Energy Value Chains
Overview of Fundamentals
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What is a “Value Chain?”
• The process of linking specific functions from input
through output to delivery, enhancing the
economic value of the final product
• Related concepts – “supply chain” “business
system,” “industry system”
• The challenge – building value chains around
dynamic commodity markets that require fixed
infrastructure for physical delivery and “liquidity”
for price risk management
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Value Chain
Support Activities
Generic Value Chain
Firm Infrastructure
M
n
gi
ar
Human Resource Management
Technology Development
Procurement
Primary Activities
Service
ar
gi
n
Marketing
& Sales
M
Inbound
Outbound
Logistics Operations Logistics
Source: Porter, 1985
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How Thinking Has Changed, I
Traditional Value Chain: Starts with core competencies
Assets/Core
Competencies
Customer
Priorities
Inputs, Raw
Materials
Products/
Service
Offering
Channels
The Customer
Channels
Offering
Inputs, Raw
Materials
Assets/Core
Competencies
Modern Value Chain: Starts with the customer
Source: Porter, 1985
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2
Value Chain
How
Thinking
Has
Changed, II
Source: McKinsey &
Company
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Energy Value Chain Issues
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Value Chain
Human
Resource
Management
Source: McKinsey
& Company
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Derivation of Basis Risk
Production
Transportation
Distribution
End Use
“Basis”
• Differential between cash/spot and nearest futures price
as a result of time, product forms, quality, location
“Basis risk”:
• Uncertainty as to whether differential will widen or
narrow
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Value Chain
Balancing the Market
Mean reversion is a reality if marketclearing participants exist
DEMAND
LOW
SUPPLY
Prices
HIGH
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Mean Reversion: Oil Price Example
80
86:02-03:12
70
82:01-03:12
60
50
40
30
20
Frequency
91:02-03:12
10
0
38 42 46
22 26 30 34
6 10 14 18
Price
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Value Chain
Price Volatility and Risk Trade Offs with
Competition: Open Access Example
Commodity price risk flows
E&P
Pipelines
LDCs
End Users
Power
Capacity price risk flows
Risk accepting entities
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Mechanisms to Manage Price Risk
•Trading in futures contracts
•Long-term contracts
•Fixed-price contracts
•Storage for physicals hedging
•Ability to use alternate fuels; efficiency;
conservation
•Allow residential customers to choose budget
payment plans; energy service contracts for
commercial and industrial customers
•Develop mechanisms for capacity risk
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Value Chain
Global Oil Market Illustration
Physical Market
Term Market
Specific Market
Spot Deals
Tenders
Forward Deals
Tenders
Bilateral
Bilateral
Futures
Swaps & Other OTC
Formal Options
Source: Oil in Asia by Paul Horsnell, 1997, Oxford Institute for Energy
Studies
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From: ESAI
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Value Chain
Industry
Organization:
Vertical
Integration?
Source: McKinsey &
Company
Willingness
to pay
“Windfall”
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Energy Value Add Comparison with
Other Industries
Source: McKinsey & Company
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Value Chain
Derivation of Market Power
Production
•Monopoly
producer
•Barriers to
entry, exit
Transportation
Distribution
•Technical economies of scale(?)
•Natural monopoly systems
•Barriers to entry, access
End Use
•Monopsony
buyer
•Barriers to
entry, exit
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Energy Value Chain and Example SD Issues
Production
Transport
Access for private investment
Rights of way and lands
ownership
Environmental impacts
Transparency
Allocation of economic
rents and revenue
management
Distribution
Conversion
End Use
Access for private investment
Environmental impacts
Transparency
Allocation of economic rents and
revenue management
Consumer interface
Local content
Access to service, reliability,
quality of service
Community relations and
community benefits
Subsidy and system loss issues
and pricing for core customers
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Value Chain
US Value Chain Example
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The Major
Energy
Value Chains
Alternative generation
technologies can be used.
Electric Power
Transmission
Electric Power
Distribution
Pipeline
Transportation
(imports/exports)
Processing
(if needed)
Regasification
Gas Separation
(if needed),
Gathering
Local
Distribution
Domestic production can
be liquefied and stored;
LNG can be regasified for
seasonal use; or used in
transport.
Liquefaction
(LNG)
LNG Tanker
Shipment
(imports/exports)
Liquids (LPG)
Transportation
Marketing and
Distribution (if
applicable)
Oil and Gas
Field
Production
Crude Transport
Oil Refining
(product
markets)
Electric Power
Generation
(utilities, IPP,
industrial)
Natural Gas Liquids
Extraction
Oil/condensate stream
Methane stream
Liquids (LPG) stream
(propane, butanes, etc.)
Power stream
Industrial
(Direct Use)
Commercial
Residential
Direct Use
(e.g., vehicle
transport)*
Compressed
natural gas
(CNG; methane)
and LPG are also
used for vehicle
transport;
alternative fuels
can be used.
Upstream
Midstream
Downstream
Product Transport
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Value Chain
A U.S. Illustration of Energy Value Chain Pricing, 1999
1999 Data (U.S. EIA, Annual
Energy Review)
Transport+Treatment
$2.26
IN – RAC
(16 mmb/d)
Domestic $17.82
Import
$17.23
Composite $17.46
CRUDE OIL VALUE CHAIN
Transportation
(pipeline, tanker,
truck, rail)
6 mmb/d
U.S. Avg.
DFPP
$15.56/bl
Oil and gas field
production
24 tcf
Wellhead
$2.07/mcf
Marketed production 20 tcf
Dry Gas 19 tcf
Net Imports 4 tcf
Gathering,
processing
MARGIN (BL)
Motor Gasoline $9.53
Jet Fuel
$5.12
No. 2 Distillate $5.04
Residual FO
($3.44)
Composite
$7.89
Refining (to petroleum
products: gasolines, jet
fuels, diesel, fuel oils,
etc.)
Wholesale and
retail marketing
End users: individuals,
businesses, governments,
institutions
Petrochemicals
(feedstocks for
intermediate products)
Wholesale
marketing
Conversion to final
products (fertilizers,
plastics, etc.)
$1.04 (to City Gate)
City Gate $3.11
Natural gas pipeline
transportation
Natural gas
distribution
Natural gas liquids
transportation
(pipeline, truck,
tanker)
NATURAL GAS VALUE
CHAIN
LNG
Field-to-liquefaction 10-20%
(Percentages reflect approx.
share of total LNG value chain
cost; $/MMBtu amounts
assume 2,500-mile voyage)
OUT (BL) (17 mmb/d)
ON HIGHWAY (BL)
Motor Gasoline $32.80 (8 mmb/d) Motor Gasoline $47.04
Jet Fuel
$22.59
No. 2 Distillate $24.15
Residual FO
$15.79
Liquefaction
(liquefied natural
gas or LNG)
25-35%
$1.00/MMBtu
End users:
Residential $6.60
$3.49 Commercial $5.26
Industrial $3.04
Electric Utilities $2.56
$0.97
Wholesale and retail
marketing and distribution
Propane* sold to resellers:
$0.78/gallon (refinery)
Propane sold to end-users:
$1.27/gallon
LNG tanker
shipment to
markets
15-25%
$0.40/MMBtu
* About 2mmb/d of propane produced at refineries, about
538,000 b/d at gas plants; about 1 mmb/d LPG sold for end use.
Industrial $3.04
(Fuel and feedstock for
industrial processes,
including petrochemicals)
Conversion back to gas
phase for pipeline,
distribution, end use
5-15%
$0.40/MMBtu
Direct use (electric
power generation)
25-35%
DFPP = domestic first purchase price (wellhead); RAC = refiner acquisition cost
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Energy Value Chain Investment
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Value Chain
$16 Trillion Energy Investment Required Across
the Energy Value Chains, 2001-2030
Source: IEA World Energy Investment Outlook 2003
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Investment Requirements in the Oil Sector ($ billion)
2001–2010 2011–2020 2021–2030
Exploration &
$689
$740
$793
Development
Unconventional Oil
49
60
96
Refining
122
143
147
Tankers
37
79
76
Pipelines
20
23
23
TOTAL
$917
$1,045
$1,135
Source: World Energy Investment Outlook, International
Energy Agency, 2003.
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Value Chain
Investments Required in Natural Gas
Sector
E&P
$1.73
LNG
$0.25
Power Generation
$4.20
Pipelines
$0.71
Transmission
$1.60
Local Distribution (Gas & Power)
$4.29
WORLD TOTAL
$12.78
Source: IEA Global Investment Outlook, 2003
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Comparative Risks and Returns:
Electricity Lags Oil & Gas
16
14
12
per cent
10
8
6
4
2
0
Oil and gas upstream
Electricity
OECD
Gas downstream
Non-OECD
Source: IEA Global Investment Survey 2003
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13
Value Chain