Structural Change in Oil Distribution


By Capt. Paul E. Mawn USN (Ret.)

Since 1865, the one constant in the oil business has been constant change. The petroleum industry has been driven by geopolitics, technology, industry leaders and management gurus (i.e. people), and external events (e.g. Ford’s Model T, wars, major spills, etc.). Major periodic changes have also impacted the secondary distribution portion of the supply chain, including terminals and fleets.

As gleaned from the annual proprietary CCG Petroleum Terminal & Trucking Productivity Analysis, the average oil products terminal in the U.S. has the following metrics:

  • 407,000 barrels of storage
  • 6.4 million barrels of annual throughput (i.e. 15 tank turns/year)
  • 76% fed by only pipeline, which is much greater than in most other countries
  • Approximately 5 terminal employees on site
  • Typical throughput costs of about 0.9¢/gallon or 90 points, including depreciation.

The characteristics of the average U.S. petroleum trucking fleet are:

  • Tractor trailer load size = 8,800 gallons with 96% full loads
  • Round trip distance = 55 miles, which takes on average 2.6 hours, depending on traffic, weather etc.
  • Fleet productivity = 3,300 gallons per hour with each truck being driven 116 thousand miles / year
  • Typical delivered cost = 2.3¢/gallon or 230 points.

Based on my experience over the last 30-plus years, the following half-dozen key factors seem to loom most significantly in the evolutionary changes affecting petroleum storage and delivery: focus on market share, the Exxon Valdez spill, multiple waves of management consulting gurus, productivity enhancement focus, merger mania, and environmental flashback pressures.

The above issues typically arose first in the U.S., but then gradually became global. As a national frame of reference, each point or .01¢/gallon (up or down) increased or decreased the secondary distributor’s bottom line by between $30,000 and $2 million for terminal operations, and between $100,000 and $400,000 for trucking operations, depending on size and number of annual transactions.

 

Focus on Market Share

As pushed by Boston Consulting Group and a few others, the prioritization of activities by market share, which advocated a retreat to competitive niches, started to take shape in the mid-1980s. Some oil companies embraced this strategy more than others. For example, if a company could not attain a minimal market share, e.g. 10%-25% in a given geographical area, these marginal market areas would be quickly or gradually abandoned so that the company could focus on high penetration markets.

As a result, product terminals were classified as “keepers” or “dogs.” The latter facilities were sold or became idle, with the related product being shifted to keepers or to third-party facilities if more cost-effective throughput arrangements or swap & exchange agreements could be negotiated. Thus, the utilization of keeper terminals increased, resulting in lower or dampened costs due to improved economies of scale as more product throughput was transferred from the dog sites, which were phased out of the total terminal network. This, in fact, happened to all the Exxon and Hess terminals for which I was once responsible in New Jersey, Connecticut and New York.

Exxon Valdez Spill

In March of 1989, a tanker owned by Exxon struck a reef in Prince William Sound in Alaska, spilling almost 11 million gallons of crude oil. This accident gave rise to the Oil Pollution Act of 1990 (OPA 90), which imposed significant environmental regulations and associated costs on all phases of the oil supply chain, including petroleum product terminals. As a result, more terminals became marginalized and labeled as dog sites for closure or sale to avoid mandated OPA 90 capital and operating costs. Thus, more terminals were removed from the system, especially the higher-cost and higher-risk small marine facilities, and especially those fed by barges rather than by tankers. The OPA 90 mandated capital and operating expenses increased significantly for the remaining keeper sites.

 

Productivity Enhancement Focus

In the 1950s and ‘60s, before the significant rise of OPEC, most of the money of integrated oil companies was made upstream in exploration and production, and the prime purpose of refining and marketing was basically to suck upstream barrels through the system. The mantra of the day was “We lose money per gallon but make it up on volume,” which was lubricated in part by mysterious internal transfer pricing schemes. When the economics changed after the rise of OPEC, each segment of the oil supply chain was expected to pull its own weight. One lever for doing so was to improve the operational productivity and thus decrease related costs of operating product terminals and trucking fleets.

In terminal operations, the average major oil company started to proactively increase its annual tank turns, from 9.2 in 1986 to 15.5 in 2015 — a 68% boost. However, over the same period, the average annual terminal throughput jumped by 100% — from 3.2 million barrels to 6.4 million. The associated headcount per terminal also increased, but only by 31%, from 4.2 to 5.5. Thus, employee productivity jumped 69%, with an 8% drop in overtime pay.

In trucking ops, there was significant upsurge in productivity from the mid-1980s to a peak in the mid-1990s. Fleet productivity increased 32%, partially due to an 8% drop in the round trip distance, fewer split loads, and a 2% increase in load size, plus there was a 3% increase in truck utilization stemming from more double shifting and weekend work. However, from the mid-1990s until recently, truck costs jumped 42% due to fuel costs, and fleet productivity declined almost 22%.

 

Multiple Waves of Management Consulting Gurus

In the early 1990s, management gurus such as Deming, Hamel, and Porter promoted concepts for a fee such as cost center focusing, total quality management (TQM), process re-engineering and core competency. As alluded earlier, terminal and trucking operations had been set up as de facto cost centers serving various profit centers. Several oil companies went through multiple internal reorganizations from centralization to decentralization and back again. Many but not all oil companies started to be more proactive in marketing their liquid warehouse facilities to third parties to use for a fee via throughput arrangements as well as swap and exchange agreements.

In the ‘50s and ‘60s, many companies under the influence of their marketing department did not want their prized facilities to be used by competitors who might end up eating their lunch. Starting in the 1990s, many terminal facilities and trucking operations were “process engineered” out of existence under the banner of “core competency,” i.e. if the function is not a core activity, get rid of it and turn it over to the external professionals. During this time, independent terminal operator activities and their use by major oil companies detectably increased. Furthermore, many U.S. oil company proprietary trucking fleets were eliminated, with the associated volume turned over to external third-party common carrier trucking companies. The total volume of product delivered by proprietary trucking fleets dropped precipitously from a peak of 69% in 1995 to only 42% in 2010.

This reshuffling of petroleum trucking operations continued to decline to a current level of less than 20%, which also reflects the impact of core-competency-driven actions of most major oil companies. Some major oil companies went even further by in effect becoming rack sellers, with their customers responsible for their own trucking. When done correctly, the shedding of assets over the last two decades may or may not have helped improve corporate ROI. However, the partial dismantling of oil company control of secondary distribution in effect represented a retreat from the time-tested vertical integration strategy developed initially by John D. Rockefeller of the Standard Oil Company. Furthermore, core-competency-driven shedding of strategic supply chain assets resulted in fewer potential sources of sustainable differentiation among competitors.

 

Merger Mania

At the very end of the 1990s and continuing after the turn of the century, the oil industry went through an intensive period of mergers & acquisitions (M&A), which in many cases were driven by upstream considerations but had a significant ripple effect on secondary distribution. For example, in the mid-1990s, I personally had 20 U.S. oil companies as clients of the Concord Consulting Group. However, by 2010, as a result of M&A activity, only nine of these companies have survived as corporate entities. In the UK due to M&A as well as market withdrawals, my 19 oil company clients in England were reduced to only four. Among major oil companies, such M&A activities may have increased their total number of product terminals, but the total number of facilities in the marketplace was reduced as redundant or marginal terminals were idled, sold to distributors, or converted for use in non-petroleum purposes.

 

Environment Flashback Pressures

A decade after the 9/11 atrocity and the Exxon Valdez spill, a second wave of environmental pressures and related costs surged as a result of the Deepwater Horizon oil spill, as well as a few major tank collapses in the U.S. and fires at petroleum product terminals, especially in the UK.

One prominent and costly manifestation of this “green” flashback was initiation and implementation of the American Petroleum Institute’s API 653 tank integrity programs, as well as greater political pressures and resulting regulations over the last decade.
To a lesser extent, these added environmental costs have precipitated a new round of keeper vs. dog product assessments, which has the net effect of reducing the total number of facilities in the marketplace.

Captain Paul E. Mawn US Navy (Ret.) is currently the president of Concord Consulting Group LLC, which executed a recent strategic alliance with Solomon Associates. Previously, he held senior line management positions with Exxon and Hess Oil in marketing and distribution, as well as managed petroleum related projects with Arthur D. Little Inc. and as a partner at Mercer Management Consulting. Captain Mawn graduated cum laude in Geology from Harvard College with a subsequent MBA from Rutgers University and currently serves as the Chairman of the Advocates for Harvard ROTC. The above article was based on a presentation given by Captain Mawn at an Energy Panel for senior foreign and US Naval officers in December 2017, hosted by the Naval Command College, which is part of the Naval War College in Newport, Rhode Island.

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