As the number of new COVID-19 cases continues to rise, so does the oil patch’s apprehension that crude oil prices could be poised to take another hit. If that happens, producers would have to review, yet again, their plans for optimizing production as best they can, given their pricing outlook. But producers do not all receive uniform prices reflecting NYMEX WTI for their physical barrels — far from it. Crude quality and proximity to a demand market can make a big difference in the price that the barrels will ultimately sell for. Price reporting agencies (PRAs) such as Argus and Platts track and publish these differentials. But how are those differentials calculated and how do they affect producers? Today, we discuss crude differentials and their impact.
A couple of weeks ago, we made the case in our blog, Cruel Summer, that there is distinct risk that crude oil prices could face another round of downward pressure if a second wave of COVID-19 again slashes refining demand and throws the supply/demand balance back out of whack. If that were to play out, producers would once more need to reckon their appropriate level of capital expenditures (see Too Soon to Know) and determine which wells to bring online and which wells to keep as inventory. As we discussed in Gimme Some Truth, those decisions will have a significant impact on the shape of our expectations for U.S. crude production.
When crude oil prices plummeted back in April and producers across the country considered whether shutting in production was in their best interest, we noted in our blog, Shut Down, that it’s not a one-size-fits-all answer. Every producer has unique acreage, contracts, and hedges that will affect their decision-making. Key in all of their processes, though, is having an expectation of what price they are likely to receive for their produced volumes. In many cases, producers sell their barrels for delivery up to a month in the future. Earlier this year, we wrote a two-part blog series called Future(s) Games that delved into how such physical crude trades are usually set up. In Part 1, we explained that the pricing mechanism in these contracts contains several pricing elements that normally include the following:
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