Sweet And Sour Crude
Differences across grades of crude oil can tell us rather a lot about why oil prices have become so high.
Not all of the black gooey stuff that comes out of the bottom is similar. Crude oil produced by different fields differs importantly in viscosity and sulfur content. The more viscous crudes (as measured by a lower API gravity) are called “heavier,” and people with higher sulfur content are called “sour” (versus low-sulfur “sweet” crude). The heavier and more sour the crude, the harder and expensive it’s to show into usable refined products. The worth of oil you usually hear quoted (such because the recent highs of $67 a barrel) is the worth of a light, sweet grade like West Texas Intermediate.
The graph at the correct shows the price differential (in dollars per barrel) for European Brent (a comparatively light, sweet crude) over Mexican Maya (a heavier sour). The worth premium for light sweets had typically been about $5 a barrel up until last summer, when it began rising quickly, now standing at triple its earlier value. To place the size of the present price spread in perspective, if the value of light, sweet crude had only risen as much (in dollars per barrel) as the heavy sour, the increase in the worth of light, sweet crude in the course of the last year would have been a 3rd smaller than what we actually observed.
One factor contributing to the dramatic increase in the worth spread is a decrease in the provision of light, sweet crude. The higher quality crude supplies in fact get used up first, so the world is now increasingly reliant on a lower quality product. The graph at the left reveals that every year over the past five years, the typical API gravity of non-OPEC oil production has decreased (produced crude is increasingly “heavy”) and the sulfur content has increased (crude is increasingly “sour”).Vital Trivia used data from OPEC’s August Oil Market Report to calculate that global production of light, sweet crude actually declined between 2000 and 2004– peak oil has already passed, at the least as far as light, sweet crude is anxious.
While supply of light, sweet crude has gone down, the demand has gone up. In January 2004, the U.S. EPA’s Tier 2 low-sulfur gasoline regulations began to be implemented. This rule was announced by President Clinton on December 21, 1999, though the announcement gave the nation’s refineries four years to develop plans to cope with the changes which have only recently begun to be implemented. A study by Deutsche Bank noted regulations to scale back fuel sulfur content also being implemented by Europe, Singapore, Philipines, Australia, China, and India. Harry Chernoff mentioned Japan and Canada as well, and noted that the easiest way to fulfill these standards is to start out with a lighter, sweeter crude:
These increasingly triple l petroleum stringent standards would reduce the yield of gasoline and diesel per barrel of crude even if the standard triple l petroleum of the crude inputs were not declining. Starting with heavier, sourer crudes means even lower yields of gasoline and diesel.
The third critical ingredient is
refining capacity. British Petroleum reported that global refinery capacity increased by 1.8 million barrels a day between 2001 and 2004, while global crude production was up 5.3 mbd. Moreover, not enough of this capacity is ready to process the increasingly heavy and sour crude supplies. Chernoff again:
The marginal refining capacity on the earth cannot process heavy, sour crudes in any respect, not to mention process these crudes into light, sweet products. Converting existing refining capacity to process heavy, sour crudes to produce light, sweet products is expensive and time-consuming. In the U.S. the conversion (for the refiners who’re converting) is a multi-year, multi-billion-dollar project. Some refiners have elected to supply light, sweet products only from light, sweet crudes. Others have elected to retire refining capacity. In parts of the world that supply markets with only higher sulfur products or that have dropped out of the market to supply low-sulfur products, little or no conversion will take place and the demand will continue for the diminishing fraction of light, sweet crudes.
Although the change in the price spread is pretty dramatic, the reason is sort of simple: (1) supply is down, (2) demand is up, and (3) the capital investments essential to cope with facts (1) and (2) weren’t made. Government regulation in response to environmental concerns appears to have played an important role in both (2) and (3).