What is 'Downstream'

Downstream operations are oil and gas operations that take place after the production phase, through to the point of sale. Downstream operations can include refining crude oil and distributing the byproducts, such as gasoline, natural gas liquids, diesel and a variety of other energy sources, down to the retail level. The closer an oil and gas company is to the process of providing consumers with petroleum products, the further downstream the company is said to be.

BREAKING DOWN 'Downstream'

Most large oil companies are described as "integrated" because they combine upstream activities, which include exploration and production, with downstream operations. Some prefer to divide downstream operations into upstream, midstream and downstream, with the refining process taking place either midstream or downstream and the distribution occurring in the downstream phase.

Operations Overview

Companies in the downstream sector are those that provide the closest link to everyday users. After crude oil is discovered and pumped in the midstream process, the crude oil is shipped and transported, which is known as the midstream process. Thereafter, the oil is refined, marketed, distributed and sold, which is known as the downstream process. However, the refining of crude oil to petroleum products may be conducted in midstream operations.

Crude Oil Prices and Downstream

Although an oversupply of crude oil may hurt integrated and upstream oil companies, companies that primarily operate in the downstream process benefit substantially. When crude oil prices fall sharply in a short period, petroleum products typically lag crude oil prices since there is demand for petroleum products. As crude oil prices fall, refining margins typically grow. However, as oil prices increase, refining margins may experience declines.

For example, assuming an oil refining company, ABC Inc., primarily processes Western Texas Intermediate (WTI) crude oil to gasoline. Since gasoline experiences seasonality, there are periods when downstream companies may only generate low profit margins or operate at a loss. Assume it is the winter and demand for gasoline is slowing but the Organization of Petroleum Exporting Countries (OPEC) has announced that it would cut production. Gasoline prices are trading at $2.50 per gallon, or $105 per barrel, while WTI crude oil prices are trading at $95 per barrel. Therefore, ABC Inc. only has a margin of $10 per barrel, or $105 - $95.

Assume the following year that gasoline prices remain at $2.50 per gallon but WTI crude oil prices fall substantially due to a global supply glut. The supply glut causes WTI crude oil prices to fall to $50 per barrel. Therefore, ABC Inc. has a refining margin of $55 per barrel, or $105 - $50. However, this margin does not take into account other costs the company may incur, as the crack spread just takes into account the costs associated with crude oil.

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