Best of the Week
Most Popular
1. Stock Markets and the History Chart of the End of the World (With Presidential Cycles) - 28th Aug 20
2.Google, Apple, Amazon, Facebook... AI Tech Stocks Buying Levels and Valuations Q3 2020 - 31st Aug 20
3.The Inflation Mega-trend is Going Hyper! - 11th Sep 20
4.Is this the End of Capitalism? - 13th Sep 20
5.What's Driving Gold, Silver and What's Next? - 3rd Sep 20
6.QE4EVER! - 9th Sep 20
7.Gold Price Trend Forecast Analysis - Part1 - 7th Sep 20
8.The Fed May “Cause” The Next Stock Market Crash - 3rd Sep 20
9.Bitcoin Price Crash - You Will be Suprised What Happens Next - 7th Sep 20
10.NVIDIA Stock Price Soars on RTX 3000 Cornering the GPU Market for next 2 years! - 3rd Sep 20
Last 7 days
Eiro-group Review –The power of trading education - 4th Dec 20
Early Investors set to win big as FDA fast-tracks this ancient medicine - 3rd Dec 20
New PC System Switch On, Where's Windows 10 Licence Key? Overclockers UK OEM Review (5) - 3rd Dec 20
Poundland Budget Christmas Decorations Shopping 2020 to Beat the Corona Economic Depression - 3rd Dec 20
What is the right type of insurance for you, and how do you find it? - 3rd Dec 20
What Are the 3 Stocks That Will Benefit from Covid-19? - 3rd Dec 20
Gold & the USDX: Correlations - 2nd Dec 20
How An Ancient Medicine Is Taking On The $16 Trillion Pharmaceutical Industry - 2nd Dec 20
Amazon Black Friday vs Prime Day vs Cyber Monday, Which are Real or Fake Sales - 1st Dec 20
The No.1 Biotech Stock for 2021 - 1st Dec 20
Stocks Bears Last Chance Before Market Rally To SPX 4200 In 2021 - 1st Dec 20
Globalists Poised for a “Great Reset” – Any Role for Gold? - 1st Dec 20
How to Get FREE REAL Christmas Tree 2020! Easy DIY Money Saving - 1st Dec 20
The Truth About “6G” - 30th Nov 20
Ancient Aztec Secret Could Lead To A $6.9 Billion Biotech Breakthrough - 30th Nov 20
AMD Ryzen Zen 3 NO UK MSRP Stock - 5600x, 5800x, 5900x 5950x Selling at DOUBLE FAKE MSRP Prices - 29th Nov 20
Stock Market Short-term Decision Time - 29th Nov 20
Look at These 2 Big Warning Signs for the U.S. Economy - 29th Nov 20
Dow Stock Market Short-term and Long-term Trend Analysis - 28th Nov 20
How To Spot The End Of An Excess Market Trend Phase – Part II - 28th Nov 20
BLOCKCHAIN INVESTMENT PRIMER - 28th Nov 20
The Gold Stocks Correction is Maturing - 28th Nov 20
Biden and Yellen Pushed Gold Price Down to $1,800 - 28th Nov 20
Sheffield Christmas Lights 2020 - Peace Gardens vs 2019 and 2018 - 28th Nov 20
MUST WATCH Before You Waste Money on Buying A New PC Computer System - 27th Nov 20
Gold: Insurance for Prudent Investors, Precious Metals Reduce Risk & Preserve Wealth - 27th Nov 20
How To Spot The End Of An Excess Market Trend Phase - 27th Nov 20
Snow Falling Effect Christmas Lights Outdoor Projector Amazon Review - 27th Nov 20
4 Reasons Why You Shouldn't Put off Your Roof Repairs - 27th Nov 20
Further Clues Reveal Gold’s Weakness - 26th Nov 20
Fun Things to Do this Christmas - 26th Nov 20
Industries that Require Secure Messaging Apps - 26th Nov 20
Dow Stock Market Trend Analysis - 25th Nov 20
Amazon Black Friday Dell 32 Inch S3220DGF VA Curved Screen Gaming Monitor Bargain Deal! - 25th Nov 20
Biden the Silver Bull - 25th Nov 20
Inflation Warning to the Fed: Be Careful What You Wish For - 25th Nov 20
Financial Stocks Sector ETF Shows Unique Island Setup – What Next? - 25th Nov 20
Herd Immunity or Herd Insolvency: Which Will Affect Gold More? - 25th Nov 20
Stock Market SEASONAL TREND and ELECTION CYCLE - 24th Nov 20
Amazon Black Friday - Karcher K7 FC Pressure Washer Assembly and 1st Use - Is it Any Good? - 24th Nov 20
I Dislike Shallow People And Shallow Market Pullbacks - 24th Nov 20
Small Traders vs. Large Traders vs. Commercials: Who Is Right Most Often? - 24th Nov 20
10 Reasons You Should Trade With a Regulated Broker In UK - 24th Nov 20
Stock Market Elliott Wave Analysis - 23rd Nov 20
Evolution of the Fed - 23rd Nov 20
Gold and Silver Now and Then - A Comparison - 23rd Nov 20
Nasdaq NQ Has Stalled Above a 1.382 Fibonacci Expansion Range Three Times - 23rd Nov 20
Learn How To Trade Forex Successfully - 23rd Nov 20
Market 2020 vs 2016 and 2012 - 22nd Nov 20
Gold & Silver - Adapting Dynamic Learning Shows Possible Upside Price Rally - 22nd Nov 20
Stock Market Short-term Correction - 22nd Nov 20
Stock Market SPY/SPX Island Setups Warn Of A Potential Reversal In This Uptrend - 21st Nov 20
Why Budgies Make Great Pets for Kids - 21st Nov 20
How To Find The Best Dry Dog Food For Your Furry Best Friend?  - 21st Nov 20
The Key to a Successful LGBT Relationship is Matching by Preferences - 21st Nov 20
Stock Market Dow Long-term Trend Analysis - 20th Nov 20
Margin: How Stock Market Investors Are "Reaching for the Stars" - 20th Nov 20
World’s Largest Free-Trade Pact Inspiration for Global Economic Recovery - 20th Nov 20
Dating Sites Break all the Stereotypes About Distance - 20th Nov 20

Market Oracle FREE Newsletter

FIRST ACCESS to Nadeem Walayat’s Analysis and Trend Forecasts

Oil Price Differentials: Caught Between the Sands and the Pipelines

Commodities / Crude Oil Jun 20, 2012 - 01:04 PM GMT

By: Marin_Katusa

Commodities

Diamond Rated - Best Financial Markets Analysis ArticleMarin Katusa, Casey Research writes: One of oil's most important characteristics is its fungibility, which means that a barrel of refined oil from Texas is equivalent to one from Saudi Arabia or Nigeria or anywhere else in the world. The global oil machine is built upon this premise – tankers take oil wherever it is needed, and one country pays almost the same as the next for this valuable commodity.


Well, that's true aside from two factors that can render this equivalency void. In fact, crude oil prices range a fair bit according to the quality of the crude and the challenge of moving it from wellhead to refinery. Those factors are currently wreaking havoc on oil prices in North America: a range of oil qualities and a raft of infrastructure issues are creating record price differentials. And with no solution in sight, we think those differentials are here to stay.

The Parameters of Pricing

The first factor in oil pricing is quality. The best kind of crude is light and sweet: "light" means its hydrocarbon molecules average on the small side within the oil range; and "sweet" means it does not contain much sulfur. Light, sweet crudes are the easiest to refine into petroleum products, which makes them more desirable than heavy, sour crudes.

No two reservoirs produce identical oil, though reservoirs in the same region often produce similar crudes. For example, conventional oils from Texas are generally lighter and sweeter than the crudes that make up the European benchmark Brent blend; this is why West Texas Intermediate crude oil carried a premium over Brent crude for years. Similarly, Bonny Light oil from Nigeria is a bit heavier and sourer than Algeria's Saharan Blend and therefore receives a slight price discount.

But wait, you say – isn't Brent more expensive than WTI? Yes, today it is. This graph shows the two prices' movements over the last 25 years.

For most of the graph the prices track very closely, with the green WTI line sitting just above the black Brent line. Then, in the second half of 2010, the relationship starts to shift: WTI prices started to lose ground against Brent. The differential was only a dollar in November 2010, but by September 2011 Brent crude was worth US$27.31 or 32% more than WTI. The differential narrowed in December but has recently opened up again, with the spot price of Brent closing US$13.88 above that of WTI yesterday.

The characteristics of WTI and Brent crude oils did not change during 2010, so the pricing reversal must have stemmed from the other factor that impacts crude-oil prices: infrastructure. More specifically, WTI prices started to slide because of a lack of infrastructure.

North America's Fantastically Flawed System

North America has a long history of oil production and processing. Decades of producing oil and consuming lots of petroleum products have left the continent with a pretty good system of pipelines and refineries… but pipelines are annoyingly stagnant things that tend to stay where you build them. And it turns out that the pipelines of yesterday are in the wrong places to serve the oil fields and refineries of today.

America's oil infrastructure was built around two inputs – some domestic production and large volumes of imports. You see, while the Middle East may be the biggest producer of crude oil in the world, most of the refining occurs in the United States, Europe, and Asia. There are two reasons for this. The first is that it's easier to ship massive volumes of one product (crude oil) than smaller volumes of multiple products (gasoline, diesel, jet fuel, and so on). The second reason is that refineries are generally built within the regions they serve, so that each facility can be tailored to produce the right kinds and amounts of petroleum products for its customers.

During World War II, the US War Department (now the Department of Defense) divided the United States into five regions to facilitate oil allocation. The regions were called "Petroleum Administration for Defense Districts," or PADDs.

The United States is split into five oil districts to help with regional administration of a crucial asset. Thanks to the US EIA for the map.

Today, refineries in PADD I on the East Coast process oil shipped to the district's Atlantic ports from all over the world. Its refineries produce enough petroleum products to meet about one-third of regional demand; the rest comes from imports of refined products, primarily from the Gulf Coast but also from Europe. PADD V, on the West Coast, processes domestic oil from California and Alaska, as well as imported oil.

While the East- and West-Coast PADDs are not connected to the rest of the crude oil system, PADDs II, III, and IV have become very interdependent. PADD III, on the Gulf Coast, has more refining capacity than anywhere in the world and accounts for 45% of total US capacity, with 45 refineries processing more than 8 million barrels of oil per day from countries like Mexico and Venezuela as well as domestic sources. Refineries in the Midwest and California push the US's total refining capacity to 18 million barrels of oil a day.

While domestic production has always helped meet the US's oil needs, imported oil has long ruled the day. The US has relied on imported oil so heavily for so long that the country's oil infrastructure is built primarily around refining imported oil and then moving refined products – gasoline and diesel and the like – north, from the Gulf Coast to the Midwest, or inland, from refineries on the coasts to customers in the interior.

It was not, it is important to note, designed to move oil from the interior of the country to refineries. But that is what is needed today.

Oil's a-Flowing, But with Nowhere to Go

North American oil production is on the rise in a serious way, and there are two prime culprits: the Bakken shale and the oil sands.

The Bakken shale formation underlying North Dakota gets most of the credit for the resurgence in US domestic output, though some of the shales in Texas are also contributing notably. Production in the Bakken is so booming that North Dakota's crude output topped half a million barrels a day for the first time in November, up from just 300,000 bpd in 2010. The state is on track to surpass both California (539,000 bpd) and Alaska (555,000 bpd) this year to become the number-two oil-producing state in the United States.

Oil from the Bakken is generally mid-weight and fairly sweet. Ideally it should stay in the Midwest, because the refineries around Cushing are still designed to process light sweet oil. However, the other area where North American oil production is booming produces just the opposite. In fact, oil from the Canadian oil sands is so heavy that it has earned a distinct moniker: "bitumen." And there is a tsunami of bitumen on the way. The two million bpd being produced in the oil sands today is set to increase 50% in just the next three years.

However, Canada's oil sands are not the only place in the world producing heavy oil. In general, global production is gradually moving towards heavier, sourer crudes because the easy deposits of light, sweet crude are being tapped out. And that has forced refineries to evolve.

A refinery designed to handle light, sweet WTI crude cannot switch to heavy, sour oil sand bitumen without some serious upgrades. To that end, US refineries have invested billions in upgrades over the last decade to enable them to process heavy oil. The catch is, now the refinery army along the Gulf Coast needs heavy oil – just as they couldn't easily switch from light to heavy, they can't switch from heavy back to light.

The obvious source is the oil sands. It's a win-win: Oil-sands producers want to get their oil to suitable refineries, and the heavy oil refiners on the Gulf Coast want Canadian crude, because without access to bitumen they are being forced to pay a premium for to secure heavy oil supplies from Venezuela.

But that potential win-win is instead a losing predicament for all, because the pipelines to move that oil simply don't exist.

Remember how the US's oil pipelines were designed primarily to move refined products from the Gulf region and the coastal refineries to inland customers? Well, those pipelines of yesterday now run the wrong way. Today what North America's oil machine needs are pipelines running from the oil sands to the Gulf Coast. At the moment there is just enough capacity to get bitumen partway there – it gets to Cushing, the oil hub. And then it gets stuck.

This chart tells the story perfectly. The vast majority of Canada's bitumen is ending up in PADD II – in Cushing – where it simply sits in tanks because there is no heavy oil refining capacity in the Midwest, and there is very limited pipeline capacity to move oil south.

Cushing is overwhelmed. The storage tanks at Cushing are at record levels, housing no less than 46.7 million barrels of oil. The recent reversal of the Seaway pipeline is helping – Seaway used to move refined products north from the Gulf Coast but has now been flipped to carry oil south. It is currently moving some 150,000 barrels of oil a day; volumes are expected to rise through the year to reach 400,000 bpd by early 2013. The pipeline's owners would ideally like to twin the pipe, but regulatory proceedings for that project are not yet under way.

The much-debated Keystone XL pipeline will also help. While routing and approval for the northern section of the pipeline are still under debate, construction of the southern leg of the project, running from Cushing to the Gulf Coast, is set to begin this summer. It could be operational before the end of next year.

But even with Seaway reversed and Keystone XL's southern leg in place, the glut of oil at Cushing will continue to grow. Production from the oil sands and the Bakken is simply growing too quickly for infrastructure to keep up. And when oil becomes landlocked, it loses that key characteristic – fungibility – that helps make it so valuable.

North American Oil Differentials: Here to Stay

With so much supply landlocked, Canadian oil prices are taking a serious hit. The benchmark price for Canadian heavy oil is Western Canada Select (WCS), which is currently trading at just US$59.33 per barrel. By contrast, WTI is priced at US$82.70, which means the differential is a whopping US$23.37 per barrel, or 28% higher.

Even Canadian synthetic – a partially upgraded bitumen product that has historically carried a premium to WTI – is trading at a discount to its American peer: Canadian synthetic is at US$79.13 per barrel.

It's a double-whammy differential: Canadian oil is heavy, which discounts its price; and the system to move it to suitable refineries is clogged up, creating another discount. Neither of those situations is going to change any time soon, and that means oil-sands projects may soon be on the chopping block.

The oil sands is one of the costliest oil regions in the world to develop; and with WCS prices so low, the economics behind many new oil-sands projects have become pretty weak. New oil-sands mines require a price of around US$80 per barrel to break even. If an upgrader is part of the plans, that break-even price rises to almost US$100. In-situ projects, which use wells and underground steam injection to extract oil from the sands in place, usually carry a break-even price near US$60 per barrel.

But even with some projects postponed and others slowed, bitumen production is still expected to climb rapidly. Estimates range, but most observers agree that it is likely the oil sands will be producing close to 2.7 million barrels a day by 2016, up from 1.6 million bpd last year.

That kind of investment means that every time new pipeline and refining capacity is built, supply will catch up and the system will remain chockablock. And that means the differential between Canadian and US oil prices is settling in for a long stay. There are ways to benefit from this differential, but given the complexity of the situation, only informed investors will be able to take advantage.

You can't afford not to be an informed investor, as a new cold war – centered on valuable but dwindling energy resources – is heating up. Learn how to play it for maximum profit potential.

© 2012 Copyright Casey Research - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Comments

Greg
21 Jun 12, 23:27
Too Late. The Collapse in Oil Sands Happened.

This is all old news and hindsight. Casey has NO Wall Street experience. The guy is a gold pumper clown who missed the collapse. These guys are a marketing and publishing copy like most of the rest.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules