Wednesday, 18 June 2008

Oil in Pictures - Price vs API

Today's picture is a bit technical, so perhaps an explanation is due.

Crude oil is sold in various varieties, based on it's lightness (API is a measure of this). The higher the API, the higher quality and lighter the crude.

As we know, the world is running out of the good stuff, the high API light oil. The second half of the oil is trying to use the heavy, sulfur rich and harder to refine oil we have left.

So, how are the prices of high and low API crude oils developing now that we are nearing the peak of the high API crudes?

As the image above shows, the price premium for high API crude (i.e. Malaysian Tapis) is rising over the low API variety (i.e. Mexican Maya).

The low API sets the floor for prices and the high API sets the ceiling. Now that we are pumping less and less of the high API oil, there is a more significant supply problem with that variety.

There is still more of the low API crude, but a bulk of refineries are not set up to handle that currently. Also, it has a lower usable energy content and takes much more time & money to distill into usable petroleum products.

This situation we now find ourselves in can lead into peculiar situations, where over a dozen of tankers full of Iranian heavy oil float on the Persian Gulf waiting for buyers, who in turn try to outbid each other on the more preferred varieties like Brent, WTI and Tapis.

Further, Arab Opec nations keep telling us that the markets are well supplied. Well, perhaps to some degree yes, but mostly with the kind of variety that the buyers do not want nor can use.

So, until the refeneries retool and buyers move over to heavier crude, there is very little temporal relief in stock for the fundamental issue driving the up the prices.

Now if there is a speculative part in the prices on top of the fundamentals, that may give in sooner, but only time will tell. Even if it does, it is unlikely to bring the price down to the level of $65/barrel like some people think. Whatever the drop, if it ever happens, it is also unlikely to last for very long.

Nothing changes the most profound fundamentals. For all liquids, we are on a production plateau, from which we may get temporarily up, but after which we face the inevitable decline.