Using strategic management tools in the downstream market

The idea of the five competitive forces was first put forward by Michel Porter in his groundbreaking piece "How Competitive Forces Shapes Strategy" in the Harvard Business Review in 1979. People who are involved in a certain business can figure out how they stack up against the competition by looking at these forces and coming up with strategies to improve their place.

The article by Michel Porter says that there are five competitive forces that decide where a player stands in a market:

The power of the supplier: What is the supplier's bargaining power compared to the consumers'?

The customer power: How flexible and many options does the customer have when it comes to your goods and services?

 Alternative goods and services—Are there alternative goods and services that can easily be used instead of the ones that are currently being offered?

The fear of new competitors: How hard is it for a new company to get into the market?

Rivalry between the current market players: How hard are the current market players fighting with each other?

Based on where a player stands in relation to each of the competitive forces, they can come up with strategies to improve their competitive situation by strengthening the point that they see as their weakness. Right now, the crude oil refining business is facing a lot of problems, including volatile raw material prices, growing public pressure to protect the environment, and shrinking profit margins. As the sulfur content in the final product dropped dramatically, refiners looked for other ways to lower the sulfur content in the intermediate streams. In this type of business setting, it's easy to see how Porter's competitive forces would affect the downstream industry.

What Are Porter's Five Forces of Competition in the Downstream Industry?

Figure 1 shows how the five competitive forces that Michael Porter wrote about can be applied to the downstream business.

· The power of suppliers to make deals – The downstream industry gets most of its supplies from crude oil producers. Refiners don't have much negotiating power because the price of crude oil is determined by a number of factors. However, refiners who use flexible hardware can benefit when they can process heavier and discounted crudes that are cheaper. In other words, having enough bottom barrel conversion capacity can give refiners a big edge over their competitors. Over the years, some companies have built integrated operations to make their prices less sensitive to changes in crude oil costs. As for the other suppliers, refiners are usually seen as big customers, and these suppliers don't have much negotiating power, so they don't pose much of a threat. This means that the most integrated players can get a competitive edge. Another important factor is operational efficiency. Refineries that can lower their operating costs can be less affected by changes in the price of crude oil. One way to do this is to make the hardware used for refining more energy-efficient, since more than 60% of operating costs are related to energy use.

Bargaining power of buyers—Customers don't have much negotiating power in the downstream industry because it's still hard to find energy sources that are both plentiful and good enough to replace crude oil derivatives. Of course, in markets with lots of players, competition can offer buyers other options, but it's hard to make a big price difference in a commodity market. Even so, what the public thinks about the downstream industry is becoming more significant and could potentially alter the energy market. One example is the rising demand from society for an energy transition to low-carbon energy sources. Threat of new entrants: In the downstream business, it's hard to deal with the new entrant threat because it requires a lot of money. However, this threat should always be taken into account because of government actions and how appealing local markets are.

Rivalry between existing competitors—This is a big problem in the downstream industry, where there are a lot of players and products are becoming more similar. This puts a lot of pressure on the refiners' profit margins, so they try to make their operations more efficient. But as soon as they do, other players do the same, which lowers the market's profitability.

Threat of substitute goods and services: This is the biggest threat that players in the downstream business face these days. In recent years, it has become common for countries, mostly in Europe, to say that they want to limit or ban the production of fossil fuel-powered cars in the middle term. This is because the consumer market is shrinking. Figure 2 from Wood Mackenzie Company shows that, despite recent predictions, the desire for transportation fuels is still the main thing that brings in money for the downstream industry.

Figure 2 shows the relationship between petrochemical feedstock, transportation fuel feedstock, and installed capacity (Wood Mackenzie, 2019).  Based on data from 2019, Figure 2 shows that the demand for transportation fuels is almost five times that of petrochemicals. The current processing hardware is also geared toward meeting the needs of transportation fuels. Even with these numbers, there is a trend toward stable demand for transportation fuels near 2030, followed by a rising market for petrochemicals. Still, Wood Mackenzie data shown in Figure 3 shows that the role of petrochemicals in meeting the world's oil needs is likely to grow in a meaningful way.