U.S. Pipelines Keep Gas Prices High
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The spread between Brent (NYSEMKT: BNO) crude price and West Texas Intermediate (NYSEMKT: USO) crude price has been the subject of a lot of discussion in the past year. At one point last year Brent traded at a $27 premium to WTI. Historically, the two have tracked each other fairly closely, but that has changed in recent years as the U.S. production of oil has increased. The current spread is back to around $15 but it is not likely to go much below that anytime soon.
The reason, for the most part, is the balkanized pipeline system in the U.S. which was designed during the Cold War. The system was designed to be regional in the case of nuclear attack which would allow oil to flow locally if one section of the country was destroyed.
Because of this system, most of the U.S. population gets their oil either from the North Sea directly, actual Brent crude, or gets it priced at a premium to Brent, i.e. the West Coast. Only ‘Flyover Country’ refineries get their oil domestically, and consequently they also have some of the lowest priced gasoline in the country.
The price of gasoline futures on the COMEX tracks much more closely with the price of Brent crude than with WTI crude. The %RSD of the ratio of Brent to gasoline futures prices for the past 13 months has been 4.67% while for the WTI:Gasoline ratio the %RSD was 7.46%.
With ConocoPhillips (NYSE: COP) selling its stake in the Seaway pipeline to Enbridge last fall the spread began to close. Enbridge then, after repairs and other maintenance work, would reverse the flow of the pipeline to flow away from the depot at Cushing, Ok. There was so much oil flowing into Cushing last fall that refiners were paying up to 30% under the spot WTI price for deliveries. Recent news noted that the work on the pipeline was ahead of the original June target date and that caused the Brent/WTI spread to drop from nearly $20 per barrel to $15-16 per barrel.
Recently the Obama administration along with the Cameron government in Great Britain hinted at mobilizing a portion of each country’s strategic petroleum reserves as a way to dampen speculation in the oil markets as well as knock the price down, especially since this is an election year and high gas prices are also highly correlated with the incumbent losing in U.S. elections.
The problem with this is, of course, that there is already an internal glut of oil in the U.S. and while it is likely that any release from the SPR would come from the coastal holding depots it would not change the overall fundamentals of the oil market.
At this point there are a number of factors impacting the price of oil, buoying it in the face of deteriorating economic conditions in the E.U. periphery and the U.S. itself. They are:
- Global demand for oil by the populous emerging markets like China, Brazil, Vietnam and India
- The war-mongering rhetoric and threats of supply disruption by the U.S. and the E.U. towards Iran.
- Profligate money creation by the five major central banks of the U.S., the E.U., Switzerland, Great Britain and Japan.
- Japan’s shift from nuclear power in the wake of Fukishima towards oil
So, while the U.S. is busy producing oil and natural gas in quantities it hasn’t been able to for decades it cannot get either of these products to international markets and take advantage of the demand for them. Natural Gas (NYSEMKT: UNG) is especially troublesome. The current futures price for natural gas on the COMEX is around $2.20 per million BTUs while the world is still paying close to $4.00 for the same amount.
Since the U.S. cannot adequately take advantage of the domestic production either directly or through international trade it is stuck with higher gas prices choking off any signs of an economic recovery. While I expect in the long run that this will change, and for the better, the present scenario only strengthens the thesis that worsening economic conditions will beget another round of money printing by the Fed which will force gasoline prices even higher as global demand for Brent as priced in cheaper dollars moves back towards $150 per barrel.
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