Guest Post: Oil Price Differentials: Caught Between The Sands And The Pipelines

Tyler Durden's picture

Submitted by Marin Katusa of Casey Research

Oil Price Differentials: Caught Between The Sands And The Pipelines

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.

(Click on image to enlarge)

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.

(Click on image to enlarge)

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.

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Dr. Sandi's picture

As soon as I see "Oil Sands" in any story, my bullshit meter goes off.

Meep, meep MEEP!

Interesting details though. Too bad the "Oil Sands" meme has worked its way into the lexicon.

They will always be TAR SANDS to me. Probably because that's what they ARE!

sushi's picture

The Canadian TAR SANDS producers came to the decision that TAR SANDS lacked market appeal and the consumer would be so much happier if they knew they were burning oil sands. So they made a cosmetic switch but you are correct, it is still TAR SANDS.

The Canadian's have a habit of doing this. They created a new brand of cooking oil and called it CANOLA as they consumer was a little put off by the name of the source which was in fact RAPE.

Dr. Sandi's picture

Oh, so it's marketing appeal and not bullshit. I stand corrected.

Yet, somehow, rape and oil go together well.

Skateboarder's picture

Megadeth is a crappy band and Dave Mustaine is an idiot, but his lyric, "held hostage by oil for food," is no joke at all. Goddamn...

p.s. @ $3.95/gallon (whoo, it went below 4), it hurts to drive the skatemobile. It costs me $2 to drive to the skatepark or $1 to drive to a chill ledge spot. One way...

Prices seemed more tolerable when I was a kid and bus rides were a quarter. It's at least $2 and probably more now.

Coke and Hookers's picture

"Megadeth is a crappy band and Dave Mustaine is an idiot"

-1 for you, blasphemer.

Skateboarder's picture

I say that as a guitarist and fan of Megadeth's past music. You do agree that Rust in Peace and Countdown to Extinction are two of the best thrash albums to have been written, right? Mustaine has always been reliant on his partner guitarist, whether Friedman, Poland, Pitrelli, or Drover, to produce an album. They were the "lead" guitarists... He's got the ego of a blubbering anus though, and he gave money to Rick Santorum's campaign.

Coke and Hookers's picture

I agree on Rust and Countdown. Youthanasia wasn't too bad either. Unfortunately he's run out of creativity in recent years like his former buddies in Metallica. Maybe his ego prevents him from seeing it.

Regarding Santorum, didn't he backtrack on that and attribute the whole thing to a 'misunderstanding'?

Skateboarder's picture

Well, the fool found Christ somewhere along the way, and that flipflopped him from a Reagan-hater to a Reagan-lover and a supporter of lunatic politics.

I don't realy care about his take, but it helps the metal scene if you're pissed off about the government and writing fast, moshable licks about it. He's cleary no longer doing that.  Erik B and Rakim would be disappointed that their metallic cousins have lost their way...

Freddie's picture

Dave Matthews is a bigger idiot and a crappier band. 

Augustus's picture

How many rapes did it take to cause you to become so full of nonsense?

palmereldritch's picture

Maybe it was the Tar Sanduskis....

cougar_w's picture

I had to verify that last one ...

And it's absolutely true!

Another entry for my book of shadows. Like how "Patagonian toothfish" isn't called "chilean sea bass" until it gets to the supermarket.

LeisureSmith's picture

Same deal with the fish Escolar which somehow can be called anything from Cod to White Tuna...and if eaten can have some comic side effects, such as oil leaking from your crack. Not kidding.

Oleander's picture

Thank you sending  me on that goole search. Sounds like a great July 4th potluck dish. 

Rainman's picture

I got buses and trash trucks around here running on CNG ...hope I live to be old enough to see the oil cartel go poof. It's been the deadliest cartel of all time, cept for banking.

CrashisOptimistic's picture

You see them running, all right.  You see them running to the fuel station, often. 

sun tzu's picture

Then you can bitch about the CNG cartel when there is a shortage due to 100 million cars running on CNG

cougar_w's picture

US oil production? Shales? Don't make me laugh.

These hi-tech plays have a half-life of years measured in the single digits. By the time they solve this "problem" the problem will no longer exist but we will have spent $100B $300B pretending to be the world's biggest oil producer.

DaveyJones's picture

Like those pesky wars. Murders aside, not so sure the return on investment is quite what the broker sold.

Augustus's picture

Spending $100 B to produce $1,000 B in oil is a very good deal.

buzzsaw99's picture

eroi is a bitch bitchez. if natty wasn't so cheap tar and shale would be bigger losers than they already are.

Matt's picture

Because 80 percent efficiency is so much worse than 95 percent?

5:1 EROI is 80 percent. 20:1 is 95 percent. 40:1 is 97.5 percent. You see, once you convert it to a more standard form of measurement, it doesn't look nearly so bad, does it?

zorba THE GREEK's picture

I worked at a plant over 45 years ago where all the fork lifts ran on propane.

All the sales reps for the propane company drove cars that ran on propane.

One rep told me that the conversion kit to allow a car to use propane cost $75,

of course, that was 45 years ago.

earleflorida's picture

'of course, that was 45 years ago' ,... and taking away 9  years,... makes it 36 years since there was a refinery built in the United States.  *Dated __ May 9, 2005 

donsluck's picture

Forgive me, but I think you're confusing propane, which isn't abundant, with natural gas, which is (today) abundant.

Augustus's picture

Excuese me.

You should know that Propane is one of the Heavy components of NG production.  The strippers/fractionators remove the Pentane, Butane, and Propane, leaving the methane for the pipes to deliver to the burner tip. 

sun tzu's picture

How much would propane cast if 100 million cars ran on propane?

akak's picture

I wouldn't have a clue --- but I bet Ben Bernanke believes he would know the answer.

Central planners are omniscient, after all.   Aren't they?

ian807's picture

Oil fungibility is an economic delusion. To conflate a barrel of light sweet crude from Texas our Saudi with heavy sour from the Orinoco basin where the first has an EROEI of 25:1 and a marginal production cost of $40 a barrel while the latter has an EROEI of 5:1 and a margin cost of $90 a barrel is simply a denial of physical reality.

sushi's picture

simply a denial of physical reality


Welcome to Fort Macmurray!

ZeroPower's picture

Considering xy years down the line, barrels with an EROEI of only 2:1 will still be produced, i'd say that 5:1 looks pretty good (of course we're not talking about ME fields where the oil sits virtually above ground...)

buzzsaw99's picture

In fact, a detailed energy balance analysis sponsored by the Alberta Government for SAGD suggests that its EROI is close to 1:1. That makes bitumen a source of energy as pathetic and tragic as corn ethanol. A few SAGD projects have even recorded EROI in negative numbers...

cougar_w's picture

Given the obvious desperation of the majors to work these plays, and the similar desperation of elected officials to have an energy policy that doesn't involve bad news or anyone walking anywhere ever 4 evar, I'd assume that propaganda and outright lies are the order of the day, and  any work claiming an EROI under 5:1 is already probably 1:2 (or negative).

post turtle saver's picture

I'd assume that if hearsay, assertions, bad science, and innuendo were energy then ZH posters would be the top producers in the world EVER and our energy crisis would be officially over.

Someone please call me when the engineers are ready to speak. Not a one of you on this board knows what the hell you're talking about when it comes to energy production. No, not one. Not even me but at least I'm smart enough to know it and humble enough to admit it.

cougar_w's picture

Heh. That's basic science to you.

post turtle saver's picture

Everyone wishes it were that easy to figure out. It's not.


Flakmeister's picture

No, it is not simple... but it is less complicated than some people would have you believe...

There are some here who know the difference between kerogen and bitumen and how fracking is the last gasp of hydrocarbon man..... 

palmereldritch's picture

Yo! Propmeister!

How's the weather in Rio...warming?

Flakmeister's picture

Let me know when an El Nino starts frying your ass...

I figure that one will be along no later than 2013...

And I imagine you are still in the narcissist denial mode about most things...  

PS Any luck on the abiotic oil thingie? Did it work out for you?

Almost forgot...

2nd Hottest May globally going back to 1880... (2010 was tops)

April-2011 to May-2012  Warmest contiguous 12 months in the US (since records were started in 1895)

Like I said, just wait till we get an El Nino of the intensity we had in '98..... 

palmereldritch's picture

Not sure if you're a Cardinal or Bishop in the TCOPOAAGW (The Church of Peak Oil and Anthropogenic Global Warming)...can't vouch for the funny hat you wear to impress others... but here's a heretic you should be pursuing for EXCOMMUNICATION!!!

Leading Global Warming Advocate Recants! ... 'Models Fail Dramatically ...' Thursday, June 21, 2012 – by Staff Report

Globalists Switching Gears: Royal Society Lecturer Says CO2 Not Affecting Earth's Temperature ... Fritz Vahrenholt, a German green energy investor, says he has reassessed his position on man-made climate change...

...Part of Vahrenholt's ire is directed at the United Nation's Intergovernmental Panel on Climate Change (IPCC), which he has now concluded falsified information regarding the threat of global warming. If the IPCC's current climate models cannot explain the climate history of the past 10,000 years, how can they help predict the future he asks.

No one expects the Carbon Inquistion!!



Flakmeister's picture

You have a talent for trotting out flawed analyses that have been publically refuted within hours of their emergence....

For example here


  • Besides the sun, purported cyclical behavior is put forward by Vahrenholt and Lüning as a dominant driver of climate. There is much that is unclear about these cycles, but they manifest themselves mainly regionally. A mechanistic understanding of these cycles –instead of fitting observations to periodic signals, which by itself can be a mathematical artifact- is lacking. Moreover, currently all climate indices (air temperatures, sea temperatures, amount of ice, ecological aspects) are moving in the warmer direction, so a re-distribution of heat within the climate system is not the cause of the current warmth. They mention some scientists (e.g. Bond, Latif) who study these cycles and who concluded that they are very influential in our climate. This view is not widely shared because of the sketchy and conflicting information available. But Bond and Latif did not draw the same conclusions from their work as Vahrenholt and Lüning did; they did not use it to downplay the important role that greenhouse gases play in our climate.
  • Vahrenholt and Lüning proclaim as fact that global temperatures in Medieval times were similar as now, although most (but not all) published research to date concluded that the warmth in Medieval times was not as globally widespread and as pronounced as the current warmth. E.g. Mann et al, in their 2008 PNAS paper (which they cite in their response) wrote “The reconstructed amplitude of change over past centuries is greater than hitherto reported, with somewhat greater Medieval warmth in the Northern Hemisphere, albeit still not reaching recent levels."). Their insinuating language like “the MWP and LIA suddenly re-appeared”, in reference to an oft discussed 14 year old paper is nothing more than a cheap dig, taken straight from the skeptics’ playbook.
  • Vahrenholt and Lüning seem to have missed our reference to the work of Pearce and Adams, who modeled the amplifying effect of cosmic rays as proposed by Svensmark and found it falling short by orders of magnitude. Besides this evidence from a physics based climate model, it is also possible to do a regression analysis of global average temperatures to the different potential climate forcings, and including time lags in the fitting procedure. This comes down to letting the data speak for themselves, without any a-priori knowledge of working mechanism (including amplification) or physics. Lean and Rind did exactly that in their 2008 paper. The result: “None of the natural processes can account for the overall warming trend in global surface temperatures.” and “According to this analysis, solar forcing contributed negligible long-term warming in the past 25 years and 10% of the warming in the past 100 years”. Note that these regression results implicitly include any amplification effects.
  • Vahrenholt and Lüning correctly conclude that fluctuations in short term trends “should not be misunderstood that warming on a 30 year scale might have stopped”. In contrast, in the original EER interview Vahrenholt said “Our critics say fifteen years is not enough to make judgments about the climate.” Apparently, he now agrees with his critics.
  • Vahrenholt and Lüning confuse what are assumptions versus what are emergent properties or outcomes of climate models. For example, the amplifying feedback by water vapor is a result of the interplay of various elements of atmospheric physics as incorporated by General Circulation Models. They also state that the small effect of solar variability is an assumption of climate models, whereas it is an outcome. Rather than handwaving inconvenient results away, the proper response would be to demonstrate where the underlying physics is wrong, e.g. by building a better model.
  • Vahrenholt and Lüning claim that stratospheric temperatures have remained stable, even though they are expected to decrease in response to a stronger greenhouse effect. Again they conclude something about a long term trend based on short term fluctuations, against their own advice. Moreover, the paper by Berger and Lübken which they cite is irrelevant because it presents temperature trends in the mesosphere, an even higher altitude. The CO2 fingerprint is mainly confined to the stratosphere and is distinct from the effect of ozone. The latter also induces cooling, but mainly above the poles, while increasing CO2 cools the stratosphere everywhere. The point remains that if the sun were the dominant cause of surface warming, this warming would also have occurred at higher stratospheric layers. This is not what has been observed.

And Varenholt was pwned by Der Spiegel,

post turtle saver's picture

Fracking has been used in the oil industry for THE PAST 150 YEARS. You guys are fucking killing me with your ignorance, please stop.

Flakmeister's picture

Yeah... but is it only recently have the shills touted fracking as the pathway to energy independence and they sure as hell weren't fracking 10,000 ft laterals 150 years ago....

BTW, the first US frack job was in 1947, that and similar earlier fracking efforts are pale comparisons to what is occuring in the Bakken, Eagle Ford, Marcellus etc......

I suggest *you* get your facts straight...

palmereldritch's picture

Just because you're smart enough to know what you don't know doesn't mean you're smart enough to know what you think you know.

DaveyJones's picture

7 weeks on a three year old site and you're making that call. The logic in your second paragraph does indicate your need for more reading

Flakmeister's picture

Turn my back for 10 minutes and look what happens.....

duo's picture

Add the waste of millions of gallons of fresh water and you have the modern equivalent of turning gold into lead.

Augustus's picture

Fresh water is not wasted in any way.  It is injected into the well and then returned.  When returned it is not much different from the water runing off of a corn field.  That argument is nonsense.