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Refine This!
Starting our downstream oil & gas study

by Jeff Fischer (TMFJeff@aol.com)

Paris, France (Dec. 23, 1998) -- By the time gasoline is finally put into your car (or, as the case may be, your significant other's car), it contains over 200 hydrocarbons and additives (not unlike some ice creams on the market) that work to provide a smooth ride all the way to grandmother's house.

How did the gasoline get this way? Refineries. Oil Refineries. (As Bond. James Bond, would say.) And how do oil refineries relate to us, our oil and gas study, the holiday season, and James Bond?

In numerous ways.

Refining is one of three parts in the downstream side of the oil and gas industry. Brian swam against the current to teach us about Exploration & Production (the "upstream" side of the industry), and now I'm going to coast downstream to explain Refining, Transportation, and Marketing (the "downstream" side of the industry). Remember it this way: All products begin upstream (in manufacturing), before drifting downstream to their final destination: the consumer.

Each aspect of the downstream business (Refining, Transportation, Marketing) is a monstrous topic, but we'll take them in order as we've done all along. After an oil conglomerate has explored for oil and found it (thank you, dinosaurs), it begins to produce it (raise it from the ground). After it begins to produce it, the next step is to refine it.

A refinery is little more than an amazing factory. But rather than taking wads of fur, disturbing plastic eyes, and cheap electronics and smashing it together into a $1,000 (auction price) Furby, the factories that we're discussing take crude oil and change its hydrocarbon molecules into gasoline and countless other useful products. Almost half of every barrel of crude oil becomes something other than gasoline. (Mainly it becomes plastic to make Furby eyes.)

Like an Intel (Nasdaq: INTC) chip factory, the typical oil refinery costs billions to build. It then costs millions to maintain and upgrade. A refinery is so valuable that it never sleeps. Unlike a Baskin Robbins store, refineries are too expensive to close for the night, so they operate 24 hours a day, 365 days a year. Oil refineries are very large and complex. They're so large that they employ up to 2,000 people who use golf carts, bicycles, rollerblades and, in some regions, camel and ostrich to get from one area to another. They're so complex that people have been known to disappear while working and later be found encased inside a large plastic tub on sale at Wal-Mart (50% off).

Tasteless jokes aside... well, tasteless jokes aside, I'm at a loss for words.

Today's most efficient factories can turn a 42-gallon barrel of crude oil into over 20 gallons of gasoline. In the 1920s, the same amount of oil could only be converted into 11 gallons of gasoline. (No, Moore's Law isn't taking place here. Essentially, that would mean doubling productivity with every generation of product refinement, but these improvements are impressive nonetheless.) The increased productivity is partially the result of reduced waste and lost molecules. Refining breaks crude oil into its various components that are then reconfigured to create myriad products, from plastics to gasoline.

This process occurs inside a complicated maze of expensive and giant hardware that is controlled (in the style of Homer Simpson at his nuclear power plant) from a largely automated control room. When workers aren't sleeping or eating donuts, they're pushing buttons and reading computer screens. The refining process that all refineries use takes crude oil through three steps: separation, conversion, and treatment.

Let's whip through them.

Separation: Just like sugar in water, this involves getting the light material in crude oil to the top, and the heavy gunk to the bottom. The process is still very close to the one used in the old days: piping oil through hot furnaces. The liquids and vapor that result are piped into distillation towers (which, next time you're walking the fence around an oil refinery, are the tall columns that ominously rise into the sky). Once crude oil is separated into its light to heavy elements, it moves to the conversion process.

Conversion: This is where all the chemistry buffs stand around and say, "Cool. That's cool." This actually is where all the fireworks occur. The most frequently used conversion method is called "cracking." It uses extreme pressure and heat to crack heavy hydrocarbon molecules into lighter ones.

Next, there's fluid catalytic cracking (cruelly called "cat cracking"), which is the gasoline-making process. By piping in typical Arizona heat (1,000 degrees Fahrenheit), with low pressure and a powered catalyst to speed up chemical reactions (one which you probably played with in high school chemistry), a cat cracker converts many heavy fractions into small gasoline molecules. Newer, more expensive and efficient hydrocracking works in much the same way.

Another form of conversion is coking. (Coke, crack, what the heck is going on here?) Cokers use more moderate pressure to turn residue into lighter products and a substance similar to coal for industrial fuel. Beyond coking and cracking (the splitting of molecules), there is also conversion that involves the rearranging of molecules, including Alkylation and general reforming.

Treatment: This, too, is a complicated and impressive process that essentially involves combining various stages (in "midstream") of the conversion process to create the desired outcome. Technicians must tweak octane levels, vapor pressure, and other variables to create gasoline for cars as opposed to jet fuel, or gasoline used at high altitudes. Not only that, according to Chevron "a major portion of refining involves blending, purifying, fine-tuning and otherwise improving products to meet [government] requirements." This is treatment.

Understanding what happens in refining plants is one thing. When we begin our study of related companies, we'll learn which firms lead in the refining arena, and how money is made.

For a detailed pictogram on the refining process, click here to Chevron's website. (The site has a great amount of helpful information on the industry.) With six gasoline-producing facilities, Chevron (NYSE: CHV) is the largest oil refiner in the United States. To discuss our oil and gas study, related companies (yup, we'll get to them) or anything Drip-related (or not), please visit the Drip boards linked in the top right of this page. We'll leave the light on for ya (just like an oil refinery: 24 hours a day, 365 days a year), and we'll have another column tomorrow.

Fool on!

--Jeff Fischer

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12/23/98 Close
Stock Close Change JNJ 78 13/16 +1 13/16 INTC 125 +5 15/16 CPB 56 3/8 +2 1/4 MEL 67 15/16 - 3/16
Day Month Year History Drip 3.53% 5.80% 35.04% 15.00% S&P 500 2.07% 5.57% 26.60% 29.14% Nasdaq 2.43% 11.44% 38.35% 36.31% Last Rec'd Total # Security In At Current 11/02/98 8.055 CPB $52.880 $56.375 09/01/98 9.727 INTC $80.238 $125.000 11/09/98 8.578 JNJ $74.090 $78.813 10/07/98 1.000 MEL $48.560 $67.938 Last Rec'd Total # Security In At Value Change 11/02/98 8.055 CPB $425.95 $454.10 $28.15 09/01/98 9.727 INTC $780.50 $1215.92 $435.42 11/09/98 8.578 JNJ $635.55 $676.05 $40.51 10/07/98 1.000 MEL $48.56 $67.94 $19.38 Base: $2200.00 Cash: $262.88** Total: $2676.89

The Drip Portfolio has been divided into 93.111 shares with an average purchase price of $23.628 per share.

The portfolio began with $500 on July 28, 1997, adds $100 on the 1st of every month, and the goal is to have $150,000 in stock by August of the year 2017.

**Transactions in progress:
10/24/98: Sent $40 to buy more INTC.
11/24/98: Sent $100 to buy more MEL.
12/19/98: Sent $100 to buy more MEL.


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