Global Patterns of Trade

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

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, 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, 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 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.

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

Crude versus Products

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. 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.

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.

Tankers and Pipelines

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.

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