Prices, Petroleum, & Gravity

By | December 5, 2018

The sudden collapse in oil prices was predictable although few of the pundits were willing to say so. The public understanding of such is even less than the so called experts. It’s about supply and demand. Moreover it is about the supply and demand for what is sold as “oil”. So let’s define petroleum first.

Oils are graded on the basic of specific gravity ranging for low thick “heavy” oils which may have gravity of 10o or less.  This is referred to as the API gravity. (API = American Petroleum Institute) It is an inverse scale. While dimensionless, 10o oil is the “gravity” of water. Numbers lower are heavier than water, numbers higher than 10o are lighter than water.  Oil sands found in Canada and elsewhere are very thick oils, less than 10o gravity. Asphalt has an API gravity of only 8o. This thick mush must be thinned with much lighter crude oils to average out to a range that the refiners prefer to get the best prices.

Shale oil plays produce light oils – often lighter than 60o gravity, some even as light as 90o. By comparison, gasoline has an API gravity of 50o.  Therefore to make gasoline a refiner needs oil that has a gravity lower than gasoline or it must be blended with heavy oil to create an artificial “intermediate” grade of oil.  West Texas Intermediate (WTI), a benchmark oil, has an API gravity of 39.6o.  And North Sea Brent oil is somewhat lighter than WTI, but has a higher sulphur content.

All the shale oils are light. It is simply not possible to squeeze larger molecules of oil out of dense shale rocks, hydraulically fractured or not, and thus the boom in oil in West Texas and elsewhere, has created a huge supply of very light crude oils but the old legacy medium weight oils needed to make gasoline are actually in decline. This is one reason we still import oil. It is also why Canada would like to build the Keystone Pipeline so they can mix the horribly thick oil from the tar sands with the very light shale oils to create this artificial blend of “medium” oil.

To create this blended oil costs money, so if 50% heavy and 50% light oil, the end result is not 100% medium weight. Some part of the crude may be consumed in the process of blending. The heavy oil in Canada is bringing barely $15 per barrel. Likewise, the very light oils, above that of the gravity of gasoline, are also discounted in the market. Therefore, they are selling oil as much as 30% below the benchmark prices such as WTI. And production of light oils produces huge amounts of natural gas, which has glutted the natural gas market.

So when you hear about WTI priced at $55 a barrel, keep in mind, the price of light oils may be $30-40 a bbl. And, the heavy oils even lower. So now about those gasoline prices.

Locally, I am seeing gasoline sell for $1.90 to $2.15/gallon. We were $2.60 and above only weeks ago. So we have seen the price of gasoline fall by 20-25% and crude oil pricing falling about the same percentage. But if you subtract the typical taxes from gasoline- which are on a per gallon basis, the price fall of gasoline is much greater. Then locally, again, it would be $1.40 to $2.10, or 33%. This reflects the fact that these blends create a differential in pricing, so the refiners may choose to use regular WTI rather than buy blends unless the blends are discounted even more. It is all about the cost of refining the “best” oil into the most useful and valuable products. This also explains why the differential between diesel and gasoline has expanded.

So the issue isn’t just a straight line relationship between oil prices per barrel and gasoline prices per gallon, but is a result of blending supplies to maximize the profit to the refiner. So we must import oil while exporting lighter and heavier oils, or to blend these two into a more marketable property.

With OPEC threatening to reduce production by 1,000,000/bbl. they will squeeze prices upward for the kind of oil our refiners need to make gasoline and similar products. Our exports may offset the cost but in the long run, it is likely to increase the price of gasoline to American consumers. Frankly, it is a complex business. And the cost of crude oil relates to supply of the right kinds of crude.

The recent increased drilling in W. Texas isn’t really helping the supply of intermediate grades of oil. And hedge funds buying into the oil and gas industry are speculating by backing winners and losers. But with the huge investments, the question comes is whether or not a real profit will be realized or whether investor machinations are creating the kind of volatility we have seen in recent oil prices. Importantly, do the investors and “energy banks” even know or understand the real mechanics behind oil. Certainly they are not going to get that information from the “trades” – those industry magazines which are more cheerleader for their advertisers than information sources for real investors.

A few years ago, Arthur Berman, running a column in World Oil magazine, criticized the economics of the shale gas play, predicting it to falter. He was dead to nuts on his prediction, but angry advertisers forced World Oil to fire both Berman and his editor. How can you rely upon information meant only to make these promoters and money men look good? You can’t.