The Gross Margin in oil sector

The quarterly results of oil companies indicate that oil sector has done well during the financial year 2006-07. The real succes story revolves around Gross Refining Margin, nowadays around $ 13 per barrel. Put crudely, refining margin is the money a comapny makes by buying an unprocessed commodity and selling the refined product. deduct the price of crude oil from the price of refined oil and you get the gross refining margin.

For instance, if a petroleum refinery buys crude oil for $100 /bbl and sells refined oil for $113 /bbl, then $13 is the gross refining margin. This $13 is what the market is willing to pay for the value addition created by the company.

Vertically integrated oil companies , such as BP, Chevron, ConocoPhillips, ExonMobil and Shell produce their own crude oil. Since several costs are shared, the margins are higher for vertically integrated companies comapred with stand-alone refineries, which buy crude from the open market. Moreover, the more efficient companies can refine the same crude oil at lower cost. So their margins are higher than those with old technology or poor economies of scale.

Sine the margin depends on the difference between price of refined product and price of crude oil, any factor which disturbs either of the two impacts gross refining margins. As a result, if higher demand or low supplies raise the price refined product, then refining margins will increase. If more refineries come up and flood the market, the margins will reduce.

The change in refinery margins is also seasonal. For instance, in end March and April, prices rise because of a tightening of supplies as refiners start normal spring maintenance and turn-aound operations at various refineries. At this time of the year, refiners are also gearing up for summer demand. That temporarily limits the availability of the supply, putting upward pressure on prices, which in turn increases refining margins until the market balance back. Finally, the margins also depend on the kind of refined products taht a comapny can produce from the feed stock. Often, a company realises different gross margins from its plants located in different locations / countries.

In a good year for refiners demand for their products grows by more than the additional capacity created and margins stay healthy. In a bad stretch, capacity can outgrow demand for several years in a row and margins get stuck in the doldrums. When the price of crude oil and the refined product are decided by outside forces, it can maximise profits only by reducing cost to the minimum. Attempts to source crude oil as cheaply as possible and trying to sell the refined product at maximum price further add to margins. Proper inventory mangemnt, hedging against foreign exchange fluctuations, and deciding the best product mix can stabilise the gross margins in the situation where demand and currency fluctuate.