Crude Oil Price Differentials and Pipeline Investment Shaun McRae - - PowerPoint PPT Presentation

Crude Oil Price Differentials and Pipeline Investment

Shaun McRae January 5, 2018

ITAM

Rapid growth in production since 2011 has reshaped geography

• f oil markets in the US

U.S. Oil Production

0.0 2.5 5.0 7.5 10.0 2004 2006 2008 2010 2012 2014 2016

Million barrels/day

Source: EIA crude oil production

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Total length of US crude oil pipelines increased by 37% between 2010 and 2016

20 40 60 80 2004 2006 2008 2010 2012 2014 2016

Miles (thousands)

Source: PHMSA Annual Hazardous Liquids data

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Economic costs and benefits of major oil pipeline projects are ignored or misstated in media reports

http://www.cbsnews.com/news/who-benefits-from-the-keystone-xl-pipeline-and-dakota-access-pipeline-pros- cons/

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This paper studies the economic effects of additions to pipeline capacity

• Additional pipelines displace shipment by more

expensive alternatives (such as rail or trucks)

• Greater use of cheaper pipelines reduces the price

dispersion across regions and the price discount to world prices

• Refiners pay more for their inputs
• Oil producers receive more for their output
• Possible environmental effects from displacement of

rail—not considered here

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Oil deliveries by pipeline to refineries increased by a third since 2009, matching increase in overall pipeline length

0.0 2.5 5.0 7.5 10.0 12.5 2008 2010 2012 2014 2016

Million barrels/day

Pipeline

2008 2010 2012 2014 2016

Rail

Source: EIA refinery receipts of crude oil by pipeline and rail

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Monthly oil shipments by rail in 2016 less than half their level during 2015

0.00 0.25 0.50 0.75 1.00 1.25 2005 2010 2015

Million barrels/day

Source: EIA movements of crude oil by rail

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Large decline in the mean absolute deviation in US wellhead prices since its peak in 2011 and 2012

0.0 2.5 5.0 7.5 10.0 12.5 2005 2010 2015

Mean absolute price differential ($/barrel)

Source: EIA state-level crude oil first purchase prices

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Similar decline in the mean discount of US wellhead prices from benchmark price (LLS)

10 20 30 2005 2010 2015

Mean wellhead discount to LLS ($/barrel)

Source: EIA state-level crude oil first purchase prices; Bloomberg

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Stylized economic framework

Suppose we have an isolated region with oil production and in- elastic oil demand from local refineries Q P

Oil supply Refinery demand

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Without any trade (“autarky”) the price of oil in this region will be very low Q P Paut Qaut

Oil supply Refinery demand

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The world price of oil is much higher... but the oil needs to be transported out of the region to a market hub Q P Paut Qaut

Oil supply Refinery demand

Pworld

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There are low and high cost methods for transporting the oil, each with a limited capacity Q P

Oil supply Pipeline Rail Local+export demand

Pworld

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Local oil producers will receive price P1, discounted from the world price to reflect the cost of transporting the last barrel Q P

Oil supply Pipeline Rail Local+export demand

Q1 P1 Pworld

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Suppose there is an expansion in pipeline capacity out of the region, so that all exported oil can be carried by pipeline Q P

Oil supply Pipeline Rail Local+export demand

Q1 P1

Expansion

Pworld

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The price received by local oil producers increases from P1 to P2, reducing the discount from the world price Q P

Oil supply Pipeline Rail Local+export demand

Q2 P2 Q1 P1

Expansion

Pworld

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Local oil producers will be better off as a result of the higher price (and slightly higher production quantity) Q P

Oil supply Pipeline Rail Local+export demand

Q2 P2 Q1 P1

Expansion

Pworld

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Local oil refineries are worse off because now they pay a higher price P2 for their crude oil input Q P

Oil supply Pipeline Rail Local+export demand

Q2 P2 Q1 P1

Expansion

Pworld

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Oil shippers with access to the original pipeline are also worse

• ff, because they can no longer profit from buying oil at P1

Q P

Oil supply Pipeline Rail Local+export demand

Q2 P2 Q1 P1

Expansion

Pworld

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Overall welfare increases after the pipeline expansion, due to reduction in transportation costs and higher oil production Q P

Oil supply Pipeline Rail Local+export demand

Q2 P2 Q1 P1

Expansion

Pworld

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Pipeline expansions in the Permian basin

Oil production in the Permian basin increased by 1.2 million bar- rels/day between 2010 and 2016

Production

0.0 0.5 1.0 1.5 2.0 2.5 2008 2010 2012 2014 2016

Million barrels/day

Source: EIA Drilling Productivity Report

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Only four pipelines out of Permian basin in 2010: Borger, Basin, Centurion, West Texas Gulf

Original pipeline New pipeline after 2012 Oil refinery Main Permian fields Rail loading terminal Rail unloading terminal Source: EIA geographical shape files

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Rail loading terminals in Permian and Eagle Ford allowed ship- ment by rail to Gulf Coast refineries

Original pipeline New pipeline after 2012 Oil refinery Main Permian fields Rail loading terminal Rail unloading terminal Source: EIA geographical shape files

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Six new pipelines were constructed (or converted) between 2012 and 2016, increasing access to Gulf Coast

Original pipeline New pipeline after 2012 Oil refinery Main Permian fields Rail loading terminal Rail unloading terminal Source: EIA geographical shape files, Sunoco Logistics

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Permian production exceeded refinery and pipeline capacity in 2012 and again in 2014

Production Refinery + pipeline capacity

0.0 0.5 1.0 1.5 2.0 2.5 2008 2010 2012 2014 2016

Million barrels/day

Sources: EIA oil production; EIA refinery capacity utilization; RBN Energy and other news reports

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Periods with excess supply associated with large price differen- tials between Permian (WTI Midland) and Gulf Coast (LLS)

Monthly Permian Basin production, less refining and pipeline capacity Excess supply −0.4 −0.2 0.0

Million barrels/day

WTI Midland discount to LLS 10 20 30 2008 2010 2012 2014 2016

$/barrel

Sources: Excess supply calculation (previous slide); Bloomberg

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Periods with excess supply associated with large price differen- tials between Permian (WTI Midland) and WTI Cushing

Sources: Excess supply calculation (previous slide); Bloomberg

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Periods with excess supply associated with large price differen- tials between Permian (WTI Midland) and Gulf Coast (LLS)

10 20 30 −0.4 −0.3 −0.2 −0.1 0.0 0.1

Excess supply (million barrels/day) Price difference ($/barrel)

Sources: Excess supply calculation (previous slide); Bloomberg

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Empirically analyze the relationship between price differences and excess supply

• Allow WTI Cushing-LLS price differential to matter when

marginal oil is sent to Cushing

• Include year fixed effects
• Change definition of refinery capacity

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Societal benefits of $1.9 million/day compare to pipeline rev- enues of $0.3 million/day

Decompose the change in revenues and costs as a result of a hypothetical pipeline expansion $ million/day Higher oil producer revenue $17.6 Higher oil refinery costs $2.7 Lower oil shipper profits $13.0 Lower transportation costs $0.9 Higher oil production $1.0

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Higher input costs (mostly) reduced refinery profits rather than being passed on to gasoline consumers

Gasoline (Houston − Midland) Crude oil (LLS − WTI Midland) −0.25 0.00 0.25 0.50 0.75 Jan 2013 Jan 2014 Jan 2015 Jan 2016 Jan 2017

Price difference ($/gallon)

Gasoline (Houston − El Paso) Crude oil (LLS − WTI Midland) −0.25 0.00 0.25 0.50 0.75 Jan 2013 Jan 2014 Jan 2015 Jan 2016 Jan 2017

Price difference ($/gallon)

Source: GasBuddy.com

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Refinery capacity utilization was already high and did not change as a result of the lower prices

0.0 0.2 0.4 0.6 0.8 1.0 1.2 10 20 30

LLS − WTI Midland differential Refinery capacity utilization

Inland Texas Refineries

5 10 15

LLS − WTI Midland differential Refinery

Big Spring El Paso

Individual Refineries

Source: EIA, Texas Railroad Commission

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Analysis for other oil producing regions

Colorado: Increase of about 250,000 barrels/day in oil produc- tion as well as greater oil pipeline capacity

Production Refinery + pipeline capacity

0.0 0.2 0.4 2008 2010 2012 2014 2016

Million barrels/day

Sources: EIA oil production; EIA refinery capacity utilization; RBN Energy and other news reports

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Colorado–WTI Cushing price differentials are higher in periods with shortfall in pipeline capacity

5 10 15 −0.2 −0.1 0.0 0.1

Excess supply (million barrels/day) Price difference ($/barrel)

Sources: Excess supply calculation (previous slide); Bloomberg; own calculations

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Large increase in Bakken production not matched by additions to pipeline capacity

Production Refinery + pipeline capacity

0.00 0.25 0.50 0.75 1.00 1.25 2008 2010 2012 2014 2016

Million barrels/day

Sources: EIA Drilling Productivity Report; EIA refinery capacity utilization; ND Pipeline Authority and news reports

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No obvious relationship between North Dakota–WTI Cushing price differential and excess supply measure

5 10 15 20 0.0 0.2 0.4 0.6

Excess supply (million barrels/day) Price difference ($/barrel)

Sources: Excess supply calculation (previous slide); Bloomberg; own calculations

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Note the pipeline expansions in North Dakota have been infra- marginal—implying no change in local price Q P

Oil supply Pipeline Rail Local+export demand

Q1 P1

Expansion

Pworld

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Other issues that complicate analysis of effect of pipeline in- frastructure investment in other region

• Source of price data: market data vs. monthly average

wellhead prices

• Capacity constraints in other parts of pipeline network
• Optimal flows through interconnected network

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Conclusion

This paper has studied the economic effects of expansions to the crude oil pipeline network

• Length of crude oil pipeline network has increased by

37% between 2010 and 2016

• Additional pipelines have reduced the variance across

regions in oil producer prices

• Magnitude of reduction depends on whether new

pipelines are inframarginal

• Most of the benefits for producers are a transfer from

refiners and shippers

• Net welfare benefits are due to reducing cost of shipment

and increasing oil production

• These exceed revenue for pipeline owners

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