This past weekend’s startling developments in Libya hit the crude oil markets almost instantly. Brent crude in Europe fell to around $105/barrel at one point, while WTI crude has gained about half a dollar to around $83/barrel. Last Friday, the differential between the two grades reached $26.21, a record. We might finally see a bit of relief at the pump for US consumers, if the Libyan oil fields can be brought back online quickly. And major oil companies could see their profits drop.

Major integrated oil companies — Exxon Mobil Corp. (NYSE: XOM), BP plc (NYSE: BP), Chevron Corp. (NYSE: CVX), and ConocoPhillips Corp. (NYSE: COP) — have enjoyed robust profits even as prices for crude have been falling because the differential between Brent and WTI has been so wide. Refiners like Valero Energy Corp. (NYSE: VLO), Tesoro Corp. (NYSE: TSO), Marathon Petroleum Corp. (NYSE: MPC), and Western Refining Corp. (NYSE: WNR) are also enjoying robust earnings on the crude oil price differential.

The reason is that most crude imports (priced relative to Brent) go to the US Gulf coast where much of the nation’s refining capacity is located. Cheaper WTI crude is bottled up at Cushing, Oklahoma, where there is no pipeline to carry the black stuff to Gulf coast refineries. The Cushing facility is essentially full, which holds prices down for WTI.

What happens is that refineries may be paying for crude at WTI prices, but selling the refined products as if the feedstock were Brent. Pump prices don’t fall as far or as fast at consumers might expect.

According to the US Energy Information Administration, in the second week of August, US spot crude (WTI) cost $82.86/barrel. The average pump price for gasoline was $3.73/gallon. In the second week of October 2010, spot WTI crude cost $82.29/barrel, and the average pump price was $2.87/gallon.

In the same week, Brent crude sold for $84.51/barrel, only a slight differential to WTI. Based on historical pricing, US consumers should be paying less than $3/gallon at the pump today. We are not because of the wide differential between Brent and WTI crudes.

For integrated oil companies and refiners, the return of Libya’s 1.6 million barrels/day of production could spell the end of this refining heyday. As the differential between Brent and WTI closes, refining profits have to decline.

Events in Libya remain undecided, and even if the current regime is replaced it will take some time to get the oil flowing again. Another factor affecting the price of crude is the gloomier outlook for the global economy. As GDP estimates fall, the effect on crude is to reduce demand and lower the price.

The price for Brent crude has further, perhaps much further, to fall. In the short term, Libyan events will drive the price. In the longer term, it’s the global economy.

Paul Ausick

 

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