case W89C99

April 7, 2010
Izak Duenyas

Petro Refinery LLC - Linear Programming Exercise

Petro Refinery LLC is a Kazakhstan-based oil refinery. Its main focus is on providing refined petroleum
products to markets in China, the United States, and several European Union countries.

The president of Petro Refinery hosts weekly meetings with select team members. This week he is
prepping his colleagues and two outside consultants, both recent Ross Executive MBA grads, for an upcoming
evaluation of the refinery operations. The goal is to maximize the firm’s financial performance.

Dimitri (President): Hello everybody, thank you for coming. I would like to introduce you all to
Jennifer and Miguel -- consultants who will help us look for areas of improvement in our business. Both of
the consultants have experience with process optimization. Jennifer has years of experience in the energy
sector, and Miguel comes to us from the automotive sector.

My assistant will be sending out several documents. First document will provide a brief overview of
the refinery business. Second document covers the crude refining process. Third document covers our firm’s
current production possibilities and costs. Those who are familiar with the details of the refining business
can ignore the first two documents and focus on the third.

For our next weekly meeting, please work with the consultants to come up with suggestions on how
our financial position can be optimized. In your analysis, please assume that the prices we pay for crude oil
will stay the same. Furthermore, assume distributors will pay us the same rates for each gallon we sell them.
Please carefully review the production possibilities and costs document for more details, along with Tables
A, B, and C on page four.

Refinery Business Overview1

A refinery is basically a factory. Just as a paper mill turns lumber into paper, a refinery takes crude oil
and turns it into useful petroleum products such as diesel.

Different crude oil input produces different volumes of petroleum products. Crude oil is classified by
density (light, medium, or heavy). If the input is a barrel of light crude, more products such as gasoline will
be produced. If the input is a barrel of medium or heavy crude, more products such as diesel will be produced.
The most modern refineries can turn more than half of every barrel of light crude oil into gasoline.
Published by WDI Publishing, a division of the William Davidson Institute (WDI) at the University of Michigan.
©2010 William Davidson Institute. This exercise was written by Research Associate Sergei Kolomeitsev under the supervision of
Professor Izak Duenyas as the basis for class discussion rather than to illustrate either effective or ineffective handling of an
administrative situation.
This case was prepared exclusively as the basis for class discussion and is not intended to illustrate either effective or ineffective
handling of a situation. The case should not be considered criticism or endorsement and should not be used as a source of primary data.

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 Petro Refinery LLC - Linear Programming Exercise W89C99

Refineries require substantial initial capital investment. Few new oil refineries have been developed over
the past 20 years. In many parts of the world, including in Central Asia, there is an effort to upgrade and
modernize older refineries. This is in fact what Petro Refinery LLC started doing with its refinery a number
of years back.

It is important to note that when it comes to oil refining, if the input is equivalent to a 42-gallon barrel
of crude, the output is roughly 45 gallons of petroleum products. (See Table A.) This is due to the overall
density changes that occur during the refining process.

Other pieces of information worth noting:

• Unless maintenance is needed, refineries operate 24 hours a day, 7 days a week, 365 days a year.
• When a US consumer goes to the pump and purchases a dollar’s worth of gasoline, roughly 68%
of that goes to pay for the crude oil, 6% goes towards the refineries, 15% goes towards taxes
imposed by the government, and 11% for marketing and distribution. The tax percentage varies
dramatically between regions such as Europe and United States, or Africa and Asia.

Crude Oil Processing2

All refineries perform three basic steps -- distillation, conversion, and blending.

Distillation
Modern distillation involves channeling crude through hot furnaces. The resulting vapors and liquids
then move into distillation towers. Inside the towers, the vapors and liquids separate according to weight
and boiling point.

Conversion
In the conversion stage, cracking and rearranging of molecules results in transforming lower-value input
into higher-value output. This is where liquids and vapors from the distillation towers are transformed into
intermediate components that eventually become finished products.

Blending
The last stages of the refinery process fine-tune the products produced in the conversion stage. This is
where different types of diesel and gasoline are configured based on customer specifications.

Production Possibilities and Costs at Petro Refinery LLC

Petro Refinery LLC purchases light and heavy crude oil and refines it into gasoline, diesel, and various
other products. The petroleum products are then sold in gallons. For the next week, the refinery expects to
be paid $2.50 per gallon of gasoline sold to distributors, $2 per gallon of diesel, and $2 per gallon for all
other refined petroleum products. Petro Refinery LLC can sell as many gallons of these petroleum products
as it can refine.

The firm’s refinery operations are grouped into three standard steps: distillation, conversion, and blending.

Capacity in each department is calculated by measuring the equipment hours needed per refining each
1,000 barrels of crude. The firm’s output possibilities are based on equipment hours available, in combination
with equipment hours required, in each step of the refining process. As an example, Petro Refinery LLC’s

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 Petro Refinery LLC - Linear Programming Exercise W89C99

weekly refining capacity is sufficient to process either 800,000 barrels of light crude or 800,000 barrels of
heavy crude if devoted fully to either crude type. However, Petro Refinery LLC usually processes both light
and heavy crude in any given week. For example, if 500,000 barrels of light crude are processed, there would
still be sufficient availability of refining equipment for also processing 360,000 barrels of heavy crude.

Data on the equipment hours required for refining light or heavy crude at each step of the way can be
found in Table B.

The Petro Refinery production schedule for the prior several months resulted in a weekly processing
of 700,000 barrels of light crude and 120,000 barrels of heavy crude. The weekly output was 15,800,000
gallons of gasoline, 8,800,000 gallons of diesel, and 12,300,000 gallons of other petroleum products. At
these levels of production, the blending facilities were operating at full capacity. However, the distillation
and conversion facilities were not maximizing capacity potential.

Table A
Crude input and output

Sweet light
Input Heavy crude
crude
Price $80/barrel $75/barrel

Output per barrel (in gallons)

Gasoline 20 15
Diesel 10 15
Other (jet fuel, heavy fuel oil, LPG gases, etc.) 15 15

Table B
Refining equipment demand per 1,000 barrels

Equipment hours
Input Sweet light crude Heavy crude
available per week

Distillation 2 hours 2 hours 3,000

Conversion 2 hours 3 hours 2,400
Blending 3 hours 2.5 hours 2,400

Table C
Overhead and labor costs

Variable
Fixed overhead Labor
overhead
Distillation $2,000,000/week $2/barrel $0.5/barrel
Conversion 3,000,000/week 3/barrel 1/barrel
Blending 2,000,000/week 2.5/barrel 1/barrel

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 Petro Refinery LLC - Linear Programming Exercise W89C99

Questions

1. How much money has Petro Refinery LLC been making per week under its current production
policy of processing 700,000 barrels of light and 120,000 barrels of heavy crude after subtracting
the labor costs, the variable overhead costs, and the weekly fixed overhead costs?
2. Can you come up with a better policy for next week given the pricing for gas, diesel, and other products?
3. Suppose distillation is available for an extra 100 hours per week. How much would that be worth
to the firm? Suppose conversion is available for an extra 100 hours per week. How much would
that be worth to the firm?
4. Suppose the price of heavy crude decreases by $1/barrel (with light remaining the same). How
much would that affect Petro Refinery’s profits?

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 Petro Refinery LLC - Linear Programming Exercise W89C99

Exhibits

Exhibit 1
Petro Refinery LLC Output from a Barrel of Crude Oil, in Gallons (2010)

Light Crude Heavy Crude


 

Diesel
‐
10
 Diesel
‐
15

Other*
‐
15

Other*
‐
15




Gasoline
‐
20
 Gasoline
‐
15


*includes jet fuel, heavy fuel oil, LPG gases, etc.

Source: Petro Refinery LLC

Exhibit 2
Typical Output from a Barrel of Crude Oil, in Gallons (2008)

Source: U.S. Energy Information Administration

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 Petro Refinery LLC - Linear Programming Exercise W89C99

Exhibit 3
How Crude Oil Is Refined into Petroleum Products
At a refinery, different parts of the crude oil are separated into usable petroleum products. How does
this transformation take place? Essentially, refining breaks crude oil down into its various components, which
then are selectively reconfigured into new products.

Source: Adapted from Chevron

Exhibit 4
Crude Oil Prices (1980-2010)

Source: U.S. Energy Information Administration

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 Petro Refinery LLC - Linear Programming Exercise W89C99

Exhibit 5
Leading Oil Production Companies from Around the World

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 Petro Refinery LLC - Linear Programming Exercise W89C99

Exhibit 6
World Oil Reserves by Country as of January 1, 2009 (billion barrels)

Source: “Worldwide Look at Reserves and Production,” Oil & Gas Journal, Vol. 106, No. 48 (December 22, 2008), pp. 23-24.

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 Petro Refinery LLC - Linear Programming Exercise W89C99

Exhibit 7
Access to Oil Reserves

Source: PFC Energy, 2008

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 Petro Refinery LLC - Linear Programming Exercise W89C99

References
1
T he Refinery Business Overview section relies heavily on the Energy Information Administration website. The website was
accessed on April 6th, 2010. http://www.eia.doe.gov/
2
T he Crude Oil Processing portion also relies heavily on the Energy Information Administrative website, particularly the section
which covers the refining process. The website was accessed on April 6th, 2010. http://tonto.eia.doe.gov/energyexplained/index.
cfm?page=oil_refining#tab2

10

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 Petro Refinery LLC - Linear Programming Exercise W89C99

Notes

11

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 Established at the University of Michigan in 1992, the William Davidson Institute
(WDI) is an independent, non-profit research and educational organization focused on
providing private-sector solutions in emerging markets. Through a unique structure
that integrates research, field-based collaborations, education/training, publishing,
and University of Michigan student opportunities, WDI creates long-term value for
academic institutions, partner organizations, and donor agencies active in emerging
markets. WDI also provides a forum for academics, policy makers, business leaders, and
development experts to enhance their understanding of these economies. WDI is one
of the few institutions of higher learning in the United States that is fully dedicated to
understanding, testing, and implementing actionable, private-sector business models
addressing the challenges and opportunities in emerging markets.

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