Techfun

In the last hour or so I was discussing oil prices on Twitter with YatPundit. As we were talking, the Financial Times released the story below.

We were discussing how much of the current price of oil is due to fundamental supply and demand issues and how much is due to speculators in the oil futures market. There is also the problem (for Americans) of a weak US dollar. I wrote about how this results in Americans paying a premium for oil in Keeping Oil Prices in Perspective back when oil was nearing 100 USD per barrel and it’s actually gotten worse in many ways since then.

As complicated as those factors are when trying to sort out oil prices, this article brings up another element.

We live in an increasingly commoditized world. As a result we tend to think of the actual real live nouns associated with trading markets as more uniform than they are. At one point every bushel of corn grown in Iowa and sold in New York had a farmer’s name printed right on the bag. Food producers who used the corn (or wheat or oats) could make a point of getting their raw materials from farmers who were known for particularly good quality or who grew corn with a certain trait that the consumer valued.

That time is long gone. Now that Iowa farmer’s corn is mixed with other corn from his area of the same basic grade and loaded onto train cars for delivery by the ton. Oil is much the same way now. We talk about and complain about oil prices but what we are actually talking about are oil FUTURES prices. When it comes to the actual black sticky stuff, it comes in many grades and with many different qualities.

Refineries are machined in such a way as to best process a certain grade of oil. The good stuff is known as “Light Sweet Crude” and thats what Saudi Arabia’s huge Ghawar Oil Field, West Texas, and Nigeria in East Africa are known for producing. This is the stuff US refineries are designed to process into good old gasline and diesel fuel.

Apparently, the refineries are paying a higher premium – on top of the already high commodity prices – to get the grades they need. The lower grades CAN be refined but its a more expensive and the USA is not really set up for that as far as our refining infrastructure. So if you want to yell at your political reps about oil prices, start by demanding that they approve the building of more refineries that can use high sulfur crude.

Refinery premiums cast doubt on speculators
By Javier Blas in London
Published: June 12 2008 18:44 | Last updated: June 12 2008 18:44

Refiners are paying record premiums for the high-quality crude oil they use to produce diesel and petrol, a sign of strong demand in the physical oil market that calls into question claims that soaring oil prices are being driven by speculators.

Refiners are paying up to $5-$6 a barrel on top of current record prices to secure high-grade oil, traders said, double the level of a year ago. The mark-ups are four times higher than the 2000-2008 average. The movement in prices paid for physical barrels of oil has gone largely undetected outside the refinery industry because financial markets pay almost exclusive attention to the price of oil futures traded in London and New York.

The fact that refiners are willing to pay a higher price for physical supplies than the futures benchmark lends weight to the argument that speculators are not the cause of record oil prices. At the same time, though, refiners are obtaining unusually large discounts for low-quality crude oil, traditionally refined into fuel oil. Traders said supplies of low-grade oil, typically produced in the Middle East, are relatively plentiful.

The premium for Nigeria’s high-grade Bonny Light oil has surged this month to $4 a barrel, up from $2.50 a year ago. In the same period, the discount for low-grade Iran Heavy oil has widened to $13.05 a barrel from $7.

The split in the physical market explains Opec’s reluctance to boost its production as most of the cartel’s spare capacity is of low-quality oil. However, the situation could change as Saudi Arabia plans to bring on stream its Khursaniyah high-quality oil field. It also highlights a lack of capacity at refineries that can turn heavy, low-quality oil into products such as diesel. Francisco Blanch, head of commodities research at Merrill Lynch, said the price of Middle East low-grade oil was falling behind because of refining bottlenecks.

“Middle East heavy crudes have been unable to keep up with the growing appetite for low sulphur middle distillates products, such as diesel,” he said, adding the difference between Saudi Arabia’s high- and low-quality oil was at a record high.

The scarcity of premium oil has been aggravated by shortfalls in Nigeria.

Copyright The Financial Times Limited 2008