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Understanding the transformation of North American oil logistics

20 May 2014 Aaron Brady

North American oil production has increased 50% since 2008. But the pipeline and refinery infrastructure is not yet in place to meet this increased supply.

Aaron Brady

I'd say that the key challenge for North America oil logistics can be boiled down to this. It's really that US or North American production is in the midst of an unprecedented turnaround. So, from 1970 to 2008, US production was basically in continuous decline. Everyone thought that was going to continue. The only question was how high US oil imports were going to go. Since that time, since 2008, US oil production has increased by about three million barrels per day. That's a 50% increase, and it's really just a stunning turnaround in a very compressed period of time.

Clearly, this is creating challenges for logistics because all this oil has to get to market, generally, to places that it-- From landlocked regions around the continent that doesn't have ready access to pipelines. So really, the challenge is to bring some of this landlocked oil, both from western Canada and places like the Bakken to refining markets, which tend to be far from the producing regions on the coast, west coast, east coast, the gulf coast. These areas are generally not served by enough pipeline capacity. So, they're turning to rail, which is a flexible way to get it to market, but it's also very expensive. So, basically, what it boils down to is getting all this new oil to market in a safe and efficient way.

I think the logistical impacts on oil prices have been pretty clear over the past few years. We've seen that North American crude prices have been heavily discounted to international prices. For example, western Canadian producers are sort of the poster child of this. At times, their crude has been discounted as much as $40 below West Texas Intermediate crude in the United States, which itself has been discounted to Brent and the international market by several dollars.

So, this is really a function of a couple things. One is, as I mentioned before, all this production is landlocked, and typically, we're moving to more expensive modes of transport, like rail. Interestingly enough, rail is potentially going to become more expensive because there's safety concerns. The government is looking at some of the safety issues surrounding rail. So, that's an expensive way of getting it to market.

The other issue is sort of a quality issue, a crude quality issue. So, case and point again for the Canadian producers. They market a very heavy crude oil, and there's not really a lot of refineries around the world that can process this very heavy crude. In the United States, they've only been able to efficiently reach a few of those sophisticated refineries. So, until they are able to get their crude oil down to the gulf, where more of the sophisticated refineries are, they're going to have a pricing problem or continue to have a pricing problem, or until they can export into the international market. They're going to continue to feel those discounts.

So, the US is the biggest consumer of oil in the world. Actually, the US still, despite all the production growth we've had, we still import 7 million barrels per day of crude oil. So, it would appear that there's plenty of room to absorb all this new domestic crude production. Again, the issue, though, is a quality issue. The issue really is fitting all this new production into the right types of refineries.

So, the issue is that the new production is from tight rock formations. It's all very light, sweet crude oil. Over the years, however, US refineries have generally been designed to run heavier types of crudes. So, the question, really, is what happens once the US stops importing offshore light, sweet crude, and domestic production continues to rise. Where's all that incremental light crude going to go? How is it going to be absorbed? A question is: will some of the refineries that traditionally have run heavier crudes, medium sour crudes, for example, will those refineries start to substitute into the light, sweet crudes? And what would be the economics that would allow that to happen? These are some of the questions that IHS is looking into as we study this issue.

Aaron Brady Senior Director, Global Oil Markets, IHS Energy

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