The Already Present Dangers Of Failing Oil Infrastructure

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The price of oil in North America is in a free-fall: The price of WTI is below $42 and a barrel of WCS (Western Canadian Select or heavy crude produced from tar sands in Alberta and Saskatchewan) can be purchased for $23. That, coincidentally, is about what Canadians pay for a case of Molson beer.

Unlike Molson beer, however, a barrel of crude oil cannot be consumed upon purchase, because after all, it is crude. As the same time, gasoline prices are spiking. This illustrates the difference between crude (unrefined) oil and gasoline and other refined petro-products that consumers can use. There is a damaging mismatch between the amount of crude oil North America is pumping out of the ground and the transportation and refining capacity which leads to simultaneously depressed crude prices and spiking gasoline prices.

When this over-stressed transportation and refining infrastructure buckles, the mismatch may be crippling. We have already had a preview:

1) Transportation Gap: Pipelines are the safest and most efficient way to transport crude oil to refineries. (See recent train disasters in North Dakota, Montana, and West Virginia). As oil production in North America started to increase in 2008, it soon outpaced the available pipeline infrastructure so that by 2012, the percentage of oil being delivered via trucks, barges, rail more than doubled. Companies have scrambled to open new pipelines, but most were built in Canada, not in the United States. American pipeline construction has picked up, but not nearly enough to accommodate the increase in production. Not only that, but existing pipelines are old, in need of repair, and have not been sufficiently updated to accommodate the increase in shale and tar sands production that started seven years ago.

Nothing illustrates this problem more clearly than the decline in the price of Alberta tar sands oil (WCS). To begin with, this oil is an extremely heavy crude that needs to be mixed with lighter crude before it is even placed in North American pipelines. The best refineries for this crude oil are on the Gulf of Mexico, in Texas and Louisiana. The existing pipeline infrastructure is not nearly large enough or direct enough to accommodate the current rate of production. The familiar debate over the Keystone XL pipeline contributes to this gap. The Keystone XL pipeline would help alleviate this bottleneck, but the plans are still languishing in American regulatory purgatory. The pipes are ready but the paperwork is not, so the oil is still sitting unusable in Canadian holding tanks, where it is now worth as little as a case of beer.

2) Refining Gap: American refineries cannot keep up with crude oil production. No new refineries have come online since the 1970s, when most of them were built with the intention of processing heavy crude imported from the Middle East. Now the United States has a glut of light crude from shale oil production with nowhere to go. The evidence that America’s refining capacity is far below demand is simple: The famous oil export ban does not apply to refined product and yet, the U.S. net export is minimal, even with stores of crude languishing in holding tanks. Yet with more refineries, the United States could become a significant exporter of petro-products and the price of WTI would realign itself with the global benchmark. In other words, the price of WTI (crude) is depressed much more than it has to be.

The recent shutdown at the BP (NYSE:BP) Whiting refinery in Indiana illustrates just how close to the edge American refining is and the disastrous effect the gap between crude oil and refining could have on the market. As crude oil prices fall, so too should gasoline prices. Except that in the Midwest, gasoline prices have jumped 50 cents to $1 and nationally prices rose 3 cents – all because the 6th largest refinery in the United States has mechanical problems. The plant should be processing over 400,000 barrels of crude oil a day but may take over a month to repair. If the United States had excess refining capacity, then customers could expect only a short jump in gasoline prices while suppliers shifted to other refineries. Instead, with nowhere to go, crude oil prices fell and gasoline prices rose.

The sad fact is that technological innovation at the pump far outpaced transportation infrastructure and refining capacity in North America and this divide only compounds the forces depressing oil prices. A fortune is ready to be made by transportation and refining corporations that can overcome the regulatory hurdles in the Unites States and start moving that crude.