Oily Apples and Oranges
The inefficiencies in the oil market could strike you dumb, honestly. I am just scratching the surface in terms of understanding the complexities and the various moving chokepoints and my brain hurts much.
One might sift through the vast quantities of fact, theory, and speculation (all of which becomes the same sickly shade of grey when you consider that none of this is a science but rather about mob rule and some of the basest of human nature) only to come up for a breath, lost in a turmoil of confusion.
Is it better to skim the top level news outlets (we know its not) or to dive deep into the technical trading deep-end where the majority of everything becomes arbitrary nothingness to even the most diligent of students.
I fear one needs a sort of economic genome project with extensive annotations and a whole new petrochemical informatics to wade through this turbulent ocean.
By way of example, not all oil is the same, as you might expect. Just as black truffles cost more than white and Matsutake mushrooms cost more than button mushrooms (like 100 to 0.01), so too does the value of oil vary from well to well.
Each well has its own special geological conditions that give rise to different oil qualities. Things like water, dirt, and sulphur contamination are considered in the grade of oil. See this link for a better understanding of Petroleum.
A barrel of Saudi Heavy crude (2.8% sulfur, 27 API gravity) is intrinsically worth less than a barrel of Nigerian Bonny Light (0.14% sulfur, 34 API), because the former will yield less high-value gasoline, diesel and jet fuel than the latter without intensive refining. But how much more a barrel of Bonny Light commands in the market depends on the relative prices of all the various petroleum products when it is sold, along with the location and availability of spare capacity in the complex refineries that have the hardware to overcome those intrinsic quality differences. SOURCE
Now, to extend this sort of analysis, the “price” for a barrel of oil from one exchange to the next is not the same either!
There is the price as it is trading on any particular day and there are “future” spot prices (as you would find on other commodities like corn or wheat or pork bellies).
I will not pretend to understand this (this is where that informatics would come in handy but what can you do!).
Today’s prices and the future price can be very different.
Now, when it comes to what a refinery pays for a barrel of crude coming in it’s doors for processing, you would think the price they pay is the going rate THAT DAY. It SEEMS that this is intuitive.
Intuition fails here though.
See below for an explanation on why the actual cost of oil going into refineries is different from what you might think (as in what you see on NYMEX, etc).
The growth of the futures exchanges over the last two decades has fundamentally changed oil trading. Most oil is now bought and sold on price formulas pegged to the futures prices, or to published market reports strongly influenced by the futures. What traders are agreeing to when they do a deal is not a fixed price, but a fixed differential above or below a particular futures contract during a set period, usually aligned with the time when the shipment will be loaded or delivered. So while these differentials fluctuate due to a variety of factors, the price that refiners pay for crude oil remains directly tied to the futures price. That means that anything that drives up the futures market, whether a disruption in supply, higher demand, or speculation by a new class of commodity investors, has a direct impact on what we all pay for the products that refineries make. SOURCE
This is an unhappy phenomenon because futures seem to be exquisitely vulnerable to the vagaries of mob action and rumor and that basest human behavior thing again (greed and panic being just two of very many).
Reminds me of Popeye’s Whimpy when he says “I’d gladly pay you Tuesday for a hamburger today“.
That Tuesday? Its rushing right at us.
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