The Midwest Oil Glut Hasn’t Lowered Gas Prices; Ending the Glut Won’t Raise Them

Sometime later this week the owners of the Seaway pipeline will announce that they’ve completed the first stage of reversing the flow of oil on the line and have started carrying 150,000 barrels of crude each day from Cushing, Oklahoma to the Gulf Coast.  This is the first of a few pipeline projects – including the southern leg of the Keystone XL — responding to the glut of oil that has built up in the Midwest as crude production in North Dakota, the Canadian tar sands, and other Midwest and Rocky Mountain locations has ramped up.  Output has expanded much faster than industry watchers predicted just a few years ago and has outpaced the pipeline capacity available to carry it to refineries in Texas and Louisiana.

The effect of the glut has been depressed prices for oil in the Midwest and at Cushing — a central hub for oil trading.  Since January 2011, when the glut began, prices for the same quality crude have been $8-$25 lower at Cushing than along the Gulf of Mexico.  The Gulf price is very close to prices in Europe and most other on-the-water locations around the world because oil tankers constantly arbitrage any price difference.   Historically, the difference between Cushing and the Gulf has been less than two dollars, because prior to 2011 available pipeline capacity made that arbitrage easy as well.  On Friday, the difference was about $16.

So what do the Seaway and related pipeline projects mean for consumers?  In a new Energy Institute at Haas working paper that Ryan Kellogg (University of Michigan, visiting the Energy Institute this year) and I are releasing today, we conclude that the answer in the short run is “not much”.

The first stage of the Seaway will narrow the crude price differential only partially, but even as its capacity expands and other new pipelines come on line, the narrowing of the price spread will have no discernible impact on prices at the pump.  Here’s why:

As the pipeline capacity expands, it will lower world crude oil prices very slightly and will raise Midwest crude prices substantially.  The change in world crude prices will be tiny because the additional supply will be well under 1% of world demand even a year or more from now.  Midwest crude prices will be pulled up to once again match the world price.

Some have been concerned that increasing crude prices in the Midwest would increase Midwest gasoline and diesel prices.  Our analysis shows that the glut over the last year and a half hasn’t lowered Midwest gasoline prices and that, for the same reason, relieving the bottleneck won’t raise them.

The reason for this surprising result is actually simple (and no, it’s not that monopoly Big Oil is ripping us off): while crude oil transportation has been impeded by a shortage of pipeline capacity, gasoline and diesel flow in a separate set of pipes that have remained uncongested.  The Midwest has been, and remains, a net importer of these refined products, and there is plenty of pipeline capacity to eliminate any price difference between the Gulf and the Midwest.

As a result, when the price of crude dropped in the Midwest during 2011 (relative to the rest of the world), the price of gasoline and diesel in the Midwest continued to be set by the marginal supply, which was coming from the Gulf Coast.  Midwest refineries made big profits refining cheap crude,  and selling the output at prices set by higher-cost crude in the Gulf.  They weren’t doing anything nefarious; they were just the lucky beneficiaries of being in an oil-rich area that, temporarily, couldn’t get its crude oil to world markets.

The new pipeline capacity between the Midwest and the Gulf Coast will have big economic impacts.  Oil producers in the Midwest and Canada will be able to sell their output for higher prices and refiners in the Midwest will see the sweet ride they’ve been on for the last year and half start to come to an end.  But this will be a non-event at the local gas station.

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5 Responses to The Midwest Oil Glut Hasn’t Lowered Gas Prices; Ending the Glut Won’t Raise Them

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