Have you ever been curious where your oil and gas price comes from? Why does the pump price constantly move up and down? In this article, we explain what the driving factors are in determining the price you pay at the pump, and teach you at a high level how the oil and gas supply chain works!

BACKGROUND AND SUPPLY CHAIN

Gas prices are important to anyone who owns a vehicle. Understanding gas prices is not as straight forward as people think. Periodically, we provide updates on where we think oil and gas prices are heading, so Like and Subscribe so you don’t miss our next update! Below, we provide one example of what drove oil and gas prices down in 2014 and 2015 to illustrate how market factors influence your price.

Almost everyone knows that gasoline comes from oil, so before we understand where gas and diesel prices come from, we need to understand where oil prices come from. Let’s look at a barrel of oil to determine where it goes.

Crude oil composition differs depending on it’s source. For example, US Midwest Oil sands crude produces more lights than gulf coast crude, and therefore produces more gasoline than sulfur. For this reason, crude oil in various regions of the world has different values, and drives the price of refined products such as jet fuel, gasoline and diesel.

Its important to understand the supply chain, in order to understand why prices move up or down. Here is a simplified view of gasoline in North America, from crude oil to your tank.

Let’s talk briefly about what WTI and Brent actually mean.

The main benchmarks

There are many different oil benchmarks, with each one representing crude oil from a particular part of the globe. However, the price of most of them are closely tied to one of three primary benchmarks:

• Brent Blend – Roughly two-thirds of all crude contracts around the world reference Brent Blend, making it the most widely used benchmark. These days, “Brent” actually refers to oil from four different fields in the North Sea: Brent, Forties, Oseberg and Ekofisk. Crude from this region is light and sweet, making them ideal for the refining of diesel fuel, gasoline and other high-demand products. Because the supply is water-borne, it’s easy to transport to a distant locations, however the USA price of Brent is usually higher than WTI due to transportation costs.
• West Texas Intermediate (WTI) – WTI refers to oil extracted from wells in the U.S. and sent via pipeline to Cushing, Oklahoma. The fact that supplies are land-locked is one of the drawbacks to West Texas crude, which restricts WTI sale to other parts of the globe. The product itself is very light and very sweet, making it ideal for gasoline refining, in particular. WTI continues to be the main benchmark for oil consumed in the United States.
• Dubai/Oman – This Middle Eastern crude is a useful reference for oil of a slightly lower grade than WTI or Brent. A “basket” product consisting of crude from Dubai, Oman or Abu Dhabi, it’s somewhat heavier and has higher sulfur content, putting it in the “sour” category. Dubai/Oman is the main reference for Persian Gulf oil delivered to the Asian market.

So where does Oil come from Nowadays? Aren’t we running out? Not really. Check out the illustration below for the location of continental US oil plays. Canada also has plentiful crude oil fields, especially in the central Canadian regions.

Many of these oil producing regions have been given names. You’ll see us refer to the “Bakan” oil field for example. The major US oil field plays and their names are shown below.

REFINING

Crude oil right out of the ground won’t do us much good. Refining is the process of cracking carbon bonds to produce a molecule of the desired size and properties. This determines flash point, boiling point, energy density etc. Basically, cracking determines if you produce a heavier molecule such as diesel, or a lighter molecule such as natural gas or gasoline. After cracking, distillation separates the different grades by boiling point, creating a clean refined product you are used to seeing.

WHAT MOVES THE PRICE?

Now that we know where petroleum products come from, what moves the price? The answer is complicated, but we’ll provide a high level view.

CRUDE OIL SUPPLY AND INVENTORY

You may have noticed that gas prices have been dropping throughout 2015. This is mostly due to increases in global crude oil production, Especially in Saudi Arabia and North America (So, Dubai and WTI benchmarks). The chart below shows global projected crude oil consumption growth versus supply growth. As you can see, the supply growth exceeds consumption growth, and therefore results in an inventory increase.

The chart below illustrates this increasing inventory (Since January 2014), and therefore price reduction in crude oil prices. This is basic supply and demand economics.

In fact, we currently have the highest recorded inventory of crude EVER. The graph below shows the Cushing, OK. inventory, which impacts WTI price directly. Cushing, OK is a major inventory and distribution center for crude oil in the USA.

As mentioned earlier, this is due to the higher US production of WTI crude, illustrated below.

The factors above have driven an incredible price decline in the crude oil market, bringing crude prices back to prices seen over 10 years ago (2004), shown below for the WTI index.

REFINING

When crude prices drop, refiners like Shell and Valero can purchase their feedstock cheaper. However, Refining capacity is often a limitation, especially when fuel demand is high, as it was in the summer of 2015. Refiners operated and nearly unprecedented rates in Q2 and Q3 of 2015, delaying outages and maintenance to maximize revenue, illustrated below. They operated at an approximate 95% utilization rate.

Dropping feed prices (due to an oversupply in crude oil), and high utilization rates helped drive gas and diesel fuel prices down throughout 2015. As you can see, US East coast average prices have fallen from $4.00 to nearly $2.00, or a fall of nearly 50% over less than 1 year.

DISTRIBUTION AND TAXES

Since distribution costs and tax rates are nearly flat, they are not expected to have a significant impact in pump prices over the next 6 months. However, it should be noted that ~50 cents of every gallon of gas you buy is directly due to taxes. The oil and gas industry are not “The bad guys” the media portrays them to be necessarily. For example, California gas tends to be among the most expensive in the nation, while their actual per-gallon price of gas charged by Exxon/BP etc are actually among the cheapest in the nation. The difference is high taxes that the voters chose to support.

For example, around this time a gallon of gas is trading for ~$1.25, while the price you see at the pump is approximately $2.50/gal. In California, of the difference, almost $1.00 is taxes, ~20 cents is distribution, and the remaining nickel is gas station cost.

PUMP PRICE (2015 and 2016)

So, what does this all mean looking forward? How do we apply this knowledge? *Updated Q3, 2015.

Fuel prices are expected to continue to drop for the remainder of 2015, and likely the first quarter of 2016, at which point they should stabilize. A drop of another 20 cents/gallon this year wouldn’t be unexpected. An economic slowdown currently in progress in China will contribute to the global crude oil supply glut, as well as lifted sanctions in Iran due to Obama’s nuclear deal, which will continue to drive crude oil prices down. In addition, the US shale industry has been more resilient than expected, keeping crude oil production on-line despite narrowing margins, however this can’t continue indefinitely. A social crisis in Venezuela could have the opposite effect, interrupting crude oil production in that country and driving global prices up. Refiner’s will be required to take scheduled maintenance outages this winter when fuel demand is lowest, which will reduce gasoline and diesel supply and stabilize the price fall moving into 2016 somewhat.

The longer term outlook (2016) is widely unknown, however WTI crude oil around 60$/barrel by mid-year is a decent estimate, which could yield gasoline east coast pricing of $2.50 -$3.00 at the pump. We don’t expect oil prices to reach 100 $/barrel as they did last year anytime soon.

When you choose your next car or work on your budget, plan on cheap gas for another 6-12 months! But the disclaimer is that nobody knows for sure.

LEFTLANEBRAIN

Ordinary Brains Keep Right! ©