The benchmark for crude oil prices for the United States is based on using a light sweet grade formally known as the West Texas Intermediate (WTI, or also informally known as Texas light sweet). Moreover, one of the major factors that contributes to determining the daily spot (a single sales transaction of an unit of oil) and closing crude oil prices of the WTI is the current surplus of crude oil that is located in the official delivery point for any grade bought on Wall Street’s NYMEX commodities exchange: Cushing, Oklahoma. In this report, the specific reasons why this surplus has occurred, as well as why it continues to grow, will be examined. Also, potential solutions to help alleviate both the surplus, as well as the price, will be presented and analysed.
The basis of this report was derived from the academic report titled “West Texas Intermediate versus Brent Crude Oil: Why is There a Disproportionate Difference in the Daily Closing Price?”. In addition, information was obtained from that report and used for clarification purposes.
Pipeline Facts and Statistics
One of the key components in determining the spot and daily crude oil prices of WTI is the primary mode of transporting crude oil, once it has been pumped out of the ground (using either drilling rigs or pumping jacks): pipelines. In the following paragraph, the relevant facts and statistics concerning pipelines will be reviewed.
Currently, there are 28 fully operational major pipelines in the United States, with the total length comprising of approximately 49,585 miles. Of those 28, four have the ultimate end point at Cushing, Oklahoma, although many of the other pipelines will intersect at this supply hub. There are three in particular that originate from two cities: Chicago and Midland (two pipelines). In addition, there’s another pipeline that lies in the state of New Mexico. The oil comes from the following areas: either the ports located near the Gulf of Mexico, the oil sands located in Canada, or from major-producing basins such as the Permian and Williston. The two main pipeline systems are the Trans Alaska Pipeline System (TAPS), as well as the Keystone Pipeline System. Many of the other major pipelines connect with one of these. In all, pipelines deliver approximately 11.3 billion barrels of petroleum per year (calculated on the basis of an 42 gallon barrel). Some of the crude oil that is transported to Cushing is currently waiting to be transported to refineries, which will be covered in the next section.
Refinery Facts and Statistics
The other key component in determining WTI prices is the 144 complex and simple petroleum refineries located in the continental United States (as well as Alaska). 134 of those are fully operational (save for certain periods of time when they are shut down for routine maintenance, or to switch to a different blend), and the ten remaining refineries remain idled. This number represents a decline of 11% from the number of operational refineries in 2009 (150), also down from an all-time high of over 300 back in 1982. Refineries process 17,322,178 barrels of oil per calendar day (as of 2012). Once the petroleum is shipped to the refineries, it is then processed into 16 different products (with finished motor gasoline using the most of the petroleum, comprising 18.9 gallons per barrel), then shipped back out to their ultimate destinations using alternate pipelines (although some are transported using a reverse-engineered process).
The Surplus of Oil in Cushing, Oklahoma
One of the contributing factors to the surplus of oil is the transportation constraints that the industry is facing today, including the closure of refineries, the limited number of refineries, as well as the need to build additional pipelines. More specifically, since September 2011, the Caribbean export refinery that supplied the East Coast (HOVENSA’s U.S. Virgin Islands refinery, which is now being used as an oil storage terminal), as well as two refineries in the Philadelphia area (ConocoPhillips Trainer and Sunoco’s Marcus Hook), have shut down permanently. In addition, a third major refinery, Sunoco Philadelphia, was idled permanently as of July 2012. Between these three metro Philadelphia area refineries, they accounted for the refining of approximately 50% of all of the petroleum located in the Northeast area. The closures of these refineries and others were attributed to the decreasing demand of petroleum products in the United States, or more specifically, motor gasoline. This is due to the combination of what economists have called the worst recession since the Great Depression (caused by the combination of the financial and housing markets crashing, primarily due to investment companies packaging sub-prime mortgage loans into Collateralised Bond Obligations and selling them off to other countries), as well as an increase in gasoline prices. Consequently, the number of automobiles sold in America declined to 14.2 million units in 2008, the lowest number on record since 1993.
The Proposed Solutions to Alleviating the Oil Surplus and Reducing the WTI Price of Oil
The two most commonly proposed solutions to alleviate the surplus of oil in Cushing, based on the current statistics, have been to build more refineries and pipelines. In regards to refineries, the last complex one that was built (also came online) in 1977. Newer (simple) refineries have been built since then, the last one being in 2008, but their capabilities are limited in comparison. As recent as the second term of the George W. Bush Administration, the President himself had offered numerous times to build new refineries to alleviate both the growing surplus, as well as the operating capacity levels, on the 98 military bases that were closed down during the Clinton Administration.
This recommendation from the Administration ultimately never came to fruition, due to refineries closing down as a result of falling demand from American consumers (down from the peak of processing 9.7 million barrels a day in 2007). However, two new refineries are currently in the process of being developed, but they are located in Yuma, Arizona (The Arizona Clean Fuels Refinery), and Union County, South Dakota (Hyperion Energy Center). There is insufficient data as to whether or not these two facilities are capable of operating at the same level as their counterparts, which is currently at 88%. It is also not known at this time whether or not these two new refineries will be processing oil from Cushing.
Concurrently, the increasing demand for new pipelines to be built continues on, as evident by TransCanada attempting to build the Keystone XL Pipeline. However, the progress in building this has been delayed for two main reasons. The first main reason why the pipeline has not been further developed is that the sensors used to detect leaks in the pipelines have detected only 5% of the recorded incidents from 2002-2012, according to the U.S. Department of Transportation Pipeline and Hazardous Materials Safety Administration Office of Hazardous Material Safety report. This is in contrast to 22% of incidents reported by the general public, as well as 62% that were reported by industry employees on the scene at the time of the incident.
The second main reason stems from concerns that the pipeline may leak and pose a threat to the Ogallala Aquifer (a sizable portion of the pipeline will be built over it), which covers portions of South Dakota, Nebraska, Oklahoma, Texas, New Mexico, Colorado, and Wyoming. This aquifer also is a primary water source for these states. Current federal government regulations imposed by the Obama Administration have resulted in delays for TransCanada to build the proposed pipeline (the last application was denied, and the Administration has requested that TransCanada submit another application).
Although there continues to be a surplus of crude oil in the American supply hub of Cushing, Oklahoma, several ongoing factors have contributed to this. From the present pipelines that are already being utilised for other purposes, the closing of several refineries due to decreased local demand, to the production of simple refineries that are not capable of processing crude oil (unlike their complex counterparts). In addition, current federal government regulations, in conjunction with pressure from the communities that oppose the building of additional pipelines and refineries, help contribute to the surplus as well.
Based on the current data, as well as the projected statistics and current federal government regulations, the surplus in Cushing, Oklahoma will continue to expand at its present rate of 150,000 barrels per calendar day. Unless there are changes in regulations from future administrations that will allow the development and construction of pipelines and refineries, the only alternative will be to build another supply hub to store the oil produced in America, continue to add to the Strategic Petroleum Reserve (which currently has the capacity to hold 727 million barrels), or begin reversing the flow of the pipelines. This last option has already begun with the Seaway pipeline, which is now transporting oil from Cushing to the Gulf Coast ports. Other modes of transportation, such as barges, semi-trailer truck fleets, and railroad trains, are currently too time and cost prohibitive. Until a viable solution can be reached, this will result in the spot and closing crude oil prices of the WTI to be depressed even more, furthering the price gap between it and Brent Crude.