Falling oil prices should be welcome news for Canadian drivers as they look for a break from the stubbornly high cost of a fill-up at gas stations across the country.
But in both Canada and the United States, gasoline prices have remained high, despite recession-level demand for oil products. Pump prices in Canada are now 22 per cent higher than they were a year ago, while the most commonly quoted oil price, West Texas Intermediate, is up only a few dollars.
Over the past several months, the oil industry has taken advantage of lower crude prices and a surprising increase in U.S. exports of petroleum products to reap fat returns. In some regions, refiners' profit margins reached levels last seen during the pre-recession "golden age of refining."
Consumers finally began to get a break at the pump after Labour Day, when vacation driving drops off. But still, the fall in gasoline prices has not matched the decline in crude costs since spring.
The most closely watched crude, West Texas Intermediate , fell from its peak of $114 (U.S.) a barrel in April to a low of $81 in mid-August. It then bounced around between $85 and $90, before tumbling back to $80 amid growing gloom over the growth prospects of the global economy.
From their peak in early May, average pump prices in Canada have dropped 12 cents a litre to $1.23.9 last week. But in that same period, refiners have increased their take by 10 cents a litre, and their operating margins are now at record levels in Canada.
Similarly in the U.S., retail gas prices have dropped from nearly $4 (U.S.) a gallon to $3.45, still 76 cents above prices this time last year. Meanwhile, oil companies have seen their refining margins swell, even as American drivers cut their gasoline consumption during the holiday driving season by 1 per cent, compared to last summer.
Why aren't motorists getting the benefit of lower crude prices?
In the short term, the crude market and gasoline market operate independently, with crude cost being only one factor in the pricing decisions in wholesale and retail gasoline markets. Foreign demand and refinery outages in the U.S. kept product markets relatively tight.
But most importantly, West Texas Intermediate simply no longer serves as a reliable benchmark for North American oil prices. If you want to follow gasoline prices, keep an eye instead on North Sea Brent, the benchmark international crude.
There is now a deep disconnect between "landlocked" crudes like West Texas Intermediate and globally-traded ones like Brent, which are processed by most North American refineries. A year ago, WTI and Brent were priced virtually the same. But early this year, the spread opened up, hitting a high of $27 in August. It's now at $21.
WTI still serves as a benchmark for Canadian oil producers, who mainly sell into that landlocked middle American market. But most of the continent is more exposed to the global marketplace for crude and petroleum products.
Many North American refiners compete for the more expensive, international crudes with dynamic emerging markets in China, the Middle East and Latin America. And it's those international crude prices that ultimately drive gasoline prices.
Consider the case of HollyFrontier Corp., a Dallas-based company that has five refineries across the mid-continental region of the United States. HollyFrontier is making record profits by processing low-cost crude into gasoline and diesel that it can sell for prices that are heavily influenced by the international – rather than North American – marketplace.
But virtually all North American refiners – from giant Exxon Mobil Corp. to Canada's Suncor Energy Inc. – are enjoying the lucrative profit margins to some extent.
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Why Is West Texas Intermediate so much cheaper than Brent?
Blame Canada, and Cushing.
In February of this year, TransCanada Corp. completed a leg of its Keystone pipeline to Cushing, Okla., adding to a glut of crude at the traditional oil hub, where the futures contracts for West Texas Intermediate are deemed to be "settled."
On top of the additional Canadian crude, the mid-continent market is being flooded with oil from the prolific Bakken play in North Dakota.
The terminals at Cushing have no pipeline connections to the Gulf Coast market, which houses roughly half of the U.S. refining capacity and is seeing increasing exports of refined products like gasoline and diesel.
As a result, producers who sell into the landlocked, mid-continent market are being forced to discount their crude. Many western oil producers – including Canadian-based companies – have their prices set off the WTI benchmark that is established in Cushing.
While the mid-continent market was flooded with crude, Brent prices soared as violent protests and revolution roiled the Middle East. The Libyan revolution erupted in February, taking 2.5 million barrels a day of high-grade oil off the global market.
The interior North American market was not immune to the Arab Spring, but WTI-based prices did not climb as fast as internationally-traded crudes.
Why has Brent become the standard for setting North American gas prices?
While many refiners have benefited from discounted oil – or feedstock, as it is called – they have not passed all those savings along to consumers. Like any company, they sell their product at the highest price the market will bear.
As a result, the wholesale gasoline price reflects the cost of Brent, as well as North American grades of crude – including Louisiana Light Sweet and Alaskan North Slope – that are trading at prices comparable to Brent.
"So far, since we've had this disconnect of crude oil benchmarks, it's been the highest price for crude oil that has established the price for gasoline," said Tom Kloza, chief analyst at Oil Price Information Service.
Refiners from the Gulf Coast and East Coast – which process Brent-benchmarked crude – reach deep across the continent to satisfy demand for products.
It makes good business sense for companies that are benefiting from lower-cost feedstock crude to maximize their profits by selling at the same price as those who are forced to refine the higher-cost crudes.
"No matter what oil you're consuming, you're essentially spitting out the same product," said Patrick DeHaan, chief analyst for Gasbuddy.com, which tracks North American petroleum markets.
"Refineries that are inputting cheaper oil are selling it at the same price as – or maybe a slight discount to – refineries that are processing more expensive crude."
As a result of an active cross-border trade, local Canadian wholesale prices move in virtual lockstep with costs in corresponding U.S. markets.
How have exports helped support North American prices?
Perhaps most galling for North American consumers is the fact that petroleum markets do not truly reflect the weakness of demand. Booming export markets have helped keep North American supplies tight, a situation that was compounded by unplanned refinery shutdowns.
After years of being an importer of petroleum products, the U.S. became a net exporter this year as sales of gasoline, diesel and fuel oil boomed. The foreign sales have helped keep inventories low and the market tight to support wholesale prices.
The U.S. now exports some 2.3 million barrels of refined products, mostly from the Gulf Coast, with destinations in Europe and rapidly growing volumes to Latin America. It imports 1.9 million barrels of product, primarily gasoline to the East Coast.
In all, U.S. exports of petroleum products have grown more than 60 per cent since 2007 as global markets have become more integrated. Much of the increase involves what are known as middle distillates – diesel and heating fuel – which are more widely used in Europe and Latin America than in North America.
The strong overseas market for distillates has led refiners to boost the percentage of distillates they produce versus gasoline, though most have only limited flexibility. The U.S. Energy Information Administration says refiners have boosted their yield of distillates to 28 per cent of their total production from 24 per cent four years ago.
That has reduced the amount of gasoline being supplied to the North American market, but has also put additional pressure on the price for diesel and heating oil.