Analyzing Changes in WTI, Brent, and Gasoline Prices

Here I comment on some recent developments affecting the prices of WTI, Brent, and gasoline.

West Texas Intermediate is a particular grade of crude oil whose price is usually quoted in terms of delivery in Cushing, Oklahoma. Brent is a very similar crude from Europe's North Sea. As similar products, you'd expect them to sell for close to the same price, and up until 2010 they usually did. But an increase in production in Canada and the central U.S. combined with a decrease in U.S. consumption has led to a surplus of oil in the central U.S. This overwhelmed existing infrastructure for cheap transportation of crude from Cushing to the coast, causing a big spread to develop between the prices of WTI and Brent.

Black: price of West Texas Intermediate, in dollars per barrel, weekly Jan 7, 2000 to Feb 8, 2013; blue: price of Brent; green: Brent minus WTI. Data source: EIA.

Related article: Driving Doldrums: Gas Prices on the Rise - Again

The Seaway Pipeline last month completed a capacity upgrade to move 400,000 b/d from Cushing down to the Gulf, though there have been some initial additional temporary infrastructure challenges with processing that new flow at the receiving end. The Gulf Coast portion of TransCanada's Keystone Pipeline Project is expected to be moving an additional 700,000 b/d from Cushing to the Gulf by the end of this year. That's going to happen regardless of whether President Obama decides to approve the separate northern portions of the Keystone Project, though political and legal obstacles could still slow completion of the Gulf Coast portion as well.

Eliminating the Brent-WTI price differential would require that any arbitrageur could buy another barrel in Cushing and transport that additional barrel to the Coast at low cost. We're still a long way from that. We need not only to balance current flows of supply and demand, but also to work down the inventory of oil that has piled up in Cushing. Commercial crude oil inventories in PADD2, the oil district including Oklahoma, today are 50 million barrels higher than they were in 2008.

Commercial inventories of crude oil in Midwest (PADD 2). Source: EIA.

Until we reach that point of having the logistical ability to transport easily as many barrels as desired out of Cushing, the only way for the Brent-WTI price gap to close is if the extra supply delivered to the coast is enough to actually bring down the world price. We may reach that point if we had capacity to move both the daily new flow and all the existing pool, but we're not there yet.

In the mean time, up to this point we have had adequate infrastructure to refine the oil domestically and transport the refined products (which move through separate pipelines from the crude) to the coast. That means the Law of One Price is much closer to holding for refined products, with U.S. refiners buying the cheap WTI, and shipping the refined product for sale throughout the world. Indeed, as Mark Perry noted, fuel oil and petroleum products were the two top U.S. exports in 2012, contributing $117B to GDP.

Related article: What's Causing the Price Gap between WTI and Brent, and Who will Benefit?

The average retail price of gasoline in the United States historically has tracked the price of crude oil pretty closely, with each $1/barrel increase in the price of crude oil showing up as a 2.5-cent increase in the retail price of a gallon of gasoline. But the fact that the U.S. can sell refined petroleum markets at the world price means that for purposes of using that rule of thumb today, you'd want to look at the price of Brent rather than the price of WTI.

Black: average U.S. price of regular gasoline, all formulations, in dollars per gallon, weekly Jan 10, 2000 to Feb 11, 2013 (data source: EIA). Blue: 0.84 plus 0.025 times price of Brent, in dollars per barrel, weekly Jan 7, 2000 to Feb 8, 2013 (data source: EIA).

This winter the U.S. retail gasoline price fell significantly below the value predicted on the basis of this historical relation. It's caught partly back up over recent weeks, though still has a ways to go. Based on a current Brent price of $118.66/barrel, you'd expect an average retail gasoline price of $3.80/gallon. With the current price only $3.59, we've got another 20 cents to go.

By. James Hamilton

Original source: http://www.econbrowser.com/archives/2013/02/prices_of_gasol.html