Fuel Focus, May 2, 2014

Rise in U.S. Gasoline Prices due to Typical Seasonal Factors

According to the U.S. Energy Information Administration (EIA), the recent gasoline price increase is mostly the result of an increase in crack spreads (the difference between the price of wholesale gasoline and the price of crude oil) attributable to typical seasonal factors such as refinery maintenance and higher travel-related demand as the driving season begins. In 2014, the average crack spread during the first four months of the year has been close to the five-year average.

Changes in the price of retail gasoline result from changes in both the price of crude oil and wholesale gasoline crack spreads. Crude oil prices do not display a seasonal pattern. Crack spreads for gasoline, however, are very seasonal.

This post-February increase is largely related to typical seasonal factors such as refinery maintenance, increasing demand from driving, and the switch to summer-grade gasoline, which is more costly to produce than winter-grade gasoline. Crack spreads then typically decline as those factors moderate, reaching the low point for the year during the fourth quarter.

Canada’s Proven Oil Reserves

Canada's proven oil reserves are sufficient to meet demand for around 140 years at current rates of production. Proven oil reserves (also called proved reserves, established reserves, or simply reserves) are defined as the amount of oil that can be recovered from known reservoirs under current technology and present economic conditions. Oil reserves are specifically proven by drilling, testing or production. Undiscovered resources are estimates of oil volumes in the subsurface which are thought to exist, based on geological information, but have yet to be proven as reserves by drilling, testing and production.

Canada's oil reserves consist of oil contained in the oil sands deposits of Alberta and in other non-oil sands deposits. Most of Canada's oil reserves – both oil sands and non-oil sands – are found in the Western Canadian Sedimentary Basin, which underlies parts of British Columbia, Alberta, Saskatchewan, Manitoba and the Northwest Territories.

Total Canadian proven oil reserves are estimated at 27.5 billion m3 (173 billion barrels), of which 26.1 billion m3 (168 billion barrels) are found in Alberta's oil sands and an additional 0.8 billion m3 (5 billion barrels) in conventional, offshore and tight oil formations. East coast offshore conventional oil reserves are currently estimated at 0.2 billion m3 (1.5 billion barrels), while Alberta's conventional and tight oil reserves are estimated at 0.3 billion m3 (1.7 billion barrels).

Changing North American Crude Oil Price Dynamics

For both Canada and the U.S., refinery oil demand is met by a combination of domestic production and imports. Canada is a net oil exporter, and the U.S. a net oil importer. For many years, Canadian crude oil – both light crude and heavy crude – has been exported to the U.S. midcontinent, almost entirely by pipeline. Both Canada and the U.S. import crude from outside North America by tanker at receiving terminals and refineries along the Canadian and U.S. east coasts, and in the U.S. Gulf Coast.

Crude oil of various reference grades is sold in various reference markets. These prices always have both oil quality and geographic components. Light oil is worth more than heavy oil, and any oil is worth more in an area of high oil demand than it is worth in an area of high oil supply. In this article, we will refer to the following reference oil markers: i) Edmonton Par – the price of light crude oil at Edmonton, Alberta; ii) West Texas Intermediate (WTI) – the price of light crude oil at Cushing, Oklahoma; and, iii) Brent – the price of light crude oil at the Sullom Voe marine terminal, UK.

Situation Prior to 2011 - Until recently, crude oil supply to the Cushing, Oklahoma area was insufficient to satisfy Cushing area oil demand. To meet Cushing demand, light oil was imported by tanker to the U.S. Gulf Coast, and flowed northward by pipeline to Cushing. Cushing is the price settlement point for the WTI NYMEX futures contract, the benchmark light crude oil price for the U.S. Until recently, the marginal supply for the Cushing market was light crude oil imported by tanker to the Gulf Coast, and moved north by pipeline. The cost of the marginal supply was equal to the Brent oil price plus transportation costs by tanker and pipeline to Cushing, or “Brent plus”.

Edmonton Par prices prior to 2011 were typically about equal to Brent prices. This reflected the fact that, to penetrate into the Cushing market, Canadian suppliers who delivered oil to Cushing received the WTI price. However, to access the Cushing market meant paying pipeline tolls to move oil from Edmonton to Cushing. Thus, Canadian producer light oil sale revenues, “netted back to Edmonton” were “WTI minus”.

New Oil Flow Patterns - The North American oil supply picture has changed significantly over the past decade. The surge in unconventional oil production (oil sands in Canada and tight light oil in the U.S.) has flooded the Cushing market with new supply. Due to inadequate pipeline capacity to bring this oil to other markets, there has been an increase in oil shipments by rail, to Gulf coast and east coast refiners, as well as to Cushing. With Cushing being oversupplied by continental U.S. and Canadian crude oil production, flows of Brent type crudes from the Gulf Coast north to Cushing by pipeline are no longer necessary. Cushing has become more of a supply point (oil flows out of Cushing), whereas before it was mainly a market point (oil flowed in to Cushing).

This reflects the new dynamic of an oversupplied continental Canada/U.S. oil market which is seeking to deliver excess crude oil to tidewater. Now, as a supply point, the price of oil at Cushing is now driven by the price of oil at the nearest market point, less the cost to ship oil to that point. Thus, the Cushing price is no longer “Brent plus” but is “Brent minus”. Cushing has gone from a location which receives oil, to a location which ships out oil. In 2013, WTI prices averaged $97.99/bbl and Brent averaged $108.72/bbl.

Edmonton Par continues to be WTI minus. However, because WTI is no longer Brent plus but is Brent minus, this also means that Edmonton Par prices are typically lower than Brent prices. In 2013, Edmonton Par prices averaged $90.23 - $18.49 per barrel lower than Brent. The oversupplied North American oil market has resulted in new oil pricing dynamics. The WTI price now trades at a discount to the Brent price. Edmonton Par trades at a discount to WTI – it typically did for many years – but now Edmonton Par is also lower than Brent.

Relationship of Crude Prices to Transportation Costs - WTI and Edmonton Par prices can be expected to trend towards Brent prices less the transportation costs to tidewater. Since pipeline tolls from Edmonton to tidewater in Burnaby, British Columbia and from Cushing to the U.S. Gulf Coast are in the $3 per barrel range, so long as pipeline capacity at this price is available, one could expect Edmonton Par and WTI prices to be close to Brent prices. However, in 2013, Edmonton Par and WTI prices were $18.49 and $10.73 per barrel lower than Brent, respectively. This was due to insufficient pipeline capacity from Edmonton to tidewater, and from Cushing to tidewater. As a result, shippers are forced to use more expensive rail transport to move oil from these locations to tidewater. This means the prices of Edmonton Par and WTI have been steeply discounted versus Brent. As pipeline capacity is added, these discounts can be expected to narrow. Our analysis has reached similar conclusions as a recent article published by Dr. Andrew Leach of the University of Alberta. Dr. Leach also observed the shift in crude oil flows and concluded that even as transportation obstacles are addressed, the dynamic of increasing North American oil production and subsequent discounts for midcontinent crudes to Brent will remain.

Conclusions - Flows of imported light crude, delivered to North America by tanker, are becoming less and less necessary. Oil is expected to continue to flow from Cushing to tidewater, replacing imported oil in the Gulf Coast market. North American crudes are replacing imports at refinery markets along the U.S. and Canadian east coast as well, and this trend is expected to continue. These flow dynamics – North America evolving from a large oil importer towards being self-sufficient or even potentially a net exporter - mean that North American crude oil prices are likely to remain somewhat lower than global prices for crudes of similar quality. This is expected to be the case even if construction of additional pipeline or rail capacity to tidewater is achieved.