Back in February, I wrote a post called Why are WTI and Brent Prices so Different? In it, I talked about a number of issues, including pipeline issues, contributing to the differential between Brent oil prices (high) and West Texas Intermediate oil prices (low).
Recently, I have had some additional insights into what is happening that I would like to share with others. These include:
1. The WTI / Brent oil price differential has, in fact, led to lower prices on oil products in the United States than the rest of the world, and has helped (at least a little) to keep the United States out of recession.
2. As a corollary to (1), if we can fix the WTI/Brent price differential, it will mean, at least initially, higher prices for oil products for US consumers. It may also cause the US to slide into recession, lowering oil prices for both WTI and Brent.
3. The situation giving rise to the WTI/price differential may be more complex than just lack of pipelines. Part of the issue may be limited refinery capacity to handle the heavier, sourer oils (even though, ironically, neither WTI nor Brent is heavy or sour). If this is the case, even if the WTI /Brent price differential is fixed, heavy sour grades may still trade at a big discount to light sweet grades, so the problem may be transformed to a new problem, not eliminated.
In this post, I will explain these observations.
What is happening to Brent and WTI prices?
The first question we might ask is, “Is Brent price high, or is WTI price low, or is it a combination?” To look at this, I compared both prices to the world average oil price, as calculated by the US Energy Information Administration.
Figure 1. Comparison of WTI, Brent, and world average oil prices, based on EIA data.
The answer seems to be primarily that WTI has fallen relative to world oil prices. Figure 1 shows that during 2010, both WTI and Brent prices tended to be a little higher than the world average oil price. Starting shortly after the beginning of 2011, Brent rose a bit relative to the world oil price–about .60 per barrel higher relative to the world oil price, while WTI dropped below the world average oil price. On average, WTI has averaged .75 lower than would be expected during 2011, based on 2010 relativities and the average world oil price.
To see if the lower WTI prices were actually translating to lower prices for refiners, I compared “refiners acquisition cost” to Brent and WTI oil prices, as shown in Figure 2.
Figure 2. Average refiners acquisition cost, Brent oil price, and WTI oil price, based on EIA data.
My conclusion was that refiners acquisition costs in 2011 have been fairly significantly lower than expected based on 2010 relationships. The amount of the difference between the actual average refiners cost and the expected average costs varies by month, from about to , averaging about or lower for the 9 month period, meaning that the average refiners cost of 0 during January to September, might have been 6 or 7, without the recent pricing shift. I checked to see if average heaviness or sourness was changing in a way that might explain this change, and it was not (even though we are importing somewhat more crude from Canada).
Are gasoline prices following the lower crude oil prices?
I next reviewed the relationship between refiners’ acquisition cost and retail gasoline prices, to see whether the relatively lower prices refiners were paying were being translated into lower gasoline prices:
Figure 3. Relationship between average retail gasoline price and refiners acquisition costs, based on EIA data.
My conclusion from Figure 3 was that savings in refiners acquisition cost have (more or less) been passed through to customers. This is too rough a comparison to say anything very precise, but suggests that high refining margins that have been reported in the Midwest are being balanced out by lower margins elsewhere.
On average, we seem to be paying a lower price at the pump than we would be without the lower cost refinery inputs that we are getting, because of the high WTI/Brent differential. In a world where high-cost gasoline and diesel tends to lead to recession, having lower fuel prices (about 20 to 25 cents lower per gallon) is no doubt helpful to the consumer. It may help explain why the US is not in not seeing as great recessionary influences as Europe.
The United States’ relatively low-cost structure in 2011 may also help explain why the US has become a net exporter of petroleum products this year, as shown in Figure 4.
Figure 4. Net imports of petroleum products. (Graph created by EIA.)
I was surprised to discover that we now even export gasoline. In recent years, we have imported gasoline from Europe and elsewhere. Our exported oil products recently have helped our balance of trade problem.
Another reason that we export petroleum products is because the amount of petroleum products the US makes (including blended-in ethanol) continues to rise each year, as shown in Figure 5, while our own consumption has leveled off or is declining.
Figure 5. Products made by US refineries, including biofuels blended in afterwards. (Graph by EIA.)
Will reversing a pipeline from Cushing to the Gulf fix the WTI/Brent differential?
There are two new pipeline plans that have been announced recently. One is that the Seaway Pipeline, that currently flows northward from the Gulf to Cushing, will be reversed, to flow southward from Cushing to the Gulf, starting the second quarter of 2012. Another is that the segment of the Keystone XL pipeline from Cushing to the Gulf will be built, possibly starting as soon as January 2012, even though rest of the route will not be built at this time.
It is not clear to me that either or both of these pipeline changes will fix the refining problems currently being encountered. One issue I see is that the Gulf Coast refineries are almost as full right now as the Midwest refineries. For the year 2010, the average refinery utilization percentage for the Gulf Coast (PADD 3) was 88.6%, compared to that of Midwest (PADD 2), at 88.7%. For 2011 through August, the Gulf Coast is averaging 88.3%, while the Midwest is averaging 90.4%.
I can think of a couple of reasons why Midwest and Gulf Coast refinery utilization rates may already be quite high:
(1) Demand for oil products is relatively high in the Midwest and South, compared to the East and West Coasts, and oil is being refined as close to its desired end location as possible, and
(2) The Midwest and Gulf Coasts seem to have a disproportionate share of ”complex” refineries that can handle heavy, sour crude, and these types of refineries seem to be more in demand.
Since Gulf Coast refineries are already close to maximum capacity, it is not clear that bringing oil from the North will add much to the quantity of oil being refined by the US. It would seem almost as likely that the pipeline reversal will result in oil from the North replacing oil shipped in from overseas, if the oil from the North is less expensive. Thus, adding southbound pipeline capacity may lead to a new pricing conflict–between the oil coming from the North, and the oil that was previously being refined on the Gulf Coast.
The place where the extra oil needs to end up is where there truly is capacity to refine it. In the US, the East Coast (PADD 1) is one such place where capacity is available. Theoretically, some imports could be diverted from the Gulf Coast to East Coast refiners, but that only will work if East Coast refiners have capacity to refine the particular type of oil being shipped. And if East Coast demand is for finished products is low, the newly refined oil may need to be shipped back to the Midwest/South, rather being added to East Coast supplies.
One thing that is unclear to me is whether there is a worldwide shortage of the more complex refineries, as more heavy, sour crude is extracted. If there is such a shortage, prices for crude oils needing complex refineries may fall. In such a situation, a pipeline reversal is likely to even-out the differential between Brent and WTI crude oil, but will replace it with a higher differential between oil that can use simple refineries and oil that requires more complex refineries. If this happens, bitumen from Canada may not be any better off, in terms of actual price, once pipelines are reversed and new pipelines added, because of a new larger light-sweet/heavy-sour differential.
A reason why complex refineries might be in short supply is because investors are unlikely to be willing to invest in such refineries in countries which either have “cap-and-trade” and “carbon pricing,” or are considering such pricing, since such pricing makes processing in these countries more expensive than elsewhere. If there are new complex refineries, they would seem likely to be concentrated in poorer countries, with less stringent emissions requirements and with a certainty of no carbon pricing. In fact, this seems to be what is happening, according to Figure 6, below, from ENI World Oil and Gas Review.
Figure 6. ENI refinery complexity chart
If more complex capacity is available elsewhere in the world, but not in the United States, the likely outcome of a pipeline reversal would be that some of the oil we are now importing would instead go to complex refineries in poorer countries in the Asia-Pacific region, and ultimately be used there.
Relationship to current US fuel problems
When we look at recent EIA graphs, we see rapidly dropping stocks of distillate fuel (diesel), shown in Figure 7, below.
Figure 7. EIA graph showing Total Distillate Fuel Stocks (Diesel + Heating Oil), as of November 16, 2011.
The problem is especially severe in PADD 2 (Midwest), shown in Figure 8.
Figure 8. PADD 2 (Midwest) Distillate Fuel Stocks
We also read stories about diesel shortages in North Dakota (a state in the Midwest), such as: Diesel fuel shortage is one of worst.
Somehow, it seems a little ironic that we are talking about turning around pipelines to send more oil south to the Gulf Coast, when oil product shortages are occurring in the Midwest. When we turn around pipelines, we may end up operating Midwest oil refineries less full, adding to our lack of distillate in the Midwest, unless more refined oil products are pumped back up to the Midwest after they are created elsewhere.
Furthermore, the problem is not inadequate production of distillate fuel. What the US is doing is making a lot of distillate fuel, and exporting a growing share of it. What we really need is higher US distillate fuel prices, if we are to compete in the world distillate market.
The situation with gasoline is not quite as severe, but is similar. Inventories are also lower in total, as shown on Figure 9, below:
Figure 9. EIA graph of total US gasoline stocks, as of November 16, 2011.
PADD 2 (Midwest) again shows more of a recent downturn in inventories than the US total, as illustrated in Figure 10, below.
Figure 10. EIA graph of PADD 2 Motor Gasoline Stocks, as of November 16, 2011.
In order to keep more distillate and gasoline fuel in the US, what the US really needs is higher diesel and gasoline prices. Of course, at a higher prices, these products will be less affordable, so demand will fall as well, and the country may enter recession again. With the level of our salaries, and the number of people laid off from work, we really cannot afford higher diesel and gasoline prices, but those higher prices are what are needed, if we are to successfully compete in the world market.
It is possible that a new equilibrium will be reached, where prices for gasoline and diesel are high enough to permit refiners to pay higher prices for crude oil. So maybe this is the direction from which the WTI/Brent gap will be overcome. But if recession occurs as a result, both WTI and Brent prices may fall in response to recession, so that new WTI/Brent equilibrium will be lower.
Any change, including pipeline changes, has indirect impacts as well as direct impacts. These indirect impacts can be more important than the direct impacts, but it is difficult to know precisely what they will be.
Source: Our Finite World
