1. Copyright © Gulf Research Center 2010 All rights reserved Giacomo Luciani Director Gulf Research Center Foundation, Geneva Dar es Salaam, July 13-14 2010 Integrating upstream or downstream of oil and gas

2. Copyright © Gulf Research Center 2010 All rights reserved The issue The impact of an export industry on the broader economic development of the nation depends on its upward and downward linkages If the export industry has few upward or downward linkages, it becomes an enclave and may damage development Hence the policy objective for oil/gas producers is to integrate upstream or downstream

3. Copyright © Gulf Research Center 2010 All rights reserved Meaning of integrating up or downstream Integrating upstream means maximizing the utilization of local inputs, including labour. Integrating downstream means maximizing local transformation and value addition, rather than exporting oil or gas in their crude or raw state. Both policy objectives face considerable challenges.

4. Copyright © Gulf Research Center 2010 All rights reserved Oil and gas as the typical enclave The exploration and production of oil and gas requires sophisticated technology and elaborate equipment which is frequently available from few suppliers globally It is capital intensive and employs a small number of workers It frequently takes place in remote, sparsely inhabited locations, or offshore Companies tend to minimize reliance on local inputs

5. Copyright © Gulf Research Center 2010 All rights reserved Potential for upstream integration Some potential for upstream integration normally exists for the provision of simple services: catering, housing, transportation… Norway provides an example of successful upstream integration, but it was an industrial country to begin with Producing countries’ governments must strike a reasonable balance between insisting on local inputs (including local employment of technical personnel) and delaying activities, losing efficiency, and adding cost

6. Copyright © Gulf Research Center 2010 All rights reserved Potential for downstream integration The potential for downstream integration, i.e. local utilization or transformation of oil or gas to add value, is vastly more important Companies generally prefer to export crude oil and gas because they are paid in strong currency and at international prices – which is generally not the case if they sell locally Downstream integration will not happen spontaneously, it has to be pursued intelligently The danger is that value is destroyed rather than added – but it does not need to be

7. Copyright © Gulf Research Center 2010 All rights reserved The difference between oil and gas Downstream integration (local utilization) is much more promising for gas than for oil simply because the netback of exporting gas is much lower than for oil This is because: –The gas calorie is paid much less than the oil calorie –The cost of transporting gas is much higher Exporting crude oil generates a very significant rent; exporting gas may generate little more than a reasonable return

8. Copyright © Gulf Research Center 2010 All rights reserved Gas flaring Oil companies tend to pay attention to gas only if it is available in very large volumes and an export project is possible. Even when gas is associated with oil, flaring remains a pervasive practice Governments must forcefully resist these tendency and impose local use or – at least – reinjection.

9. Copyright © Gulf Research Center 2010 All rights reserved The two main uses of gas Gas can be used as fuel – i.e. burned to generate heat – or as feedstock, i.e. used for its chemical properties and transformed into other molecules The volume and composition of the gas are important to determine which use is most promising All chemical processes have high economies of scale, and certain minimum volumes are required

10. Copyright © Gulf Research Center 2010 All rights reserved Power generation The main use of gas as fuel in warm climates is for power generation Two types of gas-fired power generation plants: –Open cycle: gas turbines –Combined cycle: gas turbines + steam turbines Advantages: –Low capital cost –Small scale –Efficiency of transformation –Switcheability –But: high cost of fuel

11. Copyright © Gulf Research Center 2010 All rights reserved Gas turbine and combined cycle

12. Copyright © Gulf Research Center 2010 All rights reserved Main uses of methane as feedstock Ammonia- fertilizers Methanol –Formaldehyde –Acetic acid –Dimethyl Terephthalate –Methyl Chloride –Fuel additives, DME

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14. Methanol DME Fischer Tropsch Products Fuel additives Fuel cells Olefins Proplylene Diesel Jet fuel Naphtha Lubes Fuel for Power LPG substitute > 500,000 bbl/day (13 world-scale methanol plants) > 200,000 bbl/day (4.5 world-scale DME plants) 3,000,000 bbl/day (20% of incremental product demand by 2015) Natural Gas Refinery ~2bscfd Product Volume by 2020* Gas Requirement* ~1.5bscfd ~28bscfd * ADL and BP Estimations

15. Copyright © Gulf Research Center 2010 All rights reserved Manufacturing industries Iron/steel Glass Ceramics Bricks and blocks Cement Food and beverages Metal working Rubber and Plastic products Paper Chemical (other than petrochemical) Textile Nonferrous metal

16. Copyright © Gulf Research Center 2010 All rights reserved Conclusion on natural gas Availability of natural gas offers multiple opportunities for industrial transformation and broader economic diversification All countries should explore for natural gas Rely on some gas fired power generation to establish an initial market for gas Privilege domestic use/transformation over gas exports The concept of “gas cities”

17. Copyright © Gulf Research Center 2010 All rights reserved Integrating downstream of crude oil Crude oil must be refined before it can be optimally used Crude oil from the field is a mix of hydrocarbons of different molecular length (all hydrocarbons contain carbon and hydrogen, but in different compositions) Refining is the process through which the various components of crude oil are separated

18. Copyright © Gulf Research Center 2010 All rights reserved What is a refinery? A refinery is a plant where crude oil is boiled and distilled to separate the individual components Atmospheric distillation is the essential process from which refining starts. It is normally followed by further stages: Vacuum distillation, Cracking: thermal or catalytical, etc. The objective is to increase the output of light products, which are more valuable and reduce residuals, which constitute a problem

19. Copyright © Gulf Research Center 2010 All rights reserved Petroleum Refining Process Content of a Typical Barrel of Crude Oil Gasoline 25% Kerosine 12% Distillate Fuels 25% Residual Oil 39% From Distillation Only Gasoline 58% Kerosine 8% Distillate Fuels 24% Residual Oil 10% From Modern Refining Process

20. Copyright © Gulf Research Center 2010 All rights reserved Different crude oil qualities Crude oil comes in very different qualities The two key measures are: –Gravity –Sulphur content Gravity reflects the composition of the crude: proportion of light vs. heavier fractions A crude with: –little sulphur is called sweet –sulphur in excess of 1% is called sour Other metals and impurities are also a problem

21. Yield On Crude Source: TOTAL Crude Oil Marketing C1-C4 Gas Light Naphtha Heavy Naphtha Kerosene Gasoil VGO Residue

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24. From Refining to Petrochemicals After refining, the next step in value addition is using some petroleum products (LPG, Naphtha) as feedstock in petrochemicals plants Producing petrochemicals from refinery products rather than from gas requires more capital intensive equipment but generates a richer array of intermediate products

25. Copyright © Gulf Research Center 2010 All rights reserved Conclusions on oil Integrating downstream of crude oil is only possible if large volumes are available The first step is setting up a petroleum refinery – minimum distillation size about 400,000 b/d, investment well above 10bn USD Then one may engage in the production of petrochemicals All major oil producers have established a petrochemical industry initially based on gas as feedstock. Some have then looked into refinery- based projects to overcome limited supply of gas.

26. Copyright © Gulf Research Center 2010 All rights reserved Conclusions on integrating up or downstream Experience tells us that it possible to do so while avoiding some common pitfalls Reliance on foreign expertise and partnerships is essential to the establishment of world-class projects The potential net benefit for the exporting country is likely to remain contentious. Nevertheless important successes are possible The case is especially strong for gas, less so for oil