Business Supply Chain Methods

The Elcrex refinery purchases crude oil and refines it into various petroleum products such as, gasoline, diesel and jet fuel. In addition some of the crude is refined into specialty chemicals such as benzene and xylene. These chemicals form the basis for products such as paint, ink and pesticides. The refinery supplies the entire East Coast of the United States with most of its petroleum and petrochemical products. Its customers range from airlines for jet fuel, chemical plants for its petrochemical products, and the individual consumer for gasoline and diesel fuel for cars and trucks.

The Elcrex supply chain is as follows: to purchase crude oil from a foreign source, usually Venezuela, measure the crude oil, ship the crude to its facility, measure the crude again upon arrival, discharge crude oil from the ship to storage tanks, measure the crude that remains on board the ship if any, and then measure the crude oil that is in the crude storage tanks.

There are usually two parties involved in the sale and purchase of crude oil on the open market. The buyer is known as the consignor and the seller is known as the consignee. The consignor and consignee agree on a quantity of crude oil to be bought and the price that the crude will be bought at (Messer, 2001). Once the two parties agree to the terms of sale, the crude is delivered from the buyer to the seller by ship, or oil tanker. It is the responsibility of the buyer to charter a ship to take delivery of the crude oil from the consignor and deliver it to the buyer's holding facility.

The contract that governs every aspect of the sale, delivery, receipt and the actual delivery of the crude oil from the ship to the consignee is known as the Charter party (Messer, 2001). The documents that transfer physical ownership from the seller to the buyer are known as bills of lading. The bills of lading contain the name of the seller, the buyer, the approximate quantity of crude that was sold, as well as the type of crude oil that was sold. The bill of lading also has a unique identifying code associated with each parcel of crude oil for tax purposes.

Since oil is a very valuable commodity, there is a general mood of distrust between the buyer and seller. The buyer does not fully trust the seller to deliver the full amount of crude that was negotiated and is listed on the bills of lading. Conversely the seller does not trust that the buyer will give a true accounting of the amount of crude that the buyer receives from the vessel. To further complicate the mix, neither the buyer nor the seller entirely trust the ship to deliver the full amount of crude oil that the seller has sold and the buyer has paid for.

It is entirely possible for the ship to withhold a few barrels upon discharge. A crude oil tanker can hold up to 3 million or more barrels of oil. If a vessel decided to keep 100 barrels of crude on board out of the 3 million gross quantity, this is a statistically a small amount but with the price of crude oil ranging between $50 and $70, it is a considerable sum. Vessels have been known to steal small moments of crude oil on every trip until they have a significant amount on board and then sell the oil for the vessel's benefit.
To moderate this climate of distrust an independent third-party is brought in to measure the amount of crude oil at every stage of the Charter party. These companies are known as surveyors. A Surveyors job is to measure the amount of crude oil that the buyer delivers on board the ship at the load port, and then to measure again once the vessel arrives at the buyer' discharge port (Brown, Graves & Ronen, 1987). The surveyors also measure the crude that is left on board the ship after it is finished discharging, to ensure that no significant amount of crude oil remains in the vessel. A fourth measurement is performed on the large crude oil tanks that hold the crude that is discharged from the ship. The measurement process that the surveyors perform is called an inspection. Each successive inspection acts as a check and balance for the inspection that took place immediately before it.

The bulk of the inspection fees are paid by the consignee i.e. the buyer. Inspection fees range anywhere in the amount of $8000 to $12,000 per inspection. However, if the same inspection company is used throughout the process then each subsequent inspection becomes less and less expensive. For example the first inspection done at the load port may cost $8000; the second inspection done when the ship arrives to the buyer is discharge facility may cost $5000. The third and fourth inspections may cost $3000 and $1500 respectively. Each inspection takes roughly 2 hours to perform.

The Elcrex refinery uses a four inspection method in its supply chain practice. This equates to $17500 in inspection fees and 8 hours of time per purchase of crude oil. Also it is important to note that while an inspection is being conducted the ship remains idle. Ship owners charge this idle time back to Elcrex in a fee that is known as demurrage (Brown, Graves & Ronen, 1987). The demurrage fee typically falls within the range of $1500 per hour. Demurrage fees account for approximately $12000 of cost in Elcrex's supply chain.

The supply-chain that Elcrex uses is similar to the supply-chain of other oil companies. The oil industry on a whole has standardized its system for the purchase and sale of crude oil. This is important for the industry since generally oil is not refined in the country where it is discovered. The nature of the oil industry demands that international trade is the norm rather than the exception. However the difference in the supply-chain between Elcrex and other oil companies is the way Elcrex performs its survey and inspection process, and this is the crux of the cost benefit analysis.

Currently Elcrex uses four inspections for the purchase of crude oil. However not all companies use a four inspection process. Two of the largest oil companies in the world are Exxon- Mobil and BP Amoco. Since these companies handle such huge quantities of oil, many times they use a two inspection process. Oil is measured at the load port and then measured after it has been discharged from the vessel into the crude oil storage tanks, there are no intermediate inspections. The advantage of this shortened inspection method is that larger volumes of oil can be handled more easily and quickly. Using a two inspection method is something that Elcrex can adopt into its business practices.

The cost benefit analysis of instituting a two inspection method as opposed to the four inspection method that is now in use at Elcrex is very straight forward. Instituting the two inspection method requires no addition of labor, hardware, or input resources. The new inspection method is a reduction of all costs and inputs associated with the current inspection method. Replacing the four inspection method with a two inspection method results in a steep reduction in the overall inspection costs.

The two inspection method represents a time saving as well since the two inspection method takes less time to perform than the four inspection method. This leads to a reduction of demurrage fees and also allows the company to handle more crude over a specific length of time. As a result the two inspection method has an added positive effect of increasing the capacity of the Elcrex refinery (Degaspari, 2003).

One of the ethical implications of using a two inspection method is that there is a potential for tax evasion. Elcrex like most oil refineries pays a per barrel tax for every barrel of crude oil that is brought into its facility. In the four inspection method the second inspection, typically the one that is done when the ship reaches the Elcrex facility, determines the amount of taxes that Elcrex pays on the crude oil it has just bought. A copy of this inspection report is forwarded to the government, and sometimes the government even participates in this second inspection just to ensure accuracy of the quantities that are being reported to it. The two inspection method eliminates this intermediate step and the local government has no opportunity to verify the figures that Elcrex reports in terms of crude oil. The local government is then forced to rely on the first inspection which takes place in Venezuela. However since Venezuela is a foreign country it is under no requirement to report truthfully to the local government the amount of crude oil that the refinery is buying. It would be possible for Elcrex to consistently under report the amount of crude oil that is being shipped from Venezuela into the Virgin Islands (Gramlich & Wheeler, 2003). This type of fraud would be difficult to spot and could continue unnoticed for years.

This is an ethical consideration for the company to consider before switching to the two inspection method. Will barrel figures be reported accurately to the local government, and will the appropriate taxes be paid on the true amount of true of oil that is being delivered into the Virgin Islands? Is it ethical to remove a method that is proven to safeguard against fraud and possible negative repercussions from the IRS as well as other governmental agencies and replace it with a more cost effective method that has the potential for misrepresentation of company information?

Conclusion

My recommendation is that Elcrex institute a two inspection method on a trial basis for one-year. During this is time I would recommend that an ethical review board, as well as an accounting oversight board be established to safeguard against any improprieties that may occur in terms of unreported taxes. I would recommend periodic surprise audits by an independent third-party that take place both abroad and in the Virgin Islands to ensure that the quality of oil accounting is sufficient to keep the refinery in good standing with the local government. As the refinery becomes more proficient in the two inspection method and learns to safeguard against any accounting irregularities, then I would suggest that the two inspection method be expanded to include a larger portion of the refinery's operational activities. I feel that the company can save money and at the same time be an ethical and upright corporate citizen with the two inspection method. The cost savings that the company will gain by instituting the two inspection method should be more than sufficient to discourage any misrepresentation of the barrel figures that the refinery actually brings into the Virgin Islands.

References

Brown G., Graves G., Ronen D. (1987) Scheduling Ocean Transportation
of crude Oil. Management Science Vol. 33.

DeGaspari J. ( 2003) More Gasoline From Crude. Mechanical
Engineering. Vol. 125, Issue 12.

Jefferey D., Wheeler J. (2003) How Chevron, Texaco, and the Indonesian
government structured transactions to avoid billions in U.S. income taxes.
Accounting Horizon. Vol.17, Iss. 2; pg. 107

Messer, T. (2001) Master's Handbook on Ship's Business. Cornell
Maritime Press.