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The Complexities Behind U.S. Crude Oil and Gasoline Prices

February 22nd, 2013

OMAHA (Capstone Energy Services) – Recent increases in gasoline prices have rekindled the controversy over the high cost of U.S. gasoline and crude oil prices. If the U.S. has so much new oil, why the high prices? Refinery maintenance and changing to summer gasoline blends are common explanations. Certainly those factors contribute to the increasing costs. Middle East supply threats and OPEC dominance in international markets keep crude oil prices higher than fundamental factors otherwise justify. However, some more complex factors need consideration – namely the cost of crude oil to U.S. refineries, the changing quality mix of that crude oil and the efficiency of refinery operations.

Crude oil costs are the major factor in the increase in gasoline costs. The price of domestic crude oil, as benchmarked by the NYMEX (WTI) contract in Cushing OK, increased by 15% since the middle of December from $86 per barrel to $97 per barrel. The cost of international crude oil, as benchmarked by the NYMEX Brent North Sea crude oil contract, has climbed over 10% from $108 per barrel to $119 per barrel. Unfortunately, because of delivery constraints from Cushing to the Gulf Coast refineries, the refinery cost of crude reflects more of a Brent cost than a WTI cost. Similarly, refinery costs on the East Coast also reflect Brent, since most crude must be imported.

Adding to the price complexity is the requirements that many U.S refineries must use heavy oil. Over the years as crude oil prices climbed and supplies of light sweet crude became limited, U.S. refineries were transformed to efficiently produce the maximum volume of gasoline using primarily heavier crudes, principally from Venezuela and Columbia. Reducing the mix in favor of lighter crudes from U.S. shale formations would decrease the efficiency of the refinery operation and increase refining costs. The alternative is a costly reconfiguration of the refineries. As a result, the U.S. will need to continue purchasing large amounts of heavy crude oil from South America for the foreseeable future, according to the International Energy Agency. The delivered cost of Venezuelan crude runs 10% higher than WTI despite the fact that it is much heavier. Canadian heavy crude, in contrast, is delivered to the Gulf Coast 5%-15% below the WTI price, but the capacity to deliver that heavy oil remains severely limited. The proposed Keystone XL pipeline would increase that delivery capacity, but approval of that project remains in doubt.

As U.S. production of lighter crudes increases and capacity to the Gulf Coast increases, the volume of light crude deliveries to the Gulf Coast could outstrip efficient refinery capacity, resulting in a supply surplus, discounted pricing and increased pressure for the Government to permit exports. An alternative could be for the refineries to make the necessary investments to move away from heavy crudes, which may actually reduce margins and increase costs. The outcome is unclear but, for now, it looks like all these new domestic crude supplies will not have a significant effect on gasoline costs to consumers.

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By Ed Freeman

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