The ABCs of crude supply disruptions
For the people of Libya, with life, death, and the future of their country in the balance, the price of oil probably doesn’t rank as a top concern at present. However, recent price movements suggest that the oil markets are closely following events in Libya and elsewhere in North Africa and the Middle East. Oil prices have risen from the first signs of disquiet in Tunisia to the fall of Egyptian President Mubarak to the violence and power shift in Libya, which has significantly disrupted that country’s field production and exports. Libya produced about 1.65 million barrels per day (bbl/d) of crude oil in 2010, or approximately 2 percent of global supply, while net exports (including all liquids) were roughly 1.5 million bbl/d. The incomplete information coming from Libya has not spared the oil sector, and the market grasp of the scope of disruption has been less than precise, with estimates of production declines in the middle of last week ranging from 500,000 to 700,000 bbl/d to a near total shutdown. But even an exact measurement of the crude oil, product, and natural gas shortfall in Libya would, at best, provide a partial sense of its significance. The market impact of such a supply disruption goes beyond volumetric loss and entails many different factors, which we begin to sort out below.
Crude volume versus crude quality
Although oil is generally seen as a fungible, in fact, crude comes in many different grades of varying qualities and product yields. Libya’s importance to the oil market stems not only from its substantial production, but also from the light, sweet quality of its crude grades. Es Sider, its largest stream, has a slightly lower gravity than benchmark grades Brent and West Texas Intermediate (WTI), (meaning that it is a slightly heavier grade of crude) but a slightly lower sulfur content (meaning that it is sweeter). Another Libyan grade, Sirtica, is lighter than Brent and WTI. Light crudes are, generally speaking, the easiest to process and can be run by relatively “simple” refineries that may not be able to handle heavier or sourer substitutes. A loss of light, sweet crude volumes is, as a rule of thumb, more difficult to deal with than a loss of heavier and sourer ones. This is not only because the refineries that run light, sweet grades have limited feedstock flexibility, but also because most of the spare crude production capacity tends to be at the heavy, sour end of the barrel. Fortunately, current utilization rates for U.S. refineries suggest that there is a significant margin of spare capacity at “complex” refineries that could be used to process heavy, sour crude oil.
Market outlet and destination
Although the majority of Libya’s oil output and most of its natural gas production goes to Europe, its crude market reach is wider, extending all the way to China. But the ultimate impact of any crude disruption goes beyond the immediate buyers of that specific oil. As buyers find substitute supplies for the disrupted oil, those replacement barrels, in turn, are diverted from their original use or destination, causing secondary impacts. Should it be prolonged, a disruption in Libyan exports could have a larger effect on U.S. oil supply sources than the relatively small volumes of Libyan crude actually imported into the United States would suggest. Unlike Libyan production, more than a third of Algeria’s light, sweet crude (a possible substitute from fields relatively close to Libya’s) is shipped to U.S. refiners, which sometimes use it as a blending stock to lighten heavier crude grades. Should those volumes find a stronger market in Europe, U.S. end-users would have to look for alternate supplies. Light, sweet Nigerian crude, which depending on market conditions can wind up in the United States, Europe or Asia, is another case in point. Global crude oil flows will tend to adjust to best match demand needs with available supply sources.
Short haul versus long haul
Location is another important factor affecting the impact of a disruption. The closer the fields where a disruption is occurring are to their market outlet, the more immediate the disruption’s impact on oil inventories and prices is likely to be, unless an alternate supply source equally close to market can be found. In December 2002 and early 2003, a worker strike that curtailed Venezuelan production was immediately felt in the United States, a short-haul destination. Substitute imports from distant Saudi Arabia took weeks to arrive. The rerouting of supplies increased shipping distances, tying up tankers for longer voyages and further tightening a shipping market that had already been firming even before the event. In contrast, while there can be indirect effects on long haul markets from localized substitution, those long haul effects would be comparatively subdued.
Crude versus products
Another way in which a disruption in one market sends ripples through others is via the product markets. Much of the Libyan crude oil refined in Mediterranean refineries is re-exported as product after processing by export-oriented refineries. Italy is Libya’s top crude oil customer, with Libyan crude oil accounting for roughly a quarter of Italy’s total crude imports. But the volume of its refined product exports exceeded that of its Libyan crude imports. Should the disruption force Italian and other refiners to decrease their runs, a sustained disruption in Libyan exports could result in decreased Italian product exports to other markets, tightening product markets well beyond the Mediterranean basin. At this time, however, Italian refinery runs have not been visibly affected by the current disruption.
The impact of a supply disruption is greatly affected by underlying market conditions, such as supply and demand balances, commercial and strategic stock inventory levels, and spare production, transportation and refining capacity. In 1973, the Arab oil embargo had an acute market impact because demand had been growing steeply and the market was already tight even before the event. But in 1967, an earlier Arab oil embargo ended in failure because the market was much more slack. The current disruption is occurring against a context of relatively comfortable spare capacity. Oil inventory levels are generally high by historical standards. But they are not evenly distributed throughout the world and are markedly tighter in Europe, the primary market for Libyan crude, than in North America. The European Brent market had been tightening before the start of unrest. In contrast, spare capacity in both transportation and refining remains abundant, which makes it possible to carry substitute barrels at a relatively low cost over long haul routes and to process barrels of a lesser quality than Libyan crude.
Because demand and supply are both subject to seasonal cycles, the time of year of a supply disruption affects its impact. The current disruption is occurring in a relatively low-demand season. Should it be prolonged, it could conflict with a seasonal ramp up in refinery production ahead of the peak summer driving season. Crude maintenance in the North Sea and elsewhere is also relatively low in the first quarter.
Countries with strategic reserves of crude oil and/or petroleum products must decide whether or not to release them in response to a disruption. The decision is a complex one whose potential benefits must be weighed against costs that include a reduction in pressure on suppliers with spare capacity to increase output, and a lower amount of reserves available for use in the future. Most of Europe’s strategic oil reserves are held in products at refinery sites. The United States also holds its strategic reserves in both light and heavy crudes which can meet a variety of market needs.
A supply disruption does not necessarily come in the form of a loss at the wellhead, but can result from a transit blockage. Although Egypt is not a large exporting country, it is important to the oil markets as a transit corridor. Earlier this year, as unrest mounted in Egypt, the market grew concerned that oil traffic though the Suez Canal and the SUMED pipeline might be halted. A significant amount of internationally traded oil moves through a number of chokepoints, such as the Strait of Hormuz, the Strait of Aden, the Strait of Gibraltar, the Bosporus and the Malacca Strait, to name a few of the most well known, where it is vulnerable to bottleneck and transit risks. Unrest in Yemen might raise market worries about disruption in the Strait of Aden; although repeated attacks by Somali pirates have already taken a toll on local traffic, oil has continued to flow. In the past, Iran has occasionally raised the threat of retaliating by disrupting tanker traffic in the Persian Gulf if it came under attack. However, even during the Iran-Iraq war, oil continued to flow through Hormuz.
Unrest in one country can raise concerns about potential disruptions in another through a perceived risk of “contagion.” Unrest and upheaval in economies that are non-critical to global oil supply might nevertheless rattle the markets by causing worries that they might spread to neighboring or politically- or culturally-related countries that may be of greater importance to energy market participants.
Just as many factors may shape the market impact of a disruption, that impact may manifest itself through a variety of channels. Changes in prompt crude prices are just the most visible and immediate one. Other effects have to do with changes in the relative value of prompt oil supplies across the quality and grade spectrum, changes in the crack spread (the difference between crude prices and product prices) and in the time spreads, or shape of the futures curve. A loss of crude volumes with a high distillate yield will cause distillate prices, not just crude prices, to rise. A supply disruption can cause the price of prompt barrels to rise relative to that of barrels for later delivery – thus pushing the futures curve into backwardation, as opposed to contango (when futures prices are higher further into the future). Changes in the futures curve, in turn, carry implications for inventories and oil trade flows.
Retail gasoline and diesel prices surge
The U.S. average retail price of regular gasoline gained 19 cents versus last week, marking the second largest weekly increase since the EIA began tracking weekly retail price data in 1990. The only week posting a larger increase was in September 2005 when retail prices rose sharply due to Hurricane Katrina. At $3.38 per gallon, gasoline is now $0.68 per gallon higher than last year at this time. Prices in the Midwest jumped almost 23 cents, the biggest increase in the country. The Gulf Coast followed closely behind, with gasoline prices in the region gaining 22 cents on the week. The East Coast saw an increase of over 18 cents, while the West Coast gasoline price advanced 14 cents. The smallest increase this week was in the Rocky Mountain region, where the price rose 11 cents, making gasoline in the Rocky Mountains the lowest in the country at $3.18 per gallon. The most expensive gasoline among the major regions is on the West Coast, where the average retail price is $3.62 per gallon.
Diesel prices rose for the thirteenth consecutive week with the U.S. average retail price adding more than 14 cents to last week’s price. At $3.72 per gallon, diesel is $0.86 per gallon higher than last year at this time. Diesel was up across the country, with the biggest increase coming on the West Coast where prices jumped 16 cents over last week. Diesel on the East Coast and Midwest increased more than 14 cents, in line with the national per gallon average increase. The Gulf Coast diesel price registered a gain of over 13 cents while the Rocky Mountains saw diesel increase an even 13 cents.
Residential heating oil prices increase sharply
Residential heating oil prices continued to rise during the period ending February 28, 2011. The average residential heating oil price increased to $3.76 per gallon, nearly a $0.14 per gallon over last week and $0.86 per gallon more than last year at this time. Wholesale heating oil prices increased by $0.21 per gallon last week, reaching a price shy of $3.05 per gallon. This is $0.93 per gallon higher than last year’s price.
The average residential propane price increased by more than $0.04 per gallon to reach a price just under $2.86 per gallon. This was an increase of $0.18 per gallon compared to the $2.68 per gallon average from the same period last year. Wholesale propane prices jumped nearly $0.29 with the overall price at $1.69 per gallon. This was an increase of $0.34 per gallon compared to the March 1, 2010 price of $1.35 per gallon.
Propane stocks fall as heating season nears an end
Total U.S. inventories of propane declined 1.0 million barrels last week to end at 28.5 million as heating season in the U.S. winds down. The Midwest region had the largest stock draw of 1.3 million barrels of propane. The Rocky Mountain/West Coast region also had a draw of 0.1 million barrels. Meanwhile, the East Coast and Gulf Coast regions each added 0.2 million barrels of propane inventory. Propylene non-fuel use inventories represented 9.1 percent of total propane inventories.