Over the past two years, interest in value chain optimization (VCO) has grown as downstream refining businesses come up against volatile market conditions, an emergence of “pure play” portfolios, and technological change. However, many organizations do not take a holistic approach when assessing their value chain; instead they look at each process in a piecemeal fashion, adding cost and inefficiency.
VCO, also known in refining organizations as supply chain planning and scheduling or supply, trading, and optimization, refers to activities that typically cover optimization decisions across the entire value chain. This spans crude oil sourcing, placement, and processing through to product blending and marketing.
In this article, we highlight three issues preventing refining organizations from effectively improving their VCO processes and offer three potential solutions that could capture additional value.
A potential multimillion-dollar margin increase: Now is the time to optimize
We frequently observe that North American downstream companies could benefit from improving their optimization processes.
In fact, our work with these refining companies suggests that at least a 50 cents to $1 per barrel (bbl) improvement potential is available with a well-designed VCO process that works across commercial, manufacturing, and marketing teams. This translates to between $30 million and $85 million in savings for a midsize refiner in less than six months. We see this across both geographies and refineries of different complexity.
Three major shifts impacting the industry
Markets continue to be volatile, impacted by demand uncertainty, the introduction of renewable feedstocks and products, and bottlenecks in the supply chain., McKinsey, July 1, 2021. The current market situation has led to significant EBITDA variability across refineries in the Gulf Coast and Midwest since the start of 2021 (Exhibit 1).
Finally, improvements in planning and scheduling software—such as linear programming (LP) models, crude and unit scheduling tools, and blending tools—have improved analyses, ultimately supporting rapid decision making.
To capture value, companies need to overcome tough challenges
Despite the significant potential value at stake for downstream refineries, our experience suggests that not all refiners are managing to capture it through VCO.
Common barriers include difficulty adjusting to evolving market conditions, insufficient time spent on improving business processes, and gaps in attracting and engaging the right talent. Our work driving transformations across commercial, optimization, and marketing functions suggests clear action steps that companies could take in all three areas.
Adapting to fast-evolving markets
Many refiners fall into the trap of developing and sticking to a plan without adjusting to evolving market conditions, such as fluctuations in regional demand signals.
With the help of a mature VCO function, organizations could continually evaluate incremental opportunities across the asset footprint. This may include identifying and executing opportunities such as swapping crude barrels with competitors when they are en route to refineries or buying and selling gasoline blending components across multiple regions to capture local arbitrage value.
However, seeking such incremental barrel opportunities requires a mindset shift, where planning is viewed as an ongoing process rather than an irregular practice.
Investing in improved business processes
While plenty of focus is directed toward improving tools, organizations often do not spend enough time developing or adapting their business processes, forfeiting the margin that could be captured by doing so. For example, most refiners regularly upgrade planning LP models, but processes within monthly planning—such as price forecasting, commercial constraint review, monthly crude ranking, or relative crude value (RCV)—are rarely reviewed and can be a source of value leakage.
This skewed focus may be driven by the perceived ease of upgrading tools like LP models, while process improvements require organizations to diagnose issues across functions and then develop better business solutions. Time may also be a factor as process improvements generally take longer to implement and adopt across organizations, while tools can be upgraded in a short period.
Cross-functional execution of a VCO strategy requires regular backcasting and historic performance reviews, which are often missing or overlooked in organizations. Companies need to analyze performance regularly and highlight gaps between planned, scheduled, and actual performance to understand marginal and missed opportunities.
Many organizations don’t have a robust backcasting process in place; instead, they use a margin-variance analysis to explain deviations between planned and actual performance. In contrast, an effective backcasting process compares the actual performance to the best possible performance under the same conditions, continually revealing areas of value leakage and driving organizations to collaborate across business functions to close or minimize such losses.
Attracting, engaging, and upskilling the right talent
It is becoming increasingly difficult to attract and retain employees in the oil and gas industry, especially since skill requirements are changing dramatically in the decarbonization era.
Instead of taking a holistic view of the talent pipeline within their organization, companies tend to change organizational structures and reporting lines to address the need for personnel across functions. This approach does not always account for the critical skills and experience needed in each role and can lead to a mismatch in job expectations and the skills needed to succeed.
Instead, a robust career-planning process that helps to identify high-performing talent—and creates meaningful rotations across business functions for these individuals—is required to develop a deep pool of leaders who can step into critical roles over time. A lack of such career-planning processes can lead to dissatisfaction among employees and accelerate the attrition of key talent, further compounding the skills problem.
Ongoing training and development are proving more important, too. While new tools and process automation can help increase data visibility and information transfer, insufficient training can limit the effectiveness of these tools. For instance, improving the price inputs to the crude value and breakeven analysis is the right step, but interpreting the RCVs to drive a general interest decision requires an understanding of the crack spreads, market dynamics, and refining constraints. This requires strong analytical and business-minded capabilities, which, in turn, call for a robust rotational program of commercial, refining, and technical roles for early-tenure engineers. Such programs can help to boost retention and encourage career growth.
Three ways to support a successful VCO transformation
Getting optimization right can yield rich rewards for refiners. However, an end-to-end VCO transformation is challenging. Our experience in supporting clients in these shifts has highlighted three key factors that could ensure the success of the effort: mobilizing the whole organization, including top management, in VCO, focusing on the source of value, and breaking out of silos.
Mobilizing the whole organization
A large proportion of transformation efforts fail, primarily due to a lack of leadership experience. Management can help mitigate this risk by taking steps to encourage employee engagement, support their teams, communicate effectively, and drive cross-functional collaboration and accountability.
In practice, companies do not always act on good ideas due to business constraints, such as limited resources and funding. A transformational effort is truly catalyzed when managers encourage employees, such as engineers, to voice their ideas and see actual change, even if the transformations are small.
Quick wins, such as trying a new stream routing, unclamping an advanced process control on a unit, or swapping product batches to minimize value loss, don’t require much funding but can generate value and minimize costs over a short period. These small successes energize teams and can build momentum for future organizational transformation initiatives.
Focusing on the source of value
Another common pitfall is the mismatch between the operating strategy for a refinery and its optimization approach.
For example, focused refiners—which produce only a few specific types of fuels as opposed to a diverse set of product offerings—could prioritize stable operations with limited effort to capture market swings, as they are often more protected from volatility through optimized processes, economies of scale, and lack of optionality to adjust output. In a focused refiner, a VCO function aims to ensure ratable supply to a small number of grades of feedstock and ensure predictable offtake of products, usually into long-term contracts.
In contrast, a flexible refiner can change operations significantly to chase market opportunities, handling a wide range of feedstocks to swing refinery yields toward the highest margin products seasonally or as the market changes. In this case, VCO aims to find advantaged feedstocks and opportunities for product placement into spot markets across geographies to take advantage of open arbitrages.
Success in these scenarios requires organizations to articulate their operating strategy and then align the VCO processes, organization, tools, and databases to enable the execution of the strategy.
Breaking out of silos
Finally, organizations could optimize across the full value chain by focusing on all business units, including manufacturing, marketing, retail, and chemicals.
Organizations that are optimizing across business units will often review transfer prices and use those as a signal that their manufacturing system has been optimized. This can lead to substandard results for the business as the optimization processes do not see end market price signals and may drive manufacturing decisions that are counter to the general company’s interests.
The use of transfer prices between a refinery and a marketing business, for example, could lead to the refinery choosing to produce less gasoline than is optimal for the marketing function to place into the market. This could result in the marketing team either forgoing opportunities or accessing the spot market for incremental barrels at a higher cost, resulting in a lost profit opportunity for the refinery.
Specific teams and individual engineers often find performance gaps and areas for improvement. However, challenges can arise when engaging with the broader organization to execute decisions. For example, a refinery may produce a lot of high-octane components and decide they would prefer to push for increased premium gasoline sales. Marketing may be able to place these premium barrels into the market, but VCO could be used to decide whether it is more beneficial to blend the high-octane components into a gasoline barrel or sell these as components to the market for downstream blending.
A well-designed VCO organization that can work across business units—marketing, trading, refining, and commercial—could drive a seamless work process and make the best decisions to maximize value for the whole organization.
By optimizing their value chains, downstream oil refining organizations could deliver major savings in a market shaped by volatility, increasing numbers of pure-play portfolios, and technological improvements.
The VCO process can lead not only to increased margins for refining businesses but also drive needed transformation: supporting the recruitment, training, and retention of talent and increasing efficiency throughout the full value chain.
