As an article in the Financial Times noted Monday, the simple question "What is the price of oil?" became much harder to answer this year.  The gap between the price of UK Brent crude, which the US Department of Energy recently announced it was adopting as its indicator of global oil prices, and West Texas Intermediate (WTI), their former planning benchmark and the price most commonly identified with oil by the media and US public, has grown too large to ignore.  Blame that on a combination of pipeline bottlenecks and a rapidly growing offshoot of the shale gas revolution, in the form of so-called "tight oil" or "shale oil."  Whatever the cause, the spread between Brent and some of the crude sources that are reviving US hopes of energy independence now exceeds the total price of crude oil as recently as 2003. That has big consequences for producers, refiners and consumers.

When the year began, WTI was only about $8 per barrel below Brent-- a hefty discount for a crude that routinely traded at parity or a slight premium to Brent until a couple of years ago.  As of today, however, Brent's advantage is closer to $21/bbl.  Nor is this just a US/European difference.  Recent settlements for the "swap" between WTI and Louisiana Light Sweet (LLS), a Gulf Coast crude unaffected by the massive bottlenecks in the Midcontinent, were around $22/bbl.   And if that doesn't seem like a big enough discount for a transportation disadvantage, consider that similar crudes produced near Midland, TX--another hotspot of the US crude oil resurgence--were recently selling at nearly $10/bbl below WTI. 

It's important to note that these price differences are too big to be explained by distinctions in quality. Most of these crude types are quite similar, light and sweet--low in sulfur and relatively easy to refine into valuable products like diesel and gasoline.  Instead, the discounts reflect the absence of a low-cost means of delivering much of this production from source to refinery as existing pipeline capacity has been filled or as new production unserved by pipelines emerges.  To illustrate the magnitude of this problem, in a recent panel discussion on the future of fuels Frank Verrastro of the Center for Strategic and International Studies indicated that 1.4 million barrels per day of US crude production is currently shipped by rail. 

That's a figure that ought to cause opponents of pipelines like the Keystone XL to reflect on the unintended consequences of their success in delaying such projects.  It should also warm the hearts of railroad shareholders, since rail freight is much costlier than pipeline tariffs, and the volume in question is nearly double that of US corn ethanol, which also largely moves in railcars.  Yet while this benefits railroads and refineries such as PBF's Delaware City plant, which is installing facilities to receive up to 110,000 barrels per day of low-cost crude by rail, it exacts a substantial penalty from those domestic producers who receive well below world prices for their output.   

At current price levels, that hasn't impeded the rapid growth of production in places like North Dakota. However, if global oil prices declined significantly, and the discounts between new sources and benchmark Brent didn't compress dramatically, then some of the output that the US is counting on to drive out imports could become uneconomical to produce.  Some refiners and Midwestern consumers have gained a temporary advantage from the bottlenecks that are trapping hundreds of thousands of barrels per day of oil in the Midcontinent or forcing it onto railcars. However, they, along with producers, stand to benefit more in the long run from new pipeline capacity that would make today's production more recession-proof, while supporting further development.

Relief is on its way, and at least one project, the reversal of the existing Seaway pipeline, has already started shipping oil.  Adding more capacity to transport crude oil from the Plains states and Midcontinent to the major refining centers of the Gulf Coast makes strategic sense and should eventually narrow the price differentials described above.  Despite opposition motivated by environmental concerns and organized via social media, it seems likely that many of these pipeline projects will ultimately be built, because their economic, trade and even environmental, health and safety advantages look compelling.  But that doesn't mean it will happen overnight, or without a lengthy process of give-and-take with regulators and stakeholders.  Until this new infrastructure is in place, whenever someone tells you the price of oil, be sure to ask which oil they have in mind, and where. 

The announcement of a $21 billion project to capitalize on abundant, low-cost US natural gas ought to catch the attention of everyone interested in this resource.  As reported in the New York Times, Sasol, a South African energy company, intends to build a 96,000 barrel-per-day gas-to-liquids (GTL) plant in southwestern Louisiana, in conjunction with a new gas processing plant and ethylene cracker.  The synthetic diesel fuel produced by this facility would provide a different pathway for shale gas to displace imported crude oil in the US transportation sector, in competition with compressed or liquefied natural gas (CNG or LNG.)

GTL involves a two-step conversion of the methane that makes up the bulk of natural gas into synthesis gas and hydrogen, which are recombined into liquid hydrocarbons by means of the decades-old Fischer-Tropsch (FT) process.  GTL is also energy-intensive, with an overall efficiency around 60%.  South African companies have vast experience with such synthetic fuels. Sasol are partners in the Oryx GTL plant in Qatar, and their coal-to-liquids plants in South Africa utilize a similar syngas step and the same FT process as GTL. 

With the US suddenly perceived to be sitting atop a century's worth of natural gas, mainly in the form of unconventional gas from shale, tight gas formations and coal-bed methane, T. Boone Pickens isn't the only one to see an opportunity to displace imported oil with gas.  Yet as attractive as that sounds for reasons of energy security and trade, it isn't obvious whether the public or even fleet operators are willing to switch on a larger scale to a lower-density gaseous fuel requiring both new distribution networks and new or modified powertrains. Only 0.1% of the natural gas consumed in the US now finds its way into vehicles, equivalent to less than 0.1% of US oil demand.  Under the circumstances, it would be surprising if someone weren't looking seriously at GTL, one of the few practical ways to circumvent the mechanical and logistical barriers that have impeded the fueling  of more US cars and trucks with natural gas.

When I read about Sasol's proposed project, I immediately thought of another, less well-known South African synfuels facility.  Since 1992 the Mossel Bay GTL plant has been turning natural gas into gasoline, diesel and other fuels, drawing first on the Mossel Bay gas field and then on newer fields as the original one depleted.  Although owned by another firm, the ongoing struggles to keep the "Mossgas" plant supplied are well-known in South African energy circles.  I can't imagine Sasol embarking on a project like the one in Louisiana if they had any doubt about their ability to keep it supplied for decades.

Of course volume and price are two very different aspects of supply.  A decade ago, conventional wisdom held that GTL required a gas cost of around $1 per million BTUs to be viable.  Even with the shale bonanza today's US natural gas price is well above that level.  What now makes it possible to conceive of GTL in the US is that the price of the crude oil used to make diesel and other fuels has risen so much higher than that of natural gas.  That comparison is more obvious  when one converts natural gas prices into their energy equivalent in crude oil.  Today's US natural gas price is around the same $23 per equivalent barrel that it was in 2001.  Meanwhile crude oil has increased from about $26 to $95 per barrel.  The drastically improved attraction of GTL becomes even clearer when comparing ten years of wholesale US Gulf Coast diesel prices to natural gas prices using the approximate GTL conversion rate of 10 million BTUs of gas per barrel of product. 

As the chart above reveals, this theoretical GTL margin has exploded since 2009.  Yet it also shows that if gas prices returned to the levels we experienced just a few years earlier, the proposed project would encounter significant risks.  Perhaps that helps explain Sasol's concept of a larger integrated gas complex with multiple sources of margin, capitalizing on the waste heat from the GTL process and the lighter hydrocarbons it yields as byproducts.

It remains to be seen whether GTL will prove an attractive means of leveraging the US shale gas revolution to back out imported oil.  However, if Sasol and others proceed with US GTL projects, anyone eyeing our gas surplus for other purposes, whether in manufacturing, fertilizer production or power generation, would face serious competition linked to the global oil market. That includes potential LNG exporters, who have just passed an important hurdle with the publication of a favorable analysis by the Department of Energy.