CHAPTER 1 Introduction
3.1 Literature Review
The recent World Petroleum Council (WPC) held in Johannesburg tried to address and evaluate the status of the energy industry in the world today and its future implications. The sustainability of energy resources, economic viability, social implication, discovery of energy resources, etc., were among the key questions the national and international players were trying to answer and to reassure the world that energy resources will be available in years to come.
“We can continue to meet our growth demand for energy. However, developing future energy resources is becoming more challenging and more expensive. That means that stable investment conditions will be needed to secure funding to develop those resources. It also means the energy industry will need to continue to develop and deploy new technology and good project management. In particular, it will need to ensure that it recruits and retains the people with the skills and expertise to meet those demands. The industry will also need to
well as developing renewable forms of energy. All these present challenges to the energy industry but also provide the opportunity for it to play its part in driving continuing progress in our world” (Van Der Veer, 2005).
Various studies undertaken, in this regard, include those by Miller (1979) who shows how the total market (i.e. retail service station) is made up of many small sales areas, and that nearly all competition between service stations occur within these sales areas rather than between them. His research also concluded that the consumer (particularly the private consumer) is paying substantially above world prices for petroleum products in South Africa. Hidden’s study (1989), on the other hand, showed the comparatively insignificant contribution of petrol sales to total gross profit.
In analysing the various factors and theories which influence the spatial location of the retail outlets of petroleum companies, attention is paid to the physical and legal aspects which influence the location of filling stations, after which the aspects of market demarcation and the prediction of potential are considered. Guidelines are formulated to serve as basis of decisions concerning settlement, and a concept investigation framework is set up to facilitate decisions with regard to the location of service stations. It is found that sufficient purchase must be realized on the site to ensure profitability, the site must be accessible, costs must be minimized and relocation must be avoided as far as possible. Costs and income elements as well as investment decision-making play an important role. It is concluded that service stations are distribution channels which must be designed and located to fulfill the needs of consumers (Venter, 1983).
Mlonzi’s study (1996) showed the significance of the emphasis on the improvement of service delivery in order to satisfy consumers at petrol service stations in the black areas.
Petrol service stations, it may be noted, form part of the oil companies’ operations and, as such, they need to differentiate their service offerings from those of the competitors.
Govender (1997) concentrated on the marketing of petrol and diesel in the Durban area of KwaZulu Natal Province. He analysed the sales volume of petroleum companies operating in the Durban area, but the focus of his work was on the marketing side. There seems to exist a clear understanding of the need for marketing at service station level despite the franchise system that exists in the industry. Service station managers have generally underestimated the degree of regulation of their marketing activities. Most service station managers did seem to have marketing objectives, but they lacked in communicating such objectives to their staff (Govender, 1997).
According to Odendaal (1998), the outcome of the possible deregulation of the liquid fuel sector in South Africa, on the same basis as in Australia, may actually make the retail petrol prices more volatile. In view of the high unemployment rate in South Africa, one may as well conclude that South Africa may not be ready to deal with the consequences of a higher volatility in the retail petrol price.
As to the investment opportunity, it can be linked to a collection of real options that interact with each other. The real options considered are the option to delay the initial investment, the option to abandon the investment during construction, the option to contract or expand the scope and the option to abandon for salvage. Analysing a hypothetical oil refinery, Dhlomo (1998) suggests that the investment opportunity is like a call option and that the real option explains more value for investment.
Petroleum storage depots form a vital link in the distribution of petroleum products to the market, and substantial benefits arise from efficient depot location and facilities planning.
Computer assisted methods are developed to achieve this. Depot location is optimized on an iterative basis. Mathematical expressions to minimize total depots cost through differential calculus are utilized. An activity relationship chart is used, in addition to micro computer software to optimize flow and perform layout evaluation. This combined approach leads to a layout design that is efficient both as regards flow and service relationships (Wessels, 1987).
Industrialized countries depend on oil and natural gas for most of their energy needs. Both are depletable and nonrecyclable sources of energy. One interesting characteristic of price ceilings is that they affect behaviour even when they are not binding (when the market price is lower than the price ceiling, for example) (Tietenberg, 2000).
In this connection, it may also be noted that the UK petrol market has experienced, over the last two decades, intense price competition and as such provides a rich source of information on some of the real-world issues in pricing. The petrol retailing market is found to adhere broadly to the Classical theory of price competition but its special characteristics cause interesting deviations (Cohen, 1999).
Projections by the International Energy Agency (IEA), based on the growth of the world’s economy, especially that of markets in the South, indicate that energy consumption in the next twenty years will increase by 60%. But this view is challenged by others who propose an alternative scenario in which demand for oil in the near future will fall dramatically as a result of the development of new or alternative sources of energy capable of taking over the hegemonic role played by oil (Branco, 2000). Of course, the development of alternatives could be possible only in the long run. In the meantime, it could as well be argued that the consumption of petrol could be reduced by 10 percent or so by mixing it with alcohol. It is, however, a different matter that the diversion of grains to produce alcohol could create its own problem of food shortage.
Odendaal (1998), Meiring (1991) and Gritzman (1999) focus on the deregulation of the liquid fuel industry and the industry prospects, as the petrol price is still regulated by government. Their research analysed the impact of deregulation within the liquid fuel industry in South Africa. The impact of the petrol price fluctuations has not previously been analysed extensively with regard to its effect on profitability, turnover (i.e. volume) and sustainability of retail service stations. These sources and others will be consulted and will be acknowledged by way of references.
Van Der Ham (2001) evaluated the economic (cost) of converting and running vehicles on liquid petroleum gas and compared it with those of petrol and diesel fuels. The government’s intension to tax LPG and the structure of the fuel price were also considered in an attempt to foresee what the future holds for LPG use in the motor industry. Recommendations were made as to best utilize LPG in the South African Automotive industry, so as to improve public transport and air quality in some of our cities.
Thailand certainly has moved toward LPG in running vehicles, and the running cost, it is said, is one-third of the running cost of petrol. However, this option will be viable only to the extent that LPG is cheap and that the LPG supply can be guaranteed.
According to a study by Malumo (2003), both advertising and share of distribution have an effect on sales and market share. It was, however, not possible to define the exact nature of the relationships between the factors. His study indicated that advertising in the petrol market works according to the weak theory and that advertising should be aimed at increasing the salience of a petrol brand. The presence of service stations thus seemed to reinforce the salience of a brand (Malumo, 2003).
3.1.1 Background
Oil is the largest traded commodity worldwide, either through crude oil or through refined Product (See Annexure D). As a consequence, it is essential to collect data which are as complete, accurate and timely as possible on all oil flows and products. Although oil supply continues to grow in absolute terms, its share in global total energy supply has been
decreasing, from over 45% in 1973 to around 35% in recent years (IEA, 2004).
Table 3.1: Primary versus secondary oil
Crude oil
PRIMARY OIL PRODUCT Natural gas liquids
Other hydrocarbons
SECONDARY PRODUCTS INPUTS TO REFINERY Additives/blending components Refinery feedstocks
Refinery gas Transport diesel
Ethane Heating and other gasoil
Liquefied petroleum gas Res. Fuel: low-sulphur content
SECONDARY OIL PRODUCTS Naphtha Res. Fuel: high-sulphur content
Aviation gasoline White spirit + SBP Gasoline type jet fuel Lubricants
Unleaded gasoline Bitumen
Leaded gasoline Paraffin waxes Kerosene type jet fuel Petroleum coke
Other kerosene Other products
Source: IEA (2004)
The flow of oil from production to final consumption is complex owing to the variety of elements in the chain. Figure 3.1 shows the simplified oil flow, covering supply of inputs to the refinery, supply of finished product to the end-user, and the petrochemical flows which interact in the process
Figure 3.1: Oil flow chart
Source: DRAKO OIL COMPANY (2005)
3.1.2 Petroleum Studies
The worldwide economic upheaval during the past decade has been, wholly or partly, attributed to the famous OPEC price shock. One consequence has been a revival of interest in the macroeconomic analysis of such an exogenous OPEC shock. However, very little attention has been paid to the impact of external price shocks on the OPEC economies themselves.
Darrat and Suliman (2001) examine the impact of export and import price changes on the real side of oil-based developing economies within a general equilibrium theoretical framework, and make contributions to the debate in several aspects.
Darrat and Suliman (2001) study was based on the following models:
Model 1: the model based on macroeconomic general equilibrium analysis
Model 2: the model has two traded goods (exports and imports) and a non-traded good
Model 3: the model directly considers the inherent open and small economy nature of the oil-based economics
The study concludes that the real imports are highly insulated against foreign import price shocks, perhaps due to the insignificance of import-substitution and export-consumption sectors. Moreover, due to the small size of non-traded (non-oil) consumption sectors, and the consequent zero cross-price effects between non-traded goods and exports, non-traded goods sectors are found to be highly immune to price changes of foreign exports. In the polar case of openness (absence of non-traded goods sectors), the substitution effect vanishes and the income effect dominates. In such a case, real changes depend crucially on the export supply response to changes in export prices, and on import demand response to changes in import prices (Darrat and Suliman, 2001).
3.1.3 Exhaustible Resources
The challenge of supplying the expanding energy needs on which rising living standards of billions of people depend while still preserving our environment are increasingly apparent (Brinded, 2005). The clear lack of sufficient oil refining capacity around the world is just one of the uncomfortable truths now facing producers and consumers alike (Smith, 2005).
Petroleum, in common with all other minerals, is a finite resource. That the world will one day run out of petroleum, is therefore, beyond dispute. When that day will come is, however, the subject of a great deal of controversy.
Heinberg (ERM, 2005) provides a well-constructed case that the subject is an immediate and
leaders and economists of the world deny that any problem exists and that they behave as if it is ‘business as usual’. Heinburg makes good use of the following quotation:
“In 1959 the human race discovered a huge treasure chest in its basement. This was oil and gas, a fantastically cheap and easily available source of energy. We did, or at least some of us did, what anybody does who discovers a treasure in the basement – live it up, and we have been spending that treasure with great enjoyment”
In 1950, the USA was:
a) the largest exporter of petroleum products in the world;
b) the largest lender of finance to foreign countries in the world, and c) the world’s largest exporter of manufactured goods.
By 2005, the USA became:
a) the world’s largest importer of petroleum;
b) the country with the largest foreign debt in the world;
c) the world’s largest importer of manufactured goods, and
d) had the largest balance of payment deficit in the world, with debt growing by $2 billion per day
Heinberg pointed out that, despite the continuing growth of the GDP, it is not possible to sustain such a level of debt indefinitely, and that a major collapse of the US economy will occur. The USA is, of course, not the only country that has built its prosperity during the last 100 years on fossil fuels and debt.
The countries of the Middle East contain by far the majority of the world’s declared reserves of petroleum. The reliability of the figures is difficult to verify independently, and the source data are, in some countries, even state secrets. According to Heinburg (2005), future demand growth is likely to be mainly in the developing world, with the lead being taken by China
the world; it is also the fastest growing energy consumer and the second largest importer of petroleum products, after the USA.
By 2004, the world consumed an equivalent of 8.5 million barrels of oil a day more energy than in 2003, the largest ever global increase. China’s expanding economy accounted for over 40% of this growth. This includes nearly 900,000 barrels a day more oil, almost all imported.
Taking China as an example, and as would be expected, energy consumption grows rapidly as industrialization, urbanization and personal mobility take off. It then slows as the initial spurt of development is completed, basic needs are met, and economies become more service oriented.