Email

A Tale of Two Prices

by | published March 30th, 2012

A number of you have contacted me asking some variation of the same question.

How can the price of oil be declining, yet the price of gasoline remain so high?
Good observation.

At close of trade yesterday, the West Texas Intermediate (WTI) benchmark futures crude oil contract for the near out month in NYMEX trade had declined 2.6% for the week and 4% for the month.

However, the same contract for RBOB (Reformulated Blendstock for Oxygenate Blending) – the NYMEX gasoline futures standard – was up 1.6% for the week and 4.2% for the month.

Normally, we expect that movements in the crude oil price, as the single-largest component in oil product prices, would pretty much dictate where gasoline is headed.

And in normal circumstances, that is usually the case.

Welcome to the Unusual Pricing Case

The current gasoline phenomenon results from several factors:

  • Refinery capacity utilization;
  • The continuing outsized spread between WTI and Brent oil prices in London; and
  • The mix of increasing unconventional domestic oil flow (shale, heavy, tight oils produced in the U.S., synthetic oil from oil sands coming down from Canada); and

As to the last point, the unconventional production actually adds cost to the extraction-upgrading-processing sequence.

Put simply, while we are using more of this new “replacement oil” than we ever have (a good thing for those concerned about reliance on imports from abroad), its use is also adding to the price at the pump.

Of greater importance, however, is the second element: the WTI-Brent pricing environment.

We have talked about this spread on a number of previous occasions. Brent is again selling higher by about 20% to the price of WTI.

That’s important when factoring in the actual cost of the feeder stock for refineries.

While the WTI price has been going down (until this morning), Brent has been more subdued. In fact, the Brent price is down only 0.5% over the past month and is slightly higher (also about 0.5%) over the past week.

This year, the U.S. market is likely to be importing on average about 45% to 47% of what it needs on a daily basis. Only a few years ago, that market was dependent on imports for two-thirds of its requirements.

Additionally, American domestic daily production will be close to 10 million barrels, a level not seen since the mid-1990s. That is a result of the acceleration in unconventional extractions in places like the Bakken in North Dakota, the Monterey in California, and Eagle Ford in Texas, as well as for prospects for new basins like the Utica in eastern Ohio.

There’s another important question that needs to be asked at this point. If we are becoming less dependent on imports, and if we are receiving more local production, doesn’t that mean we could be less concerned about that WTI-Brent spread?

Not quite.

The Higher Brent Price is Still a Significant Factor

For one thing, using that spread (so long as Brent remains higher priced than WTI by double digits) contributes to the refinery margin.

That margin, by the way, refers to the difference between what it costs to produce and what price the resulting products could be sold for in the market; it’s where the refinery actually makes its profits.

For another, traders are active in what is called the “crack spread.”

This is the difference between future contract prices for crude oil and similar contracts for oil products such as gasoline (RBOB) and heating oil.

That means, even though nationwide we may be less reliant on imports than we were a few years ago, that higher Brent price still factors significantly in the determination of the gasoline price.

At the same time, the rising domestic sourcing contributes to the higher price, too, given the greater cost of the unconventional crude. This is also the case with imports from Canada, heavily based now on upgraded production from oil sands.

However, the factor of Canadian imports will be figuring more prominently in American pricing as we move forward, and that plays out differently. Currently, it has actually created a discounted oil glut in the Midwest because of dwindling pipeline capacity.

This has produced a kind of refinery equivalent to the downward pressure on crude oil prices resulting from the storage surplus in Cushing, Okla.

This is good if you live close to the refineries that benefit from the glut in the Midwest… but not so good if it is translated into the wider national picture.

See, evening out the flow of Canadian crude that costs more to process will tend to increase the average retail price further down the line. A preliminary study recently concluded that completion of the controversial Keystone XL pipeline would result in about a 4- to 6-cent rise per gallon in gasoline prices overall.

We need to distinguish between the national security argument (greater reliance on domestic production) and price. They do not move in the same direction. The essential reason we became more dependent upon imports, until recently, was the cost. Foreign production was cheaper to buy.

However, if a whole range of issues are moving up the international price (i.e., the Brent price) abroad, concerns over the higher cost of domestic production decline.

The international nature of that market, however, means we cannot avoid its impact at home altogether.

And that point is driven home by the current disconnect between oil and gasoline prices.

Sincerely,

Kent

Please Note: Kent cannot respond to your comments and questions directly. But he can address them in future alerts... so keep an eye on your inbox. If you have a question about your subscription, please email us directly at customerservice@oilandenergyinvestor.com

  1. March 30th, 2012 at 15:32 | #1

    KENT–ALL MY ENGERY STOCKS ARE TAKING HITS WHILE THE PRICE OF
    OIL IS GOING UP. WHEN DO YOU EXPECT A RECOVERY IN SHARE PRICES?
    RIGHT NOW MY INVESTMENTS IN COMPANIES LIKE CHK,HAL,MMLP, ETC
    ARE ALL BELOW YOUR BUY IN PRICE RANGE OF SEVERAL MONTHS AGO.

    RON KIRKPATRICK

  2. Dom Brunone
    March 30th, 2012 at 16:02 | #2

    I spent thirty yeaar in the oil business. However, after reading your article on a Tale of Two Prices, I am still confused on how the WTI/Brent spread works its way into US nationwide gasoline prices.

    How much would you estimate that it takes to transport a gallon of gasoline from Baton Rouge to Newark, NJ?

  3. Jerome Rickert
    March 30th, 2012 at 17:26 | #3

    I question more the price difference between RBOB and the pump.

    During the first $4 Gas the difference was 60 to 70 cents. Now it’s a dollar or more. Why????

    Jerry

  4. Dale Rush
    March 30th, 2012 at 17:34 | #4

    Changing the subject back to natural gas, the US imports nearly all the nitrogen fertilizer used in agriculture and that N all starts as natural gas. With the price of gas so low, are we going to see a return to domestic production of ammonia and other nitrogen fertilizer products? If so by whom?
    Thanks
    Dale Rush

  5. Ron Martin
    March 30th, 2012 at 18:29 | #5

    Let’s try this question again. Are you still predicting $150/barrel oil by September??

  6. eric taylor
    March 31st, 2012 at 01:29 | #6

    Exxon Mobile is closing an east coast refinery, because making just
    one half a penny per gallon of gas simply is not good enough. Perhaps
    the Republican’s that sabotaged Obama’s closing big oils loopholes
    will come back for reconsideration? Bohner growled hell no we wont
    close the loopholes on big oil, after meeting with the executives
    pulling his strings. He previously thought closing the oil loopholes
    a good idea, but the executives and his fellow politicians believed
    it would raise the cost of oil, and it would be a tax increase.
    The invisible hand of free market economics is piling on the debt!

  7. enthusceptic
    April 1st, 2012 at 12:06 | #7

    Now I’m going to be presumtuous and offer advice to you gurus:
    1. Please don’t insult our intelligence and waste our time by repeating endlessly, at the end only showing your excellent – past – performance, giving us nothing except for a sales spiel at the end. Recently the Motley Fool talked about 3 stocks, giving us one for free. I promptly subscribed!
    2. When you steer us to page 2, it’s not necessary to repeat the whole intro, the first sentence or paragraph will suffice just nicely, thank you very much. Try reading a newspaper…
    3. There is a lot to be said about CNBC and other talking head outlets, but one thing they know at CNBC is: They try not to make or brains capsize with big numbers or decimals. We will find the complete numbers whe we get interested in a country, sector or company.
    Your advice is excellent, don’t cheapen it by bad presentation.
    That was all, thank you for your patience!

  8. enthusceptic
    April 1st, 2012 at 12:21 | #8

    For a change my broken record where all the songs are about how much millions of people can save by powering light road vehicles with NG will rest. Ok, that was the first song, but I have a request: An overview of what oil and NG can be used for, and especially the difference between the two.

  9. enthusceptic
    April 1st, 2012 at 12:41 | #9

    Eric – I use your first name because we are both always here, hopefully making sense once in a while – isn’t the invisible hand supposed to do the opposite of what you are indicating?
    Government has to regulate, but politicaians, often in collusion with big corporations who don’t want competition, hinder the free market.

  10. Eustus Nelson
    April 1st, 2012 at 14:10 | #10

    Kent,
    Do you know anything about the “10-86 plan” as it relates a loophole instituted by President Ronald
    Reagan; where the public benifits financially by purchasing shares of pipelines dedicated for the transportation of gasoline? Please comment on how one can avail oneself of these opportunities.

  11. eric taylor
    April 1st, 2012 at 15:50 | #11

    It’s not ironic that you make me sound sarcastic in reference to
    crony capitalistic application of free market economics. Perhaps,
    that’s why they don’t believe in rules and regulations?

  1. No trackbacks yet.