Standard Oil's first Refiery, Cleveland No. 1, circa 1897. Source: Wetern Reserve Historical Society via commons.wikimedia.org.

One of the big misconceptions of John D. Rockefeller's Standard Oil Trust is that it was able to become the all-encompassing power in the oil & gas industry through exploration and production. On the contrary, Mr. Rockefeller built the Standard Oil empire on the back of the other side of the business, refining and marketing. By owning the assets that transformed crude oil into usable products and selling them to customers, Standard Oil was able to source crude the least expensive way possible and reap the profits on the sale of the products

Today's refineries may look incredibly different from the ones back then, but the business is exactly the same, and investors can earn profits in the same way Mr. Rockefeller made his fortune. Let's take a quick look at the refining & marketing industry so you have a better idea of how it works and and what drives the industry -- so you can make the right investments.

What is Oil & Gas Refining & Marketing?

The stuff we pull out of the ground -- crude oil, natural gas liquids, and natural gas -- are all a bunch of different molecules composed mostly of hydrogen and carbon. As one single product that comes from the ground, crude oil and unprocessed gas aren't that useful, but when refined, we can separate these hydrocarbon molecules into groups and make the most of that compounds. This is the job of the refiner; it takes a barrel of crude oil and turns it into a slew of different products we use everyday.

A rough description of the products products produced from a barrel of crude oil. Source: University of Chicago.

Once these products are refined, the marketing side of the business takes over. This can involve selling large volumes of jet fuel to an airlines company on a long-term contract, or it can be as simple as selling gasoline to you at one of thousands of gas stations around the country. The same happens with natural gas, too. The natural gas pulled from the well is normally processed to separate the heating fuels we know like propane and methane (what is most commonly known as natural gas) as well as other products used in petrochemical manufacturing such as ethane.

Both refining, marketing, and retail sales of oil & gas are also categorized in the oil & gas world into what is known as the downstream side of the business. 

How big is oil & gas refining & marketing?

Just like every other part of the oil & gas industry, refining & marketing is a big business. That's in part because every barrel of oil & gas produced today -- which exceeds 100 million barrels per day combined -- needs to be processed or refined in some way or another to make it usable. In the U.S. alone, revenue from this sector is well above $700 billion. While the marketing side of the business can be as small as the mom & pop gas station around the corner, the refining industry has a few large players because of the massive size and scale of the operations.

How does the oil & gas refining & marketing industry work?

Valero's Port Charles Refinery, looks a lot different than Standard's first one, don't you think? Source: valero.com.

The refining & marketing industry can be split up into two different groups. On one side, you have refining & marketing operations that are part of a larger company such as an integrated oil & gas company or a national oil company. The job of these companies is to bring barrels of oil from the ground all the way until you consume it in your gas tank and reap profits from the big difference in price between the two end points. Then, there are the independent refining & marketing companies, which only have operations on this downstream side of the business. Their goal is to acquire crude oil as cheaply as possible and then sell the refined products either directly through their own retail stores or through wholesale contracts with large-scale consumers or retail & marketing specialists. 

The difference between what a refiner pays for crude oil and the price it can sell the petroleum products made from that barrel is known as the crack spread. It sounds like a fancy term, but it's basically industry jargon for gross margin. The goal of a refiner is to maximize the crack spread, which can be done in two ways:

  • Find a cheap source of crude to lower supply costs.
  • Create the right mix of refined products to earn the most money per barrel and sell those products to the markets with the highest demand.

What drives the oil & gas refining & marketing industry?

The fact that we fill our cars with gasoline and our trucks, trains, and whatever else with some form of refined petroleum to make the world move. Gasoline demand is one of the major markers of global economic health, and it will likely remain that way for decades, even though there are efforts to make more alternative fuels. 

Unlike the refining days of Standard Oil, though, the refining sector does not have as much control over prices as it once did. So, even though the difference in the price of crude oil and the price of refined products are the way they make money, they are pretty much subject to supplies from one side and demand on the other. There isn't much refiners and retailers can do to control this, which means the business can be rather cyclical. 

The one thing these companies can control, though, is the amount of crude they are able to process. A refiner is most efficient when it can run a facility as close to its maximum capacity as possible. Likewise, a marketing and retail agency can grow by increasing the total gallons of product sold. This means investors looking to get involved in the space should pay attention to these two things, because they are an indicator of the strength of the individual business -- regardless of the price of oil and gasoline at that given moment.

You can follow Tyler Crowe at Fool.com under the handle TMFDirtyBird, on Google+, or on Twitter @TylerCroweFool.

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