Study of crude oil and gasoline prices
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The influence of crude oil prices on provincial variations in gasoline price changes in the Consumer Price Index (CPI) since 2011
Consumer spending on gasoline accounts for a relatively large share of total household expenditures. At 5.8%, gasoline is one of the largest weighted items in the 2009 basket of goods and services for the Consumer Price Index (CPI). This means that Canadians spent on average 5.8% of their total household budget on gasoline.
As a result, changes in gasoline prices can exert significant upward or downward pressure on consumer price inflation, as measured by the CPI.
Differences in the rate at which gasoline prices change across provinces can lead to differences in the overall rates of change in consumer price indices in different parts of the country.
For much of the last decade, changes in gasoline prices in Canada have been similar across provinces. A reason for these comparable price movements is that changes in the cost of crude oils have had similar effects on changes in the prices of petroleum products, including gasoline, in different parts of the country.
Of all factors that determine the final retail price for gasoline in Canada, the cost of crude oil accounts for the largest proportion (48%), according to MJ Ervin & Associates Inc. petroleum price data for September 2012.
However, starting in 2011, divergence between provincial gasoline price indices expanded and became the largest variation observed in the last decade (chart 1).
To shed light on diverging movements in gasoline prices across Canada, this paper examines the crude oil benchmarks that influence prices in different segments of Canada's crude oil and gasoline refining markets. It also looks at how the recent divergence in crude oil benchmarks coincides with relative changes in gasoline prices across the country.
Note to readers
Heavy crude oil refers to oil which, compared to other types of oils, has a high density and does not flow easily.
Light oil refers to oil which, compared to other types of oils, has a low density and flows easily.
The terms 'sweet' and 'sour' are used to describe a crude oil's sulphur content. The New York Mercantile Exchange (NYMEX) designates oils with less than 0.42% sulphur content as sweet and oils with any higher sulphur content as sour.
The term 'landlocked' refers to crude oil which has limited ability to reach global markets as it must be transported through pipelines.
The term 'waterborne' refers to crude oils that are primarily transported to markets by oil tanker and as a result can be shipped to nearly any crude receiving marine terminal in the world.
Crude oil prices
Regardless of the source, crude oil prices are set in global and regional markets directed by supply and demand. Any actions or events which may affect the current or future supply and/or demand for oil will impact its price. Therefore, the price of crude oil (and by extension of gasoline) in Canada is influenced by foreign and domestic factors.
Not all crude oil is equal; quality plays an important role in pricing. Types of crude oil are usually differentiated by their density and sulphur content. The heavier the crude and the higher the sulphur content, the lower the quality and price, as more refining will ultimately be required to produce gasoline and other distillates.
Given that there are so many different varieties and grades of crude oil, benchmarks are often used to set crude prices. There are two crude benchmarks which Canadian refiners are likely to encounter: West Texas Intermediate (WTI), and Brent.
WTI is the price benchmark for North American-produced crude oil. It represents high quality light, sweet crude oil that can easily be refined into motor vehicle fuel. Since most crude oils benchmarked to WTI must be transported by pipeline, they cannot easily reach global markets and are thus considered to be 'landlocked' (Natural Resources Canada).
Brent is a price benchmark for crude oil coming primarily from Europe's North Sea. Brent is not as light or as sweet as WTI, but it is still a high-grade crude. It requires more refining, relative to WTI, to create gasoline.
Since the majority of crude oil benchmarked to Brent is capable of being shipped to nearly any oil receiving marine terminal in the world, Brent is considered 'waterborne' (MJ Ervin & Associates Inc., April 2012). Brent is the leading global benchmark for crude prices given its ability to reach foreign markets.
Gasoline and fuel oil market in Canada
While Canada is a large and growing net exporter of crude oil, crude imports represent roughly half of the country's petroleum refinery supply. In 2011, imported crude oil accounted for 40.7% of crude supplied to Canadian oil refiners (Statistics Canada, CANSIM Table 134-0001).
For some refiners, particularly those in Eastern Canada, it is more economical to use imported crude oil. This is because of logistical challenges and high costs associated with transporting crude oil across the country, as well as the extensive availability of 'waterborne' crudes (Natural Resources Canada, February 2012).
Refiners in Western Canada process domestically produced crude oil, while Ontario refiners often use a mixture of domestic and imported crude oil. The availability and use of both domestic and imported crudes make the crude oil economy in Canada a dual market (Natural Resources Canada).
Canadian petroleum refiners, regardless of whether they refine domestic or imported crude oil, are 'price takers'. This means that the price they pay for crude oil is based on benchmarks set in regional and global markets. Refineries that run domestically produced crude are more likely to face prices benchmarked to WTI. Users of imported crude oil generally pay prices that echo Brent (Natural Resources Canada, February 2012).
The use of various crude oils by Canadian refiners is not a recent phenomenon. Total receipts of crude oil supplied to Canadian refiners have been comprised of both domestic and imported crude since data were first collected in 1973.
The emergence of a price differential between crude oil benchmarks over the last two years highlights the dual structure of the crude oil market in Canada and can be associated with geographical differences in gasoline price movements.
Brent-WTI price differential
Historically, WTI crude has been priced slightly higher (US$1-$2 per barrel) than Brent because it requires less refining for gasoline. However, since WTI and Brent are crude oils of similar quality their prices typically move in unison. From January 2000 until the end of 2010, WTI and Brent prices followed each other closely (chart 2).
In 2011, the price differential between these two crude oil benchmarks has increased, reaching nearly US$30 per barrel as of September 2011.This trend continued into 2012, averaging US$18 per barrel at the end of September 2012.
There are a number of factors behind the price differential between WTI and Brent. The main reason for the emergence and continuation of the price gap is related to challenges of distribution facing the North American benchmark.
Since the beginning of 2011, Cushing, Oklahoma, the storage and distribution 'hub' for WTI, has experienced rising inventories. These have resulted primarily from an increase in shale oil drilling in the United States, as well as expanding supplies from Canada. 1 In addition, WTI prices have been influenced by relatively flat petroleum demand in North America (International Energy Agency, August 2012).
Finally, since crude can only be moved out of Cushing through pipelines, there has been limited ability to export the oil into global markets, particularly into regions with rising oil consumption, such as India and China (MJ Ervin & Associates Inc., April 2012).
Combined, these factors – supply glut, soft North American demand, and an inability to export to high consuming global markets – have put downward pressure on WTI crude prices.
While WTI prices have been subject to a number of downward pressures in the last couple of years, the Brent benchmark has been influenced by various upward pressures. The key difference between WTI and Brent is the ability of 'waterborne' crude oils benchmarked to Brent to reach countries with rising oil consumption.
Despite declining petroleum demand in Europe, the Brent benchmark price is influenced by rising global demand for oil (International Energy Agency, August 2012). Additionally, political instability in some crude producing countries in the Middle East and North Africa has raised concerns over future European oil supplies. This has put further upward pressure on the Brent benchmark price (Suncor Energy, September 2011).
Overall, the presence of differing supply and demand conditions over the last couple of years has resulted in a price differential, the largest in at least three decades, between the WTI and Brent crude oil benchmarks.
Given that both WTI and Brent influence gasoline prices in Canada, the price gap that has emerged and persisted between the two benchmarks can have an impact on price change for gasoline across the country.
Impact of Brent-WTI price differential on Canadian petroleum products
For most of the past 10 years, changes in gasoline prices across Canada, as measured by provincial consumer price indices, have followed similar trends. However, around the same time that the WTI and Brent benchmarks began to diverge in 2011, a more notable variation between provincial gasoline indices emerged.
Chart 3 illustrates that over the past two years, the gasoline price indices for Western provinces, where domestically produced crude oil benchmarked to WTI is refined and distributed, followed monthly movements in WTI prices.
During the same period, changes in gasoline price indices for Central and Eastern provinces, where refiners use either imported or a mixture of domestic and imported crude oils, more closely reflected movements in Brent prices.
Summary
Since 2011, the variation between provincial gasoline price indices has expanded. Around the same time, a price differential has emerged between WTI and Brent, two crude oil price benchmarks.
Aside from crude oil, there are various other factors that determine the final 'pump price' of gasoline, such as taxes, and refinery and marketing margins, which this paper does not explore. However, of all the factors crude oil has the largest contribution to retail gasoline prices in Canada. Thus, changes in crude oil benchmark prices can impact the trends of gasoline price change across the country.
A dual crude oil market exists in Canada. Most refiners in the Western provinces process domestically produced crude. Refiners in Central and Eastern provinces run different proportions of imported crude. Differences between crude oil price benchmarks, such as the divergence between WTI and Brent, can contribute to variations between provincial gasoline price indices.
Gasoline represents a considerable proportion of the CPI basket and therefore can apply significant upward or downward pressure on the CPI's for Canada and the provinces. Accordingly, understanding the factors that can influence gasoline price movements in Canada is important in being able to explain variations in provincial gasoline price indices and overall CPI's.
Acknowledgements
This study was prepared by Amanda Wright under the responsibility of the Director of the Consumer Prices Division, Richard Evans.
The author would like to thank everyone who reviewed and contributed to the article, particularly, Robert Masse, Jean Le Moullec and Oana Ciobanu of the Consumer Prices Division, Guy Gellatly of the Analysis Branch, John Flanders of Communications Division and Gwen Harding of Manufacturing and Energy Division.
In addition, the contributions made by the Dissemination Division and Dissemination Unit of Consumer Prices Division are gratefully acknowledged.
References
International Energy Agency, "Oil Market Report", August 10 2012. www.iea.org
MJ Ervin & Associates Inc., "Rising Retail Fuel Prices: An Analysis", April 2012. www.kentmarketingservices.com
MJ Ervin & Associates Inc., Petroleum Price Data.www.kentmarkeetingservices.com
Natural Resources Canada, "Fuel Focus: Understanding Gasoline Markets in Canada and Economic Drivers Influencing Prices", Vol. 7, Issue. 3, February 24 2012. www.nrcan.gc.ca
Natural Resources Canada, Refinery Economics. www.nrcan.gc.ca
Statistics Canada, CANSIM Table 134-0001, Refiner Supply of crude oil and equivalent, www.statcan.gc.ca
Statistics Canada, CANSIM Table 126-0001, Supply and disposition of crude oil and equivalent, www.statcan.gc.ca
Statistics Canada, CANSIM Table 326-0020, Consumer Price Index (CPI), 2009 basket, monthly, www.statcan.gc.ca
Suncor Energy, "WTI vs. Brent Crude – What do they mean?", September 21 2011. www.pumptalk.ca/2011/09/wti-vs-brent-crude-what-do-they-mean.html
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