Ingeniería de Operaciones MEC8S3 GR1ENG

Homework 1
Name: Diego Vinicio Parra Borja

Instructions: Select one of the applications of operation research listed on Interfaces. Write a two-page
summary of the application and the benefits it provided.

The article selected is “The Successful Deployment of Management Science Throughout Citgo Petroleum
Corporation”, which was written by Klingman, Phillips, Steiger and Young, and publicated in 1987.

Summary
In 1983, Southland Corporation acquired Citgo Petroleum Corporation in order to establish management
priorities and to transform it from an oil company, which produces its own crude oil, to an independent
refiner and marketer of petroleum products. So, they took two important decisions which made a profit
improvement of $70 million per year in 1985 over a pretax loss of 50 million in 1984. These decisions
were creating a task force to improve Citgo’s profitability and establishing an economic survival
motivation by turning Citgo as a wholly-owned subsidiary with a full debt-load. The strategies utilized
to achieve their goal were a combination of profit center focus, mathematical programming,
organizational theory, artificial intelligence, expert systems, decision support systems and forecasting
techniques.

The task force conformed by Darwin D., a management science consultant and Jhon P. his superior
realized the industry was in the middle of an information explosion which was a function of four major
environmental changes. The changes included the increased emphasis in companies on making a profit
from downstream operations, the number of new sources of crude oil and refined products, the
narrowing of the price-volume relationship associated with whole-sale terminal sales and the increase
in the cost of financing working capital since 1972. This let the task force to adopt two goals: First, to
provide Citgo makers with management science tools and then identify and implement the
organizational changes necessary which were crude oil acquisition and refining, strategic and
operational market planning and working capital control.

The task force also wanted to produce higher valued products at a lower cost in an environmentally and
operationally safe manner. So, they established data highways for data acquisition and information
dissemination, data repositories and a marriage between these data with management science tools.
Then, the refinery LP system tool was used for helping control the operating costs but after an audit it
disclosed many weaknesses on Citgo’s. Principally, the data Citgo had were inaccurate particularly the
energy cost data; in order to correct this, a physical measurements data base was created. Next, they
replaced the matrix and the optimization software in the refinery LP System to achieve a good model
which could provide critical decision information. The goal achieved with the new model after validation,
calibration and setting the inputs and outputs was to have a system capable to provide critical decision
information as crude selection, acquisition economics, refinery run levels, and others.

There were some energy losses in Citgo, that after an audit, the company showed major steam losses
and a lack of adequate metering for performing an energy balance on natural gas or electricity. The
benefits of a process control equipment and non-linear optimization models were a reducing in energy
consumption, balancing the energy load and reducing energy costs. Also, they established procedures
to evaluate operator performance and train operators that added to the new historical and accurate
data recorded, made possible achieve a better coordination between planning, scheduling and cut-point
settings.

In addition Southland were focused on maintenance management, employee efficiency and crude
scheduling for Citgo. First, an integrated maintenance information system and inventory control
function were established, allowing to reach benefits as a faster processing work orders, better use of
maintenance personnel, lower inventories of parts and less equipment downtime. On the other hand, a
reduction in personnel from 1600 workers in 1984 to 1200 employees, set a reduction in the labor costs
of $15 million per year. Also, they established a schedule for delivery and distribution of crude oil to
allow the refinery to operate effectively with lower inventories. This showed a reduction in crude
inventories of $20 million.

TRACS is a system developed by the task force that evaluates the profitability of existing markets. It is
coupled with rule-based artificial intelligence provides an economic comparison between potential
selling options and distribution channels. Thus, TRACS could evaluate sells at all Citgo owned terminals
and its inclusion of all variable costs of supplying sales, so Citgo used this system to evaluate current and
potential market segments as its strategic marketing planning effort.

PASS in another system, which is a data base that allowed Citgo to brake some information walls
between industry departments. The system contains sales, inventory, trades and exchanges for all
refined products for the past (historical data), present (scheduled activity) and future (forecasts); this
improved interdepartmental coordination. Nevertheless, PASS needed to improve operational
coordination and control, so they developed the SDM system which is an optimization-based supply,
distribution and marketing model used to make economically rational decisions, such as where to sell
products, what prices to charge, where to buy or trade product, how much to buy or trade, and else.

A few several organizational changes were made like the creation of four new positions: a senior vice-
president of refining, an internal management consultant and two product managers. These positions
had the objective to facilitate the coordination and implementation of the operational tools
recommended by the task force.

The benefits of all changes developed are numerous. They include improved communication and
coordination between supply, distribution, marketing and refining groups; improved data; reduced
inventories with smaller variance in inventory levels; elimination of unnecessary product terminals;
improved management of exchange agreement and purchase/sale/trade agreements; added insight
into pricing strategies; better forecasts; and economically rational decision making.

The task force also considered a working capital control analyzing Citgo’s cash flow cycle. The modified
Citgo’s refinery LP model combined with SDM model, provided detailed and integrated information on
optimal quantities and qualities of refined products and crude oils to be purchased. The control of
product and crude oil payables has reduced working capital by an estimated $8.5 million, yielding an
annual decrease in interest expense of approximately $1 million. Although it is difficult to calculate the
precise economical changes in working capital because of the changes in sales, volumes and lines of
business; the reduction in working capital is calculated on 145-155 million between 1983 and 1985.

One of the major difficulties to the project was the cost for implementing the new systems, a price that
was near of $20-$30 million; but with the information explosion they noticed that there were too much
data to analyze and cover. So, despite of the incremental cost of adding management science
technologies, it was very small in light of the enormous benefits they provided.