We generally think of oil as having “a price,” that there’s something called the global price of oil. Indeed, we generally think that oil is fungible, which means much the same thing in effect. We can use pretty much any barrel of oil to do pretty much any of the things we can use a barrel of oil to do, therefore they’re all pretty much the same price. This isn’t all quite true. Partly, oils do differ and you’ve got to change refineries to be able to use the different types. Rather more though oil is indeed fungible and so does obey Ricardo’s dictum about prices.The same thing will cost the same in different places but, crucially, only when taking transport prices into account.
This aiding in explaining why oil is only $20 a barrel in parts of Canada while gasoline costs the same it does everywhere else.
The blue-light special price for Canadian oil has reached ridiculous levels — and it’s getting worse.
The price for Western Canadian Select (WCS) crude fell to just US$26 a barrel on Thursday, while benchmark West Texas Intermediate crude closed at $71.98.
At one point, the price differential sat at US$52 a barrel, according to Bloomberg, and it didn’t get much better on Friday, with the discount closing at $48.50 a barrel.
The problem here is that all that lovely cheap Western Canada oil is, well, it’s in Western Canada. Where’s there’s not a great deal else other than Meece* and trees, neither of which are great users of oil:
The drop has come as rising production from Canada’s oilsands overwhelms the nation’s pipeline capacity, and as refinery capacity in the U.S. dwindles amid planned maintenance.
We have in fact seen something similar in the US recently. WTI (West Texas Intermediate) was at a substantial discount to Brent. The reason being that fracking had vastly increased the amount of crude being produced in the US. Refining and transport capacity was stretched. But the US also wouldn’t allow the export of crude oil, a hangover from the 1970s. So, crude continued to trade well below international prices.
However, those who owned that transport capacity – Warren Buffett’s Burlington Northern for example – were able to earn premium prices for transporting what they did have the capacity to move. The oil at the other end of the transport network was worth what international oil was, the people transporting earning that premium. Similarly, the US has always allowed import and export of gasoline and refined products. So those who owned refineries could buy at the depressed domestic price, refine and earn the global and higher price on refined. That meant those who refined and sold locally also got the international price given that ability to export if they didn’t.
Here the situation’s a little different, in that it’s physical transport capacity, not legal prohibition, that is the problem. The price effects are the same. Producers trying to sell into that local crude market are getting a pittance as the price. Those able to transport that oil out to global markets are making a fortune. So too are those able to refine and transport, or even those refining for the local market.
Another way to put this is that the profits always flow to whoever possesses what is in short supply, here that being refining and transport capacity. Or, as Ricardo pointed out, prices will be equal across markets including transport costs.
So, anyone with any bright ideas about how to transport crude oil, there’s a vast fortune awaiting you. How do you get oil out of Alberta to where there’s more than Mooses** and trees to consume it? The only real problem with such solutions being that many, many, thousands of really rather bright people have also thought about this and not come up with a solution as yet. Well, actually, we all know what to do, build more pipelines, but being allowed to do that is the problem, not the knowing of the what to do.
Oh, and just as an added bonus. You know all those environmentalists insisting that no more pipelines be built? This WCS discount is the price of what they’re doing. That’s actually the cost of those anti-pipeline actions turned into actual dollars. Production volume times the discount is what Swampy is costing in economic losses.
*This may or may not be the plural of Moose.
**This may or may not be the plural of Moose.