This section looks at petroleum trade and transportation. The main oil producing areas are not the same as the main consuming areas. Hence, oil must be moved from regions where supply is greater than demand -- exporting regions -- to regions where demand is greater than supply -– importing regions. The "have/have not" balance results in oil flows from one international region to another, from one country to another, and from one region within a country to another. These flows, dictated by economics, logistics, and temporary imbalances in supply and demand, are central to the efficient operation of the oil market.
Regional Importers and Exporters
As one might expect, the world’s three largest consuming regions -- North America, Europe, and Asia-Pacific -- are all importers. All the other regions are exporters.
The Middle East still exports vastly more oil than any other region, despite the strong growth in production in other areas in recent years. This global dependence on Middle East oil makes the geo-political importance of the Middle East readily understandable.
There is less variation among the importing regions. In the decade preceding its 1997-98 financial crisis, Asia-Pacific's economic boom propelled it into the Number 1 spot, with import growth more than double that of any other region’s. Even though the United States is the largest individual importer, both net and gross, North America as a region ranks third; because Canada and Mexico are two of the United States’ three top oil suppliers, their exports to the United States offset U.S. imports from these neighbors in the regional calculation. (Net imports are gross imports minus gross exports). This has kept North America’s import dependency down to not much over 30 percent, half that of the Asia-Pacific region at its 1997 peak. The latter’s import dependency, and even its import volume, have declined since then, but not by enough to threaten its position as the world’s top importing region. (See discussion of U.S. import dependency below.)
Oil Trade: Highest Volume, Highest Value
There is more trade internationally in oil than in anything else. This is true whether one measures trade by how much of a good is moved (volume), by its value, or by the carrying capacity needed to move it. All measures are important and for different reasons. Volume provides insights about whether markets are over- or under-supplied and whether the infrastructure is adequate to accommodate the required flow. Value allows governments and economists to assess patterns of international trade and balance of trade and balance of payments. Carrying capacity allows the shipping industry to assess how many tankers are required and on what routes. Transportation and storage play a critical additional role here. They are not just the physical link between the importers and the exporters and, therefore, between producers and refiners, refiners and marketers, and marketers and consumers; their associated costs are a primary factor in determining the pattern of world trade.
Distance: The Nearest Market First
Generally, crude oil and petroleum products flow to the markets that provide the highest value to the supplier. Everything else being equal, oil moves to the nearest market first, because that has the lowest transportation cost and therefore provides the supplier with the highest net revenue, or in oil market terminology, the highest netback. If this market cannot absorb all the oil, the balance moves to the next closest one, and the next and so on, incurring progressively higher transportation costs, until all the oil is placed.
The recent growth in United States dependence on its Western Hemisphere neighbors is an illustration of this "nearer-is-better" syndrome. For instance, Western Hemisphere sources now supply over half the United States import volume (see graph), much of it on voyages of less than a week. Another quarter comes from elsewhere in the area called the Atlantic Basin, those countries on both sides of the Atlantic Ocean. This oil, coming especially that which comes from the North Sea and Africa, and takes just 2-3 weeks to reach the United States, boosts the so-called short-haul share of U.S. imports to over three-quarters. Most North Sea and North and West African crude oils stay in the Atlantic Basin, moving to Europe or North America on routes that rarely take over 20 days. In contrast, voyage times to Asia for just the nearest of these, the West African crude oils, would be over 30 days to Singapore, rising to nearly 40 for Japan. Not surprisingly, therefore, most of Asia’s oil comes instead from the Middle East, only 20-30 days away.
Mexico and Venezuela have consciously helped the trend toward short-haul shipments. They pro-actively took the strategic decision to make as large and as profitable a market as possible for poor quality crudes, since their reserves are unusually biased toward those hard-to-place grades. Both countries therefore targeted their nearest markets, the U.S. Gulf Coast and the Caribbean, for joint venture refinery investments. They began with refineries that had traditionally run their crudes, and then with refineries that might be upgraded to do so. This policy has turned poor quality crudes into the preferred crude at these sites, significantly increasing the crude oil self-sufficiency of the Western Hemisphere.
A change in trade flow patterns can also be of critical importance to the shipping industry. For example, the Suez crisis of 1957 forced tanker owners back to using the much longer route around the Cape of Good Hope, and resulted in the development of Very Large Crude Carriers (VLCC’s) to reduce that voyage’s higher costs. The shift to short-haul routes in the 1990's was also critical. Using the growth in world trade volumes as a proxy for demand, tanker owners had been expecting a return to a strong tanker market. But the combination of the surge in short haul imports in the Atlantic Basin and the shift of Middle East exports from the longer United States to shorter Asian voyages led to a sharp decline in average voyage length. This decline was accelerated by the return of Iraqi crude exports, many of which move on the extremely short route from the Black Sea end of the Iraq-Turkey pipeline to the Mediterranean. The tanker owners' outlook was thus fading even before world trade volumes were undermined by the Asian crisis.
Quality, Industry Structure, and Governments
In practice, trade flows do not always follow the simple "nearest first" pattern. Refinery configurations, product demand mix, product quality specifications –- all three of which tie into quality -- and politics can all change the rankings.
Different markets frequently place different values on particular grades of oil. Thus, a low sulfur diesel is worth more in the United States, where the maximum allowable sulfur is 0.05 percent by weight, than in Africa, where the maximum can be 10 to 20 times higher. Similarly, African crudes -- low in sulfur -- are worth relatively more in Asia, where they may allow a refiner to meet tighter sulfur limits in the region without investing in refinery upgrades. Such differences in valuing quality can be sufficient to overcome transportation cost disadvantages, as the relatively recent establishment of a significant trade in long-distance African crudes to Asia shows. The cost of moving oil into a particular market can be further distorted from the principle of nearest first by government policies such as tariffs, as discussed in the chapter on Prices.
In addition, both buyers and sellers may impose restrictions. For instance, the United States prohibits the importation of Iranian and Libyan oil, and the United Nations allows only limited sales of Iraqi oil. On the seller's side, Mexico formerly limited sales to the United States to 50 percent of its exports, reflecting concerns about dependence on the United States specifically and about dependence on one geographic market in general. Saudi Arabia's national security concerns, on the other hand, dictate that it maintain a very high profile as a supplier to the United States market, even at the cost of lower netbacks. Indeed, it was the top United States crude supplier in 1999.
Crude oil dominates the world oil trade. The risk-weighted economics clearly favor siting refineries close to consumers rather than close to the wellhead. This siting policy takes maximum advantage of the economies of scale of large ships, especially as local quality specifications are increasingly fragmenting the product market (see Demand). It maximizes the refiner’s ability to tailor the product output to the market’s short-term surges such as those caused by weather, equipment outages, etc. In addition, this policy also guards against the very real risk that governments will impose selective import restrictions to protect their domestic refining sector.
As noted in the section on Refining, there are a limited number of refining centers that are at odds with this general rule, having been developed to serve particular export markets. These export refining centers -- Singapore, the Caribbean, and the Middle East -- give rise to some regular inter-regional product moves, but they are the exception. The inter-regional products trade is largely a temporary market-balancing function. Some inter-regional flows are extremely short lived, as when extremely cold weather in Europe causes the United States to export heating oil there. A longer-lived example arose when a large proportion of European drivers opted for diesel cars, leaving the region in the late 1990's with surplus capacity to produce gasoline for export to the United States.
There are two modes of transportation for inter-regional trade: tankers and pipelines. Tankers have made global (intercontinental) transport of oil possible, and they are low cost, efficient, and extremely flexible. Pipelines, on the other hand, are the mode of choice for transcontinental oil movements.
Not all tanker trade routes use the same size ship. Each route usually has one size that is the clear economic winner, based on voyage length, port and canal constraints and volume. Thus, crude exports from the Middle East -- high volumes that travel long distances -- are moved mainly by Very Large Crude Carriers (VLCC’s) typically carrying over 2 million barrels of oil on every voyage. The VLCC's economies of scale outweigh the constraints imposed: they are too large for all the ports in the United States except the Louisiana Offshore Oil Port (LOOP). Thus, they must have some or all of their cargo transferred to smaller vessels, either at sea (lightering) or at an offshore port (transshipment). In contrast, ships out of the Caribbean and South America are routinely smaller and enter ports in the United States directly. Because of such ship size differences, a long voyage can sometimes be cheaper on a per barrel basis than a short one.
Pipelines are critical for landlocked crudes and also complement tankers at certain key locations by relieving bottlenecks or providing shortcuts. The only inter-regional trade that currently relies solely on pipelines is crude from Russia to Europe. Export pipelines are also needed for production from the Caspian Sea region, where the protracted commercial and political debate illustrates the greatest negative for pipelines crossing national boundaries: their political vulnerability.
Pipelines come into their own in intra-regional trade. They are the primary option for transcontinental transportation, because they are at least an order of magnitude cheaper than any alternative such as rail, barge, or road, and because political vulnerability is a small or non-existent issue within a nation's border or between neighbors such as the United States and Canada. (Pipelines are also an important oil transport mode in mainland Europe, although the system is much smaller, matching the shorter distances.)
The development of large diameter pipelines during World War II allowed the development of the vast pipeline network in North America that moves crude oil and product within Canada, from Canada into the United States, and within the United States. Domestically, the 200,000 miles of pipelines account for about two-thirds of all the oil shipments, when adjusted for volume and distance. They move domestic crudes from producing areas like California, the Rockies, and West Texas, and imported crudes from the receiving ports, and transport them to the refining centers. The United States also relies heavily on pipelines to transport petroleum products from refining centers, such as the Gulf Coast, to consuming regions, like the East Coast.
Fungibility is an important factor in transportation economics. Because the oil is broadly interchangeable (fungible), it can be mixed without a significant diminution in value. As environmental mandates have required different regional and seasonal qualities of gasoline, the required batching for transport and segregation for storage has increased substantially. Thus the logistics flexibility inherent in a product's fungibility -- the ability to substitute one shipment for another, to exchange between regions, for instance -- has disappeared. While this is invisible to consumers during normal times, it contributes to market upheavals and price spikes in times of surprises in demand or supply, as during the early driving season in 2000.
As already noted, the United States continues to sit at the top of the national rankings of importers, now accounting for around a quarter of total world imports. Yet its import dependency, the percentage of demand met by imports, is significantly lower, at about 50 percent, than that of its international partners. Industrialized countries such as Japan and Germany have import dependency levels of 90-100 percent.
The Middle East has long been regarded as politically unstable and its oil supply, therefore, subject to disruptions. U.S. policy makers have viewed its increased dependence on Western Hemisphere supplies and its decreased dependence on the Middle East as a welcome development. (Again, an international contrast: the Asia-Pacific region now relies on the Middle East for almost 90 percent of its imports and hence 50 percent of its consumption.)
As the Middle East holds the majority of the world’s oil reserves (see Supply), increasing U.S. dependence on this region had been viewed as the inevitable partner of import growth. In light of the shift toward Western Hemisphere, short-haul import sources, Saudi Arabia is the only significant Middle East supplier left, and then only because of its willingness to trade security for revenue as noted above. Yet, although U.S. dependence on the long-haul Middle East has fallen sharply, this has not made U.S. prices less vulnerable to a disruption in Middle East supplies. Since oil is a global market, the relevant measure for that vulnerability is not U.S. dependence, but world dependence on Middle East oil -- and that has not shrunk.
While interdependence in the Western Hemisphere has been a major United States policy objective, it is important to realize that this combination of size and geographic closeness creates its own short-term vulnerability. Take for instance the case of Hurricane Roxanne, which severely damaged a large part of Mexico’s production facilities in the Gulf of Mexico in late 1995. Some 40 million barrels of Mexico’s production was eliminated, the vast majority earmarked for refineries along the U.S. Gulf Coast. These refiners, less than a week’s sailing time away, had little time to compensate for this sudden hole in their planned supplies.
Crude oil dominates U.S. imports just as it dominates world trade and for much the same reasons (see Crude versus Products, and see graph). Therefore, all of the U.S. leading suppliers are major crude producers. Imports of crude oil, having grown to replace declining domestic production and to meet growing demand, now account for around 80 percent of the total. Product import volumes have stayed relatively stable.
In spite of the seeming stability in product imports, there have been significant structural shifts over the last couple of decades in the mix of products that the United States imports. Residual fuel oil, for instance, formerly accounted for the majority of all product imports, but its share has shriveled into insignificance as utilities and industrial users have switched to other fuels, particularly nuclear and natural gas. In its place, the United States now imports a much higher proportion of petroleum products that are reprocessed or blended by the oil industry, such as the unfinished gasoline and gasoline blending components that are central to reformulated gasoline supply.
Canada is the one country that delivers oil to the United States by pipeline. (Only its relatively new offshore Eastern Canadian production, from fields like Hibernia, depends on tankers.) The vast majority of Canada’s crudes are landlocked and rely almost exclusively on trunk-lines from Western Canada that tie into the U.S. transcontinental network to reach their main export markets, which lie all across the Northern Tier of the United States. As domestic production has declined, these Canadian crudes have had a greater reach into the United States.
Since the United States is the world’s largest importer, it may seem surprising that it also exports around 1 million barrels a day of oil, predominantly petroleum products. Due to various logistical, regulatory, and quality considerations, it turns out that exporting some barrels and replacing them with additional imports is the most economic way to meet the market’s needs. For example, the Gulf Coast may export lower quality gasoline to Latin America while the East Coast imports higher quality gasolines from Europe. Exports in the 1990’s have been at record highs, the efficiency of the oil market has been increased, and consumers everywhere have benefited.
There are significant differences between different parts of the United States in terms of their involvement in and dependence on international trade. Most of these differences are the direct result of the uneven distribution of both production and refining across the United States (see U.S. Supply, U.S. Refining). Thus, as shown in the graph, the East Coast imports over half of all the products that come to the United States, because it is the largest consuming area in the United States but, for historical reasons, it has only enough capacity to meet around 1/3 of those needs from its own refining. It fills the product gap with supplies from other parts of the United States, particularly the Gulf Coast, and with imports. Its limited volume of refining capacity also keeps it a distant third as a crude importer. However, because its local production is so insignificant, its crude import dependency is the highest of all, at almost 100 percent.
The only other region that imports significant amounts of products is the Gulf Coast. Its focus is not, like the East Coast's, on products that can be supplied directly to the consumer, but on refinery feedstocks and blendstocks, to support its role as the main U.S. refining and petrochemical center. That role, plus the need for all the Midwest’s non-Canadian crude imports to move through the Gulf Coast’s ports and pipelines too, has also led to the Gulf Coast being by far the most important crude oil importing region in the United States, accounting for nearly two-thirds of the total.
The trade among regions of the United States is focused on the eastern half of the country. As shown in the graph, the Midwest and East Coast account for 90 percent of the inter-regional flow, the flow between Petroleum Administration for Defense Districts (map). The Gulf Coast is by far the largest supplier, accounting for more than 80% of the inter-PADD flow. In contrast, the Rockies and the West Coast are isolated, in petroleum logistics terms, from the rest of the country. The easy flow of petroleum from the Gulf Coast to the Midwest and the East Coast mean that incremental supply is more readily available to those markets in the event of a demand surge or supply drop. In contrast, the West Coast, and the California market in particular, cannot so readily attract incremental supplies. Thus, the California refinery outages that occurred in the Spring of 1999, resulted in a large price increase as market players scrambled for additional supply, none of which was available close at hand, or cheaply. The California market's isolation is more than just geographic: the State imposes unique and stringent quality restrictions on both its gasoline and its off-highway diesel, making what otherwise might be available to augment California product supplies unsuitable.
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