Oil prices in the U.S. can vary substantially. Prices can change quite a bit within the same state. Much of the value of a barrel of crude is determined by its type or makeup. Crude type isn’t the focus of this article, but it’s worth reviewing.
Light-Sweet crude is generally the best. Heavy crudes like those produced in Venezuela or Utah require more complicated refining processes. For that reason, heavy crude is worth less. Condensates, very light crudes, or even natural gasoline trade at a discount to your typical light-sweet crude. “Sweet” means the crude has a low sulfur content. Begin producing sulfur and the value of the crude goes down. WTI is a light-sweet crude and is likely what you see reported in the news. It’s considered the benchmark in the U.S. Almost all crude oil traded in the U.S. is priced at a discount or premium to WTI.
Now, on to logistics. There’s a factor that can have significant influence on the price of crude and it has more to do with Fedex than a geology (maybe Fedex doesn’t move much crude, but you’ll get the picture). Transportation and the ability for crude to make it to refineries is essential. In the U.S., most of the country’s refinery demand is in the Gulf Coast. Even then, not every refinery is created equal. While WTI might be the preferred crude type, a refinery might be set up to handle heavier crudes (low API gravity) and taking a light-sweet crude might be inefficient. For that reason, a refiner might pay less for WTI than it would otherwise. The important take away is: if the crude can’t get to market, it is not worth much.
Growing U.S. Oil Production Puts a Strain on Infrastructure
U.S. oil production is growing. Growing at rates that have analysts touting the potential of the U.S. being the world’s largest crude producer. That’s amazing when you consider what the same analysts have been saying a few years. Most were singing a tune similar to that of peak oil theorist.
It’s like most good things. There are obstacles. Production growth means new infrastructure is needed. Oil companies need ample transportation capacity to move product to market
Typically, oil is transported by:
- Pipeline (Cheapest)
- Truck (Most Expensive)
When there is a shortage of pipeline capacity, operators will move crude by rail to the various refinery centers in the U.S. Trucks are used for shorter distances. Moving oil from North Dakota to Louisiana by truck simply doesn’t make economic sense. When you don’t have reasonable pipeline, rail, or truck options, prices get ugly.
Oil Prices Vary Widely
In 2012 alone, WTI, which is priced in Cushing, OK, has traded at as much as $25 less than Brent crude. Brent is a comparable crude, but is priced outside the U.S. It’s an interesting discrepancy. Almost 25% of the world’s crude is consumed in the U.S., but the benchmark crude in Cushing, OK, is tens of dollars cheaper than international equivalents. If that doesn’t tell you we’re in the middle of a U.S. oil boom, I don’t know what will.
Let’s go back to what I said earlier. Most U.S. crude is priced a some premium or discount to WTI. If the crude needs to travel through Cushing, you can bet it’s going to trade at a discount. How big can the discount be? In November of 2012, oil prices in the Permian Basin (West Texas) were trading at a discount of more than $20 to WTI. At several points during 2012, oil in North Dakota’s Bakken Shale traded at discounts that large. That means crude in West Texas and North Dakota sometimes sells for as much as $40 less than similar crude oil in Europe or even closer to home – Louisiana.
If you are tracking your royalty payments (you should be), $40 is likely more than you were getting for the whole barrel ten years ago.
We suggest tracking prices just to make sure you catch any potential problems. You can track oil prices in several places, but Plains All American Pipeline has an easy to download pricing bulletin that is published every day. Check it ever so often to see if your royalty checks are similar. It’s worth noting, Plains is quoting physical prices, so it’s very likely your operator will be realizing better prices. With significant volumes, operators make term commitments on pipelines and realize prices better than physical spot prices.
Oil pricing dynamics are not the topic of discussion at most homes, but don’t fret. Use the sources quoted above and do spot checks a few times a year (at a minimum). At the end of the day, it’s in everyone’s best interests to see oil pricing discounts shrink. The big discounts we see today will shrink, but it’s going to take time. Bring on the pipelines!