by Jerome a Paris
Tue May 29th, 2007 at 06:54:29 AM EST
Oil prices, when you look at the most commonly used index in America, the WTI, quoted on the NYMEX and shown above (via wtrg.com), does not appear to have moved much in the last 6 months: after coming down from last summer's peaks, it has mostly traded sideways between $60 and $65 per barrel, with a short excursion to the low 50s in January.
So why have gasoline prices been going up so much lately? Price gouging by the oil companies is a temptng answer, but there is actually a simpler answer: the price of oil is wrong.
For an explanation of that bold claim, follow me below...
Promoted by whataboutbob
The claim is actually quite simple, and quite easy to document:
This graph above shows the evolution of the price of Brent, the other widely used international oil price, quoted in London. Brent and WTI are both light crudes (i.e. the best quality, most expensive kind), and WTI used to trade slightly above Brent (typically up to $1 higher). In recent weeks, WTI has been trading several dollars lower than the Brent - and than other international prices - thus creating an impression in the US of stable oil prices when they have in fact been going up again lately.
The reason behind this is that WTI no longer reflects the balance of the world oil market, but only that of the Cushing, OK oil market.
As this article (WTI Benchmark Temporarily Breaks Down: Is It Really a Big Deal?) explains, this has been caused by narrow logistical considerations:
It is interesting to note that in the past, the main logistical bottleneck was how to get enough oil into Cushing. In many instances this resulted in serious dislocations and WTI rising to very high levels compared to other benchmarks. The problem is now reversed: while the ability to get oil into Cushing has increased, the ability to shift this oil out of the region and to provide a relief valve for Cushing has been very limited. This situation has led to a larger-than-expected build-up of crude oil inventories in Cushing. According to the EIA data, in the first week of April 2007, crude oil inventories reached 333.4mn barrels, an increase of around 8.1mn barrels compared to the previous four weeks. According to the EIA, more than half of this increase (4.7mn barrels) occurred in Cushing where inventories had reached 27mn barrels in the first week of April 2007.
As a result of this large build-up, the WTI price has been decoupled not only from the rest of the world, but also from other US regions, particularly from the US Gulf.
In short, WTI's dislocation has had serious implications across the various crude oil markets, resulting in unusual price differentials. These effects, however, do not imply that the local market is not functioning well. On the contrary, price movements are efficiently reflecting the local supply-demand conditions in Cushing. The main problem is that when localized conditions become dominant, WTI can no longer reflect the supply-demand balance in the US, nor act as an international benchmark for pricing the millions of barrels of oil imported into the US.
The problem, as the article alludes to, is that many financial instruments are based on WTI prices, and that it would be highly inconvenient to change the benchmark (what do you move to? How do you convince everybody to move to the same benchmark at the same time? what do you do with existing outstanding transactions? How do you test the reliability of a new benchmark? - in fact, many of these arguments are the same that make people stay with Microsoft even when its products are worse than competitors, and the same that make the creation of an Iranian oil bourse very hard - it's the network, and the coordination effects that matter more than anything else). In fact, most industry players are aware of the situation and are finding ways to deal with it (including with more financial instruments), so trading is not really disturbed.
What is distorted is the way oil prices are currently perceived. To most outsiders, the WTI price is the only one ever used and headlined, and it is not showing the price increase that other indices (and that gas prices, that follow actual oil supply prices) are 'enjoying' lately. Thus that apparent mismatch between oil prices and gas prices.
Oil is currently not in the low 60s, it is above $70 per barrel and that explains 30 cents on gas prices.
Earlier Countdown diaries:
Countdown to $100 oil (40) - Undulating plateau
Countdown to $100 oil (39) - BigOil running out of oil
Countdown to $100 oil (38) - Who gets Champagne edition
Countdown to $100 oil (37) - OPEC says peak oil (and $100 oil) is near
Countdown to $100 oil (36) - Free game! win champagne! no risk! (eurotrib)
Countdown to $100 oil (36) - Free game! win champagne! no risk! (DailyKos)
Countdown to $100 oil (35) - peak oil: the last skeptics capitulate (CERA)
Countdown to $100 oil (34) - Oil major CEO calls for demand reduction
Countdown to $100 oil (33) - Below zero
Countdown to $100 oil (32) - peak oil is, like, so over. Not!
Countdown to $100 oil (31) - $15 oil? The cornucopians are fighting back
Countdown to $100 oil (30) - senior politico fears looming oil wars
Countdown to $100 oil (29) - Alaska joins axis of evil (unreliable oil suppliers)
Countdown to $100 oil (28) - New records suggest more to come
Countdown to $100 oil (27) - 'Mission Accomplished' - High oil prices are here to stay
Countdown to $100 oil (26) - Time to bet again (eurotrib)
Countdown to $100 oil (26) - Time to bet again (dKos)
Countdown to $100 oil (25) - Iran vows that oil prices will not go down
Countdown to $100 oil (24) - What markets are telling us about future energy prices
Countdown to $100 oil (23) - Running out of natural gas in North America
Countdown to 100$ oil (22) - gas shortages in the UK - 240$/boe
Countdown to $100 oil (21A) - The 4 biggest oil fields in the world are in decline *
Countdown to 100$ oil (21bis) - long term vs short term worries (dKos)
Countdown to 100$ oil (21) - 8-page extravaganza in the Independent: 'we're doomed'
Countdown to 100$ oil (20) - Meteor Blades is Da Man in 2005
Countdown to 100$ oil (19) - Your bets for 2006 (Eurotrib)
Countdown to 100$ oil (19) - Your bets for 2006 (DailyKos)
Countdown to 100$ oil (18) - OPEC happy with oil above 50$
Countdown to 100$ oil (17) - Does it matter politically? A naked appeal for your support
Countdown to 100$ oil (16) - We'll know on Monday
Countdown to 100$ oil (15) - the impact on your electricity bill
Countdown to 100$ oil (14) - Greenspan acknoweldges peak oil
Countdown to 100$ oil (13) - Katrina strikes / refinery crisis
Countdown to 100$ oil (12) - Al-Qaeda, oil and Asian financial centers
Countdown to 100$ oil (11) - it's Greenspan's fault!
Countdown to 100$ oil (10) - Simmons says 300$ soon - and more
Countdown to 100$ oil (9) - I am taking bets (eurotrib)
Countdown to 100$ oil (9) - I am taking bets (dKos)
Countdown to 100$ oil (8) - just raw data
Countdown to 100$ oil (7) - a smart solution: the bike
Countdown to 100$ oil (6) - and the loser is ... Africa
Countdown to 100$ oil (5) - OPEC inexorably raises floor price
Countdown to 100$ oil (4) - WSJ wingnuts vs China
Countdown to 100$ oil (3) - industry is beginning to suffer
Countdown to 100$ oil (2) - the views of the elites on peak oil
Countdown to 100$ oil (1) (eurotrib)
Countdown to 100$ oil (1) (dKos)
* added to the series after the fact