Making Sense of Oil Dollars & Cents
While complex, there’s method to the oil-price madness
Seems simple enough—the price of oil, that is. It’s $47.60 per barrel, or $51.98 per barrel, or whatever it happens to be on any given day. It’s often expressed by West Texas Intermediate (WTI) or Brent Blend, whatever those mean.
The price of oil has real-world consequences because it’s a key factor used to decide energy development and to assess reserves. And, of course, it helps determine the price of gasoline and other fuels—something that impacts all of us.
So how is the price determined? It’s complex business, but ultimately the price of oil comes down to economics. Prices are determined by what traders expect supply and demand will be, which in turn are influenced by such factors as economic activity, seasonal temperatures, and market access.
And then there are the oil’s physical properties, which influence how much processing is needed to produce refined petroleum products, like gasoline.
“Despite how complex the markets appear, the price of oil comes down to what buyers and sellers of oil think supply and demand will be,” says Charles Tamblyn, Alberta Energy Regulator (AER) manager of energy forecasting. “Oil moves to the market that offers the best return, provided transportation is available.”
Differential makes a difference
Not all crude oil is the same—there are multiple grades of oil, depending on the geological formation they’re produced from. WTI acts as a reference price, traded at Cushing, Oklahoma, against which other grades of oil are priced. This results in a price “differential”—the difference between the WTI price and the price of other crudes—based on factors such as the quality of the oil and distance from markets.
Canadian Light Sweet and Western Canadian Select (WCS) are reference crude oils in the Canadian market.
Canadian Light Sweet is high-quality, low-sulphur, lighter-grade oil, which means Canadian-based companies producing this product receive a price that’s closer to WTI—hence a narrower differential of US$3.62 per barrel for 2015.
On the other hand, WCS is much heavier and has a higher sulphur content. Therefore, the differential between WCS and WTI is wider—US$13.52 per barrel in 2015. The AER forecasts that the differential will remain around this level in 2016 before beginning to narrow to historic levels over the next couple of years.
It should also be noted that both Canadian Light Sweet and WSC take a per-barrel hit because they are farther away from markets and therefore face higher transport fees.
More information about oil prices can be found in the AER’s Alberta's Energy Reserves and Supply/Demand Outlook report.