Marketing - British Petroleum and Applications of Game Theory - PowerPoint Presentation Example

BRITISH PETROLEUM AND APPLICATIONS OF GAME THEORY, CRITICAL PATH AND LINEAR PROGRAMMING BRITISH PRETROLEUM British Petroleum (BP), an oil giant, is the surviving entity which arose from the merger in 1998 of British Petroleum (English) and Amoco (American). The merged company made it number three in the world in oil and gas behind Exxon Mobil (American) and Royal Dutch Shell. British Petroleum operates in several fields: With reserves mainly in Alaska and the North Sea, the group is the American number one in oil and natural gas, its leading activity, which it distributes to different sectors, namely aviation, the navy, or business and industry. It is also worth noting that it acquired half of the capital of the German subsidiary E. On VEBS Oel, which specializes in oil products and petrol distribution. It is also highly successful in the refining sector, for example, selling 6.4 million barrels of fuel daily to gas stations. BP also produces polyethylene, polypropylene and acetylene amongst others. BP is also now involved in the solar energy sector. BP, undeniably a giant, is located in Europe, North and South America, Asia, Australia and Africa. (BP 2008). GAME THEORY Game theory is responsible for the coordination processes in a given functional structure. Schmidt (2002) explained that these coordination processes usually follow physical flows. Each division (purchasing, production, sales, etc.) is constrained in throughputs by other internal divisions while adapting to local uncertainties (labor, breakdown of equipment, input and output changes with regard to the firm environment, etc.). Routines are used to balance ex ante budgets and define buffer inventories. Chandler pointed to the successive organizational changes which occurred in Du Pont de Nemours from 1907 to 1920, when coordination within a functional firm becomes clearly inefficient and that it was then broken down into parts and that a multidivisional structure emerges. Then much simpler coordination procedures can be implemented under the authority of the division manager while the benefits of the specialization by function are lost (economies of scope). Consider a stylized firm with a functional structure consisting of a purchasing, a manufacturing, and a selling division. It is assumed that manufacturing involves fixed costs, so that it pays to increase the volume of throughput. However, the environment is assumed to be uncertain both in the downstream and upstream markets. This suggests that corresponding decisions should be flexible in order to benefit from favorable market conditions. Altogether these conflicting objectives may endanger the financial position of the firm through over-stocking and/or high cost inefficiency. How can one decentralize decisions in such an organization? The model The model implements some drastic simplifications while retaining the difficulties of the coordination process. Only two divisions are introduced: purchasing/manufacturing on one hand, and selling on the other hand. These two divisions are respectively denoted by M and S. Production function and technical constraints The activity of the firm consists in buying an input at market price pm, transforming it into a final good which can be sold at market price ps. The production process is characterized by a fixed cost F. It transforms one unit of input into one unit of output 2 and requires a production cycle of, say, one period. The whole quantity of input bought at the price pm is immediately engaged in the production process: There are no stocks of inputs and no rejects. At the end of the production cycle, the final good can either be sold in the retail market at the current price ps, or be kept in stock in order to be sold at a future time. Due to the production cycle, at a given moment the firm can only sell the quantity s of final good that was produced in previous periods. Besides this physical stock, the firm is also endowed with a financial stock denoted t, that it can use to finance the production of the period. Contrary to physical transfers, financial transfers inside the firms are supposed to be instantaneous (no customer or supplier credit), so that the returns from the sales of the current period can also be used to finance production. The couple (s, t) represents thus the initial state of the organization. We assume that the firm operates on the sole basis of its physical and monetary wealth. These assumptions restrict the operational decisions that the firm can make. Let Qm be the quantity of input bought at price pm and Qs the quantity of output sold at price ps. The first technical constraint reflects that the firm has no access to an outside market for the final good Game Theory and the Petroleum Industry Crude oil and petroleum products are traded in either of two categories: by contract or by spot transactions. Razavi, Hossein and Fereidun Fesharaki (1991) explained that a contract sale commits the buyer and seller to trade oil over a set period of time and often at fixed prices. In the past, this period could have been as far ahead as three years. More recently, both the contract period and the price have been much more flexible. Spot sales, on the other hand, refer to short-term trading, usually involving one cargo of oil per deal, with each deal struck at an agreed price for prompt lifting or delivery. Spot trading can thus be defined as a process by which cargoes of petroleum are exchanged on a day-to-day basis rather than under long-term contracts. During the last decade, spot trading in petroleum has grown dramatically, from 10-15 percent to about 30-35 percent of total volume traded in the international market. In addition, a new wave of spot-related transactions that link the contract price to spot market price has emerged. These deals, which were virtually nonexistent before the 1980s, now comprise an estimated 50-55 percent of total trade. Chaudhri (2005) explained that game theory includes strategic bidding behaviour and auction performance. The first of these, auctions in theory and practice, compares the theoretical and empirical evidence of auction behaviour and performance. Game theory includes the economics of auctions and bidder collusion and takes the game theoretical lens to assess the susceptibility of alternative auction institutions to collusion. Game theory consists of activity rules for an iterated double auction which is an exercise in auction design for a particular trading problem. The iterated double auction allows buyers and sellers to revise bids as the auction proceeds, with the stated aim of both early and reliable price discovery and efficient final prices and exchange. A number of specific activity rules are posited to ensure serious bidding and the meeting of the stated objectives of the auction format. Ronen (2005) states that the Critical Path Theory (CPT) in Project Management identifies the longest sequential task in a project which determines the length of a project. Recognition of the CPT and the constraint resource in the planning and execution of a project incorporates the impact of human behavior in task estimation and completion times. LINEAR PROGRAMMING AND THE PETROLEUM REFINING PROCESS Crude selection Modern petroleum refineries are designed to process a variety of indigenous and imported crudes.   As the crude cost is about 90% of the refinery input cost, the selection of optimum crude mix is extremely important to achieve higher margins.  However, the number of options for buying the crudes under a fluctuating price scenario and transporting them to refineries are so enormous that it is very difficult to evaluate all the crudes and decide on the optimum crude mix for the refinery.  Refineries buy crudes both on term contracts with leading suppliers and also by spot purchases from the market. The optimum selection of term and spot crudes is extremely difficult when multiple refineries are involved and work in an integrated scenario. Crude transportation Once the crudes are selected and purchased, the focus is to optimize the transportation cost from the crude suppliers to refineries.  The transportation cost can be minimized by considering the multiple options available for cargo sizes, sea routes, loading and unloading infrastructure facilities, taxes and duties, etc. Crude processing The crudes often land at refinery sites as a mix of various crudes and various options of crude blending are evaluated before it is processed.  The ultimate challenge a refinery faces is processing the crudes in the best possible manner and maximize the $/bbl (dollars per barrel) for the crude input.  Determining the “best possible” option is a very difficult task, as modern day refineries are built with complex processing schemes, having a combination of various technologies for heavy ends upgrading, product quality improvement, efficient fuel usage and controlling refinery emissions.  The most common configuration includes catalytic cracking, hydro cracking and thermal cracking to maximize the bottom of the barrel.  The other process technologies like catalytic reforming, hydro treating and sulfur recovery are a must to comply with stringent environment and product quality regulations (Refer to Fig. 2.0 for a process flow diagram of a modern refinery). The ex ante payoff function is the expectation of the ex post payoff with respect to the probability laws of the prices, that is 4 (Π (Qm, Qs)), where designates the product law. The game is then in normal form. Due to the infinite penalty associated with bankruptcy, the expected payoff takes a finite value only for the strategies that respect the technical constraints for every realization of the prices. Those strategies are called admissible. Finding the optimal policy comes down to determining the best Nash equilibrium of the incomplete information game, the one which gives the highest ex ante payoff to the team. First we show that the equilibria of the game can be parametrized by the minimum revenue of the sales. This parameter can be interpreted as an ex ante financial transfer from division S to division M. Second, we determine the optimal way of fixing such an ex ante transfer. Due to the increasing returns to scale, the optimal policy is either no transfer or maximum transfer between the two divisions. Figure 2: Process flow diagram of a modern refinery http://www.uop.com/refining/1010.html Product demands The product demands, quality and prices drive the entire crude processing and secondary unit operations.  Multiple streams with multiple blending options to make different grades of a product further make the task of refinery planning cumbersome and demanding. Moreover, the future promises to add even more complexity through additional product specifications, environmental norms, changing feedstock, product prices, mergers and acquisitions. Need and Scope for optimization in Refinery operations Most refineries are owned by integrated oil companies having a variety of interests, from exploration and production through refining and marketing to retail sales. Within such an organization the refinery works under the direction of the Head office.  The Head office negotiates long-term and short-term crude supply contracts while the product Supply and Distribution department sells products.  The refinery itself typically works within the overall framework of the organization to maximize the corporate profitability.   This makes the refining an extremely complex and dynamic activity.  Along with the complexity of refining, there also exists a great degree of freedom in refinery operations.  For example, one of the most commonly used refinery products is fuel for automobiles, and the customer does not care about the complexity or simplicity of the refinery, what crudes it purchased, which processing technology it used, what blending or additive components it used in making the fuel.  The customer is only concerned with the proper running of his vehicle and the value for the money spent.  Therefore, the refiners have got both an enormous complexity and considerable freedom to satisfy the customer requirement and make profit.  This requires the optimization of multiple objectives in the refinery’s business supply chain. The table below provides a glimpse of the multiple objectives of refinery optimization: Minimize  crude landed cost at refinery Optimize refinery crude mix  Optimize black oil generation and upgradation, optimize overall product mix and dispatch Minimize quality giveaway Optimize fuel consumption, minimize losses Optimize utilization of the assets Optimize inventory management Optimize capacity utilization and shutdown planning Optimize unit operations maintaining highest standards of safety All of the objectives mentioned above present a refinery with a challenging problem and an opportunity to maximize the overall profitability. The need and scope for LP is important so it is essential to use models to arrive at the best plan, but also to quickly evaluate the new optimum with internal or external changes in the business scenario. Optimization means "the action of finding the best solution within the given constraints and flexibilities.”  Linear Programming (LP) is a mathematical technique for finding the maximum value of some equation subject to stated linear constraints.  It is commonly used in refinery planning to identify with confidence the most profitable refinery-wide operating strategy.  The refinery-wide optimization using an LP model has been proven to bring economic gains far higher than unit-specific simulation models or advance process control techniques. Implementation of LP for Refinery planning and optimisation Refinery planning forms the foundation for the business decisions that have the biggest impact on refinery profitability. A refinery typically prepares the following types of plans: Annual plans for annual budgeting, term crude contracts and maintenance shutdown planning Monthly rolling plans for spot crude purchases and conducting refinery operations inline with product  demands  Weekly plans for finding operating strategies for units at the weekly level, i.e. the refinery knows precisely which crudes it has and must decide which crude cocktails to run, how long to do so and how it is going to meet any particularly large or difficult product demands Strategic plans for future years and expansion projects  Profitability improvement plans for plant -level modifications and revamp projects The preparation of any of the above types of plans requires a set of standard procedures and an LP model customized for the refinery configuration. Bibliography Chaudhri, Vivek. (2005) “Game Theory and Business Applications”, Economic Record. Volume (81), Issue: 252. p.88. Ronen, Boaz. (2005) The Theory of Constraints. New York IOS Press. Schmidt, Christian. (2002). Game Theory and Economic Analysis. London: Routledge. Razavi, Hossein and Fereidun Fesharaki.(1991). Fundamentals of Petroleum Trading.Westport: Praeger Publishers. Online References British Petroleum. The British Petroleum in the UK viewed on January 28, 2008. http://www.bp.com/home.do?categoryId=1.. Sahdev, M. K., Pankaj Srivastava and K.K. Jain., “Petroleum Refinery and Linear Programming.” Viewed on January 28, 2008. http://www.cheresources.com/refinery_planning_optimization.shtml Read More