Crude Oil
California Crude Oil Price Fluctuations Are Consistent with Broader Market Trends Gao ID: GAO-07-315 January 19, 2007California is the nation's fourth largest producer of crude oil and has the third largest oil refining industry (behind Texas and Louisiana). Because crude oil is a globally traded commodity, natural and geopolitical events can affect its price. These fluctuations affect state revenues because a share of the royalty payments from companies that lease state or federal lands to produce crude oil are distributed to the states. Because there are many varieties and grades of crude oil, buyers and sellers often price their oil relative to another abundant, highly traded, and high quality crude oil called a benchmark. West Texas Intermediate (WTI), a light crude oil, is the most commonly used benchmark in the United States. The price difference between a crude oil and its benchmark is commonly expressed as a price differential. In fall 2004, crude oil price differentials between WTI and California's heavier, and generally lower valued, crude oil rose sharply. GAO was asked to examine (1) the extent to which crude oil price differentials in California have fluctuated over the past 20 years and (2) the factors that may explain the recent changes in the price differential between California's crude oil and others. GAO analyzed historical data on California and benchmark crude oil prices and discussed market trends with state and federal government officials and crude oil experts.
California crude oil price differentials have experienced numerous and large fluctuations over the past 20 years. The largest spike in the price differential began in mid-2004 and continued into 2005, during which the price differential between WTI and a California crude oil called Kern River rose from about $6 to about $15 per barrel. This increase in the price differential between WTI and California crude oils occurred in a period of generally increasing world oil prices during which prices for both WTI and California crude oils rose. Differentials between WTI and other oils also expanded in the same time period. The differentials have since fallen somewhat but remain relatively high by historical standards. Recent trends in California crude oil price differentials are consistent with a number of changing market conditions. First, beginning in mid-2004, Middle East producers began to increase the supply of heavy crude oils in the world marketplace, which helped depress prices for heavy crude oils, including those produced in California, and contributed to the expanding price differential between California crude oils and WTI. Second, the price differential of California crude oils to WTI increased when the rise in global crude oil prices caused prices of light crude oils to increase faster than the prices of heavier crude oils. This occurred because the petroleum products from heavy crude oils compete against other fuels, such as coal. Third, events that only impact regional crude oil markets or individual crude oils can also affect price differentials. For example, in September 2004, Hurricane Ivan disrupted crude oil production in the U.S. Gulf Coast region, resulting in decreases in the region's crude oil supply. The resulting scarcity of crude oil in the Gulf Coast region caused the prices of WTI and other regional oils to increase relative to crude oils produced outside the region. This also would have increased the price differentials between WTI and California crude oils. Finally, manipulation of crude oil prices could also affect price differentials, but experts and officials GAO interviewed generally believed that this was not a factor during this recent period.
GAO-07-315, Crude Oil: California Crude Oil Price Fluctuations Are Consistent with Broader Market Trends
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Report to Congressional Requesters:
January 2007:
Crude Oil:
California Crude Oil Price Fluctuations Are Consistent with Broader
Market Trends:
GAO-07-315:
GAO Highlights:
Highlights of GAO-07-315, a report to congressional requesters
Why GAO Did This Study:
California is the nation‘s fourth largest producer of crude oil and has
the third largest oil refining industry (behind Texas and Louisiana).
Because crude oil is a globally traded commodity, natural and
geopolitical events can affect its price. These fluctuations affect
state revenues because a share of the royalty payments from companies
that lease state or federal lands to produce crude oil are distributed
to the states.
Because there are many varieties and grades of crude oil, buyers and
sellers often price their oil relative to another abundant, highly
traded, and high quality crude oil called a benchmark. West Texas
Intermediate (WTI), a light crude oil, is the most commonly used
benchmark in the United States. The price difference between a crude
oil and its benchmark is commonly expressed as a price differential. In
fall 2004, crude oil price differentials between WTI and California‘s
heavier, and generally lower valued, crude oil rose sharply.
GAO was asked to examine (1) the extent to which crude oil price
differentials in California have fluctuated over the past 20 years and
(2) the factors that may explain the recent changes in the price
differential between California‘s crude oil and others. GAO analyzed
historical data on California and benchmark crude oil prices and
discussed market trends with state and federal government officials and
crude oil experts.
What GAO Found:
California crude oil price differentials have experienced numerous and
large fluctuations over the past 20 years. The largest spike in the
price differential began in mid-2004 and continued into 2005, during
which the price differential between WTI and a California crude oil
called Kern River rose from about $6 to about $15 per barrel. This
increase in the price differential between WTI and California crude
oils occurred in a period of generally increasing world oil prices
during which prices for both WTI and California crude oils rose.
Differentials between WTI and other oils also expanded in the same time
period. The differentials have since fallen somewhat but remain
relatively high by historical standards.
Recent trends in California crude oil price differentials are
consistent with a number of changing market conditions. First,
beginning in mid-2004, Middle East producers began to increase the
supply of heavy crude oils in the world marketplace, which helped
depress prices for heavy crude oils, including those produced in
California, and contributed to the expanding price differential between
California crude oils and WTI. Second, the price differential of
California crude oils to WTI increased when the rise in global crude
oil prices caused prices of light crude oils to increase faster than
the prices of heavier crude oils. This occurred because the petroleum
products from heavy crude oils compete against other fuels, such as
coal. Third, events that only impact regional crude oil markets or
individual crude oils can also affect price differentials. For example,
in September 2004, Hurricane Ivan disrupted crude oil production in the
U.S. Gulf Coast region, resulting in decreases in the region‘s crude
oil supply. The resulting scarcity of crude oil in the Gulf Coast
region caused the prices of WTI and other regional oils to increase
relative to crude oils produced outside the region. This also would
have increased the price differentials between WTI and California crude
oils. Finally, manipulation of crude oil prices could also affect price
differentials, but experts and officials GAO interviewed generally
believed that this was not a factor during this recent period.
Figure: WTI and Kern River Crude Oil Price Differentials, December 1987
to August 2006:
[See PDF for Image]
Source: GAO analysis of Platts data.
[End of figure]
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-07-315].
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Jim Wells at (202) 512-
3841 or wellsj@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Price Differentials between California and Other Crude Oils Have
Fluctuated Significantly over the Past 20 Years but Have Risen
Significantly in Recent Years:
Recent Increases in California Crude Oil Price Differentials Are
Consistent with Other Market-Based Factors:
Appendixes:
Appendix I: Objectives, Scope, and Methodology:
Appendix II: GAO Contact and Staff Acknowledgments:
Tables:
Table 1: API Crude Quality Classes and Representative California Crude
Oils:
Figures:
Figure 1: WTI and Kern River Crude Oil Prices and Price Differentials,
December 1987 to August 2006:
Figure 2: Quantities of Crude Oil Grades Produced in California, 1987
to 2005:
Figure 3: Sources of California Crude Oil and Major Refining Centers,
2005:
Figure 4: Quantities and Sources of Crude Oil Consumed in California,
1987 to 2005:
Figure 5: WTI, Kern River, Thums, and Line 63 Crude Oil Prices and
Price Differentials, December 1987 to August 2006:
Figure 6: WTI, Maya, and Arab Heavy Crude Oil Prices and Price
Differentials, July 1988 to August 2006:
Figure 7: Wyoming Sweet and WTI Crude Oil Prices and Crude Price
Differentials, December 1987 to August 2006:
Abbreviations:
ANS: Alaska North Slope:
API: American Petroleum Institute::
bpd: barrels per day:
CEC: California Energy Commission:
CIPA: California Independent Petroleum Association:
DOE: Department of Energy:
EIA: Energy Information Administration:
MMS: Minerals Management Service:
NYMEX: New York Mercantile Exchange:
OPEC: Organization of Petroleum Exporting Countries:
WSPA: Western States Petroleum Association:
WTI: West Texas Intermediate:
January 19, 2007:
The Honorable Henry A. Waxman:
Chairman:
Committee on Oversight and Government Reform:
House of Representatives:
The Honorable Dianne Feinstein:
United States Senate:
California is the nation's largest consumer of gasoline and consumes
about 44 million gallons every day. California is also the nation's
fourth largest producer of crude oil, behind Texas, Louisiana, and
Alaska, and has the third largest oil refining industry, behind Texas
and Louisiana. Despite a history of self-reliance in petroleum
supplies, California crude oil production has been declining since
1996, and California increasingly relies on oil from other states and
countries. California currently produces about 37 percent of the crude
oil it uses, with the remainder coming largely from Alaska, Saudi
Arabia, Mexico, Ecuador, and Iraq. Crude oil is a globally traded
commodity, so natural and geopolitical events worldwide can affect its
prices. These fluctuations can affect state revenues because a share of
the royalty payments collected from companies that lease state or
federal lands to produce crude oil are distributed to the states. For
example, in fiscal year 2006, the Department of the Interior's Minerals
Management Service (MMS), which collects royalties from federal lands,
distributed more than $303 million to the states, with California's
share totaling over $44.7 million, or roughly 15 percent of the total
state disbursements. States rely on these revenues to fund education
and infrastructure projects and to assist local counties where the oil
production occurs. Consequently, oil producing states typically monitor
crude oil price fluctuations and are interested in ensuring that the
crude oil produced in their state trades at a fair price in the
marketplace.
Crude oils produced from different regions and geologic structures vary
in important ways that also affect each crude oil's value in the
marketplace. Specifically, the value of a given crude oil is determined
by its inherent quality and the amount and value of petroleum products
that can be refined from it. Crude oil is commonly classified according
to two parameters: density and sulfur content. Less dense crudes are
known as "light," while denser crudes are known as "heavy." Crudes with
relatively low sulfur content are known as "sweet," while crudes with
higher sulfur content are known as "sour." In general, heavier and more
sour crudes require more complex and expensive refineries to process
the oil into usable products but are less expensive to purchase than
light sweet crudes. Because much of the oil produced in California is
heavy and sour, California refiners have made significant investments
in more technically complex equipment that enables them to process
these crudes into higher value products such as gasoline, jet fuel, and
diesel.
Because of the large number of grades of crude oils, buyers and sellers
use benchmark crude oils as a reference in pricing crude oil. A
benchmark crude oil is typically an abundantly produced and frequently
traded crude oil. There are currently three widely used crude oil
benchmarks--West Texas Intermediate (WTI), Brent, and Dubai. WTI is a
very high quality light crude oil produced in Texas and refined in the
Midwest and Gulf Coast, and it is typically the benchmark for crude oil
produced in North and South America. Other oils are often priced with
reference to one of these benchmark crude oils. The relationship
between the prices of specific crude oils and a benchmark crude oil is
commonly expressed as a price differential--calculated by subtracting
the specific crude oil price from the benchmark price. For example, if
WTI is selling for $60 per barrel and Kern River (a California crude
oil) for $45 per barrel, the WTI-Kern River price differential is $15.
Crude oil price differentials are generally not constant over time;
they reflect changes in world crude oil markets, as well as more local
or crude oil specific factors. When prices of the crude oil produced in
a state fall to an unusual degree relative to prices of benchmark oils
or similar quality oils, crude oil producers and state collectors of
crude oil royalty revenues become concerned. In fall 2004, crude oil
price differentials in California rose sharply when the price of WTI
increased relative to California crude oils. In this context, you
requested that we provide additional information on crude oil price
differentials in California. As agreed with your office, this report
discusses (1) the extent to which crude oil price differentials in
California have fluctuated over the past 20 years and (2) the factors
that may explain the recent changes in the price differential between
California and other crude oils. To provide additional context for this
report, we also evaluated recent increases in the price differential
between WTI and crude oils produced in the Rocky Mountain region.
To determine the extent to which California crude oil price
differentials have fluctuated over time, we obtained historical data on
California and benchmark crude oil prices from Platts--a major provider
of news and information on energy commodities. We obtained data on
three California crude oils: two heavy crude oils (Kern River and
Thums) and an intermediate crude oil (Line 63). We used these data to
calculate price differentials by subtracting the price for California
crude oils from benchmark crude oils and analyzing these differentials
for trends over time. We also interviewed officials from the Energy
Information Administration (EIA), MMS, and the California Energy
Commission (CEC). To identify factors that may explain the recent
changes in the California oil price differentials, we interviewed
officials from EIA, MMS, CEC, and the California State Controller's
Office. In addition, we interviewed industry experts from state,
regional, and national trade organizations, such as the California
Independent Petroleum Association, the Western States Petroleum
Association, and the Independent Petroleum Association of America;
representatives from crude oil production and refining companies in
California and the Western United States; and independent energy sector
consultants. We also discussed the possibility of price manipulation
with numerous officials and experts to determine whether or not it was
a relevant factor in explaining recent changes in crude oil price
differentials. We conducted our work between May and December 2006 in
accordance with generally accepted government auditing standards.
Results in Brief:
California crude oil price differentials have experienced numerous and
large fluctuations over the past 20 years. The largest spike in the
price differential began in mid-2004 and continued into 2005, during
which the price differential between, for example, WTI and Kern River
rose from about $6 to about $15 per barrel. This increase in the price
differential between WTI and California crude oils occurred in a period
of generally increasing world oil prices during which prices of both
WTI and California crude oils rose. Price differentials between WTI and
other oils also expanded in the same time period. Specifically, price
differentials between WTI and two other California crude oils, Thums
and Line 63, as well as price differentials between WTI and other non-
California heavy crude oils, such as Mexican Maya and Arab Heavy, also
increased. The price differentials have since fallen somewhat but
remain relatively high by historical standards, while world crude oil
prices and the price of crude oil in general have risen further. Figure
1 shows historic prices of WTI and Kern River, as well as the price
differentials between these two crude oils.
Figure 1: WTI and Kern River Crude Oil Prices and Price Differentials,
December 1987 to August 2006:
[See PDF for image] - graphic text:
Source: GAO analysis of Platts data.
[End of figure] - graphic text:
The recent trends in California crude oil price differentials are
consistent with a number of changing market conditions. First,
beginning in mid-2004, Middle East producers began to increase the
supply of heavy crude oils in the world marketplace. This increase in
supply helped depress prices for crude oils of similar quality, such as
California's crude oils, and contributed to the expanding price
differential between California crude oils and WTI. In addition, EIA
officials told us that the recent increases in global crude oil prices
caused prices of light petroleum products, such as gasoline and diesel,
to increase more than the prices of heavier products, such as residual
fuel oil, because these heavier products compete against other fuels,
such as coal, that are not immediately affected by rising oil prices.
As a result, prices for light crude oils, which produce greater amounts
of lighter, higher value products, increase faster than heavy crude
oils, which produce greater amounts of heavier, lower value products,
and thus the price differential widens. Third, events that impact
regional crude oil markets or individual crude oils can also affect
price differentials. For example, in September 2004, Hurricane Ivan
disrupted crude oil production in the U.S. Gulf Coast region, resulting
in decreases in crude oil supply, primarily in that region. Some
experts believe that the resulting scarcity of crude oil in the Gulf
Coast region caused the prices of WTI and other regional oils to
increase relative to crude oils produced outside the region. This also
would have increased the price differentials between WTI and other
crude oils, including those from California. Finally, the state of
California has alleged in the past that some crude oil producers in
California manipulated prices of their crude oil to reduce their
royalty payments, which would, in turn, cause crude oil price
differentials between WTI and California crude oils to rise. Most
officials and experts we interviewed did not believe that this type of
price manipulation was a factor in explaining recent changes in price
differentials. However, we cannot completely rule out this possibility
or other possible factors that we could not observe that could explain
some of these recent changes.
Background:
Two-thirds of all crude oil consumed in the United States is used by
the transportation sector, with gasoline accounting for two-thirds of
that total. The second largest consumer of crude oil is the industrial
sector, including refineries and petrochemical industries, which
account for another 25 percent of that total. In the residential and
commercial sectors, crude oil consumption was as high as 15 percent of
that total in 1970 but had since fallen to 6.5 percent in 2004.
Similarly, the burning of crude oil to generate electricity peaked in
1975 at 8.6 percent, declining to 2.5 percent in 2004.
Crude oil is supplied through onshore and offshore domestic production
and international imports. In 2005, the United States produced 6.8
million barrels per day (bpd), a 5.5 percent decrease from 2004.
California is currently the fourth largest oil producer (including
onshore and offshore production) in the United States, behind
Louisiana, Texas, and Alaska, respectively, but its production has
declined at a rate of 2.4 percent per year for the past 10 years.
California produced 731,150 bpd in 2004 (the most recent year for which
numbers are available). Figure 2 shows the decline in California crude
oil production and the quantity of various grades of crude oil produced
in California.
Figure 2: Quantities of Crude Oil Grades Produced in California, 1987
to 2005:
[See PDF for image] - graphic text:
Source: CEC, California Department of Conservation, MMS.
[End of figure] - graphic text:
In 2005, the United States imported 13.5 million bpd, or 27.1 percent
of total global oil imports. The EIA estimates that California imported
40.7 percent of all crude processed by the state's refineries, with the
bulk of imports coming from Saudi Arabia, Ecuador, Iraq, and Mexico.
The remainder of California's crude oil was either produced in state,
or transported by tanker from Alaska. Figure 3 shows the sources of
California's crude oil and the state's major refining centers as of
2005, the last full year of data available, and figure 4 shows the
trend of California's crude oil supply over the past two decades.
Figure 3: Sources of California Crude Oil and Major Refining Centers,
2005:
[See PDF for image] - graphic text:
Source: GAO, CEC, and EIA; California map, Map Resources. Images Corel
Corp. All rights reserved.
[End of figure] - graphic text:
Figure 4: Quantities and Sources of Crude Oil Consumed in California,
1987 to 2005:
[See PDF for image] - graphic text:
Source: CEC.
[End of figure] - graphic text:
WTI crude oil is a widely traded oil that is commonly used as a
benchmark for measuring crude oil prices in the United States. Prices
for WTI are collected at Cushing, Oklahoma. Crude oils delivered by
pipeline generally use WTI first month delivery (WTI crude oil
delivered 1 month from a specific date) as a price benchmark, and crude
oils delivered by tankers use WTI second month delivery (WTI crude oil
delivered 2 months from a specific date) as a price benchmark.[Footnote
1]
Crude oils are commonly classified by their density and sulfur content.
The gravity of a crude oil is specified using the American Petroleum
Institute (API) gravity standard, which measures the weight of crude
oil in relation to water, which has an API gravity of 10 degrees. As
shown in table 1, crude oil is generally classified as heavy (API
gravity of 18 degrees or less), intermediate (API gravity greater than
18 and less than 36 degrees), and light (API gravity of 36 degrees or
greater). In addition, crude oils vary by their sulfur content--crude
oil is classified as sweet when its sulfur content is .5 percent or
less by weight, and sour when its sulfur content is greater than 1
percent. Other natural characteristics, such as the presence of heavy
metals and level of acidity, are also taken into account when
classifying crude oils. In general, heavier and more sour crude oils
require more complex and expensive refineries to process the oil into
usable products but are less expensive to purchase than light sweet
crude oils. Based on the API's classification, California crude oils
are almost all in the heavy and intermediate range. WTI, on the other
hand, is a very light oil with an API gravity of just under 40. Table 1
shows the API classification and the API gravity of California's three
primary crude oils.
Table 1: API Crude Quality Classes and Representative California Crude
Oils:
Crude type: Heavy;
API gravity: 18 degrees or less;
Percentage of Calif. crude oils, 2005: 51%;
Representative Calif. crude oils with API gravity in parentheses: Thums
(17) Kern (13.4).
Crude type: Intermediate;
API gravity: >18 degrees;
