West Texas Intermediate (WTI) is the benchmark price for essentially all crude produced in the U.S. But few crudes are actually priced at the WTI level. Most are subject to some kind of discount based on location, quality or competitive conditions. And that means that producers and royalty owners rarely realize a WTI price.
Last Friday we began to delve into crude oil pricing in the Bakken by explaining crude oil postings. Today’s blog is the second in a series designed to uncover how crude is priced, what the transportation costs are and how refiners determine the profitability of processing one crude versus another. In Part II of our tutorial on crude oil pricing, we compare posted prices with the pipeline hub trading markets for Bakken crude at Clearbrook, Minnesota and Guernsey, Wyoming.
If you missed Part I of the tutorial last Friday you can catch up here: The Bakken Buck Starts Here - Bakken Crude Pricing Tutorial - Part I. To recap the highlights; we took a look at the crude oil postings that gathering companies like Plains All American publish to their websites every day. We used the Bakken example of Williston Basin crudes in North Dakota, learned that posted prices refer to particular crude oil specifications, and that they can be discounted by a complicated gravity adjustment mechanism to maintain the purchaser’s desired quality.
Crude Oil Postings – Who Sells at These Prices and How Are They Determined?
We start today’s tutorial with two innocent sounding follow up questions about posted prices. The answer to the first question is straightforward; the answer to the second question turns out to be a nest of vipers. Pay attention.
First - who sells their crude at the posted price? Posted prices are typically paid to lease holders with limited quantities of crude barrels for sale. They are the small guys. These equity players rarely own infrastructure (or capacity) to transport their barrels to a pipeline or a refinery. The posting companies who buy from these sellers are either refiners looking to feed their refineries or aggregators building up volumes through small purchases to sell in larger transactions at pipeline trading hubs.
Second - how do posting companies determine the posted prices they publish? Well the answer to that question is a topic that’s pretty much guaranteed to start a brawl in a Williston bar.
The market theorists tell us that Bakken postings should be determined by a discount to the price of West Texas Intermediate (WTI) at Cushing, OK - a similar quality crude that has a liquid and transparent market price. The WTI discount should include quality differences between the posted crude and WTI as well as transport costs from North Dakota to Cushing, plus some margin for the posting company. Indeed, if you look back at archive postings for Williston Sweet in 2003 and 2004 you will find they did exhibit a more or less fixed $5 to $6/Bbl discount to WTI. This school of thought is obviously supported by the small equity producers who sell at posted prices and are just looking for a decent college fund for their grandkids.
It is our belief, however, that posting companies hold most of the cards in this relationship because they decide the postings and how often to update them. If they don’t want to use the WTI discount theory, they don’t have to. Let’s face it, posting companies are naturally motivated to buy low and sell high, so they will try to keep the lid on prices for as long as they can. It is true that posters have to remain competitive with their peers or they won’t find any takers. It is also true that posting companies will be tempted not to raise their posting so quickly when the crude market is on the way up and to lower the posting more rapidly on the way down. Anyway, rather than get into a theoretical argument that’s going to end up in the street outside a Williston bar, let’s just step back and look at the data.