Trends, Cycles, and Kinks


	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 increases.

	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 expands.

	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.