Crude oil and product value differentials: Historical perspective and outlook

Quality differentials between light/sweet and heavy/sour crudes increased dramatically both during the 1973 Arab oil embargo and the 1979–1980 Iranian political upheaval. Along with the rapid increase in crude oil quality differentials, there also emerged a widening gap between the prices of light and heavy products. The huge gap between light and heavy crude prices on one hand and the growing difference between light and heavy product prices on the other created an environment conducive to the many refinery upgradings that have taken place in recent years. The investments involved have been heavy, particularly in the United States, where in the last few years billions of dollars have been spent to either upgrade existing facilities or add new capacity to convert heavy crudes, residues, or both to lighter products. The economics of these upgrading projects have now come under attack on two fronts. First, the quality differentials between light and heavy crudes have dwindled significantly. Second, while the differential between light products and heavy fuel oil has narrowed considerably, the premium once enjoyed by gasoline relative to distillates has also virtually disappeared. Obviously if these developments prove to be permanent, the rates of return originally expected from the refinery upgradings will not be realized. This study shows that price differentials for crude oil and products are interrelated and that their value basically depends on the same factors. Although numerous factors currently affect the differentials, the important ones are real oil prices, the world refinery utilization rate, the demand for heavy fuel oil, the world average refinery complexity index, and the quality of crude supply. Given these factors, differentials are likely to become smaller in the short run but are bound to widen in the long run.