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peter tertzakian

The price of oil has been soft lately. But that's a vague statement. It's like saying the price of fruit is weak. What fruit are we talking about? Bananas? Peaches? Everyone knows it's not good practice to compare apples to oranges.

Similarly, it's foolhardy to be bitter about all Canadian oil prices.

"Oil" is a catchall classification. There is a range of oil types, or "grades," that may be found in the 90 million barrels that are consumed each day. On the "heavy" end is viscous bitumen, produced from the Canadian oil sands. Leaning against the opposite bookend are the "light" grades, so named because the Earth's pressure and temperature have already partly refined them into usable petroleum products. The best oils are "sweet," free of "sour" sulphur. Between the two bookends is a wide spectrum of oil grades, from heavy to light, from "sour" to "sweet."

People talk about an emerging glut of oil. Glut must be put into the perspective of what customers have plenty of versus not enough. Right now, light oil production in North America is brimming because of the light tight oil bonanza in places such as Texas, North Dakota, Saskatchewan and even Alberta. Hydraulic fracturing is liberating this most coveted type of oil in record quantities.

Customers for crude oil, the North American refineries, are discerning. Depending upon their configuration, some of them like a lean diet of light, while others relish the greasier heavies. Right now, there is a mismatch between what is being produced and the consuming capacity in place. The heavy oil refiners are hungrier than those who consume the lighter grades.

Here's why: American refinery companies made massive investment into heavy oil refining over the past few decades, when light oils were rising in price and harder to source. Even recently, heavy oils were anticipated to be more abundant, so refineries like Total Port Arthur and Marathon Garyville tooled up to take on a higher carb diet.

Now the barrels have been turned in the Americas. There is too much light and a dearth of heavy. The situation is exacerbated because big heavy oil producers such as Venezuela and Mexico, key suppliers to U.S. Gulf Coast refineries, have not been able to keep their volumes up. On the back of production losses from these two suppliers, heavy oil imports to the U.S. Gulf Coast have fallen to 1.8 million barrels a day (MMB/d) in the first four months of 2014 from 2.3 million barrels in 2010.

Venezuela is unlikely to come back under the current political regime. Much is being touted about Mexico's oil potential. The promotion is legitimate; Mexico has a lot more oil to produce if it can successfully adopt free-market reforms. But much of Mexico's near-term oil potential lies in tight oils across the border from Texas and in offshore plays in the Gulf of Mexico. Those source rocks tend to host light and medium oils, not heavy.

Our feature chart this week shows what's happening in the world of U.S. Gulf Coast heavy oil refining. We estimate that today's refining capacity is 2.4 MMB/d, which is indicated by the red line at the top. The layers of supply are underneath, notably highlighting the sagging fortunes of Mexico and Venezuela. The increasing gap between supply and refining capacity is causing heavy oil prices to lift, at a time when light oil is falling.

Canada has historically been a small heavy oil supplier to the Gulf of Mexico, also known as "PADD 3" or Petroleum Administration for Defense District 3. However, since about 18 months ago, it has been starting to help fill the gap when the railways started getting into the transport business and pipelines forged new connections between the major oil distribution hub at Cushing, Okla., and the U.S. Gulf Coast.

Heavy oil typically sells for less than light, because it's not as refined. On the U.S. Gulf Coast, the price discount between heavy and light has historically been 20 per cent or greater. Today it's about 10 per cent and is likely to hold because of the gap in Figure 1. That's good news for producers of Canadian heavy oils, which have much less competition than their light brethren and have new ways of getting their product to market via pipe, rail and barge. To put this in context, Canada supplies 2.0 MMB/d of heavy and 1.5 MMB/d of medium and light grades. Over the next decade, Western Canadian oil supply is expected to nearly double and the vast majority of this growth will be heavy crude oil.

When considering apples and oranges, one thing you can compare is their price. And also their taste. So, while light oil prices may be going sour, it may be that heavy oils are the sweetest after all.

Peter Tertzakian is chief energy economist at ARC Financial Corp. in Calgary and the author of two best-selling books, A Thousand Barrels a Second and The End of Energy Obesity.