Oil has hit $100 a barrel again. A host of factors play into the price of a West Texas Intermediate crude — demand, global market conditions, the activity of speculators. Evan Smith, co-manager of the Global Resources Fund at U.S. Global Investors believes the recent run-up can be ascribed in part to activity (or the lack of activity) surrounding pipelines.
It’s hard to get excited about the tubes that facilitate the movement of crude oil around the country. But pipelines have been in the news in recent weeks. First, the U.S. government decided November 10 to postpone a decision about the proposed Keystone line, which would allow the movement of a large quantity of oil from Canada to the southern U.S. On Wedesday, Canadian company Enbridge said it would buy a 50% interest in a pipeline that runs from the huge oil terminal in Cushing, Oklahoma, to the Gulf Coast. Both moves have helped push the price of WTI up.
Here’s why. Oil is priced on global markets. But the price can vary depending on where you’re buying. WTI, the benchmark commonly used in the U.S., refers to the price of oil at the landlocked Cushing, Oklahoma terminal. Brent crude, the benchmark for oil traded in the U.K., is a much more (excuse the pun) liquid market, and is a better indicator of the global market price. Historically, WTI has traded at a small premium to Brent, in part because Americans guzzled gas as domestic production fell.
But for much of the past year, WTI has traded at a huge discount to Brent — of up to $30 per barrel. As Smith explains, that’s because demand for oil in the rest of the world is growing far more rapidly in the U.S., while production in the middle of the U.S. has soared, thanks to a boom in oil production in North Dakota.
On Wednesday, Enbridge said it would buy a stake in a pipeline that runs from Cushing, Oklahoma to the Texas Gulf Coast. The significance is that the company is going to reverse the flow, and start sending oil from the terminal to refiners operating on the coast. In theory, increasing the supply of crude to refiners on the Gulf Coast should bring down the price of oil. “Right now, there’s too much oil production in the mid-continent, and not enough capacity to get it to the Gulf Coast,” said Smith.
But oil used by refiners on the coast can come from anywhere, and is therefore priced closer to global prices than to regional ones. “Now that there is a prospect that some of the oil will get down to the coast, it raises the price closer to global benchmarks,” said Smith. In other words, opening up more of the supply languishing in Cushing to refiners who operate on the coasts has the effect of pushing up prices. That’s bad news for consumers, on the one hand. But it also means that refiners will buy less foreign oil going forward.
That’s a short-term impact. The decision on the Keystone pipeline will have a longer-term impact, and may serve to keep the price of domestic oil and gas high. On Monday, the State Department, responding to environmental concerns raised in Nebraska and elsewhere along the route, said it would defer until 2013 a decision on whether to permit the construction of the pipeline from Canada to the southern U.S.
“That’s a 700,000-barrel-a-day pipeline that would bring crude down to the Gulf Coast and keep the U.S. well-supplied,” said Smith. The decision means it is likely that the supply of crude to U.S. refiners won’t be as large as previously thought, and that Canadians might look for other routes to export oil production — to Asia, for example. All things considered, the prospect of less supply over the long-term will push prices higher.
Smith argues that bringing more crude from Canada is vital to the U.S. market. For even though production is booming in North Dakota and Texas,
Daniel Gross is economics editor at Yahoo! Finance