How shipping costs affect global oil prices

A couple of years ago, different types of oil were priced differently.

Louisiana Light Sweet crude was priced higher than land-locked crudes like West Texas Intermediate, and both types were more expensive than oil from Alberta, says Scott Vali, formerly vice-president, Equities, for CIBC Asset Management.

But since then, price differentials across North America have narrowed, he adds, due largely to the development of more efficient transportation systems.

Vali explains, “We saw bottlenecks in the pipeline systems and in other transport systems, [so] greater pipe capacity has been put in place.”

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In particular, “We’ve seen a lot of additional pipe capacity put in place in the U.S., and that’s moving crude from the northern part of the U.S. down to [Oklahoma], and then down to the Gulf of Mexico,” which Vali suggests is a key market due to the large number of refineries located there.

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An increase in rail transportation has also contributed to the narrowing oil price spreads. “We’ve seen a lot of additional [rail] capacity added,” says Vali, and that’s freed up pipeline capacity and allowed producers to move “marginal barrels to different markets.”

As a result, North America has been able to produce more oil and put pressure on other global producers.

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The pros and cons

The tightening of oil price spreads has had two outcomes.

On the upside, Canadian oil producers have benefited from getting fairer prices for their product, says Vali.

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Meanwhile, the benefit of moving oil by rail has declined. For example, says Vali, “When [price] differentials were very wide, you could load crude onto a rail carrier and ship it from the North Dakota Bakken to the East coast of Canada for about $10 to $12 per barrel. For [refinery companies] such as Irving Oil, that made a lot of sense since, even with extra shipping costs, North American crudes were still cheaper than international crudes.”

This is no longer the case, he adds, since “paying the extra cost for rail transport doesn’t make sense when international crudes could be the same price, if not cheaper. That’s going to hurt the volume of crude [shipped] by rail, and that may have an impact on the earnings of rail companies.”

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At the same time, with oil prices now so low, many companies are struggling, says Vali. He explains, “The value of crude itself has fallen, but the cost of moving [it] hasn’t changed.” For example, paying $10 for transportation on a barrel of crude when crude is $100 means you’re only giving up 10% of its value. When barrels only cost $50, however, paying $10 extra for transportation means you’re giving up 20%.

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Vali predicts that since oil prices have dipped, “we’ll continue to see crude price differentials remain relatively tight. We expect it to remain [this] way for the next couple of years until we see production growth again exceed the capacity of some of” the major pipelines that move product.

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