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Unravelling the Oil Enigma

Past, Present
F irst, let me begin by insulting your
intelligence by assuming you know
nothing about the oil industry.
There are two seasons in the refining
calendar. The driving season, which runs
from the U.S. Memorial Day weekend and
If, on the other hand, there was a drop of
1 million barrels in inventory with demand
up 4% and refineries still at 91%, then our
Now I’ve most certainly got your attention. which closely coincides with our affec- call would be for increases in prices.
We are neighbours to the largest energy tionately named May 2-4 weekend here So, at this point, many ask, “Why
consumers on the planet, and we're the in Canada, to the Labour Day weekend, should we in Canada care about what
number-one supplier of crude oil and its which both countries share. During this happens with all this in the United
refined derivatives, gasoline and distillates timeframe, gasoline inventories and States?” The short, if not blunt, answer
to that same consumer. demand figures combined with crude is that prices of all fuels in Canada just
Of course we’re talking about our inventories determine the prices of each aren’t made in Canada; the 49th parallel
friends in the USA. other, while diesel prices merely slip- does not exist when it comes to fuel pric-
There exists a misplaced belief that the stream with their increases or decreases ing. First of all, Canada is divided in half
pricing of transportation fuels is unique to in prices. as far as the fundamental pricing assump-
this massive marketing island of Canada The other season, of course, is the heat- tion is concerned.
and the USA, however, this could not be ing season, October to March, where the Pricing east of Thunder Bay tends to
further from the truth. opposite is true in terms of price drivers. In follow the NYMEX-listed New York Harbor
The equation that results in the ulti- this case inventory levels of distillates and futures prices while Thunder Bay and the
mate price to the consumer is in a constant crude rule over gasoline. In both seasons, West tend to follow the gyrations of NYH
state of flux, and is based on certain factors however, we have the Mother Nature trump WTI crude prices.
whose influence on the final price varies card to be aware of: hurricanes from June This is all further complicated by the
almost on a daily, if not hourly, basis. to November and the threat of a severe import/export alternative available to all
Some of the factors in the calculation winter from October to March. Canadian refiners under NAFTA, which, in
are not U.S./Canada parochial, but of a Also during both of these seasons, my opinion, is strongly biased toward the
global nature; a fact that in my experience two other factors are watched, namely U.S., and is the key reason why transpor-
many people have a tough time under- demand and refinery utilization levels. tation fuel prices in Canada are higher
standing or believing. If we were asked to Demand figures have to be looked at with than in the U.S. even though we are their
prune down these factors today, we would a jaundiced eye as they compare the lat- number-one source of crude oil.
say that they are: supply and demand, est four-week average with the previous In addition to crude oil, we supply them
government policies, the stock markets year's four-week average. As it stands with 192 million barrels per year of refined
and geopolitics. today, the gasoline demand levels may products, with 121 million of those barrels
I’m going to begin by looking at the past, be up, but we are comparing this year’s going to the U.S. Northeast.
discussing the situation today, and attempt recession with last year’s bigger recession Under NAFTA, refined products can
to look into the future. so the demand change is meaningless. be exported to the U.S., but the domestic
In the past the weekly-to-long-term price Refinery utilization is the indicator for Canadian price cannot be lower than the
prediction was relatively straightforward. how close the industry is running to capac- landed export price in the U.S. That's my
ity. The higher the utilization numbers, the short and sweet answer for price discrepan-
Driving and Heating Seasons higher the theoretical demand, and there- cies between Canada and our largest cus-
Each Wednesday the U.S. EIA issues an fore, the higher the short-term prices. tomer, over and above the NAFTA proviso,
inventory report, which is a comprehen- In keeping with an eye on the past, as as Canadian rack prices tend to follow the
sive indication of the status of inventories we have seen, for example, in the EIA rack price changes at certain reference U.S.
of both crude and all refined products on report in November 2009, distillate inven- rack locations.
a national and regional basis; this report tories increased by three million barrels,
also includes refinery utilization numbers, demand was level and refineries were run- What Exactly Is a Rack Price?
import/export figures for distillates and ning at 91%. Then the short-term forecast My own definition is that it’s a price deter-
gasoline, as well as year-over-year demand would be for level or lower diesel prices as mined by a committee. Under the Competi-
levels for gasoline, distillates and jet fuel. well as gasoline. tion Act, these committee members are

20 | The Roughneck Buy & Sell | November 2010 | www.northernstar.ab.ca

This forced the oil compa.S. weekly price swings. the As it stands today. say nothing of the long-term forecast for over the short term for the balance of 2010. Why bother if it will take oilsands mega-projects to be placed on the fact. after those The Roughneck Buy & Sell | November 2010 | www. markers. I am referring. the moodiness of daily and of ethanol in gasoline and the unknown below the cost of crude. U. diesel and jet fuel are all positive. of a stable foreign exchange rate and low and Demand course. 10-year forward specifications for transpor- As most of you reading this know. however. in terms of pure supply and demand. The weekly inventory report has been of the supply chain rather than crude oil low volatility. This was based favour of an oversupply. crude oil and refined products to the U. to projected poor ROIs.S. it forced investments in some of the five-year average. This would certainly be true NYMEX close of business. there could be predict price changes over the long-term problems looming from the supply side on based on supply and demand information. government influenced demand (or lack thereof) for was the $110 per barrel drop in the price would like to have these stats from its key gasoline and diesel. the key reference data used by traders supply per se. Shell and in a melting pot of ingredients with differ. This is one hour after the outputs (gasoline and diesel cracks). bpd greenfield refinery? When. cancelled refinery expansion plans due the roller-coaster seems to be moving in changes were – and are – set by 3:30 p. This has diminished to fewer than 140 You won’t be surprised that there aren’t Without this data. As a matter of in the near future. This is due to ments would be like playing darts with a been from independent refiners – Valero. given the restrictions just mentioned. a new refinery built in the U. when mind high stock levels. of crude in the five-month period of July to supply source. so they’re at the mercy of daily ent boiling points. some of It is no wonder that there has not been between the acquisition cost of crude and them objective but some very subjective. riddle me this. the rack price. and the refining sector has said term crack refers to the spread or refining appears to be taking a back seat to other enough is enough! margin. Current inventories of crude. Chevron. Beyond that. gasoline And. in the past it was relatively easy to declining gasoline demand. with no upstream crude oil rev- underexposed. which is understandable when bearing in up at exactly the same levels at the end of At the other end of the scale. who are buyers of crude day. those at about 1. which for all intents and purposes appears are comparing red apples to green apples. Western Refining and overexposed. the increasing inclusion parts of the country at negative "crack" – customers. The next day Canadian rack price ties. while others are dangerously I find it unfortunate to the point of Flying J. and it seemed it line and distillates have been consistent It’s truly amazing.and Future By Roger McKnight Senior Petroleum Analyst En-Pro International Inc.northernstar.S.25 million barrels per Rack prices and eventual retail prices refiners like Irving. specifically to the refining portion number of price influencers. total petroleum product stocks are the 10 years and $7 billion to build a 400. some say that $80/bbl In view of the end of the driving sea- prices posted by five suppliers in Montreal is the real number to justify investments in son. which should lead EST Monday through Thursday. was going to surpass the $150 mark. but we cate directly in any way.S. meet or communi. So.000 back burner due to the fact that crude did highest on record. not to mention the fact Add in the potential greenhouse gas December 2008. refinery runs are down to below 90%. Demand for gasoline. Pricing Today – Supply both sides of the border.ca | 21 . and Toronto and across the country all end the oilsands. the threatened cap and nies into selling gasoline and diesel in some figures to justify to themselves. but around on a high cost of inputs and low return of to lower prices for the transportation fuel noon on Fridays.ab. forecasting price move. that Canadians would also appreciate the emissions costs.0 and 0. and their trade legislation. The crack being the difference factors in the pricing equation. to consumers. today.S. Imports of gaso- the business day? crude was rising up to. gasoline and distillates. in other words. Tesoro. Sunoco. We now have high volatility annoyance that the largest supplier of enue to fall back on like Exxon. With crude falling from $147 to the and distillates are all above the upper limit we cannot see any chance of one being built $30 level. One movements of crude oil and the recession- An obvious example of hyper-volatility would think that the U. rack with no exploration or production capabili. a multitude of optics some of which are revolving dartboard. cannot provide similar inventory data. respectively. All the closures in the past year have the same options today. not meet the threshold number of $60/bbl. how do the rack to a moving target. and analysts to set or guess the futures In 1981 there were 324 refineries in the The Situation Today numbers for crude. never allowed to speak. So. the inventory data tation fuels. since 1976.m. So. across the country follow these U.

The logical buyer would be Irving exist in China or India. that perceived image requirements may have changed since the the Shell plant closes in Montreal. Ottawa and Kingston crude supply. If ever there was a clear and present danger Shell plans to turn the former refinery Suncor was. the this scenario as a proviso. with duplication Oilsands Image Suncor’s 130.000 bpd refinery in Oakville. an upstream company. sold. the image is still there as refining situation is not much better. known. one in Michigan.000 to 130. and higher prices If Irving were to buy it then this would recession to the point where the excess due to the fact that the refining capacity allow them to stay in the Montreal. Esso also uses Ultramar condition of the sale of Petrocan to Suncor I’d like to ask a simple question of in exchange for the same courtesy being would have been the retention of the Petro. Those refineries to be the powerhouses behind any potential Toronto market they reversed the Toronto in the Sarnia hub may also be looking over recovery from this recession. Midwest tumbleweed. The Suncor facilities.S. And so I find it disturbing that if and diesel to be sent to their storage terminals Crude supply for these refineries is Alberta- when these so-called “green shoots” of a in Oakville from Montreal. in the Montreal. the BP debacle. until such time as the that also spur off to the key U. but this begs the more interested in the exploration and ner and ourselves. California.northernstar. to the intermi- up product from Shell to service the new business venture. The And add to that this ultimate cautionary are the politicians and regulatory entities announced closure of the 130. to say the Although Enbridge has reacted with Irving or Husky Stepping Up? least. serious stress. citing the well. Ottawa refined product capacity has meant that in Montreal has now been reduced from Kingston markets while freeing up the St. the U. due to the less strin. as I see it. To continue supply for the Quebec and the Maritimes. and so should consumers. which is as smoothly as expected. the other in down the dangerous path of dependence of facilities in Montreal. to Montreal pipeline to allow gasoline and their shoulders. and pricing forecasts should include relative lightning speed when compared to For the same reasons here in Canada. we can could be maintained even if the Montreal initial design. Irving picks stream. marketing orbits will be tense.000 bpd. have resulted in a severe cutback in imported gasoline. When cial and retail fuels. and is. supply and pricing Illinois. driving the price of crude up.S.S. closed.ca . only foresee the potential for tighter sup. Shell refinery in Montreal leaves us with 15 ery in Montreal is untouchable.S. American refinery capacity when you are reduced sulphur specs required for gasoline Supply problems will not be limited to playing against a stacked deck that happens and diesel. government who is an employee provided to Ultramar in the Toronto and can image of national supplier of commer.S. which would allow Irving to pick up in refinery. If Shell’s intent is John refinery for more exports to the U. refinery were at best. of course.000 bpd note: do not assume that the Suncor refin. comment ten years. will be at the mercy proposed $300-million pipeline linking the refinery system. and set up an exchange agreement with mental controls in China and India. and only one in Montreal. to use the Suncor refinery as its Montreal It would also give Esso the opportunity to Needless to say. source then this will place the facility under close the antiquated Dartmouth refinery gent. nable discussions in the media concerning Montreal market and from Ultramar for Although we must assume that a key the oilsands and its “dirty oil” image. the current leak scenario question: Where will they get supply? development of the oilsands than the down. So everybody’s happy. supply message to our largest trading part- into a storage terminal. the U. where In 2005 Petro-Canada closed its Irving for the southern Ontario market as it does not take 10 years to build a new 80.000 bpd unit. rampant throughout the new company. it does not make economic sense inability to justify an investment of close to Sarnia or Nanticoke in return for Esso pick- to attempt to increase domestic North $300 million in order to comply with the ing up in Montreal. based. Over the last month or so. mainly through the Enbridge lines recovery turn into something other than So. could not paint a clearer picture. of crude oil imports as well as heading Ultramar refinery in Quebec City to storage two leaks. public: If you don’t want the 22 | The Roughneck Buy & Sell | November 2010 | www.ab. As we understand it. GHG and spec Southwestern Ontario markets. The same myriad of legislation does not ply and higher prices. two areas where Tighter supply options because Irving or Husky. or dare we say. now imports gasoline from China. non-stringent environ. the emission. the Quebec orbit. excluding upgraders and asphalt buyout of Petrocan has not transformed Clear and Present Danger – the plants. with the toughest fuel specs 260. refining and marketing side of the I am referring. of the U. and at worst. that must approve any restart. refining capacity has increased during this may have to withdraw.

oilsands crude oil then what are your even if it is approved. dollar. En-Pro’s team provides • What about expanding offshore drilling on fly out of equities and into treasuries. teamwork. up by Hugo “Huggy Bear” Chavez. supplier of crude on the planet is the of the speculators and traders in both the former head of the KGB. I do not see where ing the cost of crude. the best available prices at all times for reliability of supply and stability of the If. The best advice we can give those laden of gasoline and diesel from you guessed it. economy allow foreign oil companies to assist them when compared to the more mysterious. Although threaten cutbacks in crude oil production. When OPEC sees ments would be a hybrid of the past and • Then there’s Saudi Arabia: it used to be the Western economies in full-blown present pricing methods. derivatives have virtually no relation to 1-800-686-6449. By this I mean that quotas.and long-term price projections ico’s Gulf resources are drying up. Pemex. on a given day. rather than fact. it will take ten years If.ab. Looks to me Add to this the weather forecasts in who has in reality kicked out or national. The daily Contact Roger McKnight at: natural gas supply agreements went with movements of crude oil and its refined rmcknight@en-pro. thereby lowering the dollar and increas- high-sulphur crude from a country headed Given the options. the price of En-Pro is celebrating 25 years of Pemex situation in the Gulf of Mexico.html) helps clients receive traits required in a supplier profile are nabe” equity. As a result.S. price fixing. as meetings. shows solid recovery symptoms then short-.ca | 23 . the geopolitical forces with the task of setting budget require- the USA! are relatively comatose. The the cartel members loses cohesion as crude crude down. are rarely adhered to thus defeat. is crude is following emotion and intuition providing innovative strategies in complex rapidly drying up. funds and analysts. will not The supply and demand situation is simple Until such time as the U. subjective. integrity in presidential moratorium on this idea. on the other hand. like the Canadian and Venezuelan offer. we see an uptick preferred alternatives? to bring a drop of extremely expensive in employment levels then money goes the crude onshore. it claims to have spare capacity.S.S. Sorry this doesn’t work statistic such as the nebulous Consumer a staff of 24 dedicated team members for these two. • Then there’s Iran/Iraq: two of the key Crude oil pricing has become a “wan. when resources are already stretched to the the economic prospects seem more prom. However misdirected. Just ask how the financial and equity markets. They have governing powers. As it stands today. it is In times like these the co-operation of General rule of thumb: U. and above all. sour. En-Pro (www. dollar up. times of unpredictability. non-measurable factors that medium. That’s what we do in my business – ising than that of the U. and lowering crude prices.com and/or Belarus and Ukraine. diesel down. and watch for sud- now it has slipped to #2 or #3. diesel up. forecasting short.S. consensus is that it is heavy and sour just oil revenue becomes more important than crude up. forcing include the financial markets and geopoliti. • What about the North Sea Brent crude? inventory levels.000 bpd cal influences on potential price changes. either the hurricane or winter seasons and ized all foreign oil company projects. ing the purpose of OPEC. energy markets. which is basically max. more like a long-term solution. as It’s certainly a lot to keep up on for ings. but recession it is not in their best interest to U. other way into equities and out of treasur- • Venezuela? Good pick.northernstar. com/25/index. All heavy. den movements in the U. unbiased and the East Coast? The BP mess has placed a increasing the value of the dollar and trusted advice. will be difficult.or long-term price move- • Mexico? Another good pick since that Subjective Pricing Factors ments becomes smoke and mirrors. a government their energy and commodities. U.S. The Roughneck Buy & Sell | November 2010 | www.S. ies.en-pro. refinery runs or demand Sorry. But the Saudis are gradually turning announced following the regular OPEC major consumers of petroleum at times their attention to China as a customer. Watch the weekly the number-one supplier to the U. inventory reports. nation’s oil company. it’s getting more complicated. help navigate and guide consumers through • How about Russia? A dubious choice By far the most important factor in the oil enigma because it’s not getting any given that the true leader of the largest today’s pricing theory is the involvement easier. dollar down. in deep-sea exploration. proven. the supply. Confidence Level shows a decrease. Mex.S. that country now to import 460. somewhat secretive on the quality. just like the levels. again. the oilsands are a problem. exceptional service.