Making sense of crude oil supplies, prices
There's an old oilman's saying: "It ain't just a matter of how much crude ya' got, it's how 'refined' your crude is."
This saying has always had good meaning, but not as much as it has over the last week regarding oil prices. Two weeks ago when things calmed down in Egypt, the commentators were saying that we are awash in oil and the price should plummet. Their comments need to be broken down into two parts. First, is the world awash in oil? And second, should that, if true, cause prices to plummet?
There is a big difference between being awash in oil and storage being full. Yes, there are now rumblings about the lack of storage in Cushing, Okla., and concerns that capacity will be reached soon. That is a fact. We are awash in oil, for storage purposes. And should ample supplies of oil in storage cause prices to decline? Yes, to a certain extent. But you also need to look at overall demand, which has been increasing.
Before the global recession the world consumed on average 86.2 million barrels per day. At the depth of the recession, it fell to 84.4 million barrels per day. In the "recovery" phase the world consumption in Q4 of 2010 was 87.8 million barrels per day. Demand has increased.
China and India have developed and are adding to their strategic petroleum reserves. Both countries want to have at a minimum a 30-day supply of imported oil in storage. Other countries are starting to develop the same reserves, which will drive demand for oil even higher than before the global recession.
As a little humor, the same commentators who just knew oil was going down are now wondering just how high oil will rise. We understand it can be hard to keep up!
There are two key drivers in the current price of oil. First and foremost is the balance between supply and demand. A few weeks ago it appeared that a nice balance had been met, prices retreated a little and a relative plateau had been established. Egypt came unraveled, which gave a temporary scare to the market because it is a key transportation route for oil and oil-based products. Once a general direction of new control was established, oil came back down in price. Keep in mind most of the oil that is routed through Egypt is from the Saudi Arabia region, and Egypt is not a large producer of oil or natural gas.
Here is the rub and how understanding the difference between types of oil can help guide you in making decisions--or at minimum give you something to tell your friends about.
The headline price we normally are quoted is for WTI oil delivered to the Cushing, Okla., facility, which then gets delivered to refineries in the Midwest. WTI continues to be the favorite one reported by most media outlets. But is this an accurate price to use? In normal situations it works just fine. But there are some interesting things taking place globally that you need to be aware of.
WTI stands for West Texas Intermediate crude. Intermediate is the key word and refers to the weight and sulfur content of the oil. Low sulfur is sweet and high sulfur is sour. Removing sulfur requires specific equipment and costs extra to refine. WTI for the most part is high sulfur oil. Light sweet crude usually receives a premium due to its ease of refining. The U.S. does produce light sweet crude, commonly called Louisiana Light Sweet Crude, and it is the best in the world. It is harvested from the Gulf of Mexico and transported to mainland refineries. This grade of oil normally receives a premium to WTI; in October 2010 that premium was around $2 per barrel.
Today we see an imbalance starting to occur, not in the supply of crude oil but in the supply of a certain grade of crude oil. This imbalance is becoming a global issue with the happenings in Libya. Most refineries in Europe are designed to process light sweet crude. When heavier oil is delivered, it is blended with high-quality oil so the refineries can still process low-quality oil. Europe is fearful that any prolonged disruption in oil it purchases from Libya is not long lasting. As its storage of high-quality crude starts to dwindle it may have to close refineries that are incapable of processing more sour oil. Europe must also hope that Algeria remains a strong producer of light sweet crude; if not, it's not good for anyone.
Unfortunately, what might be happening in Europe might not stay in Europe. Another major producer of sweet crude is Nigeria, which is a large supplier to the United States. If Libya cannot supply Europe with the necessary oil and Algeria cannot pick up the slack, Europe is going to be on the phone with Nigeria to buy oil.
At the end of the day the U.S. might start having to compete with Europe for light sweet crude. The highest bidder for a tanker of oil will win the loyalties of the seller, at least until the next highest bid comes in.
As we mentioned earlier, the premium for Louisiana Light Sweet Crude was around $2 last October. Today, it's more around $15 per barrel. The price of this high-quality crude tracks more in line with Brent Crude, which is hitting up against $115 per barrel today. Due to the nature of the beast, until the Middle East conflicts start to calm down and supplies are certain of being delivered, prices should remain where they are today or higher.
With world events as they are today, we have now gone from worrying about the amount of oil we have to worrying about the type of oil we have. The media thought that Saudi Arabia increasing production would drive down prices. It might drive down the price of sour crude but it will do nothing to ease the supply side of light sweet crude. And you wouldn't know this unless you dug into how the type of crude can affect you.
We will keep you updated on the energy markets as things materialize.
Editor's note: Agvisors provides commentary about agricultural markets, including grain, dairy, livestock, equities, financials, and energy, highlighted by a live weekly webinar discussing conditions and responding to questions. For more information, visit http://agvisors.com.