|SThe scatter plot illustrates the relatively strong
relationship between crude oil prices and light-heavy crude oil price
differences. As the price of crude oil
was rising, the prices of lower quality crude oils were increasing more
slowly than the prices of higher quality light crude oils. That is, the difference between light and
heavy crude oil prices was expanding.
We expect the light-heavy crude oil price difference to expand when
prices increase because of the way product prices change when crude price
|SA primary driver of crude price differentials is the
product market. Refiners evaluate crude oils by what they can earn from the
products the different crude oils produce.
|–Heavy crude oils contain more heavy bottoms material like
residual fuel oil, which sells below the price of crude oil. When crude prices rise, residual fuel oil
price does not rise as much, since it competes with other fuels such as coal
and natural gas.
|–However, gasoline and distillate prices rise as much as or
more than crude oil prices, depending on the tightness of the market.
|–Refineries that set the price of heavy crude oil produce a
larger share of residual fuel from heavier crude oils than other
refineries. As a result, the price of
heavy crude oils that contain proportionally more of this residual fuel. tend
to rise more slowly than the light crude oils. Thus residual fuel oil price acts like an
anchor, slowing down the increase of the lower quality crude oil prices, and
hence, the difference in price between the light crude oils and heavy
|S As crude oil prices fell back to the $40 range, the
light-heavy crude price differential fell back. But in this plot, the scatter around the
line indicates that the dynamics behind this relationship may keep the movements
from being a simple relationship – even though we show a fitted line for
discussion purposes. Other factors
also affect the light heavy differential, such as availability of bottoms
upgrading capacity and the market availability of heavy crude oils relative
to lighter crude oils.