
- Inventory management – just-in-time inventory and lean thinking
Kaminski, V. (2013). Energy Markets. London, UK: Risk Books.
Chapter 17. Oil Pricing
• Understand the physical and financial characteristics of Brent, the role of dated Brent, the Brent
complex, and the use of a Brent CFD

- Brent
o API 38.3, sulphur content of 0.37%
o Standard contracts 500,000 bbls, though now typically 600,000
o Port of loading being Sullom Voe in Shetlands Islands, operated by Shell
o Seller obligated to nominate a cargo of physical Brent to buyer with a three-day lay-day
loading date with minimum 25 day notice
o Once loading range has been established, cargo becomes tradable as ‘dated Brent’, i.e.
a tanker with a specific date assigned to it.
o Buyer can choose to accept cargo or continue selling, but decision has to be made by
5pm of day of deadline
 Forward / dry contract mutates into a wet / physical deliverable contract
 Buyer has to decide whether to:
 Sell the cargo on the spot market
 Nominate a vessel to collect (lift) cargo within the lay-day and pay for
cargo in full 30 days after B/L
 Brent can be cash-settled if two counterparties have offsetting positions
o BFOE = Brent Forties Oseberg Ekofisk
- Brent Complex, consists of:
o Dated Brent with confirmed loading range in the next 25 days
 It is a price reflecting activity over a specified time window, not on a single day
o Forward Brent (25-day BFOE) = cash or paper BFOE
o Brent futures traded on ICE Futures in London, Nymex and DME
o OTC Brent-related derivative contracts (options, swaps, swaptions), CFDs, and related
dated-to-frontline (DFL) contracts

• Calculate and apply crude oil spreads or differentials

- Differential = Forward-dated Brent – second month forward Brent

- Forward Date Brent = Differential + second month forward Brent
Where “forward” means dated Brent averaged over some future time window
- If contango, then Forwarded-dated brent < second month forward Brent, therefore negative
spread / differential
o If negative spread becomes more negative, spread increases (trader earns more).
o Buyer would pay fixed price differential and received floating differential at settlement

• Explain the market factors that prompted the emergence of the Dubai-Oman benchmark and discuss
the issues associated with its adoption and operation
 - Oman-Dubai Crude
o Used by Persian Gulf countries and the Asian importers
o Persian Gulf more sour than WTI and Brent
o Falling output of Dubai Crude led Platts to add delivery of Oman crude
o Size 500k bbl
o But can be partially settled in ‘partials’ of 25k bbls and in cash
o Oman partials are assessed based on Dubai benchmarks, and therefore can be
influenced by a small number of players

- Argus
o Links Brent and Duba prices under the Exchange for Swaps (EFS) contract
o No basis risk

• Identify and differentiate crudes referenced in global trade, such as WTI, WTI Houston, Brent, Dubai,
Urals, Saudi Light, Bonny Light, and Maya

- WTI
o Traded on NYMEX, with option to make physical delivery in Cushing, Oklahoma
o API 39.6m 0.24% sulphur
o Parity pricing
 Level of prices of different crudes which results in the same refining margin
 Differences in margins will trigger the flows of crudes between different
locations until parity is restored
o Factors contributing to evolving price dynamics at Cushing
 Increasing availability of Canadian crudes made possible by reversal of flows of
oil on the Cushing-Chicago pipeline (Spearhead pipeline)
 Shortage of storage capacity contributed to steeper contango
 Limited pipeline capacity to flow crude from Cushing area to refineries located
at the US Gulf Coast
 Drop in the North Sea oil output (arbitrage prices got delinked from Brnet)
o Saudi Arabia abandoned WTI as a price marker in 2020 and instead used Argus Sour
Crude Index (ASCI)
 ICE ASCI Futures (outright contract)
 ICE ASCI – contract on the spread between ASCI and WTI

• Identify global spot markets with active trade and benchmark prices, including Cushing/WTI, Brent,
and Dubai

Above

• Explain the differences between trade in spot and forward cargoes

• Describe the relationship between inventories and how the cost of storage shapes the forecast of
spot prices

• Identify market fundamentals that drive changes in spreads of various types, including location
spreads, and quality spreads

Johnson, O. (2018). The Price Reporters. New York, NY: Routledge.

Chapter 3. How Price Benchmarks Work
• Understand the rationale for using pricing benchmarks and the benefit in using benchmarks in
petroleum commodity transactions

- Benchmark
o Price reference point that is acceptable to both buyer and seller
o Rationale
 Physical commodities vary greatly in terms of specifications; very time
consuming to negotiate from scratch
 Immense volatility of commodity prices, difficult for traders to predict how
prices will evolve; difficult to agree on overall price level. Easier to agree on size
of the premium or discount to this index
 Ensures both sides can focus on the element of the price risk they can control
(premium or discount) and not the element that they can’t (flat price)
 Reduce friction in negotiations

• Describe the rationale for using price reporting agency (PRA) assessments as pricing benchmarks

- Trust that PRA index will reflect actual prices being traded
- Due to first-mover advantage and habit

• Explain why markets rarely switch PRA benchmarks and the steps taken to prevent benchmark price
manipulation

- Path dependency – continued used of product or practice based on historical preference

- Innate suspicion of anyone who proposes a switch
- Question of habit
- Do not want to change the contract terms to reference a different benchmark out of fear that
the entire contract may be subject to renegotiation
- Steps taken to prevent manipulation
o Self-regulation
o Encourage firms to be more aware of their responsibilities
o Innovation from PRAs
o Regulatory scrutiny (see next chapter)

• Identify and explain the usage of other types of benchmark prices, e.g., exchange benchmarks and
official selling prices
 - Exchange benchmarks (regulated by governments)
- Official selling prices (posted prices by NOCs)
o Cannot be challenged by buyer, although two parties can agree to discounts
o Mostly abandoned / not used
o Open themselves up to undercutting by rivals
o Legal and compliance implications
- Broker benchmarks
- Perceived risk that largest customer can intimidate broker and adjust the index to their favour
- May not capture bilateral activity

Chapter 11. PRA Pricing Methodologies

• Understand the role of pricing methodology within PRAs and the trend towards transparency in
these methodologies in recent years

- Methodology – ‘how to’ guide, ensures users can understand exactly how the assessment is
derived. Also act as a guide to market participants about format in which they should present
any info that they wish to be included in the discovery process.
- Formalize and publish their methodologies to comply with IOSCO Principles, which require
formal documentation and disclosure of all criteria and procedures and show transparency of
procedures
- Trend towards greater automation or mechanization of pricing – reduces role of human element
(price reporter), who many be subject to biases

• Explain the use of various types of panels by PRAs in establishing prices, including the key strengths
and weaknesses of the panel methodology
 - Relative value methodology
o Leverage on assessments of a liquid benchmark, and use differentials for other markets
that are less liquid
o This allows price indications for a much wider range of markets than they can otherwise
cover, especially if there is insufficient trading activity in these markets to support a
standalone assessment
o Useful intermediate stage in development of markets
o Weakness – provides indications of price levels rather than an actual assessment, which
is possible for them to diverge severely from actual levels over time
- Best offer methodology
o Used in Uranium markets and cotton markets
o Provides clear view of exactly where the most competitive sellers are offering their
product
o Weakness – does not provide much information about buying interest. In a typical
market, best offer shouldn’t differ too much from best bid. But if market is thinly traded
there will be substantial difference between the two

• Describe the circumstances under which a volume-weighted average is most likely to be used and its
relative strengths and weaknesses when compared to the panel methodology

- Panel approach
o Works well in markets where there is a good range of buyers, sellers and traders
o Less successful in markets where there is an imbalance, or where both sides are looking
for the same outcome
 o Potential to generate an assessment that is at odds with actual deals happening
- Surveys
o Extremely common
o Some market participants value their interactions with price reporters, who are
important conduits for news and gossip
o Popular due to flexibility and common in opaque markets
o Come under intense regulatory scrutiny as firms are not comfortable allowing traders to
speak freely to PRA reporters
- VWAP
o Heavily used when there are lots of small deals that takes place in large numbers
(wholesale natural and gas markets, crude oil and refined products, pipeline and wire
markets)
o Suffers from ‘sleeving, where parties transact through a third party. A small premium is
attached as payment for the sleeve, the fcosts of which is borne by either parties or
both. This leads to double counting. A sleeved deal may show up as two transactions but
is actually only one genuine transaction
o Can be subject to market manipulation, “wash trades”, false reporting

• Define market-on-close (MOC) and explain its usage

- “Platts’ window’
- Single 30-min window during which traders indicate their bids and offers and transact deals on a
trading screen, with the last visible price setting that day’s assessmentPrice discovery now takes
place onscreen and in public so the price reporter is principally a witness and judge rather than
active agent
- With emphasis on the final few seconds, MOC emphasizes timing of price assessments and all of
Platts’ assessment lined up perfectly to the second.
- Believes that price is a function of time and averages do not reflect actual market activity

• Understand why a PRA may choose to adopt a hybrid methodology combining several different
methodologies to determine a price for a given market

- Stems from desire to ensure special robustness in assessment

- Strengthen assessment building with checks and balances
- No individual price signal can get out of line or be overly influenced.
- In line with trend towards greater precision and automation
Office of the Comptroller of the Currency. (March 2016). Oil and Gas Exploration
and Production Lending.*
• Identify risk factors associated with oil and gas production lending and explain how these risks can
arise

- Credit risk
- Market volatility
- Limited purpose collateral
- Interest rate risk
- Liquidity risk – capped or abandoned wells, reduced exploration, population migration
- Operational risk
- Compliance risk
- Reputation risk

• Explain guidelines for the governance of production lending operations, including underwriting,
financial analysis and valuation of collateral, assessment of engineering reports, and equipment

• Explain guidelines and best practices for monitoring and documenting performance of a lending
portfolio
 - Collateral documentation

• Describe guidelines for assigning a rating to oil and gas production loans

Wright, C. (2017). Fundamentals of Oil & Gas Accounting, 6th Edition. Tulsa, OK:
PennWell Corp.
Chapter 15. Conveyances
• Define conveyances and the types of interests covered under a conveyance, including working
interests, royalty interests, production payment interests, and net profits interests

• Describe the circumstances in which a farm-in or farm-out arrangement is used

• Define the term sole risk, under what circumstances sole risk can arise, and its financial implications

• Understand how a working interest may be sold to a third party; calculate the payouts distributed
under a working interest

• Explain how working and nonworking interests are affected by pooling or unitization decisions and
how the interests are valued after pooling or unitization

Chapter 17. Reserve Valuation

• Understand the specific categories of information that must be included in the financial statements
of oil and gas companies

• Describe and calculate the factors that make up the reserve life, reserve replacement, and net wells
to gross wells ratios

• Calculate the reserve cost ratios and their application in the financial analyses of oil and gas
companies
• Explain why lifting costs per BOE is a popular performance indicator and how it is applied to
depreciation, depletion, and amortization calculations

Chapter 18. Accounting for International Petroleum Operations

• Differentiate among the characteristics of various fiscal systems used in global petroleum contracts
including concessionary, contractual, and production sharing/service agreements

• Calculate the economic revenue generated from various global petroleum contracts, given a set of
inputs

• Explain how profit oil is derived and how it impacts project economics

• Illustrate the application of a joint operating agreement and describe the circumstances when it is
used

READINGS FOR NATURAL GAS MARKETS AND LNG TRENDS | 24 QUESTIONS

Rogers, H., & Stern, J. (December 2014). The Dynamics of a Liberalized European
Gas Market – Key
Determinants of Hub Prices, and Roles and Risks of Major Players. Oxford
Institute for Energy Studies.*
• Explain factors driving the change from long-term contracts to hub-based trading and the steps
taken by some market participants to maintain oil-index pricing methods

See below

• Explain why prices among European hubs have diverged during the past few years

Hub pricing and liberalisation and competition are secular trends which are dominant in the north west
European gas markets and are spreading to the south and east of the Continent. Individual markets –
especially in central/south Eastern Europe – may take much longer to adopt hub pricing and open to
competition (due to government opposition), or will be too small for serious competition to develop.

Due to a combination of price concessions negotiated with Gazprom and Dutch and Norwegian sellers of
gas under long term oil-indexed contracts; and the increasing impact of hub-priced gas imports into
Germany – probably from TTF.

- LNG supply has been a major determinant of the spread of hub pricing, demonstrated by the
fact that prices fell during 2009-11 when supplies flowed into Europe; rose during 2011-13
- after the Fukushima nuclear accident in Japan when LNG flowed out of Europe; and fell in
- 2014 as supply flowed back into Europe
- Russian price/volume policy, with the 2009-12 period demonstrating that refusal by Gazprom to
adapt prices in its long term contracts to hub levels led to a dramatic reduction in Russian
 exports to Europe, followed by a recovery in exports in 2013 when Russian prices came into line
with the hubs;
- With the arrival of shale gas freeing up North American gas supplies which would have been
needed in the US, and leading to the construction of liquefaction facilities promising to add
significantly to global LNG supply;
- Developments in Asia have been important, as Japan closed its nuclear plants post- Fukushima,
and Chinese regasification capacity continues to expand rapidly.
- Global market dynamics have played a bigger role in European gas price formation than in the
past.
- gas demand (specifically in the power sector); weather events – e.g. the very cold spell of
March/April 2013 followed by the very warm winter of 2013/14 – which impacted the need for
gas to fill storage; security events – eg the Russian/Ukraine crisis of January 2009; and events
involving both weather and security issues e.g. the February 2012 price spike caused by a
combination of very cold weather and Russia/Ukraine problems.
- The decline in European gas demand has been a 5 year trend. None of the weather and security
events has had any lasting impact on hub dynamics beyond the duration of the event.

• Describe the origin of natural gas supplies for European hubs, including price determinants for
imported gas
Bradford, T. (2018). The Energy System: Technology, Economics, Markets, and
Policy. Cambridge, MA:
The MIT Press.
Chapter 18. Natural Gas (Book 1 – Pg 34)
• Describe the natural gas value chain: exploration, development, production, transportation,
distribution, and marketing

- Exploration
o Start with understanding geology using surface conditions, previous drilling, site work,
geological history, and below-ground conditions
o Supplement with seismic technology
o Use exploration wells to confirm estimates and chemical readings
o Use development wells to confirm precise field characteristics
- Drilling process
o Construction of well pad and drilling work site
o Setting up of drilling equipment
o Drilling the well
o Lining the well boreholes with a casing to protect against contamination
o Perforating the case to allow gas to flow into the well
o Connect offtake equipment such as the gathering line (pipeline) to a gathering
infrastructure that will eventually feed it into the processing plant
o Remove waste material, such as produced water
o Remediating the well to conditions agreed with owner / regulator
- Processing
o Raw guess straight from the well needs to have contaminants removed before it is
suitable for distribution through natural gas pipeline
o Pipeline-quality natural gas is defined as 97% pure methane
o Natural gas processing plants – either close to well head (lease operations) or at the
processing plant (plant operations)
 Removal of condensates, water, nitrogen, contaminants, and natural gas liquids
(ethane, propane, butane and pentane)
o Storage
 Match seasonable demand fluctuations
 Most economical to store underground, in depleted gas reservoirs, aquifers, salt
caverns
 Depleted reservoirs usually do not require injection of as much upfront cushion
gas to create baseline volume and pressure of gas
o Pipelines and tankers
 Compressed natural gas (CNG) – economically useful for moving small volumes
 Natural gas typically runs through a compressor to allow it to be injected into
the pressurized natural gas transmission system (for distribution) via intrastate
or interstate transmission pipeline
 Distribution infrastructure
 Transmission ends when it enters the distribution infrastructure
referred to as ‘City Gas’.
 ‘City-gate’ price is the price paid at this point of entry, and often used as
proxy for delivered wholesale natural gas
 Once natural gas enters infrastructure, it is slowly depressurized and
diverted into various customers via pipeline networks
 Gas meter is needed to determine gas usage
• Interpret a natural gas production chart and understand the factors that can impact natural gas
production

Factors

- Regulation and deregulation

o Federal Energy Regulatory Commission (FERC) provides regulatory approval for pipeline
construction
- Deregulation
- Emission and environmental risks in natural gas supply chain
o Fugitive emissions
o Volatile organic compounds (VOCs)
o Methane – higher heating effect than C02
- Intangible drilling credit (IDC) in the U.S., allows investments in drilling to be written off
immediately for tax purposes
- Master limited partnerships (MLP) – tax advantage vehicle designed to invest in midstream and
downstream assets

• Understand different measurement units, such as Mcf and Mcm, and calculate basic conversions

Mcf = million cubic feet – imperial measures

1.028 MMbtu / Mcf

1 Btu = energy required to raise 1 pound of water by 1 degree Fahreinheit at 1 atm

Mcm = SI unit
• Understand how rig counts are used as a metric to analyze natural gas markets and the criticism of

this method

• Explain why wells may be categorized as “drilled but uncompleted” (DUC)

• Define the following natural gas production categories: associated, non-associated, condensate, and

unconventional; differentiate between wet and dry natural gas production

- Manufactured gas – gaseous fuel primarily from coal

- Associated – during oil production
- Non-associated – in gas fields without substantial oil
- Condensate
- Wet gas – high in NGL and condensate; may improve economics of production if NGL can be sold
separately, esp. helium
- Dry gas – low in NGL and condensate, lesser processing needed
- Unconventional gas – tight gas (low-permeability and needs hydraulic fracturing / fracking/ well
stimulation; shale gas (deeper, denser), coal-bed methane
- Condensates – light liquid hydrocarbons, similar to a very light (high API) crude oil, separated
from natural gas at field separation

• Explain the factors that have led to a steady natural gas production surplus in North America since
2007

- Shale gas
- Mineral rights in the U.S. grants ownership – less risky and cheaper
- Limited federal oversight
- Well-defined contractual relationships
- Less densely populated than Europe

• Identify the primary drivers of natural gas consumption and explain the dynamic between natural
gas and coal consumption in the power sector

- Demand growth
o Electricity fuel switching into gas (goal-to-gas switch)
o Conversion into value-added output – production of chemicals and fertilizers that need
natural gas as feedstock
o Attract energy-intensive industries – cement, glass steal
o Natural gas in transport
 Vehicles that operate CNG, dual-fuel vehicles
o Gas-to-liquids
 Chemically converts natural gas into liquid fuels
 Process is called syngas, using Fisher-Tropsch synthesis
 Very expensive process, needs large scale
 Only 5 plants built in the world so far

• Understand the role seasonality plays both in consumption trends and in the utilization of natural
gas storage facilities
• Understand why storage capacity is needed for the natural gas market to function effectively

- Because of demand seasonality which is heavily dependent on weather

• Differentiate between the types of natural gas storage facilities and identify key characteristics, such
as base gas percentages and injection/withdrawal rates, for each

• Understand the difference between firm and interruptible capacity on a pipeline network, and the
process and associated costs to secure access to a pipeline for shipment

• Describe the process for scheduling a gas day on a pipeline, including the procedure for dealing with
cuts and balancing decisions

• Explain the effect shale gas production has had on established natural gas supply and demand
trends in the North American market

Le Fevre, C. (2013). Gas Storage in Great Britain. Oxford Institute for Energy
Studies.*
Chapter 2. The Role of Gas Storage
• Describe the role of cushion gas in the operation of a natural gas storage facility and understand
how cushion gas affects the economics of a storage site

To provide a required level of deliverability any storage facility requires an element of cushion gas. This
is the volume of gas required to be kept in a facility in order to maintain operating pressure and can
represent a significant element of total capital cost, as it is not recovered until the store cease
operations.

Amount of cushion gas required depends on the pressure of the facility relative to the transmission
system and the method of operation.

• Differentiate between the major types of natural gas storage facilities and the
strengths/weaknesses of each
Cycle rate is the number of times the facility can be filled or emptied.
• Understand how system operators use storage facilities to provide volume flexibility to natural gas
consumers

Volume flexibility is important because demand can vary (for a variety of factors). Demand for gas is
price inelastic and consumers place high premium on having reliable uninterrupted supply.

Types of tools available to provide volume flexibility

- Those that increase supply flexibility, such as variations in supply from producers
- Those providing a buffer stock – principally gas storage but also from line pack provided by
utilizing the gas under pressure in a pipeline system
- Those requiring some form of demand side response either through fuel switching in response
to higher gas prices or shipper / transporter-initiated interruptions

• Explain how the market value of storage is determined within a liberalized natural gas market,
including its intrinsic and extrinsic value
• Identify the broad categories of risk associated with natural gas storage, and how these risks are
identified and evaluated
Leffler, W. (2014). Natural Gas Liquids: A Non-Technical Guide. Tulsa, OK:
PennWell Corp.
Chapter 6. Refineries and the Unnatural Gas Liquids
• Explain how the various units within a refinery complex produce NGLs and which NGLs are produced
by a specific unit

• Describe how each type of NGL is applied, both within the refinery, and by external consumers
• Understand why some NGLs are more volatile than others and the steps a refinery will take to safely
manage them

- Units in refinery
o Separation (by boiling points; vapours on top, liquids below)
 Light gases (butane, propane) – to refinery gas plant (butane most significant)
 Gasoline – to gasoline blending
 Naphtha – catalytic reforming for upgrading to gasoline and distillates
 Kerosene- hydrotreating to jet fuel
 Light gas oil / distillates – treating to diesel / distillates
 Heavy gas oil - catalytic cracking / hydrocracking
 Residue – vacuum flushing which goes to the cracker
o Crackers
 Breaking up complex molecules by cracking the bonds
 Turn heavy lower valued streams into gasoline and distillates, which are lighter
and higher value
 Cokers take in the heaviest streams, the flasher bottoms and crack them into
higher valued products as well
 Small portion of them falls into ethane, propane, butane (collectively, “NGL”)
 Cat crackers
 During cracking process, short of hydron atoms, so molecules usually
have double bonds resulting in ethylene, propylene, and butylene
 Amount of ethane and ethylene too little, so it is typically burned with
methane in furnace as refinery fuel (raising steam or generating heat)
 Propane – chemical feedstock (most important feedstock)
 Butane – blending component for gasoline and used as chemical
feedstock; Refineries need more butane than produced so many
refineries buy more from the gas plant sector
 Propylene / Isobutane / Butylene / Isobutylene – used in refinery
alkylation plant, where it is reacted with isobutane to make high-octane
gasoline blending components or sold as base chemical
o Refinery grade propylene – 40% propane (few petrochem
process)
o Chemical grade propylene – 5-8% propane (most petrochem
process)
o Polymer grade propylene - <1% propane
 Hydrocracker
  Operate differently from cat crackers (different catalysts, higher
temperatures, pressures and add voluminous hydrogen)
 Main products have single bonds, not double bonds (no ethlyne,
propylene, or butylene)
 As much as 15% more volume of products come out than the feed that
goes in (same weight) – i.e. “fluffing up the barrel”
 Cokers
 Operate without catalyst
 Just heat up very heavy feedstock to 1,200 fahrenheit, put them in a
coke drum and let them cook
 Make a lot of coke, a coal-like substance of nearly pure carbon
 Lighter products are produced and handled same as above
o Rearrangers
 Catalytic reforming
 Works on naphtha which has lower octane number and unsuitable for
blending directly into gasoline
 Uses platinum / palladium catalysts, and not heat
 Converts low octane gasoline material to a high-octane gasoline
blending component
 Chemical reaction – straight chain to branch chain; each of this step
results in a higher octane number
o Normal hexane  isohexane
o Normal hexane  cyclohexane
o Cyclohexane  benzene
 Isomerization
 Uses platinum-palladium catalyst, HEAT and PRESSURE to turn straight
chain paraffin into branched parrafin
 Not perfect process, small amounts of by-products of ethane, propane
and butanes are created in the process
 Normal hexane  isohexane
 Normal butane  isobutane
 Alkylation (or “un-cracker”)
 Catalyst – sulfuric acid or hydrofluoric acid
 Takes cracked by-products (propylene, butylene) which are volatile and
react them with isobutane and turns them into alkylate (high-octane
gasoline blending component) + butane / propane (feedstock)
o Heavier, goes from C3 to C4, and C7 to C8
o Less volatile
o Higher boiling point, easier to split in fractionating column
o Treaters
 Use heat, pressure, and catalyst to force sulfur components to react with
abundance of hydrogen, by-product will be H 2S which gets rid of the sulfur
o Blenders
  Use butane as blending component for motor gasoline
 Meet market and regulatory specifications
 Pure propane goes straight to marketplace, the rest are usually blended

Chapter 7. Logistics
• Understand the basic methods of transporting NGLs by land and the common sizes of transportation
vehicles

- Trucks
o Highway transportation
o Large tankers (9,000-12,000 gallons) or Smaller bobtail truck (2,800-3,500 gallons)
o Pressurized tank leads to liquefication
o Minimum and max design pressure of 100psi and 500psi
o Unloaded by liquid pump
o Compressor is used during liquid transfer to facilitate vapour recovery
o Transfer normally takes place at bulk plant, into or out of storage tank
- Rail pressurized tank cars (standard parcel size 32,000 gallon)
- Design regulations that allow car to be protected in a 1,600 fahrenheit fire for 100 minutes
-

• Explain the different methods for moving NGLs by pipeline, including batch shipments, and the
challenges involved with pipeline shipment of NGLs
- Single pipelines at 100-1,000 psi to keep product in the liquid state
o Easiest way to transport and store
o Ethane difficult to handle this way due to critical temperature of 90F; in places where
there is enough heat to exceed critical temperature, ethane will not liquefy no matter
what pressure, becoming a supercritical fluid
- Batching
o Propane buffered with butane on both sides; just abit of propane in gasoline / diesel will
be very bad
o Use pigs (suction-cup-like) that provide a seal at either end of the parcel to keep one
product from leaching into another
- Diluted crude
o Dilute butane with crude and then separate it later using the distilling unit
o Crude oil can absorb butane like a sponge
 o Natural gasoline does not create vapor pressure problem, and can be mixed with heavy
crude oil, which reduces the viscosity and makes heavy crude pumpable

• Understand how NGLs are stored in both above-ground and underground facilities, and the rationale
for the use of each

- Above ground
o Gasoline - Large cylindrical tanks
o Ethane – need steel surge tanks; can only be stored for a few hours as the tanks need to
handle pressures in the hundred of psi
o Propane and Butane – need rounded steel storage structure, engineered to spread the
internal pressure to reduce tank’s structural steel requirement (cheaper to build)
o May use refrigerators and insulated tanks to reduce steel requirements
o Safety components to flare any emergencies if temperature rises
o At depots, industrial sites  bullet. Can handle 100,000 gallons or more
- Underground storage
o Salt Caverns
 Can accommodate many different commodities (NGLs, crude oil, petrochem
such as ethylene and propylene)
 Petroleum products (gasoline, diesel fuel) typically not stored in salt caverns –
get worse with age; double-bonded reactive will react with one another
o Rock
 Pressure from water in the rock keeps hydrocarbons from slowly leaching into
rock formation
 Deep enough, constant temperature all year round
- Ethane transported mostly by pipeline, some by sea in tankers
- Propane and Butane move as liquids in pressurized pipelines, railcars, trucks, barges and
tankers
- NGLs can be stored in large volumes in salt caverns, and rock caverns; small volumes in
pressurized steel tanks or refrigerated tanks

Lassander, R., & Swindle, G. (2018). Natural Gas Trading in North America.
Princeton, NJ: Scoville
Risk Partners.
Chapter 8. Basis Markets
• Understand how the concept of basis is typically applied in the natural gas markets

- Prices are generally lower where production occurs and higher where demand is located
- Price differentials pay for transport infrastructure; cost of transport is a driver for price
differential (locational price risk)
 - Basis – difference between price at a particular geographical delivery point and a benchmark
price
- Basis trading
o trading of natural gas delivery at delivery location other than Henry Hub
o Makes use of benchmark futures contract, and most view their risk in reference to it

• Describe the operation of a pipeline network, including how charges incurred in pipeline shipments
affect natural gas price determination

• Explain the role temperature plays in natural gas storage, shipment, and price formation, including
the occurrence of price spikes

• Understand how supply imbalances affect local natural gas pricing

Chapter 3. Natural Gas Markets

• Understand the types of market participants who constitute “natural” long and shorts

- Producers (natural longs) – E&P

- Consumers (natural shorts)
o Utilities
o Local distribution companies – regulated entities which supply natural gas to their
customers
o Independent Power Producers (IPPs)
o Energy retailers
o Industrial consumers

• Describe the risk exposure faced by various market participants

- Lenders and shareholders care a great deal about stability of cashflows

- Intermediaries – dealers, commodities trading shops, hedge funds – often hold residual risk
position for short position of time
- Market facilitators – commodity exchanges, electronic trading platforms, CME, ICE, brokers,
ETFs
- Regulators (FERC, CFTC)

• Explain the factors affecting natural gas prices in the forward markets, including the impact of
seasonality

- Higher prices in winter due to heating demand

- Glut of natural gas from shale gas production has reduced forward prices overall
- Forward prices always reference calendar delivery months
- Physical trades – commodity delivered
- Financial trades – only cash is exchanged

• Describe the composition of a typical natural gas trading desk, including the following elements:
origination, regional desks, and exchange desks

See below
• Understand how a typical natural gas transaction is handled by a natural gas trading desk

- Origination
o Sales force / client interaction
o Organized by geography, location etc
- Regional desks
o Transferred to portfolio of trading desk once executed
o Organized to tenor of risk
 Term traders – longer tenor delivery periods
 Cash traders – managing trades with delivery during cash month (intra-month)
 Schedulers – responsible for immediate delivery of physically settling trades
o Need to track detailed locational information to handle specific risks in portfolio
- Exchange desks
o Traders who focus exclusively on henry hub market
o Henry hub is the benchmark for U.S. natural gas with higher trading volume and liquidity
o Desk deals with larger volumes of benchmark hedging activity
o Work closely with regional desks (who have local / regional knowledge)
o Absorbs large components of price risk being hedged by end users
Griffin, P. (Ed.). (2017). Liquefied Natural Gas: The Law and Business of LNG.
Surrey, UK: Globe Law and Business Ltd.
LNG Shipping
• Describe trends in the LNG shipping industry

- First LNG carrier – Methane Pioneer (1959 converted; first cargo 1960s) from Lake Charles
Louisiana to Canvey Island UK
- Next generation of LNG carriers service new LNG projects in Abu Dhabi, Indonesia and Australia
to transport gas to emerging markets of Japan, Korea and Taiwan
- Entry of korean shipyards, aggressive pricing
- Huge increase in demand for LNG carriers driven by LNG export projects and large energy
companies
- Q-Flex, Q-max vessels, 215,000 and 240,000 m 3 respectively, though most LNG carriers are
170,000 m3
- Dual fuel diesel electric systems to tri-fuel diesel electric vessels
- Initially, fleets mostly owned by large gas companies
- Second-hand sales and scrappings are rare
- New buyers, sellers and traders enter market generating demand for vessels on shorter-term
charter
- Introduction of permanently moored regasification units (floating LNG) and FSRUs

• Describe the considerations for owning and chartering an LNG tanker, given a set of market
assumptions

- Either purchase or charter

- Owning
o Can realize residual value
o Greatest degree of flexibility in operation
o Need to have technical and operational support

• Describe and differentiate among the variety of charterparty contracts

- Time Charter
o For a period of time
o Shipowner provides vessel, crew, stores and provisions
- Voyage Charter
o Hired for specific voyage
o Contract of affreightment – shipowners agrees to transport quantity of cargo in
shipments
- Bareboat Charter
o Charterer responsible for operation and maintenance of vessel

• Identify and describe shipping-related terms in sale and purchase agreements

- Loading and delivery, timing and condition of vessel on arrival

 - Laytime and demurrage – party responsible for shipping to compensate terminal
- Terminal arrangements – charterer obliged to make arrangements; shipowner responsible for
ensuring vessel is compatible with terminal specifications
- Insurance arrangements
o Third party P&I insurance (indemnities for third-party liabilities such as cargo damage,
damaged to fixed and floating objects, terminals, pollution, wreck removal, crew claims)
o Hull and machinery (underwriters will cover ¾ of any damage caused to another vessel
as a result of the collision; the other one-quarter covered by P&I)
o
- Consequential loss – shipowner seek to exclude these losses

• Discuss emerging issues and risks related to floating LNG

- Considerable technical complexity and contractual issues

- Bespoke design, shipyards assume a much limited degree of design responsibility
- Higher level fo change orders
- Delays
- Operating risk higher due to complexity; owner might be exposed to potential claims if FPSO /
FSRU underperforms below its required availability
- Country risk
o Designed to operate and permanently moored in a single location
o Subject to laws and regulations of flag state and international maritime convention
o Subject to local taxation

LNG Trading
• Describe the factors facilitating increased LNG trading

- Increased number of market player called aggregators – have contractual flexibility to take
advantage of opportunities created by virtue of their own asset portfolio
- More active in Atlantic and Mediterranean Basin, where there is scope to trade with Europe and
North America
- Not so much in Asia, lack of established underlying market, and lack of domestic energy sources
- Change in supply and demand – shale gas revolution, increase buyer’s power
- Increased supply creates demand – increased number of regasification terminals
- Increased push for power plants to use natural gas
- Growth of spot and short-term NG market

However, several constraints:

- For new LNG projects, lenders unwilling to accept significant exposure to spot
- Difficult to source capacity at short notice
- Lack of standardization of quality specifications
- Lack of standardization of terminal and tanker design
- Lack of transparent price reporting

• Identify different LNG trading models

 - Short-term trading contracts – up to 5 years
- Spot cargoes
- Swaps

• Understand how LNG spot risk allocation is similar or different to long-term contracts in terms of
pricing, volume and destination flexibility, and termination rights

- Master Sales agreements and confirmation notices

o Used for Spot-trade / short-term trade
o Reciprocal agreements (where either party may be buyer or seller) makes agreements
fairly balanced

Risk Allocation Spot / Short-term Long-term contracts

Price - Set to reference or sold to fixed - Contain price review clauses in
at fixed price case contractual price varies
- At fixed price  need to hedge significantly with market price in
downstream market; protects
seller from selling into market at
significantly lesser than market
will bear
Volume - Net proceeds mechanism / - Take-or-pay mechanism / make-
flexibility Cargo-based damages – buyers up rights
pay for cargo if fail to take
cargo, but entitled to receive
net proceeds if it is sold to third
party
- Stipulated unwind mechanism
– if seller gives notice, parties
agree trade will not proceed;
buyer expected to receive a sum
in exchange for the right to
unwind; seller can divert cargo
elsewhere; buyer gets a price
reduction to reflect risk of non-
delivery
Destination Yes No
Flexibility
Termination - May trigger cross default on Buyer gets termination rights if seller
rights other trades that are on foot fails to ship / deliver
and documented under one
Masters Sales Agreement

• Demonstrate knowledge of common swap structures and how swaps can serve the interests of
buyers and sellers

- can result in reduction in costs due to shipping distances

- can mitigate scheduling mismatches
 - saves both buyer’s liabilities under the take-or-pay regime
- Sharing of upside
- Consent required
o destination clause
o scheduling provisions
- must verify onshore infrastructure to be used are mutually compatible and cargoes are of
similar / consistent quality
- ensure does not offend applicable competition law – the upside sharing may disincentivize
buyer to sell to other customers / destination
- must be aware of counter-party credit risk

Financing LNG Projects

• Explain project-level debt financing and why it is an attractive option for LNG project sponsors

- Limited or no recourse to shareholders

- Highly capital-intensive projects with substantial upfront outlays
- Limitations to party’s ability to raise funds
- Raise funds at project level
- Availability of debt finance for well-structured deals remain strong
- Active involvement of governments, staleholder interface
- Increase funding sources (PE, infrastructure funds etc)

• Identify the major sources of LNG funding and their characteristics. Understand the expectations of
each lender

- Commercial banks
- ECAs (insurance / direct loans)
- Multilateral agencies / development financial institutions
- Development banks , nexus with their own nation as pre-requisite for providing finance,
fulfilment of national goal (China Development Bank, JBIC, Korea Development Bank) or
fulfilment of development mandate
- Capital markets
- Islamic Finance
- Alternative financing (PE, infra funds, SWFs, pension funds)

• Identify the key actors in LNG financing (e.g., sponsors, project company, financial advisor) and their
typical roles

- Sponsors
- Borrower / projectco
- UJV
- Financial advisor
- Other advisors (technical, reserves, environmental, shipping, market)
- Lender advisors
- Host government / approval authorities
- Key contract counterparties (fuel supply, EPC, offtake, O&M, vessel charter)
 - Lead arrangers
- ECA / DFIs
- Agents (intercreditor agent, facility agent, bond trustee, security trustee)
- Others – technical bank, modelling bank, insurance bank, account bank, hedging counterparties

• Explain challenges sponsors may face in the financing process and in securing a project final
investment decision

- Creating detailed financing term sheet

- Obtaining various financing sources
- This creates different interests in terms of risk allocation and policy requirements, which are
governed by a common terms agreement and inter-creditor arrangements
- Voting entitlements, decision making procedures and thresholds
-

• Describe core concepts typically found in LNG financing terms (e.g., feedstock supply, LNG pricing,
cash flow ratios)

- Banking Case model

- Feedstock supply
- LNG pricing (price volatility, s-curves, hedging, correlation to oil price)
- Cash-flow ratios
o LLCR – NPV CFADS during loan life / principal outstanding
o DSCR
- Completion support
- Equity lock-up
- Credit enhancement
- Political risk carve-out
- Release conditions
- HSE / Equator principles
- Security
- Catering for project expansions in the financing documents
- Ability to replace or add additional debt
- LNG vessel financing – quiet enjoyment arrangements

Portfolio LNG
• Describe the factors that led to the emergence of "flexibility" in the LNG market and the "portfolio
player"

- Demand from traditional Asian buyers tapered

- Rise of US shale gas – increased availability for FOB supply
- ‘Portfolio player’
o Players who do not have dedicated gas reserves and dedicated LNG production facilities
on a long-term basis
o Catalyst towards the move towards the new market
o ‘aggregators’
• Explain key features of portfolio LNG and contrast it with traditional LNG contracts and structures

- Diverse sources of supply

- ‘third party LNG’ that has a combination of long-term sales, third-party spot, strip and medium-
term arrangements
- Might own one or more lNG vessels, hire vessels on time or voyage contracts
- Flexible storage and regasification capacity rights

• Identify emerging risks and benefits of portfolio LNG

- Potential mismatches in liability and misalignments, which are difficult to manage and the
portfolio suppler needs to absorb
- Charter rate price risk
- Force majeure risk
o Doesn’t really work for portfolio arrangements
o A more achievable comfort for buyers is a targeted obligation requiring supplier to pay
cargo-based damages
 Rather than waiting until the end of a year (or reconciliation period) to
determine whether buyer has failed to take at least the minimum qty,
 The buyer’s failure to take is assessed at the time of delivery for each cargo
 If the buyer does not take the cargo, liable to pay for full cargo price without
accruing any make-up entitlements
 Seller can resell missed cargo and obliged to pay the buyer the net proceeds,
after deducting incremental costs
 If the seller fails to deliver, buyer entitled to compensation for reasonable
incremental costs of obtaining alternative fuel, though expected to be capped at
an agreed %.
 Beneficial to all parties because it crystallizes the relevant failure to take, avoids
heavy negotiation
 The mechanism captures actual losses more accurately and reliably
o Quality / spec risks – possible wide specification range; not every source will match
requirements of each buyer
o Scheduling provisions take on greater significance in portfolio arrangements, key driver
of optimization value
o Benefits – portfolio supplier generally better placed to offer buyers skewed delivery
profiles (though the cost of such cargoes are generally expensive given timing)
o Potentially higher credit risk
o Benefits – able to provide destination flexibility, though may be subject to some
limitations / suppliers might seek to be covered by their buyers for any incremental
shipping costs
o Needs to manage reserves risk (supply risk), although portfolio players are insulated
from a single reserves risk exposure
o Diversion provisions
 Allow either party to propose to divert a cargo for reasons which are either
operational or economic, which is not otherwise a Force Majeure event
  Seller must be covered for any incremental costs, subject to no anti-trust issues
and agreement to share any upside from diverted sale

US LNG and the Global Market

• Describe how political and market forces shaped the trajectory of US LNG from the 1950s to the
present day

- Early concerns in 2000s over potential for natural gas supply deficit in U.S.
- U.S. expected to be increasingly reliant on natural gas imports
- Gold-rush to develop LNG import capacity
- Excelerate Energy’s Gulf Gateway Deepwater Port – commissioned in 2005, world’s first offshore
LNG receiving facility and the advent of the FSRU
- By 2009, shale gas revolution, pushed HH prices to well below other LNG markets
- Top 3 LNG importers by 2020, after Qatar and Australia
- Production of tight oil / shale gas now represents 50% of US natural gas production
- Cheniere Sabine Pass Import Terminal – first company to file for LNG project export license. BG
Group signed up for almost all capacity from train one at Sabine Pass.
- As of 2017, 5 brownfield export terminals – Sabine Pass, Freeport, Cameron, Cove Point and
Elba Island; 1 greenfield export terminal – Corpus Christi
- Competitive, transparent, well-defined regulatory environment led to a large volume of
potential or latent supply
- Current proposals are based on smaller, mid-scale trains which is expected to reduce costs
through modularization and standardization

• Understand differences between tolling and sale/purchase models

- Tolling
o Buyer is responsible for procuring gas from US market and pipeline capacity to transport
gas to the liquefaction plant. Buyer pays LNG for service
o Buyer bears full price, commodity, pipeline availability, disruption cost risk
- Sale / Purchase Model
o LNG is sold directly to customer under SPA with LNG seller responsible for gas feedstock
procurement and transportation of gas to terminal
o Seller bears full price, commodity, pipeline availability, disruption cost risk

• Describe how developments in US LNG will likely impact the global LNG trade

- Towards commoditization of LNG

o Destination-free, flexible nature
o Increasing flexibility and liquidity of trade
o Expected to swing balance of power to buyers
- Near-term supply abundance
o Depress spot prices, increase supply availability
o Together with FSRU, likely to increase potential for LNG demand
- US provides latent future supply
- Changing geopolitics of natural gas
o Europe – high dependency on Russia’s
o Asia – accounts for 57% of global energy consumption by 2040 and 48% of consumption
growth