Cover story: Why a reliable, flexible supply chain is vital to our nation and economy

“Somehow I managed to miss the enormous queues at 11.30pm tonight while travelling home. People were queuing to fill up anything available before fuel rationing comes fully on board here. The noise from this place could be heard from a distance as fights broke out . . . police were at hand to calm things down but it didn’t seem to help much.”

These are the words of an Iranian blogger, writing in June 2007. Although the country is OPEC’s second-largest oil exporter, a lack of local refining capacity at the time led to a rationing scheme and continuing fuel shortages.

This demonstrates what can happen when a country has too few refineries and an inadequate supply chain for bringing in sufficient imported products to meet demand. There are lessons in this experience for Australia.

Thanks to years of unrestricted supply, Australian drivers take for granted that quality fuel will be available from their usual sources whenever they choose to buy it. When they go to fill up at the pump, it’s impossible, understandably, for them to fully appreciate the complexity of investment and expertise that allows them to make their purchase so easily and freely.

Yet, behind each simple transaction is a massive and complex supply chain made up of thousands of people, facilities and highly specialised refining and logistical processes. It enables a company like Caltex to buy crude oil, transport it to refineries, transform it into Australian-grade fuels and send them, along with imported fuels, to terminals around the country. From there these fuels are supplied to customers at service stations and depots – at a competitive price.

Caltex’s roots go back to 1918 when the precursor to what is now Caltex was incorporated in Australia. The 1995 merger with Ampol, the iconic refining and marketing company incorporated by Sir William Walkley as the Australian Motorists Petrol Company in 1936, further strengthened Caltex’s Australian heritage. It is the only refiner and marketer listed on the Australian Stock Exchange and managed entirely in Australia.

The Australian oil industry exists to supply quality fuels safely and reliably to customers. However, the existence of Australia’s seven refineries is under threat. Many in the industry predict that competition from refineries overseas and costs flowing from local, federal and state government taxes and regulations and the proposed Carbon Pollution Reduction Scheme (CPRS) could make some local refineries unsustainable.

If that happens, Australian-grade fuel could become harder to obtain and more expensive, and jobs in the industry could be lost.

The risks of this happening are real. Sceptical? Here’s the evidence:

Without local refineries, there would be upward pressure on fuel prices.

At present, there’s no shortage of refining capacity in the region but that will change as it has always done, just as surely as markets move up and down, says Product Trader and Risk Manager, Alan Bartram. “Demand for petroleum products will be around for decades,” says Alan.

The closure of local refineries would mean many costs now absorbed by refineries would be added to the price of imported products. For example, importers would need to maintain more inventory, says John Heike, Manager Supply Planning.

Freight costs would mount as importers would have to place orders with refineries further and further afield, observes Ken James, General Manager Supply and Distribution. They’d start with countries like Singapore, Japan and Korea. Then, once all available Australian-grade product was extracted from the region, it would become increasingly difficult to source them.

“In that context you’d expect that the price of fuel made to Australian standards would, on average, rise,” says Ken. “There’ll be times when it’s cheaper, like now when there’s spare refining capacity, but these times won’t last.”

Australians could then expect the overseas refiners to pass on to them a portion of all the costs associated with running their refineries, including their financing.

Asia may struggle longer term to keep up with demand growth so countries short on refining capacity will be more vulnerable to disruption of overseas supply.

As evidence, Alan Bartram points to Korea where Australia imports some of its refined fuel from. “In their peak season they can’t supply us because we’re second cab off the rank,” Alan says. “So we’re already having to extend the supply chain to buy refined product that meets Australian specifications which means higher costs.”

Having to rely entirely on other countries for refined fuel could threaten energy security.

Australia is a member of the International Energy Agency, under which it has commitments and entitlements. One of IEA members’ responsibilities is to share their crude oil with other nations if there is a global shortage; an entitlement is to access refined product from others.

But Ken James points out those agreements have never really been tested in times of sustained crisis. Will countries that refine fuel see to their own needs first or will they honour their agreements at a cost to their own economies?

Australia has sufficient crude oil to supply roughly 60 per cent of its domestic needs. While it has refineries, it is within the power of the government to ensure that at least some of our fuel requirements can be provided from our own crude oil run in our own refineries if international cooperation breaks down.

“If we’ve got crude oil and no refineries we’d have to send out crude oil and hope to get refined product back,” Ken says. “There’s not much sense in that.”

Another supply security issue relates to imported cargoes that are “off-spec,” Ken refers to cases in recent years where another company imported jet fuel into Sydney that did not meet Australian specifications. Caltex was able to correct the cargo at its Kurnell refinery. If that hadn’t happened, supplies to Sydney airport could have been threatened.

“If a cargo arrives and it’s off-spec a number of things may happen,” says Mike Raleigh, Caltex’s National Distribution Manager.

“One is that the market may run out if it depends on the import. It takes about three weeks to get an emergency cargo, and longer if no product meeting Australian specifications is available for sale in the region. The next point is the vessel carrying an off-specification product can do nothing with it. It cannot discharge it and the importer will have to try to on-sell it to a regional refiner prepared to buy it. It becomes a big, expensive logistical issue.”

Domestic refineries give us flexibility to get the fuel we want, when we want it.

If all Australia’s fuel had to be imported, it would have to be ordered about two months out, says John Heike. “Many things can change between the time you place an order and the time it arrives,” he says.

Refineries have the flexibility to change production modes in a day or two to meet rapidly changing users’ demands for petrol, diesel and jet fuel. Suppliers relying on a supply chain in which it takes up to two months to get finished product need more inventory to cope with changing demand until product arrives.

Relying solely on imports would make it more difficult to get fuel with the required specifications, particularly premium fuels, and especially if it’s needed quickly.

“You become more exposed to the whims of other refiners, other countries,” explains Ken James. “Having your own refineries gives you more flexibility to do stuff, make stuff, fix stuff. As such, they represent a key input to economic activity and quality of life.”

Without our refineries, other industries and local communities would suffer and thousands of jobs and invaluable expertise would be lost.

Caltex accounts for around 35 per cent of the nation’s oil refining capacity. Its refineries employ nearly 900 people and around 550 contractors. For major projects the numbers can rise by an extra 1,200.

The simple equation is that, if Australian refineries close, those jobs will be lost or move offshore because new refineries will have to be built elsewhere. “Eventually if you close Australian refineries somebody, somewhere, is going to have to build a new refinery to make that product,” says Ken James.

Refineries’ influence extends beyond physical products to suppliers, contractors and the communities that benefit directly from their presence. They support sporting, environmental and other sponsorships. “Refineries are also repositories of expertise in the people who work in them and run the supply chain,” says John Heike.

Refineries give Australian governments greater control.

Governments can influence outcomes when they have influence over refineries. For example, if there are fuel quality specifications the government believes that Australia needs and which may not be generally available in the region, it can work with the local refining industry to find ways of making this happen.

This has occurred in Australia over the past decade. The Government gazetted new clean fuel standards which reduced air pollution from our cars and trucks.

“With no local refineries, governments are essentially taken out of play,” says Ken James. “They’d have to set the specs and hope other refiners would be interested in producing products that met them. That would be very risky.”

Once refineries have gone, we won’t get them back.

Is Caltex likely to close its refineries? Will it build a new refinery to replace imported products? Caltex considers both strategic and economic questions in determining the future of its refineries, says Group Manager Strategy, Planning & Development, Mike McMenamin.

“Caltex supplies about one out of every three litres of petrol, diesel and jet fuel consumed in Australia and our refineries are a key part of the supply chain that keeps Australia moving,” says Mike. “As cost pressures rise and new mega-refineries with greater capability and scale are built in the region, the viability of our refineries is threatened.

“Looking to 2020, it’s difficult to see all refineries in Australia surviving unless we can keep them competitive. I am sure this is something government will look at in the Energy White Paper currently being prepared.”

“Local refiners won’t stay in the market if cost and tax burdens become too great,” says Caltex Crude Trading Manager Geoff Sharpe.

“When you shut down infrastructure like a refinery, history shows you lose it forever because replacement costs are astronomical.”

“At the same time, local refiners won’t stay in the market at any expense if cost and tax burdens become too great,” adds Geoff.

Mike makes a comparison with the huge new Reliance refinery in India. If Australia had to build a single refinery like this to meet the existing needs of its 21 million people, it would cost over $10 billion.

“The work we’ve done indicates it would be more economic to build the refinery offshore and import the production,” he says. “Construction and operating costs are less in other countries in the region, and governments in other countries provide incentives for the construction of refineries.”

Why refineries are integral to the supply chain.

In fifty years’ time, Australia’s transport and fuel needs may look very different from today, with renewable electricity and biofuels having a much greater role. But one thing is for certain: we’ll still need refined petroleum products for decades to come, says Alan Bartram.

Alan borrows the words of former Saudi Arabian Minister for Oil, Sheik Ahmed Yamani, to illustrate his point. “The Stone Age didn’t end because they ran out of stones,” he says. “We won’t run out of oil in our children’s lifetimes, and oil will still be required but it will be harder to find and produce and will be more expensive.”

Refineries will also be required as key components in the Caltex fuel supply chain, which is made up of many interlocking and interdependent parts – from crude oil ordering and shipping to refining, storing and handling in terminals, and marketing.

“Do we need all the pieces?” asks Mike McMenamin. “Can we de-aggregate it and run it all separately? Are we an integrated business or not? What we find, through long experience, is that Caltex is an integrated business. If you were to ask whether you can have a successful sales and marketing business the size of Caltex in this industry without a strong supply chain and refining capability, history will tell you it’s very unlikely.”

So while Caltex looks for much of its future growth to come from sales and marketing, having readily available quality fuel for customers will always depend on the supply chain, of which local refineries are a crucial part.

SUPPLY CHAIN SECURITY – THE GOVERNMENT’S VIEW

Two important reports released by the government support Caltex’s view that reliable, affordable and secure supplies of energy are critical to Australia’s economic prosperity.

Extracts below from “The National Energy Security Assessment” and “An Assessment of Australia’s Liquid Fuel Vulnerability” show the government agrees it is important that a ell unctioning supply chain, including local oil refineries, needs to be maintained and that local industry is responding well to the challenges of keeping up with demand.

“The dequacy of domestic liquid fuels supplies is assessed as high. This is due to robust and flexible supply chains and diversity of supply which includes domestic refineries as well s Australia’s access to well functioning international markets.

“Reliability of domestic liquid fuels is assessed as high. Domestic refining disruptions to date have been managed through effective supply chain management, with supplies sourced from both alternative domestic sources and imports.

“Reliability of liquid fuels is assessed as moderate in 023. This is expected to stem from an increased reliance on long global supply chains sourcing crude oil from unstable regions which will more than offset continued effective upply chain management and good access to regional refining capacity. There is also the ongoing risk of domestic refinery closures in the face of strong competition from Asian efineries.” – extracted from The National Energy Security Assessment 2009.

“Despite a growing dependence on imported sources of oil and refined petroleum products,adequacyin terms of suppliers being able to keep up with demand has generally been maintained.

This is likely to continue, although capacity constraints in global oil infrastructure may see continued upward pressure on prices. Recent experience suggests refiners have become adept at managing production disruptions with no major supply shortages in any market for which close substitutes were not available ...(While) there remains some pressure in the supply chain from bottlenecks in importing and distribution infrastructure ... industry is responding to this pressure with plans for investment in new and upgraded infrastructure.” – extracted from An Assessment of Australia’s Liquid Fuel Vulnerability, November 2008, report for the Ministerial Council on Energy.

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