Crude Oil: California Crude Oil Price Fluctuations Are Consistent
with Broader Market Trends (19-JAN-07, GAO-07-315).
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.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-07-315
ACCNO: A64988
TITLE: Crude Oil: California Crude Oil Price Fluctuations Are
Consistent with Broader Market Trends
DATE: 01/19/2007
SUBJECT: Comparative benchmarking products
Crude oil
Domestic crude oil
Economic analysis
Fuel prices
Oil importing
Petroleum industry
Petroleum prices
Prices and pricing
Standards
Supply and demand
California
******************************************************************
** This file contains an ASCII representation of the text of a **
** GAO Product. **
** **
** No attempt has been made to display graphic images, although **
** figure captions are reproduced. Tables are included, but **
** may not resemble those in the printed version. **
** **
** Please see the PDF (Portable Document Format) file, when **
** available, for a complete electronic file of the printed **
** document's contents. **
** **
******************************************************************
GAO-07-315
* [1]Report to Congressional Requesters
* [2]January 2007
* [3]CRUDE OIL
* [4]California Crude Oil Price Fluctuations Are Consistent with
Broader Market Trends
* [5]Contents
* [6]Results in Brief
* [7]Background
* [8]Price Differentials between California and Other Crude Oils
Have Fluctuated Significantly over the Past 20 Years but Have
Risen Significantly in Recent Years
* [9]Recent Increases in California Crude Oil Price Differentials
Are Consistent with Other Market-Based Factors
* [10]Changing Conditions and Events in Global Crude Oil
Markets Have Affected Price Differentials
* [11]Local and Regional Events Have Affected Prices of
Specific Crude Oils and Markets
* [12]Manipulation of Crude Oil Prices Could Affect Price
Differentials
* [13]Objectives, Scope, and Methodology
* [14]GAO Contact and Staff Acknowledgments
Report to Congressional Requesters
January 2007
CRUDE OIL
California Crude Oil Price Fluctuations Are Consistent with Broader Market
Trends
Contents
Tables
Figures
January 19, 2007Letter
The Honorable Henry A. Waxman
Chairman
Committee on Oversight and Government Reform
House of Representatives
The Honorable Dianne
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
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
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
Figure 4: Quantities and Sources of Crude Oil Consumed in California, 1987
to 2005
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.^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 API gravity Percentage of Representative Calif. crude
Calif. crude oils with API gravity in
oils, 2005 parentheses
Heavy 18 degrees or 51% Thums (17) Kern (13.4)
less
Intermediate >18 degrees; 48.8% Line 63 (29)
Light 36 degrees or 0.2%
greater
Sulfur type Description
Sweet .5% or less by
weight
Sour greater than 1%
by weight
Sources: API, CEC, Platts.
The sale of crude oil primarily occurs through one of three types of
transactions: a spot transaction, a contract arrangement, or as a futures
contract. Spot transactions are agreements to sell or buy one shipment of
oil at a price agreed upon at the time of the arrangement. Spot
transaction prices in various regional markets are available through
private publishers that monitor and record market transactions and prices.
Oil is often traded in long-term contracts at prices that are tied to a
market indicator, such as the spot market or the futures market. While
most contract prices are set in reference to a market index or a benchmark
crude oil, some domestically produced crude oils are also sold using
posted prices, which are usually set by buyers, refiners, and gatherers,
and apply to a particular crude stream (a crude oil or blend of oils of
standardized quality). International crude oils sold through contract
arrangements are generally priced using a formula that includes a base
price, which is referenced to a market indicator, plus or minus a quality
adjustment. A futures contract is a standardized agreement that obligates
the holder of the contract to make or accept delivery of a specified
quantity and quality of a crude oil during a specific month at an agreed
upon price. Futures contracts are bought and sold on a commodities
exchange, such as the New York Mercantile Exchange (NYMEX). However,
unlike spot transactions and contract arrangements, futures contracts very
rarely result in the delivery of physical barrels of oil. Instead, the
contract may be satisfied by a cash settlement prior to contract
expiration by selling or purchasing other contracts with terms that offset
the original contract or by exchanging a futures contract for the
commodity.^2
Price Differentials between California and Other Crude Oils Have
Fluctuated Significantly over the Past 20 Years but Have Risen
Significantly in Recent Years
From December 1987 to August 2006, price differentials between WTI and
California crude oils fluctuated significantly, generally increasing since
mid-2004 and reaching a high in January 2005. This recent increase in
crude oil price differentials coincided with a general increase in world
crude oil prices and reflected a more rapid increase in WTI prices
relative to prices of the three California crude oils we evaluated (Kern
River, Thums, and Line 63).^3 Large price differentials also occurred in
2004, 2005, and 2006 for heavier crude oils imported into California, such
as Maya and Arab Heavy. Since January 2005, the price differentials
between WTI and these heavier California and imported crude oils have
fallen somewhat from their peak in 2005 but remain large by historical
standards.
During the period from December 1987 through August 2006, all crude oil
prices we evaluated tended to follow similar patterns, rising and falling
in concert. However, the rate of increase or decrease in prices often
varied by crude oil type and, consequently, the price differentials
between these crude oils fluctuated. For example, California crude oil
prices rose and fell in relation to WTI during the same period, with the
higher quality Line 63 mirroring the price of WTI more closely than the
lower grade Kern River and Thums. Specifically, the price differential
between WTI and Kern River ranged from a low of $3.20 in July 1995 to a
high of $14.99 in January 2005. Similar variable changes also occurred for
the WTI-Thums price differential, which fluctuated between a low of $2.47
in June 1995 and a high of $13.92 in February 2005. For Line 63, the price
differential was lowest in September 2000 at $0.84 and highest in January
2005 at $9.57. Fluctuations in prices for WTI, Kern River, Thums, and Line
63, as well as price differentials between WTI and the three California
crude oils can be seen in figure 5.
Figure 5: WTI, Kern River, Thums, and Line 63 Crude Oil Prices and Price
Differentials, December 1987 to August 2006
While numerous fluctuations in crude oil prices and crude oil price
differentials have occurred over the 20-year period, global crude oil
prices rose precipitously in mid-2004, with the price of WTI rising from
$40.79 in July 2004 to $75.83 in August 2006--an increase of about 86
percent. This general rise in oil prices also occurred in California
crudes, where prices for Line 63 rose from $41.44 in August 2004 to $70.72
in August 2006--an increase of about 71 percent, followed by Kern River
and Thums, which rose from $40.45 and $41.41, respectively, in October
2004, to $63.32 and $65.02, respectively, in August 2006 --both increases
of about 57 percent. Because WTI rose faster than California crude oils,
price differentials between California crude oils and WTI also increased
during this period. The price differential for Line 63 rose from $6.54 in
September 2004 to a peak of $9.61 in December 2004--an increase of about
47 percent. The price differential between Kern River and WTI rose from
$5.95 in June 2004 to a peak of $14.99 in January 2005--an increase of
about 152 percent. The price differential for Thums and WTI followed a
similar pattern, rising from $7.13 in August 2004 to a peak of $13.92 in
February 2005--an increase of about 95 percent.
Crude oils imported into California, including Arab Heavy and Maya,
followed a similar pattern of fluctuating prices and increasing price
differentials during the same recent period. These intermediate crude oils
compete with Kern and Thums in the California marketplace because of their
similar quality and characteristics.^4 Price differentials between WTI and
Arab Heavy increased from $7.84 in June 2004 to a high of $16.24 in
January 2005--an increase of about 107 percent. Price differentials for
Maya and WTI were $8.39 in June 2004 and rose to a peak of $18.68 in March
2005--an increase of about 123 percent. Figure 6 provides an overview of
the rise in prices for WTI, Arab Heavy, and Maya and price differentials
between WTI and these imported crude oils from July 1988 to August 2006.
Figure 6: WTI, Maya, and Arab Heavy Crude Oil Prices and Price
Differentials, July 1988 to August 2006
Since mid-2005, price differentials for the three California crude oils
and the two imported crude oils have moderated somewhat but remain high by
historical standards. For example, the price differential for Kern River
fell to $12.17 in August 2006 (the last month for which data was
available), a decrease of about 19 percent from its high of $14.99 in
January 2005. For the lighter California crude oil, Line 63, the price
differential fell to $5.11 in August 2006, a decrease of about 47 percent
from a peak of $9.61 in December 2004. The price differentials for Arab
Heavy and Maya followed similar patterns. For example, the WTI-Arab Heavy
price differential fell to $12.56 in August 2006, a decrease of about 23
percent from its high of $16.24 in January 2005. Nonetheless, all the
crude oil price differentials between WTI and the heavier crude oils we
evaluated remain high by historical standards.
Recent Increases in California Crude Oil Price Differentials Are
Consistent with Other Market-Based Factors
According to EIA officials and other crude oil market experts we
interviewed, a range of market-based factors have affected recent crude
oil price differentials. First, changing conditions and events in the
global crude oil market influenced the relative prices of light and heavy
crude oils, causing crude oil differentials between WTI and heavier crude
oils to increase. Second, local and regional events that impacted
specific regional crude oil markets affected crude oil prices and affected
the price differential with WTI. This was particularly evident in oil
production in the Rocky Mountain region in early 2006 when an increase in
crude oil supplies and a lack of crude oil transportation capacity caused
a decrease in prices and an increase in the price differential. In
addition, the state of California has alleged in the past that crude oil
producers in California manipulated prices lower to avoid making royalty
payments. While most of the officials and experts we interviewed did not
believe that California crude oil producers have recently engaged in this
type of price manipulation, we cannot rule out this possibility or other
possible factors that we could not observe that could explain some of the
changes in price differentials.
Changing Conditions and Events in Global Crude Oil Markets Have Affected
Price Differentials
EIA and other officials we interviewed told us that price differentials
between light and heavier crude oils are driven primarily by supply and
demand economics in the global crude oil and petroleum products markets
and stated that these factors have influenced recent trends in price
differentials between heavy California crude oils and the light crude oil
benchmark WTI. For example, increases in the supply of light crude oil
result in lower prices for those crude oils, which would decrease the
price differential in comparison to heavy crude oil, such as those oils
typically produced in California. Conversely, an increase in the supply
of heavy crude oil can result in lower prices for those crude oils, thus
increasing the price differential between heavy crude oils and WTI. For
example, according to EIA officials, between January 2003 and January
2005, world demand for crude oil increased substantially, in China and the
United States in particular and in response, crude oil producers in the
Middle East increased their production of heavy crude oil to meet the
rising overall demand for crude oils. EIA officials and others stated that
this caused prices of WTI to rise at a faster rate than heavy crude oils
and contributed to rising price differentials between WTI and heavier
crude oils such as those produced in California. EIA officials also told
us that when crude oil prices increase, as they have in recent years,
prices of lighter petroleum products, such as gasoline and diesel, rise
faster than prices of residual fuel oils and other heavier crude oils
because the latter products face greater competition from coal and natural
gas, which are not initially affected by increases in crude oil prices.
Because heavier crude oils typically generate a greater proportion of
heavier petroleum products than do lighter crude oils, the value of the
heavier crude oils falls relative to lighter crude oils. This causes the
price differentials between WTI and heavier oils to rise further. Both of
these factors helped push the price of heavy crude oils lower in relation
to light crude oils. Specifically, between January 2003 and January 2005,
the price of WTI increased by about 42 percent, while the price of Kern
increased by about 16 percent. Consequently, the price differential
between these two crude oils expanded from about $6 to about $15.
Local and Regional Events Have Affected Prices of Specific Crude Oils and
Markets
Local and regional events, such as hurricanes off the U.S. Gulf Coast and
refinery outages, can cause fluctuations in the price of crude oils
produced in the region and benchmark crude oils. Consequently, these
events can increase or decrease price differentials. These events are
tracked by analysts in the private sector crude oil markets, financial
markets, and the federal government. From 1970 through the end of 2005,
EIA examined 72 different events and their effects on crude oil prices,
such as the Organization of Petroleum Exporting Countries oil embargo in
1973, the terrorist attacks of September 11, 2001, and the multiple
hurricanes that struck the U.S. Gulf Coast in 2004 and 2005. For example,
when Hurricane Ivan hit the Gulf of Mexico region in September 2004, oil
tankers importing crude oil into the Gulf were delayed, and oil producers
were forced to evacuate 3,000 employees from the region. MMS estimated
that Hurricane Ivan caused crude oil production to decrease by 61 percent
and resulted in spikes in the price of WTI. This would have increased the
price differential between WTI and other crude oils, including those
California crude oils we evaluated.
In addition, in early 2006, the price differential of local crude oils in
the Rocky Mountain region rose to an unusual extent. The increase was
most pronounced with the price differential between WTI and Wyoming Sweet,
a regionally produced crude oil with a gravity and sulfur content very
similar to WTI. From 1988 through mid-2005, the price of Wyoming Sweet
was roughly equal to WTI, with price differentials ranging between zero
and $3. However, beginning in January 2006, the price of Wyoming Sweet
dropped suddenly. Consequently, the price differential between Wyoming
Sweet and WTI increased from about $2 in the beginning of 2004 to over $24
in February 2006. In contrast to California, where crude oil prices and
price differentials to WTI have experienced regular fluctuations, there
was no historic precedent for crude oil price differentials of this
magnitude occurring in the Rocky Mountain region. Although the Wyoming
Sweet price differential has since fallen to less than $10, this is still
unusually high for this region. Figure 7 shows prices for WTI and Wyoming
Sweet and their price differential between December 1987 and August 2006.
Figure 7: Wyoming Sweet and WTI Crude Oil Prices and Crude Price
Differentials, December 1987 to August 2006
State officials and officials representing crude oil producers in the
region told us that the principal cause of the expanding Wyoming Sweet
price differential was inadequate crude oil transportation
infrastructure. In 2005, crude oil production in this region increased,
and Canadian producers also increased imports into the region. However,
the existing pipeline, railroad, and trucking infrastructure for
transporting crude oil was insufficient to move this large influx of crude
oil out of the Rocky Mountain region to other markets where it could have
received a higher price. The resulting oversupply of crude oil in a
region with comparatively low demand prevented the price of the regional
crude oils from increasing similar to WTI prices, causing a large price
differential. State officials we interviewed predicted that, until
transportation infrastructure can be expanded, price differentials for
oils produced in the Rocky Mountain region will continue to be above the
historical trends.
Manipulation of Crude Oil Prices Could Affect Price Differentials
Market manipulation is a final factor that could cause crude oil price
differentials to increase. In the past, the state of California alleged
that crude oil companies in California manipulated crude oil prices to
lower their royalty payments to the federal government. While we did not
find any evidence that any market players had manipulated crude oil prices
in California or elsewhere during the recent period of increasing crude
oil price differentials, we cannot rule out this or other possible factors
or events that we could not observe that could explain some of the changes
in price differentials.
The sales price of crude oil is an important variable in the equation that
determines the amount of royalties paid by oil companies who produce crude
oil on federal lands. Royalty revenues are calculated using the following
formula:
Volume of Crude Oil Sold X Sales Price X Royalty Rate = Royalty Revenues
Consequently, changes in either the sale prices or the volume sold can
greatly affect the total amount of royalties oil companies pay and the
states receive. Historically, posted prices were widely accepted as the
true market value and the measure that should be used in determining
royalty payments by crude oil producers, refiners, state governments, and
the federal government.
In litigation starting in 1975 and continuing through 1995, the state of
California and the city of Long Beach alleged that seven major oil
producing companies had conspired to keep posted prices low and that their
posted prices did not reflect the true market value of their crude oil,
thus illegally reducing the amount of royalties the oil companies paid.
Six of the companies eventually settled their cases, while the seventh
went to trial and was exonerated. Although MMS was not a party to this
litigation, it continued to independently evaluate whether posted prices
reflected market value. In June 1994, MMS formed an interagency task force
with some of the agencies that had previously reviewed the issue,
including the Departments of Energy, Justice, and Commerce, to evaluate
documents from the litigation and other data and determine whether the
companies had wrongfully undervalued crude oil to avoid paying royalties.
In May 1996, the task force concluded, among other things, that (1) oil
companies in California typically received proceeds higher than posted
prices and, therefore, royalties were underpaid and (2) much of the crude
oil produced in California was not sold as contemplated in the royalty
revenue formula, but rather moved through various transfers or exchanges
either within a company that owned both the production and refinery
operations, or between two companies for purposes of reducing
transportation costs. Consequently, the reported sale price was
frequently lower than actual market prices.
In March 2000, MMS changed its regulations for valuing crude oil from
federal lands to address the conclusions of the task force. Among other
things, the regulations changed for determining the value of crude oil
sold in a "non-arms length" transaction--crude oil transferred within an
oil company between its production and refining affiliates. Currently,
royalties for these non-arms length transactions are calculated using a
sales price that is imputed based on the price of Alaska North Slope (in
California) or NYMEX (for the rest of the country) and adjusted for
differences in quality. In arms-length transactions--sales between two
separate and unaffiliated companies--the actual sale price, and not the
posted price, is used to calculate royalties.
In the course of our work, most of the officials and experts we
interviewed thought the new MMS regulations were effective in addressing
this problem and neither believed that crude oil producers were engaging
in this sort of price manipulation during the recent period of increasing
crude oil price differentials, nor did they provide any evidence of such
manipulation. However, we cannot rule out this or other possible factors
or events that we could not observe that could explain some of the changes
in price differentials.
As agreed with your offices, unless you publicly announce the contents of
this report earlier, we plan no further distribution until 30 days from
the report date. At that time, we will send copies to interested
congressional committees and Members of Congress, the Secretary of Energy,
and the California State Controllers Office. We also will make copies
available to others upon request. In addition, the report will be
available at no charge on the GAO Web site at www.gao.gov.
If you or your staff have any questions about this report, please contact
me at (202) 512-3841 or [email protected] . Contact points for our
Offices of Congressional Relations and Public Affairs may be found on the
last page of this report. GAO staff who made key contributions to this
report are listed in appendix II.
Jim Wells Director, Natural Resources and Environment
Appendix I
Objectives, Scope, and Methodology
The objectives of this review were to determine (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. As part of
the second objective, in order to provide additional context to the issue
of price differentials in California, we also evaluated the unusually high
crude oil price differentials that occurred in the Rocky Mountain region
in late 2005.
To determine the extent to which California crude oil price differentials
have fluctuated over time, we obtained data on the spot prices of the
North American benchmark crude oil, West Texas Intermediate (WTI), and
three California crude oils: two heavy crude oils (Kern River and Thums)
and an intermediate crude oil (Line 63). We also obtained price data for
two heavy crude oils that are imported into California in large volumes:
Arab Heavy, a Saudi Arabian crude oil, and Maya, a crude oil imported from
Mexico. These data included prices from December 1987 through August 2006.
While most of the data we obtained listed a monthly average price, some
crude streams used daily or weekly averages. In these instances, we
calculated the monthly average price in order to make appropriate
comparisons. We used this data to calculate price differentials by
subtracting the price for the subject crude oil from the price of the
benchmark crude oil and analyzing these differentials for trends over
time. We interviewed officials from the Energy Information Administration
(EIA), Minerals Management Service (MMS), and the California Energy
Commission (CEC) to get background information on the major crude oils
produced in California and imported into the region.
To identify factors that may explain the recent changes in the California
price differentials, we (1) interviewed key officials and experts, (2)
reviewed studies on crude oil prices and price differentials, and (3)
reviewed historical studies and interviewed agency officials about the
history of crude oil price manipulation in California. To better
understand the key factors that affect crude oil price differentials in
general and specifically in California, we interviewed federal agency
officials from EIA and MMS; state agency officials from CEC and the
California State Controller's Office; and experts from organizations
representing crude oil producers and refiners, including the California
Independent Petroleum Association (CIPA), the Western States Petroleum
Association (WSPA), and the Independent Petroleum Association of America.
We reviewed studies, reports, and presentations on crude oil pricing and
differentials written by or produced for EIA, MMS, CEC, CIPA, and WSPA. We
also reviewed a study prepared for the California State Controller's
Office on crude oil price differentials in California, written by IIC
Inc., and interviewed its author. To evaluate the issue of crude oil price
manipulation in California, we reviewed documents, regulations, and
studies from the 1980s and 1990s regarding the history of allegations of
oil producers manipulating prices to avoid making royalty payments. We
also interviewed officials with the California State Controller's Office,
MMS, CIPA, and WSPA, regarding the history of manipulation in California,
and whether they believed or had evidence that such price manipulation
might have occurred in the recent period of unusually high price
differentials. We did not seek to acquire proprietary records on the
prices received for sales of crude oil from crude oil producers or their
buyers for this engagement.
To evaluate the unusually high price differentials in the Rocky Mountain
region, we obtained data on the spot price of Wyoming Sweet, a light sweet
crude oil similar in quality to WTI. We used this data to calculate price
differentials by subtracting the monthly average price for Wyoming Sweet
from the monthly average price of the WTI and analyzed these differentials
for trends over time. To understand the causes of the high price
differential in the Rocky Mountain region and to learn what stakeholders
in the region are doing to address the issue, we interviewed officials
with the Wyoming Pipeline Authority, the North Dakota Petroleum Council,
the Interstate Oil and Gas Commission, the Colorado Oil and Gas
Commission, and oil producers and refiners in the region.
We conducted our work between May and December 2006 in accordance with
generally accepted government auditing standards.
Appendix II
GAO Contact and Staff Acknowledgments
GAO Contact
Jim Wells, (202) 512-3841, or [email protected]
Staff Acknowledgments
In addition to the individual listed above, Frank Rusco, Assistant
Director; Jeffrey Barron; Casey Brown; Alison O'Neill; Kim Raheb; Barbara
Timmerman; and Wilda Wong made key contributions to this report.
(360701)
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
[email protected].
Highlights of GAO-07-315, a report to congressional requesters
January 2007
CRUDE OIL
California Crude Oil Price Fluctuations Are Consistent with Broader Market
Trends
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.
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.
WTI and Kern River Crude Oil Price Differentials, December 1987 to August
2006
*** End of document. ***