a study of the relationship between spot product … study of the relationship between spot product...
TRANSCRIPT
OXFORD Ns-nrn E N E R G Y STUDIES
= FOR-
A Study of the Relationship Between Spot Product
Prices and Spot Crude Prices
Robert Bacon
Oxford Institute for Energy Studies
WPM 5
1984
The c o n t e n t s o f t h i s paper a r e f o r t h e purposes of s t u d y and d i s c u s s i o n and d o not represent the v iews of the Oxford I n s t i t u t e for Energy Studies or any of its members.
Copyright 0 1984 Oxford I n s t i t u t e for Energy S t u d i e s
ISBN 0 948061 05 7
TABLES
Table I R e l a t i o n s h i p s Between Spot P r i c e Measures f o r Arab Light
I1 R e l a t i o n s h i p s Between Spot P r i c e Measures f o r Nigerian Light
111 Months wi th Extreme Disagreements Between S e r i e s
I V R e l a t i o n s h i p s Between Netbacks f o r Arab Light
V R e l a t i o n s h i p s Between Netbacks f o r N i g e r i a n L i g h t
V I C o r r e l a t i o n s f o r Saudi Netbacks (1981.01-1983.06)
V I 1 C o r r e l a t i o n s f o r Nigerian Netbacks (1981.01-1983.06)
V I 1 1 The Normal Margin Model (1976 .01-1983.06)
IX Estimated Normal Margins f o r Various Sub-Per iods
X Estimated Normal Margins a t D i f f e r e n t Refinery Centres
XI Regression of Arab Light Margin on Nigerian Light Margin
XI1 R e l a t i o n s Between Netbacks and Spot Crude P r i c e s for Arab Light
XI11 R e l a t i o n s Between Netbacks and Spot P r i c e s f o r Nigeria
XIV The Impact of Spot and O f f i c i a l P r i c e s o n Metbacks for Arab Light
XV The Impact of Spot and O f f i c i a l P r i c e s on t h e Netback f o r Nigerian Light
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TABLE OF CORTEldS
B . l
B.2
B.2.1
B.2.2
8.3
B.3.1
B . 3 . 2
B.4
B.5
B . 5 . 1
B.5.2
B.5.3
B . 5 . 4
INTRODUCTION
PART A: PRINCIPAL FINDINGS OF THE STUDY
PART B: DETAILED ANALYSIS
The R e l a t i o n Between Spot Crude P r i c e s and Spo t Product Values
The Data
Spot Crude P r i c e s
Netback Data
A Simple Model R e l a t i n g Spot Product Values and Spot Crude Prices
The Model
The Goodness of F i t of t h e Normal Margin Model
Economic F a c t o r s Determining t h e Netback t o Crude Margin
Further S t a t i s t i c a l Tests on t h e R e l a t i o n s h i p s Between Product and Crude P r i c e s
An Unconstrained Re la t ionsh ip
O f f i c i a l P r i c e s as Explanatory Var i ab le s
Dynamic Equation6
V a r i a t i o n s B e tween Ref i n e r ies
DATA APPENDIX: KEY TO ABBREVIATIONS
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3 7
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NOTES 96
XVI Lags Between Spot Prices and Netbacks of Arab Light
XVII Lags Between Spot Prices and Netbacks for Nigerian Light
XVIII Relat ion Between Netback and Spot Price for Various R e f iner ies fo r Arab Light f o r the Third Episode
X I X Relat ion Between Netback and Spot and O f f i c i a l Prices f o r Arab Light for Various Ref iner ies for the Fourth Episode.
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I ATBODU CT I OH
T h i s p a p e r i s an i n v e s t i g a t i o n i n t o t h e r e l a t i o n
between crude o i l p r i c e s and t h e p r i c e s of the products made from
r e f i n i n g crude o i l . Commentators on t h e o i l market o f t e n focus
o n a measure of t h e d i f f e r e n c e be tween t h e " v a l u e " of t h e o i l
once c o n v e r t e d i n t o p r o d u c t s and t h e c o s t of t h e c r u d e o i l
i t s e l f . There has been very l i t t l e pub l i shed work on the n a t u r e
and b e h a v i o u r of t h i s m a r g i n and t h e f i r s t p a r t of t h e s t u d y i s
a d d r e s s e d t o t h e p r o b l e m of m e a s u r i n g and summar i s ing its
behaviour.
Once some p a t t e r n s f o r t h e margin between t h e two s i d e s
of t h e o i l market - crude and products - have been e s t a b l i s h e d ,
t h e p a p e r i s t h e n a b l e t o t u r n to t h e q u e s t i o n of model l i n g t h e
r e l a t i o n s h i p be tween t h e t w o se r i e s , and t h i s r e q u i r e s some
a n a l y s i s of t h e markets concerned.
The p a p e r c o n c e n t r a t e s on two c r u d e o i l s (and t h e i r
a s s o c i a t e d p r o d u c t values), A r a b i a n L i g h t (33.9 'API) and
N i g e r i a n L i g h t (37.7 OAPI). The r e a s o n f o r c h o o s i n g t h e s e two
p a r t i c u l a r crudes i s t h a t d a t a i s a v a i l a b l e for long per iods and
t h a t t h e i r p r i c e behaviour is n o t t o o s imilar (as would be Arab
and I r a n i a n Light f o r example).
A p a r t i c u l a r p r o b l e m w i t h s t u d y i n g t h e s e c o n c e p t s i s
t h a t t h e r e is n o " o f f i c i a l " s o u r c e of d a t a f o r t h e c r i t i c a l
c o n c e p t s . I n s t e a d t h e r e a r e s e p a r a t e e s t i m a t e s p roduced by
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v a r i o u s p r i v a t e agencies and t h i s l e a d s t o t h e unusual s i t u a t i o n
of having mu1 t i p l e o b s e r v a t i o n s ( e s t ima tes ) f o r t h e same concept.
An important p a r t of t h e paper is t h e r e f o r e devoted t o comparison
of t hese v a r i o u s d a t a sources.
The p a p e r i s d i v i d e d into two s e c t i o n s . Part A
d e s c r i b e s t h e main r e s u l t s , both a n a l y t i c a l and s t a t i s t i c a l , of
t h e study. This s e c t i o n i s se l f - con ta ined but does n o t i nc lude
any d i s c u s s i o n of how t h e r e s u l t s were der ived. For r e a d e r s who
are i n t e r e s t e d i n t h e d e r i v a t i o n of t h e r e s u l t s and t h e d e t a i l s
of t h e i n v e s t i g a t i o n Part B cove r s t h e same m a t e r i a l but a t much
g r e a t e r l e n g t h . The a r r a n g e m e n t of p a r t B i s a s follows.
S e c t i o n B.l p r e s e n t s t h e b a s i c c o n c e p t s t o be u s e d i n t h e
a n a l y s i s and t h e f u n d a m e n t a l h y p o t h e s i s of t h e "normal margin"
(between s p o t crude p r i c e s and s p o t product p r i ces ) . Sec t ion B.2
is concerned wi th t h e d a t a used, w i th t h e va r ious sou rce of d a t a
and w i t h a c o m p a r i s o n be tween d i f f e r e n t s o u r c e s f o r t h e same
concep t . S e c t i o n B.3 p r e s e n t s t h e s t a t i s t i c a l a n a l y s i s of t h e
b a s i c h y p o t h e s i s which i s t h a t t h e 'netback' ( t h e v a l u e of t h e
p r o d u c t s o b t a i n e d from a b a r r e l of c r u d e l e s s t r a n s p o r t and
product ion c o s t s ) moves i n a d o l l a r f o r d o l l a r r e l a t i o n s h i p with
t h e s p o t c r u d e p r i c e a t t h e p o i n t o f s a l e . T h i s s i m p l e
h y p o t h e s i s is n o t s u p p o r t e d by t h e d a t a . S e c t i o n B.4 t h e n
o u t l i n e s some new h y p o t h e s e s , a s a r e a c t i o n t o t h e r e s u l t s of
s e c t i o n B.3, which a n a l y s e t h e e x t e n t t o which concen t r a t ion on a
s imple market i n e q u i l i b r i u m (as assumed i n B.3) does c o r r e c t l y
inco rpora t e prob 1 e m s r a i s e d by c e r t a i n impor t a n t i n s t i t u t i o n a 1
f e a t u r e s eg geograph ica l s e p a r a t i o n of markets, t h e e x i s t e n c e of
2
a two t i e r c r u d e p r i c e s y s t e m , and t h e e x i s t e n c e of r e f i n e r i e s
wi th d i f f e r e n t cos t s t r u c t u r e s . Some of t hese new hypotheses a r e
t h e m s e l v e s t e s t e d and t h e r e s u l t s p r e s e n t e d i n B.5. The
conclus ion t o s e c t i o n B is i n e f f e c t p a r t A of t h e paper so t h a t
no s e p a r a t e conclusion i s r e q u i r e d . The unifying d e v i c e f o r
hand1 i n g a v e r y complex marke t is t h a t of a s k i n g how t h e two
s i d e s (crude and products) would be r e l a t e d i f the market were i n
e q u i l i b r i u m and u s i n g t h e s i m p 1 i c a t i o n s t h a t t h i s p e r m i t s t o
carry out a s e r i e s of tests on t h e o p e r a t i o n of t h e market.
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PART A : PRIBCIPAL FIRDIIVGS OF THE STUDY
The b a s i c h y p o t h e s i s t h a t r u n s t h r o u g h a l l s t u d i e s
r e l a t i n g product p r i c e s t o crude p r i c e s i s t h a t t h e v a l u e of t h e
p r o d u c t s , n e t t e d back t o t h e p o i n t of s a l e of t h e c r u d e , should
be s y s t e m a t i c a l l y r e l a t e d t o t h e p r i c e of t h e c rude . The
d i f f e r e n c e between t h e two c o n c e p t s , which w e s h a l l c a l l t h e
" n e t b a c k margin", or s i m p l y t h e "margin", h a s been used a s a
measu re o f p r o f i t o r loss f o r r e f i n e r i e s o r as a tool t o d e c i d e
w h e t h e r t h e marke t i s s u b s t a n t i a l l y out of equi l ibr ium. There
has been an i m p l i c i t assumption t h a t t h e r e i s a ''normal" margin
between t h e two s e r i e s and t h a t t h e a c t u a l v a l u e of t h e margin i s
n o t expected t o move away from t h i s v a l u e by s u b s t a n t i a l amounts
or f o r l o n g p e r i o d s . We show t h a t , i n d e e d , i f t h e r e i s
e q u i l i b r i u m in t h e markets w i t h a p e r f e c t l y compe t i t i ve s t r u c t u r e
t h e n t h e n e t b a c k c o r r e c t l y c a l c u l a t e d f o r a m a r g i n a l r e f i n e r y
would b e e x p e c t e d t o b e s l i g h t l y a b o v e t h e c r u d e p r i c e b u t t o
move with it.
To t e s t t h i s hypothes is of t h e "normal" margin d a t a on
both ne tbacks and spot c rude is required. There i s no " o f f i c i a l "
d a t a on e i t h e r concept but t h e r e a r e s e v e r a l u n o f f i c i a l series of
d a t a . Comparing t h e d a t a o n i d e n t i c a l c o n c e p t s on a m o n t h l y
b a s i s over t h e p e r i o d 1 9 7 6 t o 1983 r e v e a l s two g e n e r a l and
important f ind ings . Sources d o d i f f e r s y s t e m a t i c a l l y o v e r t h e
w h o l e p e r i o d and t h e r e a r e s u b - p e r i o d s of g r e a t d i s a g r e e m e n t .
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For crude d a t a fou r sources were used:
( i > OPEC B u l l e t i n
( i i ) Petroleum I n t e l l i g e n c e Weekly
( i i i ) Middle East Petroleum and Economic Pub l i ca t ions
( i v ) An indus t ry es t imate .
The main s p e c i f i c f i n d i n g s were t h a t t h e OPEC B u l l e t i n f i g u r e is
s i g n i f i c a n t l y g r e a t e r on average than t h e o t h e r sou rces over t h e
p e r i o d (by be tween one and two p e r c e n t ) . On a v e r a g e t h e o t h e r
t h r e e sources a r e c l o s e but vary between each o ther by an amount
e q u a l t o abou t 65 c e n t s . I n t h e f i r s t e i g h t months of 1 9 7 9 t h e
d i f f e r e n c e between sources i s o f t e n very g r e a t - f o r Arab Light
the maximum d i f f e r e n c e reaches $6 w h i l e for Nigerian t h e maximum
d i f f e r e n c e i s $3. This "measurement e r r o r " i n t h e spo t p r i c e i s
s o l a r g e t h a t no s t a t i s t i c a l work shou ld i n c l u d e t h i s period.
For netback d a t a t h r e e sou rces were u t i l i s e d :
(i) Petroleum I n t e l l i g e n c e Weekly
( i i ) OPAL
(iii) An i ndus t ry e s t ima te .
Netback d a t a d i s t i n g u i s h e s not on ly t h e crude used but a l s o t h e
l o c a t i o n of t h e r e f i n e r y and t h e t y p e of r e f i n e r y assumed.
Comparisons between t h e sources f o r i d e n t i c a l concepts r e v e a l e d a
c l o s e agreement between a l l t h r e e b u t w i th OPAL below b o t h o t h e r
sources f o r both crudes. Again t h e d i f f e r e n c e s between sources
a r e a t t h e i r g r e a t e s t i n 1979. Rather s u r p r i s i n g l y t h e agreement
between sources i s c l o s e r f o r netbacks than f o r crudes. However,
c l o s e n e s s of s e r i e s i s n e i t h e r a n e c e s s a r y n o r a s u f f i c i e n t
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c o n d i t i o n f o r t h e s e r i e s to be a c c u r a t e , e v e n though i t d o e s
i n c r e a s e c o n f i d e n c e in t h o s e s e r i e s w h i c h a r e a r r i v e d a t
independent ly . Hence a l l t h e subsequent s t a t i s t i c a l work, which
i s b a s e d on u s i n g a s e r i e s which i s n o t an " o u t l i e r " , must b e a r
t h e q u a l i f i c a t i o n t h a t measurement e r r o r is p o s s i b l e . However it
is an i m p o r t a n t f i n d i n g t h a t n o n - i n d u s t r y p u b l i s h e d d a t a on
n e t b a c k s a r e v e r y c l o s e to t h o s e a c t u a l l y u s e d by an an a c t u a l
a g e n t . The d e t a i l e d knowledge of t h e m a r k e t d o e s n o t p roduce
n o t i c e a b l y d i f f e r e n t f i gu res .
Given the amount of measurement e r r o r t h a t t hese ser ies
r e v e a l i t i s q u i t e l i k e l y t h a t t h e o r e t i c a l models, based on i d e a l
d a t a , w i l l n o t be a b l e t o be f i t t e d e x a c t l y t o t h e d a t a . T h e r e
w i l l b e a n e r r o r t e r m of a n i r r e d u c i b l e minimum however t he
a n a l y s i s is conducted.
The d e t a i l e d e x a m i n a t i o n of d a t a on p r o d u c t n e t b a c k s
and spo t crude p r i c e s ove r t h e lengthy per iod 1976 t o 1983 makes
it c l e a r t h a t t h e r e is a very c l o s e t i e between t h e two s i d e s of
t h e o i l m a r k e t , i e be tween p r o d u c t s and c r u d e . However, t h e
exac t n a t u r e of t h e r e l a t i o n s h i p raises some i n t e r e s t i n g a s p e c t s
t h a t a r e u n l i k e l y t o h a v e b e e n a p p a r e n t s o l e l y f rom a p r i o r i
t h e o r i s i n g or from empi r i ca l a n a l y s i s of s h o r t runs of da ta .
The two major f i n d i n g s a r e t h a t :
(i) The r e l a t i o n s h i p between spot product netbacks and s p o t crude pr ices a p p e a r s t o b e e p i s o d i c (however t h e r e l a t i o n s h i p i s f o r m u l a t e d ) . The s h i f t i n g i n the r e l a t i o n s h i p d o e s n o t a p p e a r t o b e c o n t i n u o u s , i n d i c a t i n g the o m i s s i o n of some c o n t i n u a l l y v a r i a b l e factor, but is rather discontinuous, indicating the e f f e c t of a factor vhich changes at d iscrete in terva l s .
( i i ) The r e l a t i o n s h i p between the two series c o u l d only be c o n s i s t e n t v i t h a prof i t maximising o p e r a t i o n of t h e
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market i f the period of adjustment to change i s slow and/or there are large fixed cost elerents involved in adjustment to large shifts in the market situation. The persistence of the netback a t a l e v e l below the spot p r i c e ( r a t h e r than above i t ) i s an important characteristic of the market which requires explanation. In particular the persistence of th i s phenomenon even when the data are analysed separately for each episode i d e n t i f i e d i n (i) c l e a r l y r e q u i r e s f u r t h e r inve s t i g a t ion.
The v i e w i m p l i c i t in t h e " t r a d e j o u r n a l s " a p p e a r s t o b e
t h a t t h e d i f f e r e n c e between t h e netback and t h e s p o t crude p r i c e s
- t h e netback margin - f l u c t u a t e s around a normal v a l u e (which is
by i m p l i c a t i o n c o n s t a n t ) . D e v i a t i o n s f rom t h e m a r g i n c a n be
t a k e n a s i n d i c a t i n g changes i n t h e s t a t e of t h e m a r k e t and a l s o
t h e f i n a n c i a l ( p r o f i t o r l o s s ) p o s i t i o n o f f i r m s . The "normal
margin" hypothesis has t o be d i sca rded for two s e p a r a t e reasons.
F i r s t l y , o v e r l o n g p e r i o d s , t h e a v e r a g e o r t y p i c a l m a r g i n
changes. F igu res I and I1 make i t c l e a r how sharp t h e s e changes
a r e . The second r e a s o n f o r a b a n d o n i n g t h e "normal marg in"
c o n c e p t , e v e n for i d e n t i f i e d e p i s o d e s , i s t h a t the d o l l a r € o r
d o l l a r response i t imposes can be b e t t e r e d by a r e l a t i o n s h i p w i t h
a m a r g i n t h a t v a r i e s c o n t i n u o u s l y w i t h t h e g e n e r a l o i l p r i c e
l e v e l . The e x i s t e n c e o f a p e r c e n t a g e r a t h e r t h a n a n a b s o l u t e
mark-up (or mark-down) r e c e i v e s s t r o n g s u p p o r t f rom t h e d a t a .
However, i t i s i m p o r t a n t t o n o t i c e t h a t t h i s p e r c e n t a g e m a r g i n
changes be tween e p i s o d e s and t h a t no f i n a l e x p l a n a t i o n for why
t h i s should be i s a r r i v e d a t .
The e p i s o d e s t h a t a r e i d e n t i f i e d f o r b o t h Arab L i g h t
and N i g e r i a n L i g h t a r e : ( a ) f rom J a n u a r y 1 9 7 6 t o l a t e i n 1978;
( b ) from l a t e 1978 t o l a t e summer 1 9 7 9 ; ( c > from l a t e summer
7
1979 t o sp r ing 1981; (d) from sp r ing 1981 t o t h e end of 1983.
In t h e first episode ( Jan 1976- l a t e 1978) spo t p r i c e s
and t h e netback a r e a lmost i n a d o l l a r f o r d o l l a r r e l a t i o n s h i p
( w i t h a s t a n d a r d e r r o r of e s t i m a t e of 30 c e n t s f o r Arab and 50
c e n t s f o r N i g e r i a n ) . T h i s seems t o f i t t h e e x p e c t e d p a t t e r n ,
p a r t i c u l a r l y f o r t h e indus t ry d a t a - t h e two s i d e s of t h e market
are very c l o s e l y r e l a t e d and t h e netback is s l i g h t l y h igher than
t h e s p o t p r i c e . T h i s wou ld be q u i t e c o n s i s t e n t w i t h a n M C = M R
cond i t ion f o r p r o f i t maximisation, wi th a f a 1 l i n g demand cu rve
h a v i n g a l o w e r MR t h a n t h e c o s t of p r o d u c t s and a r i s i n g c o s t
c u r v e wi th a higher MC than t h e cos t of r e f i n i n g average b a r r e l .
Both e f f e c t s would be expected t o be very s l i g h t ; hence t h e s m a l l
p o s i t i v e margin of t h e netback over spot i s not su rp r i s ing . The
very t i g h t f i t f o r t h i s per iod sugges t s t h a t i t is u n l i k e l y t h a t
o t h e r v a r i a b l e s w o u l d h a v e a s i g n i f i c a n t r o l e t o p l a y
( p a r t i c u l a r l y t h e o f f i c i a l p r i c e which was almost i d e n t i c a l t o
t h e s p o t p r i c e ) . T h i s p e r i o d , f o r R o t t e r d a m p r o d u c t p r i c e s , i s
c o n s i s t e n t w i th t h e "normal margin" hypothes is where t h e margin
is v e r y s l i g h t l y p o s i t i v e o r n e g a t i v e d e p e n d i n g on t h e d a t a
source. One s t r ange f i n d i n g (common t o a l l per iods) i s t h a t the
margin f o r Arab Light is c o r r e l a t e d wi th t h e margin f o r Nigerian
Light. I n equ i l ib r ium t h e r e would be no such c o r r e l a t i o n and so
t h i s suggests t h a t t h e r e are demand s i d e shocks (hence common t o
a l l c r u d e s ) which a r e f e l t on a l l p r o d u c t p r i c e s b u t which a r e
t r a n s l a t e d back to d i f f e r e n t d e g r e e s t o t h e v a r i o u s c r u d e s .
S ince t h e "normal margin" model is t h e b e s t f i t t i n g found f o r t h e
f i r s t e p i s o d e , t h e f i n d i n g c a n n o t be s i m p l y a t t r i b u t e d t o
8
s p e c i f i c a t i o n e r r o r .
The second episode, f rom l a t e 1 9 7 8 t o mid 1979, saw a
l a r g e number of unexpected e v e n t s and e x t e r n a l p r ice movements
a p p e a r in a v e r y s h o r t p e r i o d . I t can s c a r c e l y be t r e a t e d a s a
s i n g l e homogeneous p e r i o d ( e v e n t h e d a t a i s more t h a n u s u a l l y
suspect) and a l l a t tempts t o do so produced r e l a t i o n s h i p s of t o o
poor a s t a t i s t i c a l f i t f o r u s e f u l a n a l y s i s . The one s t r i k i n g
f e a t u r e of t h i s p e r i o d ( o f t e n t h o u g h t of as b e i n g domina ted by
t h e s u p p l y d i s r u p t i o n of t h e I r a n i a n r e v o l u t i o n ) i s t h a t
on averaRe netbacks were some 5 % higher than s p o t f o r Arab Light
and 12% higher f o r Nigerian Light. This f i n d i n g is a l l t h e more
remarkable because i n a l l o t h e r episodes netbacks have been on
average below s p o t pr ices . Rowever, the v a r i a t i o n s w i t h i n t h e
p e r i o d a r e so g r e a t t h a t o n l y a m o n t h by month a n a l y s i s of t h e
f i g u r e s b a s e d on i n s t i t u t i o n a l and f a c t u a l m a t e r i a l c o u l d
e s t a b l i s h any f i rm conclusion.
The t h i r d episode, s t r e t c h i n g f rom l a t e i n 1979 t o
e a r l y in 1981, corresponds to a period i n which t h e s p o t p r i c e of
t h e crude i n q u e s t i o n was above t h e o f f i c i a l p r i ce . This can be
i n t e r p r e t e d as a per iod of excess demand ( a t the g i v e n o f f i c i a l
p r i c e s ) where l i m i t e d s u p p l i e s meant t h a t b u y e r s of m a r g i n a l
c a r g o s w e r e w i l l i n g t o pay more t h a n t h e o f f i c i a l p r i c e . Fo r
t h i s p e r i o d t h e "normal margin" was v e r y s t r o n g l y n e g a t i v e -
(around $3 f o r Arab Light and $2 f o r Nigerian). There has been a
temptat ion t o suggest t h a t t h i s i n d i c a t e s producers ope ra t ing a t
a loss, b u t t h i s i g n o r e s t h e d i f f e r e n c e be tween m a r g i n a l and
a v e r a g e c o n c e p t s . S i n c e most c r u d e was bough t a t o f f i c i a l
9
p r i c e s , below t h e spo t p r i c e , t h e t o t a l c o s t s of r e f i n i n g cou ld
w e l l have been below t h e t o t a l revenue even though t h e marginal
c o s t f o r t h e r e f i n e r y chosen was above marginal revenue according
t o t h e d a t a .
For t h i s p e r i o d t h e p e r c e n t a g e m a r g i n model e x p l a i n s
t h e d a t a b e t t e r t han t h e a b s o l u t e margin model, and g i v e s a Saudi
netback a t 90% of s p o t p r i c e and a Nigerian netback of 95% of t h e
spo t p r i ce . The accuracy of t h e equa t ions i s s u b s t a n t i a l l y l e s s
than those f o r t h e f i r s t per iod f o r Arab L igh t , suggest ing t h a t
some o t h e r v a r i a b l e may be invo lved . The low v a l u e of t h e Durbin
Watson s t a t i s t i c confirms t h i s f inding. There a r e two cand ida te s
f o r i n c l u s i o n i n t h e equations. F i r s t l y , t h e o f f i c i a l p r i c e must
be t e s t e d s i n c e , i n a p e r i o d when t h e s p o t i s h i g h e r t h a n t h e
o f f i c i a l p r i c e i t m i g h t b e e x p e c t e d t h a t t h e l o w e r p r i c e wou ld
d e t e r m i n e p r o d u c t p r i c e s , a t l e a s t i n p a r t . When b o t h s p o t and
o f f i c i a l p r i c e s were included a s exp lana to ry v a r i a b l e s f o r t h e
n e t b a c k t h e n t h e s p o t v a r i a b l e c o n t i n u e d t o be s t r o n g l y
s i g n i f i c a n t , but t h e o f f i c i a l p r i c e was comple t e ly i n s i g n i f i c a n t
and added n o t h i n g t o t h e d e g r e e of e x p l a n a t i o n . T h i s i s s t r o n g
c o n f i r m a t i o n of t h e h y p o t h e s i s t h a t p r i c i n g was c a r r i e d o u t o n
m a r g i n a l i s t l i n e s and n o t on an average c o s t basis . T e s t s were
a l s o c a r r i e d o u t f o r t h e p r e s e n c e of l a g s by a n a l y s i n g spot
p r i c e s l e a d i n g n e t b a c k s and n e t b a c k s l e a d i n g s p o t p r i c e s . No
e v i d e n c e f o r l a g g e d r e l a t i o n s h i p s ( w i t h o r w i t h o u t o f f i c i a l
p r i c e s ) cou ld be found f o r t h i s episode.
Hence f o r t h e per iod of excess demand t h e d a t a s u p p o r t s
a h y p o t h e s i s of m a r g i n a l i s t p r i c i n g w i t h r a p i d a d j u s t m e n t t o
10
s h o c k s a r i s i n g f rom e i t h e r side of t h e marke t . The one f e a t u r e
wh ich c a n n o t b e s o s i m p l y e x p l a i n e d is t h e d e g r e e t o wh ich t h e
netback i s p e r s i s t e n t l y below t h e spo t pr ice . If it was p u l l e d
down by t h e o f f i c i a l p r i c e we migh t h a v e e x p e c t e d t o f i n d t h e
o f f i c i a l p r i c e s i g n i f i c a n t . The d a t a from a l l sources confirms
t h i s n e g a t i v e margin and f o r a genuinely marginal r e f i n e r y t h e
n e t b a c k would h a v e been l o w e r s t i l l . I n o r d e r t o a r g u e t h a t
marginal revenue was s y s t e m a t i c a l l y underestimated by t h e netback
c o n c e p t i t would be n e c e s s a r y t o show t h a t t h e s p o t p r o d u c t
p r i c e s were n o t t h e a p p r o p r i a t e marginal concepts and were lower
than t h e t r u e marginal revenues from products , o r t h a t t h e c o s t s
n e t t e d o u t ( t r a n s p o r t , r e f i n e r y e t c . ) were t o o l a r g e . S i n c e
t h e s e cos t elements were probably less than a d o l l a r i n t o t a l t h e
margin of e r r o r on t h e c o s t s i d e cou ld not p o s s i b l y e x p l a i n t h e
n e g a t i v e netback margin.
The o b s e r v a t i o n t h a t n e t b a c k s were b e l o w s p o t c r u d e
p r i c e s t h e n p r e s e n t s a p r o b l e m of i n t e r p r e t a t i o n . I t i s w e l l
known t h a t some r e f i n e r s r a n a t a loss and o u r d a t a m e r e l y
a p p e a r s t o c o n f i r m it . Even t h e p e r s i s t e n c e of t h e l o s s o v e r a
year and a h a l f is eas i ly exp la ined i f t h e r e a r e l a r g e e x i t and
r e - e n t r y c o s t s ( m o t h b a l l i n g c o s t s ) . C l e a r l y i t c a n o f t e n be
b e t t e r t o run a t a s m a l l l o s s t han t o incur t h e s e l a r g e shutdown
c o s t s . However t h e p e r s i s t e n c e of mara ina l l o s s e s cannot be so
e a s i l y explained. Sec t ion B4 of t h e paper a n a l y s e s a series of
a s p e c t s of t h e m a r k e t i n o r d e r t o s e e w h e t h e r i n s t i t u t i o n a l
f a c t o r s c o u l d e x p l a i n t h i s f i n d i n g . I t i s a r g u e d t h a t u n l e s s
t h e r e i s g e n e r a l n o n - p r o f i t making b e h a v i o u r w e do n o t h a v e a n
11
adequate exp lana t ion f o r t h i s phenomenon. Thus w e must conclude
t h a t t h e t h i r d e p i s o d e p r e s e n t s a p u z z l e - p r i c e s were s e t o n a
m a r g i n a l i s t b a s i s but t h e r e was a p e r s i s t e n t margina l l o s s on t h e
d a t a a s c a l c u l a t e d .
The final episode, which r u n s f r o m e a r l y 1 9 8 1 t o end
1983, a l s o p re sen t s a complex p i c tu re . The percentage margin and
a b s o l u t e margin hypotheses work e q u a l l y w e l l and both show t h e
netback below t h e spo t p r i c e f o r Arab Light , w i t h Nigerian Light
showing a lmost a d o l l a r f o r d o l l a r r e l a t i o n s h i p . The goodness of
f i t is b e t t e r t h a n i n t h e p r e v i o u s e p i s o d e and as good a s t h e
f i r s t episode f o r Nigerian (but no t f o r Arab Light) . The period
of t h e f i n a l e p i s o d e w a s one i n which t h e s p o t p r i c e was l ower
than t h e o f f i c i a l pr ice . S ince t h i s phenomenon is d i f f i c u l t t o
e x p l a i n i n a t w o - t i e r marke t s y s t e m u n l e s s b u y e r s t a k e a
p o r t f o l i o t y p e choice even a t t h e margin ( i e buy some o f f i c i a l
even though i t is more expens ive than spot ) , t e s t s were c a r r i e d
o u t t o s e e w h e t h e r t h e o f f i c i a l p r i c e a s we1 1 as the s p o t p r i c e
a f f e c t e d t h e netback. There was confirmation of t h i s hypothesis
for Arab Light but not f o r Niger ian Light. Such a f ind ing could
be e x p l a i n e d i f b u y e r s f e l t i t l e s s i m p o r t a n t t o pay t h e
i n s u r a n c e of p u r c h a s i n g N i g e r i a n a t o f f i c i a l p r i c e s t h a n
purchasing Saudi a t o f f i c i a l p r i ces .
A second, unusua l , f e a t u r e of t h e l a s t episode i s t h a t
f o r t h e f i r s t time ev idence of lagged r e a c t i o n s was found. The
spo t p r i c e was r e l a t e d t o both t h e cu r ren t and one month lagged
netback f o r bo th Arab and Niger ian crudes. It i s n o t obvious why
t h e r e s h o u l d be a l a g t o demand s i d e i n f l u e n c e s only when t h e
12
s p o t is below t h e o f f i c i a l pr ice . The e f f e c t was small ( w i t h an
ave rage l a g of one week) and o n l y w i t h d a t a based on s h o r t e r time
pe r iods could a proper dynamic a n a l y s i s be undertaken.
Even f o r t h e f i n a l episode when netbacks a r e r e l a t e d t o
s p o t and o f f i c i a l p r i c e s (and o f f i c i a l p r i c e s a r e h i g h e r t h a n
s p o t ) t h e sum of t h e c o e f f i c i e n t s i s less than un i ty , i n d i c a t i n g
a l o s s a t t h e margin. Since the netback i s c a l c u l a t e d t o be l e s s
t h a n t h e s p o t p r i c e t h e n e v e n on a n a v e r a g e c o s t i n g b a s i s a
r e f i n e r y would show a loss according t o these f igu res . Hence t h e
f i n a l p e r i o d p r o v i d e s d a t a which s u g g e s t s t h a t t h e p e r i o d of
a d j u s t m e n t t o a new marke t s t r u c t u r e i s v e r y l e n g t h y ( o v e r 4
y e a r s ) o r t h a t o n a c o n v e n t i o n a l c o s t i n g b a s i s most r e f i n e r i e s
a r e prepared not t o prof it maximise because continued product ion
s e r v e s o t h e r ends. These f i n d i n g s mus t be l o o k e d a t i n t h e
con tex t of t h e wider range of d a t a on r e f in ing . The s t a t i s t i c a l
a n a l y s i s has concent ra ted l a r g e l y on b a s i c r e f i n i n g a t Rotterdam.
T h i s c h o i c e took i n t o a c c o u n t s e v e r a l f a c t o r s . F i r s t l y , i t
a l l o w e d t h e l o n g e s t r u n o f d a t a . S e c o n d l y , i f m a r k e t s a r e i n
e q u i l i b r ium then t h e netback should be t h e same everywhere except
f o r random f l u c t u a t i o n s . Th i rd ly , on a m a r g i n a l i s t argument i t
wou ld be t h e h i g h e s t c o s t p l a n t s u r v i v i n g i n a n i n d u s t r y t h a t
w o u l d j u s t b r e a k e v e n and which s h o u l d t h e r e f o r e be u s e d f o r
t e s t s concerning market behaviour. Data on complex r e f i n i n g show
t h e n e t b a c k h i g h e r t h a n t h e s p o t p r i c e f o r most o f t h e f i n a l
pe r iod under study. This of course i s n o t a proof t h a t e v e n such
a r e f i n e r y o p e r a t e d a t a p ro f i t ( b e c a u s e o f f i c i a l p r i c e s were
somet imes h i g h e r s t i l l ) b u t d o e s warn a g a i n s t t h e u s e of
13
gene ra l i s a t i o n s on prof i t s or l o s s e s .
A n a l y s i s of t h e m o d e l s when a p p l i e d t o n e t b a c k s as
d i f f e r e n t i a t e d by l o c a t i o n ( and by t e c h n o l o g y ) shows t h a t as
be tween c e n t r e s t h e r e s u l t s a r e v e r y s i m i l a r . Ne tbacks a r e
r e l a t e d to s p o t p r i c e s when t h e r e is " e x c e s s demand'' d u r i n g t h e
t h i r d episode, and a r e r e l a t e d t o both spo t and o f f i c i a l p r i c e s
d u r i n g t h e f o u r t h e p i s o d e when t h e r e i s " e x c e s s supply." The
weakest l i n k between netbacks and crude p r i c e s appears t o be f o r
t h e US case. In g e n e r a l , t h e r e l a t i o n between Rotterdam netbacks
and c r u d e p r i c e s f o r Arab L i g h t i s as c l o s e a s f o r any o t h e r
c e n t r e .
The a n a l y s i s of t h e r e l a t i o n s be tween t h e p r o d u c t
p r i c e s , as summarised by t h e netback, and crude p r i c e s shows t h a t
t h e two s i d e s of t h e market a r e very c l o s e l y I inked on a month by
month bas i s . The n a t u r e of t h e l i n k has changed, n o t always i n a
p r e d i c t a b l e f a s h i o n (eg between t h e f i r s t and t h i r d episodes) ,
b u t t h e r e l a t i o n s h i p s seem f a i r l y s t a b l e o v e r t h e medium r u n .
There is, however, a r e s i d u a l d i f f e r e n c e between t h e s e r i e s which
a p p e a r s t o b e u n p r e d i c t a b l e . The a v e r a g e m a g n i t u d e of t h i s
u n e x p l a i n e d component i s a t l e a s t a b o u t 50 c e n t s . T h i s means
t h a t ( u s i n g t h e u s u a l 9 5 % c o n f i d e n c e i n t e r v a l ) g i v e n t h e s p o t
p r i c e t h e n e t b a c k c a n be p r e d i c t e d w i t h i n p l u s o r minus $1 ( and
v i c e v e r s a ) . It d o e s n o t a p p e a r l i k e l y , g i v e n t h e p r e s e n c e of
measurement e r r o r s i n t h e d a t a , t h a t any s u b s t a n t i a l improvement
can e a s i l y be made i n t h e e x p l a n a t i o n of t h e r e l a t i o n s h i p between
t h e two s i d e s of t h e marke t . I t i s p o s s i b l e t h a t v e r y complex
dynamic m o d e l s m a y improve t h e f i t of t h e model and i n d e e d t h e
14
s h i f t i n g m a r g i n h a s i t s e l f to be e x p l a i n e d . However t h e
t e c h n i q u e s r e q u i r e d would p r o b a b l y be of a n o r d e r o f magn i tude
more d i f f i c u l t t o u s e and t h e p o t e n t i a l g a i n f rom any a p r i o r i
model r a t h e r u n c e r t a i n and p o s s i b l y s m a l l . The marg in of
accuracy of e x p l a n a t i o n is c r u c i a l when we t u r n t o t h e o t h e r use
of netbacks - t h a t of judging whether o f f i c i a l d i f f e r e n t i a l s a r e
o u t of l i n e . The t e c h n i q u e , a s e x p l a i n e d by PIW, is t o compare
t h e n e t b a c k / o f f i c i a l d i f f e r e n t i a l f o r v a r i o u s c r u d e s . Those
which a r e h i g h ( o r low) r e l a t i v e t o t h e d i f f e r e n t i a l f o r t h e
"marker" (Arab L i g h t ) i n d i c a t e w h e t h e r an o f f i c i a l p r i c e i s
r e l a t i v e l y t o o low ( o r h igh) . S y m b o l i c a l l y w e c a l c u l a t e f o r
example :
(MN - NO) - ( S A - SO> (1)
where :
NN = Nigerian netback NO = O f f i c i a l p r i c e of Nigerian Light SN = Saudi netback SO = O f f i c i a l p r i c e of Arab Light .
If this i s z e r o the o f f i c i a l p r i c e s a r e s a i d t o be i n
l i n e wi th market r e a l i t i e s - i f i t i s p o s i t i v e t h e o f f i c i a l p r i c e
of N i g e r i a n i s r e l a t i v e l y t o o low, w h i l e i f i t i s n e g a t i v e t h e
o f f i c i a l p r i c e of N i g e r i a n is r e l a t i v e l y t o o h igh . T h i s
c a l c u l a t i o n assumes t h a t t h e n e t b a c k s d o a c t u a l l y measu re t h e
v a l u e of t h e c r u d e a t t h a t t i m e and t h a t t h e m a r g i n i s a b s o l u t e
and not r e l a t i v e . The measurement e r r o r s i n t h e netback toge ther
w i t h t h e e v i d e n c e t h a t n e t b a c k s d o n o t measu re t h e e q u i l i b r i u m
v a l u e of t h e c r u d e a t t h e m a r g i n i m p l i e s t h a t t h e r e w i l l b e a
15
random term or even a systematic term missing from (1). Hence a
systematic study of d i f f e r e n t i a l s would be needed t o investigate
t h e i r behaviour and i n p a r t i c u l a r t h e r e l a t i v e s i z e of spot
d i f f erent ia 1 s t o ne tback d i f f e r e n t i a l 6.
16
PART B : DETAILED ABULYSIS
B. 1 THE BELBTIOB BETWEEH SPOT CRUDE PRICES ARD SPOT PRODUCT VALUES
The b a s i c hypothes is i s t h a t crude p r i c e s and t h e v a l u e
of t h e p r o d u c t s o b t a i n e d f rom t h e c r u d e a r e s y s t e m a t i c a l l y
r e l a t e d . S p e c i f i c a l l y we c a n c o n s i d e r t h e % y i e l d of p r o d u c t s
(naphtha, g a s o l i n e , f u e l o i l e t c ) from crude o i l f o r a " typ ica l "
r e f i n e r y . The sum of t h e s h a r e s times t h e p e r u n i t p r i c e f o r
each product i s known as t h e "gross product va lue" (worth) and i s
t h e revenue f o r t h a t r e f i n e r y r e s u l t i n g from the r e f i n i n g of one
e x t r a b a r r e l o f o i l . I n o r d e r t o compare t h i s w i t h t h e c o s t of
i n p u t s w e must look a t t h e c o s t o f t h e c r u d e o i l c i f , and t h e
o the r r e f i n i n g costs. I f we concen t r a t e on a shor t - run marginal
a n a l y s i s t h e n t h e r e i s no e x t r a c a p i t a l c o s t i n v o l v e d i n
r e f i n i n g another b a r r e l of o i l (below f u l l capac i ty ) but t h e r e
a r e r u n n i n g c o s t s of o p e r a t i n g t h e r e f i n e r y . I t wou ld t h u s be
p o s s i b l e t o b u i l d up t h e e x t r a s h o r t - r u n c o s t s by t a k i n g t h e
crude o i l p r i c e ( a p p r o p r i a t e l y def ined) fob, adding on t r a n s p o r t
and insurance c o s t s t o o b t a i n t h e c i f o i l p r ice and then adding
on t h e r e f i n i n g c o s t . The r e s u l t i n g c o s t could b e compared t o
t h e r e v e n u e f i g u r e . However , i n d u s t r y p r a c t i c e h a s been t o
"Netback" t h e revenue by s u b t r a c t i n g r e f i n i n g c o s t s and t r a n s p o r t
c o s t s t o o b t a i n t h e "value" of the o i l i n t h e p r o d u c e r c o u n t r y .
T h i s c o n c e p t i s known by s e v e r a l names: o f t e n c a l l e d t h e " fob
1 7
n e t b a c k " o r t h e " i m p l i e d f o b c r u d e o i l n e t b a c k v a l u e ' ' (OPAL) or
t he ''spo t product e q u i v a 1 e n t v a 1 uel' ( i ndus t ry t e r m ino 1 ogy).
The d i f f e r e n c e between what w e s h a l l from now on c a l l
t h e "netback" and t h e c r u d e p r i c e , w e s h a l l c a l l t h e "ne tback
margin". The r e s u l t i n g f i g u r e is f r e q u e n t l y used in t w o ways :
( i ) "General ly , t h e spo t v a l u e of t h e r e f i n e d b a r r e l a t t h e
producer ' s l o a d i n g p o r t i s compared w i t h .... c r u d e p r i c e s t o
determine p r o f i t o r l o s s " (PIW(supp) 7 March 83 p4).
( i i ) Dif fe rences between spo t product v a l u e s of the major
c rude o i l s are r e l a t e d t o d i f f e r e n c e s i n o f f i c i a l crude ( f o r t h e
same p a i r s of c r u d e s ) t o show w h e t h e r " t h e v a r i a t i o n s o r
" d i f f e r e n t i a l s " among the o f f i c i a l crude p r i c e s a r e a l i g n e d w i t h
s p o t product market r e a l it ies" (PIW, ib id) .
I n a l l s u c h a p p l i c a t i o n s t h e d i f f e r e n c e be tween t h e
r e l a t e d s e r i e s have been c a l c u l a t e d which i m p l i e s t h e e x i s t e n c e
of a 'normal' a b s o l u t e margin between the series. I n f a c t , t h e r e
are f o u r d i s t i n c t t ypes of netback margin t h a t can be c a l c u l a t e d
and t h i s i s o n e s o u r c e of v a r i a t i o n t h a t mus t be a l l o w e d f o r .
The p l u r a l i t y arises because crude o i l is s o l d e i t h e r on t h e s p o t
m a r k e t ( a t s p o t p r i c e s ) o r a t o f f i c i a l p r i c e s , and p r o d u c t s a r e
s o l d e i t h e r on t h e s p o t p r o d u c t m a r k e t ( a t t h e f a c t o r y g a t e ) o r
a t c o n t r a c t p r i ces . Furthermore, it i s p o s s i b l e (OPAL) t o extend
t h e l e n g t h of t h e c h a i n of n e t t i n g back by s t a r t i n g w i t h t h e
i n l a n d ' ' m a r k e t p r i c e s of p r o d u c t s and s u b t r a c t i n g d u t i e s and I'
marketing c o s t s ( t o give composite proceeds ex-ref inery).
18
I n f a c t s t a n d a r d a n a l y s i s of t h e c r u d e o i l m a r k e t
( r a t h e r than t h e product market) concen t r a t e s on using t h e s p o t
product concept and combining t h i s e i t h e r w i t h spo t crude p r i c e s
o r w i t h o f f i c i a l crude p r i ces .
B e f o r e w e t u r n t o t h e q u e s t i o n of which of t h e s e two
, m a r g i n s t o examine we must f i r s t look in more d e t a i l a t t h e
c a l c u l a t i o n of t h e netback i t s e l f . The netback is r e f e r r e d t o by
t h r e e c r i t i c a l parameters:
(i) t h e t y p e of crude being used;
(ii)
( i i i )
t h e type of r e f i n i n g process being used;
t h e l o c a t i o n of t h e r e f i n e r y .
The f i r s t two c a t e g o r i e s must be t aken into account because t h e r e
i s no u n i v e r s a l l y t y p i c a l r e f i n e r y - t h e y i e l d s v a r y b e t w e e n
c r u d e s , t h e y a l s o depend on t h e t y p e and l o c a t i o n of t h e
r e f i n e r y . The c r u d e s w e c o n s i d e r a r e j u s t Arab L i g h t and
N i g e r i a n L i g h t , b u t t h e s e h a v e d i s t i n c t l y d i f f e r e n t y i e l d
percentages a s the PIW annual supplement r e v e a l s . Furthermore,
e v e n f o r a g i v e n t y p e of r e f i n i n g t h e t y p i c a l o r a v e r a g e y i e l d
f o r a p a r t i c u l a r c r u d e w i l l v a r y b e t w e e n l o c a t i o n s , b e c a u s e
r e f iaeries a r e s p e c i f i c a l l y designed w i t h l o c a l demand c o n d i t i o n s
i n mind. Hence PIW u s e s y i e l d p e r c e n t a g e s w h i c h a r e c r u d e and
l o c a t i o n s p e c i f i c f o r t h e same t y p e o f r e f i n i n g . T h e r e a r e s i x
19
l o c a t i o n s f o r r e f i n e r i e s used by PIW:
( i ) Rotterdam
( i i ) US Gulf Coast
( i i i ) Caribbean
( i v ) P e r s i a n Gulf
( v ) Singapore
( v i ) I t a l y .
Other sources concen t r a t e on Rotterdam and/or t h e US Gulf .
The techniques of r e f i n i n g assumed by t h e v a r i o u s d a t a
sources a r e d i f f e r e n t , eg PIW assumed t h a t non-US r e f i n e r i e s a r e
of a s imple toppinglreforming type w h i l e its f i g u r e f o r t h e US is
for a c o n v e r s i o n t y p e r e f i n e r y . OPAL u s e s f o r R o t t e r d a m b o t h
b a s i c hydro-skimming (p r imary d i s t i l l a t i o n and r e f i n i n g ) and
c o n v e r s i o n ( c a t a l y t i c c r a c k i n g and a l k y l a t i o n ) t y p e r e f i n e r i e s .
These two t y p e s of r e f i n e r y w e s h a l l r e f e r t o a s b a s i c and
complex ( a l though the l a t t e r is something of a h o l d a l l term).
G i v e n t h a t we d e c i d e wh ich r e f i n e r y we w i s h t o u s e w e
must t h e n v a l u e i t s p r o d u c t s by l o c a l s p o t p r o d u c t v a l u e s and
s u b t r a c t m a r g i n a l r u n n i n g c o s t s , i n s u r a n c e c o s t s and f r e i g h t
c o s t s . This l a s t i s c a l c u l a t e d on a m a r g i n a l b a s i s u s i n g
Wor ldsca le f r e i g h t r a t e s from t h e producer country t o t h e country
i n which t h e r e f i n i n g i s being eva lua ted .
From d e f i n i t i o n s w e n e x t t u r n t o t h e b a s i c h y p o t h e s i s
which is t h a t , f o r a g iven crude, t h e netback and crude p r i c e a r e
r e l a t e d . G i v e n t h a t w e h a v e d e c i d e d t o u s e s p o t p r o d u c t
v a l u a t i o n s w e must d e c i d e which c r u d e p r i c e t o use . The
c a l c u l a t i o n s a re e x p l i c i t l y on a margina l b a s i s , as t h e exc lus ion
20
of c a p i t a l c o s t e lements makes c l e a r . Hence t h e c o r r e c t p r i c e i s
t h a t which i s m a r g i n a l t o t h e buyer . Here i t m i g h t be t h o u g h t
t h a t t h e lower of t h e o f f i c i a l and s p o t p r i c e s would be marg ina l ,
but t h i s ignores how a t w o - t i e r p r i c e s y s t e m o p e r a t e s . We must
a s k why t h e two p r i c e s a r e n o t e q u a l i s e d by p u r c h a s e s s h i f t i n g
demand t o t h e l o w e r (and d r i v i n g i t u p u n t i l t h e two meet). I f
t h e s p o t p r i c e i s a b o v e t h e o f f i c i a l , i t i s h e l d t h e r e by t h e
r a t i o n i n g of s u p p l i e s on t h e o f f i c i a l m a r k e t - i n s u c h a
s i t u a t i o n t h e s p o t p r i c e is g e n u i n e l y m a r g i n a l . The more
d i f f i c u l t c a s e i s t h a t where t h e s p o t is ( p e r s i s t e n t l y ) b e l o w
o f f i c i a l . Given t h a t n o t a l l crude is being bought on s p o t t h i s
w i l l only happen i f t h e r e is some reason f o r p r e f e r r i n g o f f i c i a l
o i l d e s p i t e t h e f a c t t h a t it is more expensive. We w i l l r e t u r n
t o this po in t later and assume f o r t h e p r e s e n t t h a t spot crude is
t h e m a r g i n a l s o u r c e of s u p p l y where s p o t p r i c e s a r e a b o v e o r
below o f f i c i a l p r i c e s .
Thus t h e b a s i c h y p o t h e s i s i s t h a t t h e n e t b a c k (NI i s
r e l a t e d t o t h e s p o t crude ('3) pr i ce :
N = f (SI (2 )
T r a d i t i o n a l l y a n a l y s i s has centred on t h e margin between those
two magnitudes so t h a t w e cou ld s p e c i a l i s e t h e f u n c t i o n t o
N = a + S (3 )
Since t h e r e l a t i o n s h i p i s n o t thought t o h o l d i d e n t i c a l l y a t a l l
t i m e s we can make i t s t o c h a s t i c by adding a t e r m U, which s t a n d s
for t h e sum of a l l o t h e r i n f l u e n c e s on t h e r e l a t i o n :
Nt = a + S, + ut (4)
where t h e s u b s c r i p t d e n o t e s t h e t i m e p e r i o d . The t e r m U s h o u l d
21
e x h i b i t no s y s t e m a t i c b e h a v i o u r - i f i t d o e s t h e n t h e
r e l a t i o n s h i p between t h e netback and t h e spot c rude p r i c e would
n o t be just on a v e r a g e a c o n s t a n t . Hence it would n o t b e
p o s s i b l e t o dec ide whether a p a r t i c u l a r v a l u e of t h e margin was
high or low - t h i s would have t o be decided r e l a t i v e t o t h e o the r
f a c t o r s determining t h e margin. Another way t o look a t t h e same
p o i n t i s t h a t i n d e c i d i n g w h e t h e r a p a r t i c u l a r v a l u e of t h e
marg in was u n u s u a l l y h i g h o r low t h e v a r i a n c e of t h e random
f l u c t u a t i o n (U> i s a c r i t i c a l component. I f we were a b l e t o
e x p l a i n p a r t of U b y i n c l u d i n g e x t r a f a c t o r s t h e n t h e r a n g e o f
randomness for t h e margin would decrease and we should be a b l e t o
spo t more e a s i l y when an i n d i v i d u a l v a l u e was abnormal.
E q u a t i o n ( 4 ) p r o v i d e s a p u r e l y mechanis t ic hypothes is
t o tes t . Although w e have i m p l i c i t l y suggested t h a t t h e concepts
used a r e margina l revenues and c o s t s w e have not y e t s p e l l e d ou t
t h e economic a s s u m p t i o n s which would j u s t i f y s u c h c l a i m s , and
w i t h o u t which a h y p o t h e s i s of how t hey a r e l i n k e d c a n n o t be
constructed. This deeper ques t ion is taken up i n s e c t i o n B.3.
22
B.2 THE DATA
B . 2 . 1 SPOT CRUDE PRICES
The d i s t i n g u i s h i n g f e a t u r e of spot p r i c e d a t a for crude
o i l is t h a t t h e r e i s no o f f i c i a l s e r i e s . I n s t e a d i n t e r e s t e d
p a r t i e s , s u c h as p r o d u c e r s , r e f i n e r s and c o n s u l t a n c i e s t e n d t o
produce t h e i r own f i g u r e s , This has r e s u l t e d i n a m u l t i p l i c i t y
of e s t ima tes f o r t h e same concept, caused i n p a r t by t h e l a c k of
an agreed methodology and i n p a r t by c e r t a i n f e a t u r e s of t h e o i l
market.
Crude o i l i s no t t raded on a p a r t i c u l a r market “ f l o o r ”
- t h e r e is no l o c a t i o n a t which a l l t h e d e a l s a r e made and a t
which t h e d a t a might be c e n t r a l l y r e g i s t e r e d . In s t ead d e a l s are
i n d i v i d u a l l y r e g i s t e r e d between agen t s who a r e spread worldwide.
Hence d a t a must b e c o l l e c t e d by some form of s u r v e y approach .
T h i s l e a d s t o a f i r s t s o u r c e of v a r i a t i o n - an a g e n t a t a
p a r t i c u l a r t i m e may b e a b l e t o p r o v i d e a p r i c e “done” (ie
a c t u a l l y t r ansac ted ) or m e r e l y a pr ice I’offered”. Pub1 i c a t i o n s
which sometimes r e p o r t both f o r t h e same time per iod sugges t t h a t
a t p re sen t ( i n a r a t h e r t r a n q u i l environment) t h e s e two concepts
a r e v e r y c l o s e . Hence t h e r e i s a s o u r c e of a m b i g u i t y i n t h i s
a s p e c t of t h e d a t a . T h i s sho r t - coming is l i k e l y t o be more
s e r i o u s i n t h e f i r s t p a r t of our per iod , when t h e spo t market was
v e r y “ t h i n “ and few t r a n s a c t i o n s a c t u a l l y t o o k p l a c e e v e n € o r
major crudes.
23
A second p r o b l e m f o r s p o t p r i c e d a t a i s t h e d a t i n g of
t h e c o n t r a c t . I f w e a r e c o n s i d e r i n g , s a y , December p r i c e s w e
c o u l d e i t h e r f o c u s on p r i c e s " in t h e month" o r p r i c e s " f o r t h e
month". The fo rmer r e f e r s t o c o n t r a c t s made i n December wh ich
w i l l a c t u a l l y be implemented some l i t t l e t i m e ( u p t o 2 o r 3
months) ahead , w h i l e t h e l a t t e r r e f e r s t o p r i c e s s e t on o r
be fo re December t h a t w i l l be payable on o i l r e c e i v e d i n December.
C l e a r l y t h e l a t t e r w i l l be much more l a b o r i o u s t o b u i l d up on a
t i m e s e r i e s b a s i s . These two c o n c e p t s a l s o s u g g e s t t h a t
d i f f e r e n t a g e n c i e s may h a n d l e t h e d a t i n g p r o b l e m in d i f f e r e n t
ways. I n f a c t , s i n c e t h e r e i s no c l e a r s t a t e m e n t of t h e
p r i n c i p l e s on which any series i s c a l c u l a t e d , i t i s not p o s s i b l e
t o come t o any d e c i s i o n as t o which s e r i e s i s t h e b e s t for
e m p i r i c a l work. We need t o l o o k a t a l l t h e s o u r c e s and compare
t h e i r performance.
For t h e purposes of this study w e ob ta ined monthly d a t a
from four d i f f e r e n t sources.
(1) OPEC B u l l e t i n
We c a l l t h e s p o t p r i c e s f rom t h i s s o u r c e SSO and NSO.
This s o u r c e , which is a v a i l a b l e on a w e e k l y b a s i s , b e g i n s i n
J a n u a r y 1 9 7 9 and r u n s c o n t i n u o u s l y u n t i l t h e end of our p e r i o d
(December 1983). It is a n a v e r a g e of 4 w e e k l y f i g u r e s and i s a
mid-month f igu re .
( 2 ) Middle Eas t Petroleum and Economic P u b l i c a t i o n s (MEPEP)
T h i s d a t a s o u r c e p r o v i d e s w e e k l y d a t a f r o m t h e
b e g i n n i n g of our p e r i o d (which s t a r t s at J a n u a r y 1976) . The
week ly a v e r a g e s a g a i n p r o d u c e a mid-month f i g u r e . W e d e n o t e
24
t h e s e by SSM and NSM.
( 3 ) Indus t ry Sources
Many l a r g e r e f i n i n g and producing companies c o n s t r u c t
t h e i r own " b e s t e s t i m a t e s " of t h e p r i c e by combining a l l t h e
knowledge a v a i l a b l e t o them. We h a v e one such s o u r c e ( S S I and
N S I ) f rom t h e b e g i n n i n g of o u r p e r i o d ( J a n u a r y 76) t o t h e end o n
a monthly bas i s .
( 4 ) Petroleum I n t e l l i g e n c e Weekly (PIW)
This aga in is a mid-month average.
This p u b l i s h e s d a t a on spot p r i c e s from January 1978 t o
t h e p re sen t f o r t h e two crudes i n ques t ion (denoted S S P and NSP).
We can summarise t h e r e l a t i o n s h i p s between t h e v a r i o u s
s p o t p r i c e s i n terms of r e g r e s s i o n models. The model r e g r e s s e s
one se r ies on a n o t h e r ( o v e r t h e maximum d a t a p e r i o d common t o
b o t h ) w i t h o u t i n t r o d u c i n g a c o n s t a n t . I f t h e s e r i e s were
i d e n t i c a l t h e r e g r e s s i o n c o e f f i c i e n t would b e u n i t y , t h e
c o r r e l a t i o n u n i t y and t h e s t a n d a r d e r r o r o f e s t i m a t e ( a v e r a g e
r e s i d u a l ) zero. The r e s u l t s a r e shown i n Tab le s I and I1 ( ~ 2 7 ) .
The t a b l e s show two important f e a t u r e s .
(i> For b o t h c r u d e s t h e OPEC B u l l e t i n f i g u r e is
s i g n i f i c a n t l y g r e a t e r t h a n a l l t h e o t h e r f i g u r e s (by a f a c t o r
r a n g i n g f r o m 1 t o 2 p e r c e n t ) . T h i s i m p l i e s t h a t a t a p r i c e of
$30 p e r b a r r e l t h e OPEC b u l l e t i n p r i c e would be about 30-60 cen t s
a b a r r e l higher t han o t h e r series.
(ii) The o the r t h r e e s e r i e s a r e a l l very c l o s e t o each
o t h e r and i n g e n e r a l do not d i f f e r s i g n i f i c a n t l y . However, t h e
s tandard e r r o r of estimate f o r a l l s i x cases , exc lud ing t h e OPEC
B u l l e t i n , i s between 50 c e n t s and 80 cents. Hence a l though t h e
25
c o r r e l a t i o n i s very h igh t h e average e r r o r i s t h e same o rde r of
m a g n i t u d e a s t h e d i f f e r e n c e be tween t h e s e s e r i e s and the OPEC
B u l l e t i n s e r i e s when t h e p r i c e i s around $30. I n v e s t i g a t i o n of
t h e r e s i d u a l s r e v e a l s a few months when t h e r e s i d u a l s a r e many
t i m e s the s tandard e r r o r of es t imate . S ince t h e r e s i d u a l s f o l l o w
a "t" d i s t r i b u t i o n i t would be expected t h a t approximately one i n
a hundred would be more than t h r e e times as l a r g e as t h e s tandard
e r r o r of es t imate . Table I11 ( ~ 2 8 ) l i s t s t h e months and t h e s i z e
o f t h e m u l t i p l e when t h i s c r i t e r i o n is exceeded . It i s n o t
s u r p r i s i n g t h a t t h e only per iod of s u b s t a n t i a l d i s a g r e e m e n t i s
t h e f i r s t e i g h t months of 1979, when t h e s p o t p r i c e w a s moving
with g r e a t r a p i d i t y and t h e r e was a g r e a t d e a l of u n c e r t a i n t y i n
t h e marke t . F o r t h e c a s e of Arab L i g h t t h e s p o t p r i c e f o r May
1979 r a n g e s f rom $28.35 f o r SSI, t o $28.95 f o r SSO, t o $30.67 f o r
SSM and up t o $34.25 for SSP. The extreme d ive rgence i s f o r SSP
w h i c h is usually v e r y c l o s e t o SSI and SSM. With 8 r a n g e of $6
in $30 t h e r e i s c l e a r l y a very s u b s t a n t i a l measurement e r r o r f o r
t h i s month, and i t s h o u l d n o t b e i n c l u d e d i n any s p e c i f i c t e s t s
o f h y p o t h e s e s s i n c e such a n ex t r eme " o u t l i e r " c o u l d a f f e c t t h e
t o t a l p i c t u r e t o a g r e a t e x t e n t . By compar i son t h e r a n g e o f
p r i c e s for Nigerian Light i n t h e same month i s SSO a t $31.13, SSI
a t $33.35, S S P a t $34.25 and SSM a t $ 3 4 . 5 . T h i s r a n g e o f $3 is
l a r g e , but only h a l f t h a t of Arab Light. The per iod of extreme
disagreement f o r Arab Light i s s h o r t e r being j u s t May, June and
J u l y of 1979, w h i l e for N i g e r i a n L i g h t t h e p e r i o d e x t e n d s from
J a n u a r y t o August 1979 w i t h t h e a d d i t i o n of J u n e 1981. As a
check an agreement between t h e s e r i e s which are a v a i l a b l e for t h e
26
TABLE I: RELATIOIM€IPS BETWEEB SPOT PRICE MEASURES FOB ARAB LIGHT
Regress ion Dependent Independent Per iod C o e f f i c i e n t Sqd. SEE DWS Equat ion va r i a b l e var iab 1 e (SE) c o r r e l - No. a t ion
(R1) S S I S SM 76.01- 0.997 0.997 0.51 1.59
(R2) s SP SSI 78.01- 1.000 0.991 0.81 2.21
(R3) s SP S SM 78.01- 0.997 0.992 0.71 2.72
(R4) s SP sso 79.01- 0.985 0.954 1.01 2.01
(R5) sso SSI 79.01- 1.015 0.989 0.51 1.19
(R6) sso S SM 79.01- 1.011 0.984 0.61 1.61
( R I 3 ) SSI S SM 76.01- 1.00 0.999 0.22 0.79
........................................................................
83.12 (0.002)
83.12 (0.003)
83.12 (0.003)
83.12 (0.004)
83.12 (0.002)
83.12 (0.002)
78.12 (0.001) 81.01- 83.12
TABLE 11: BELBTIOASHIPS BETWEEB SPOT PRICE LIRASWES FOR HIGEEFA% LIGHT
(R7) NSI NSM 76.01- 83.12
(R8) NSP NSM 78.01- 83.12
(R9) NSP NSI 78.01- 83.12
(R10) NSP NSO 79.01- 83.12
(R11) NSO MSI 79.01- 83.12
(R12) NSO NSM 79.01- 83.12
(R14) NSI NSM 76.01- 78.12 81.01- 83.12
1.004 0.996 0.63 1.90
0.998 0.993 0.70 1.97
0.994 0.995 0 . 5 9 1.56
0.981 0.972 0.81 1.16
1.012 0.973 0.79 1.81
1.017 0.960 0.96 1.76
1.0037 0,999 0.30 1.37
(0.002)
(0.003)
(0.002)
(0.003)
(0 .003>
(0.004)
(0.0013)
27
TABLE 111: MOHTHS WITH EXTBEHE DISBC;BKEMENTS* BETWEEH SERIES
( a ) Arab Light
SSI s SP s SP SSP sso sso +SSM SSI S SM sso S S I SSM
79.05 4.3 79.05 7 . 3 79 .05 5.2 7 9 . 0 5 5 .7 7 9 . 0 5 3 . 4
79.07 5.0 79.06 3 . 4 79 .07 3.7
( b ) Nigerian Light
NSI NSP NSP NSP NSO NSO NSM NSI NSM NS 0 NSI NSM
79.01 81.06 79.06 79.02 79.05 7 9 . 0 5 3 . 8 3 . 5 3 . 2 3 . 2 3 . 3 4.1
7 9 . 0 8 3.7
* An extreme d ive rgence i s a r e s i d u a l g r e a t e r t han t h r e e times
t h e s tandard e r r o r of estimate. It is measured i n m u l t i p l e s of the SEE.
l o n g e s t per iod, we re-ran the r e g r e s s i o n s omi t t i ng t h e two y e a r s
1979 and 1980. The r e s u l t s a r e shown i n T a b l e s 1 and I1 and as
e q u a t i o n s (R13) and (R14). Over t h e n o n - t u r b u l e n t p e r i o d t h e
s e r i e s are extremely c l o s e with s t a n d a r d e r r o r s of estimate t h a t
a r e a b o u t h a l f t h o s e of when 1979 and 1 9 8 0 d a t a a r e i n c l u d e d .
The measurement e r r o r problem f o r t h i s abbrev ia t ed pe r iod i s n o t
non-existent but is very small and shou ld not b i a s t h e r e s u l t s t o
1 any g r e a t ex ten t .
I n c o n c l u s i o n we c a n f e e l f a i r l y s a f e t h a t t h e PIW,
28
MEPEP and industry based s e r i e s w i l l g i v e s i m i l a r r e s u l t s ,
part icular ly i f some months during 1979 are de leted from whatever
s t a t i s t i c a l t e s t s are t o be run. The OPEC B u l l e t i n s e r i e s i s
s ign i f i cant ly greater than the other ser i e s and its use could be
expected t o lead t o d i f ferent r e s u l t s from the others.
29
B.2.2 HETBBCK DATA
The cons t ruc t ion of netback series r e q u i r e s information
on f o u r elements:
( i ) t h e spot product p r i c e s i n a p a r t i c u l a r market;
(ii) t h e r e f i n e r y y i e l d s i n t h a t market ;
( i i i ) t h e running c o s t s per b a r r e l f o r t h e r e f i n e r y ;
( i v ) t h e t r a n s p o r t and insurance c o s t s between t h e r e f i n e r y and the expor t po in t of t h e crude under cons idera t ion .
Given these requirements and t h e absence of any o f f i c i a l
agency i t i s n o t s u r p r i s i n g t h a t t h e r e a r e a m u l t i p l i c i t y of
e s t i m a t e s of t h e n e t b a c k e v e n f o r a g i v e n c r u d e a t a g i v e n
r e f i n e r y l o c a t i o n . G i v e n t h e c o m p l e x i t y o f t h e c a l c u l a t i o n s
r equ i r ed it is not s u r p r i s i n g t h a t t he re should be susp ic ion of
f i g u r e s produced by agencies no t i nvo lved i n r e f i n i n g . However,
pub l i shed f i g u r e s are an important source of common information
which must be inves t iga t ed .
We have used t h r e e sources of d a t a bu t f o r each source
t h e r e i s more than one ne tback s o t h a t t h e t o t a l number of series
a v a i l a b l e i s r a t h e r l a rge . Each source i d e n t i f i e s e i t h e r more
t h a n one l o c a t i o n of t h e r e f i n e r y or more t h a n one t y p e of
r e f i n e r y (or both).
30
( i > Petroleum I n t e l l i g e n c e Weekly (PIW)
This major source p u b l i s h e s d a t a on Saudi netbacks from
R o t t e r d a m on a m o n t h l y b a s i s f rom t h e b e g i n n i n g of o u r p e r i o d
(SNPIWR). Four o t h e r c e n t r e s , t h e C a r i b b e a n (SNPIWC), t h e
P e r s i a n Gulf (SNPIWP), Singapore ( S N P r W S ) and I t a l y (SNPIWI) were
added i n September 1976 and a s i x t h c e n t r e , t h e U S Gulf (SNPIWU)
i n J a n u a r y 1977. The a v e r a g e of t h e s e s e r i e s (SNPIW6) h a s a l s o
been cont inuously publ ished from t h e beginning of 1977. S i m i l a r
s e r i e s h a v e b e e n p u b l i s h e d f o r N i g e r i a n s i n c e 1979 f o r f i v e
c e n t r e s ( N N P I 8 5 ) i n c l u d i n g R o t t e r d a m (NMPIWR), w i t h 4 c e n t r e s
back to January 1979 and j u s t Rotterdam back t o January 1976.
A l l t h e PIW d a t a , w i t h t h e e x c e p t i o n o f US n e t b a c k s ,
assume t h e r e f i n i n g t o be of t h e b a s i c t o p p i n g / r e f o r m i n g t y p e .
The y i e l d p a t t e r n s a r e v a r i e d be tween summer and w i n t e r months
b u t a p a r t f rom t h i s were unchanged u n t i l J u l y 1983. From t h a t
month on the y i e l d s were a l t e r e d and t h i s i n c r e a s e d t h e Gross
Product Value by approximately Z X , g i v i n g a sharp d i s c o n t i n u i t y
a t t h a t d a t e . F o r t h e U S a r e f i n e r y w i t h c o n v e r s i o n
p o s s i b i l i t i e s ( u p g r a d i n g h e a v i e r p r o d u c t s i n t o l i g h t e r ) i s
assumed throughout t h e period.
PTW assumed i n 1982 t h a t t h e r e f i n i n g c o s t w a s about 20
c e n t s a b a r r e l ( t h i s f i g u r e is a l t e r e d y e a r l y ) and t r a n s p o r t
c o s t s ( c a l c u l a t e d on a m o n t h l y b a s i s ) were 8 5 c e n t s a b a r r e l .
E r r o r s i n t h e s e e l e m e n t s a r e n o t l i k e l y t o a f f e c t t h e n e t b a c k
very g r e a t l y .
I t i s c l e a r t h a t t h e PIW d a t a o f f e r s a v e r y wide
geograph ica l coverage and t h a t f o r b a s i c r e f i n i n g t h e long r u n s
31
of d a t a on a cons t an t b a s i s a r e very v a l u a b l e .
( i i > OPAL
A second source of pub l i shed d a t a is provided by OPAL.
They g i v e d a t a s t a r t i n g i n J a n u a r y 1980 f o r n e t b a c k s f rom
R o t t e r d a m for b o t h b a s i c hydroskimming and a c o n v e r s i o n t y p e
r e f i n e r y (SNOPAB, SNOPAC, NNOPAB and NNOPAC). I n 1983 t h e y
assumed r e f i n i n g c o s t s of 30 cen t s and 45 c e n t s f o r t h e two types
of r e f i n e r ies .
( i i i ) Indus t ry Data
As wi th spo t crude p r i c e s it i s important f o r companies
i n t h e o i l i ndus t ry t o c a l c u l a t e t h e v a l u e of netbacks based on
t h e i r own e x p e r i e n c e r a t h e r t h a n on t h a t o f some h y p o t h e t i c a l
t y p i c a l r e f i n e r y . We h a v e s u c h d a t a , c a l c u l a t e d f o r a s i m p l e
( b a s i c ) r e f i n e r y from J a n u a r y 1 9 7 6 for R o t t e r d a m ( S N R B I , N N R B I )
and f o r complex r e f i n i n g from January 1981 f o r both Rotterdam and
t h e US Gulf (SNRCI, SNUCI, NNRCI and NNUCI) .
There a r e v a r i o u s t y p e s of comparisions t h a t might be
made between t h e netback ser ies (between l o c a t i o n s , between types
of r e f i n e r y and be tween d a t a s o u r c e ) . For r e a s o n s t h a t w i l l
become apparent , it i s s e n s i b l e t o concen t r a t e on t hose f i g u r e s
wh ich a r e f o r t h e same l o c a t i o n and t h e same t y p e of r e f i n i n g
process. W e begin w i t h b a s i c r e f i n i n g a t Rotterdam €or which a l l
t h r e e s o u r c e s g i v e d a t a . ( p p s 34 and 35) g i v e
t h e r e s u l t s for r e g r e s s i o n s between t h e ser ies (without i n t e r c e p t
terms) r u n o v e r t h e l o n g e s t pe r iods a v a i l a b l e .
T a b l e s I V and V
We can s e e from t h e t a b l e s
t h e l o n g e s t per iod (PIW and indus t ry
t h a t t h e d a t a a v a i l a b l e f o r
bas i c r e f i n e r y a t Rotterdam)
32
a r e i n c l o s e agreement ( E q u a t i o n s (Et151 and (R20)). The OPAL
d a t a , f o r b a s i c r e f i n i n g , h a s a v e r y c l o s e f i t t o PIW, a s
measured by t h e s tandard e r r o r of es t imate , for both Arabian and
N i g e r i a n . For A r a b i a n i t i s s i g n i f i c a n t l y l e s s t h a n t h e o t h e r
two s o u r c e s (by 1.5 t o 2 p e r c e n t ) . For N i g e r i a n t h e OPAL f i g u r e
i s j u s t s i g n i f i c a n t l y l e s s t h a n t h e PIW f i g u r e bu t i t is
s u b s t a n t i a l l y l e s s t h a n t h e i n d u s t r y d a t a . Hence f o r b a s i c
r e f i n i n g at Rotterdam t h e r e i s a very l a r g e measure of agreement
between t h e series, w i th s tandard e r r o r s much less than those f o r
equat ions l i n k i n g t h e va r ious spo t p r i c e measures.
For complex r e f i n i n g i n Rotterdam t h e OPAL s e r i e s f o r
Arabian and Nigerian a r e s i g n i f i c a n t l y l o w e r t h a n t h e i n d u s t r y
d a t a (3 -4%) , w h i l e f o r US d a t a using complex r e f i n i n g t h e PIW and
indus t ry d a t a a r e a lmost i d e n t i c a l on average.
An e x a m i n a t i o n of t h e r e s i d u a l r e v e a l s o n l y two
obse rva t ions f o r which t h e r e s i d u a l is g r e a t e r than t h r e e times
t h e s tandard e r r o r of es t imate . One case is May 1 9 7 9 f o r S N P I W R
and SMRBI, and t h e o t h e r is January 1981 f o r SNPIWU and SNUCI ( i n
both cases t h e margin was o n l y j u s t ove r t h r e e s tandard e r ro r s ) .
The c a s e of May 1 9 7 9 is n o t s u r p r i s i n g - t h e t u r b u l e n c e i n t h e
c r u d e spot marke t a f f e c t e d t h e s p o t p r o d u c t m a r k e t , and s l i g h t
v a r i a t i o n s i n d a t a c o l l e c t i o n p r o c e d u r e s a t s u c h a t i m e c o u l d
e a s i l y change t h e sampled v a l u e by $1.5.
I n summary t h e netback series a r e i n c l o s e r agreement
than the p r i c e d a t a - t h e r e a r e g e n e r a l l y h ighe r c o r r e l a t i o n s and
fewer p o i n t s of extreme disagreement. The i n d u s t r y and PIW d a t a
correspond extremely c l o s e l y and a r e a t v i r t u a l l y t h e same l e v e l ,
33
TABLES IV: BELBTIOBSBIPS BETWEEN BETBACKS FOE ARAB LIGHT
( a ) Basic Refining a t Rotterdam
(RI51 SNIWR SNRBI 76.01- 1.001 0.997 0.47 1.04
(R16) SNPIWR SNOPAB 80.01- 1.016 0.985 0.30 1.39
(RI 7 ) SNRBI SNOPAB 80.01- 1.020 0.977 0.37 0.45
83.06 ( 0 . 0 0 2 )
83.06 (0.001)
83.12 (0.002)
(b) Complex Refining a t Rotterdam
SNOPAC SNRCI 81.01- 0 .954 0.985 0.32 0 . 3 5 (RI81 83.12 (0.002)
( c ) Complex Refining i n US
(R19) SNPIWU SNUCI 81.01- 0 . 9 9 5 0 .955 0 .53 1.50 83.06 (0.003)
34
TABLE V: RELBTIOHSEIPS BKTWIZElU HETBACKS FOR BIGERIBlP LIGHT
(a) Basic RefininE a t Rotterdam
(R20) NNPIWR NNRBI 76.01- 0.981 0 .998 0.43 1.12
(R21) NNPIWR NMOPAB 80.01- 1.003 0.985 0.34 0 .94
(R22) NNRB I NNOPAB 80.01- 1.020 0.986 0 . 3 6 0.74
83.06 (0.002)
83.06 (0.002)
83.12 (0.002)
(b) Complex Refining a t Rotterdam
(R23 1 NNRCI NNOPAC 81.01- 1.030 0.984 0.42 0.52 83.12 (0.002)
w h i l e t h e OPAL d a t a move l e s s c l o s e l y wi th t h e o t h e r two sources
and a r e below them on average. This is an important r e s u l t g i v e n
t h e n a t u r a l tendency t o t r u s t i ndus t ry d a t a more i n t h i s case.
F i n a l l y , t o r o u n d o f f t h e p i c t u r e , we g i v e t h e
( u n s q u a r e d ) c o r r e l a t i o n m a t r i x be tween a l l n e t b a c k s f o r t h e
common p e r i o d f o r which w e h a v e d a t a on a l l of them ( T a b l e s V I
and VII) . It i s c l e a r f rom t h o s e t a b l e s t h a t t h e h i g h e s t
c o r r e l a t i o n s occur be tween s e r i e s w i t h d i f f e r e n t s o u r c e s but
which have i d e n t i c a l d e f i n i t i o n s . Corr e 1 a t i o n s b e tween s e r i e s
f o r s imple and complex r e f i n i n g or between Rotterdam and t h e US
a r e apprec i ab ly lower even when t h e d a t a sou rce i s t h e same.
For both p r i c e and netback d a t a t h e r e a r e a l t e r n a t i v e
s o u r c e s o f d a t a which ma tch v e r y c l o s e l y and w h i c h e x t e n d o v e r
long per iods. It i s tempting t o assume t h a t t h e c l o s e n e s s of t h e
s e r i e s p roves t h a t they a r e c o r r e c t and o t h e r s e r i e s a r e wrong;
however , a l t h o u g h t h i s c l e a r l y s t r e n g t h e n s t h e i r c l a i m t o b e
35
correct it does not const i tute a proof, and we w i l l need to bear
t h i s i n mind when using t h e s e r i e s in t h e l a t t e r part of t h i s
paper .
TABLE VI: COBBELATIOBS PCR SAUDI EETBAmS (1981.01-1983.06)
SNPIWR SNRBI SNOPAB SNOPAC SNRCI SNPIWU SNUCI
SNPIWR 1.000
SNRBI 0.988 1.000
SNOPAB 0.992 0.993 1.000
SNOPAC 0.966 0.964 0.981 1.000
SNRCI 0.966 0.956 0.978 0.976 1.000
SNPIW 0.910 0.884 0.915 0.933 0.907 1.000
SNUCI 0.919 0.894 0.927 0.933 0.920 0.977 1.000
TABLE V I I : COBBELBTIORS FOB HIG'HtIAH HETBAmS (1981.01-1983.06)
NNPIWR NNRB I NNOPAB NNOPAC NNRCI
NNPIWR 1.000
NNRB I 0.989 1 .ooo
NNOPAB 0.993 0.993 1 .ooo
NNOPAC 0.983 0.976 0.990
NNRCI 0.976 0.973 0.980
1 .ooo
0.990 1 .ooo
36
B . 3 A SIHPLE MODEL BELBTIHG SPOT PRODUCT VBLWS Al9D SPOT CRUDE PRICES
B.3 .1 THE HODEL
I n t h e i n t r o d u c t o r y s e c t i o n o f t h i s pape r w e a r g u e d
t h a t t h e netback and spo t p r i c e for a g i v e n crude a r e t r e a t e d i n
t h e l i t e r a t u r e a s i f t h e y were r e l a t e d by a s i m p l e e q u a t i o n of
t h e type :
where ut i s a random term a t time t. I f t h i s term is random then
i t s v a l u e should on average be zero and success ive v a l u e s of t h e
random term should n o t be s y s t e m a t i c a l l y r e l a t e d . Such a model
has two imp 1 i c a t ions:
( i > If t h e s t a t i s t i c a l d i s t r i b u t i o n of t h e random t e r m were
known t h e n any p a r t i c u l a r v a l u e of t h e m a r g i n ( N t - S t ) could b e
c o m p a r e d w i t h t h e " n o r m a l m a r g i n " a n d a m e a s u r e m e n t of
abnormali ty der ived . Extreme d e v i a t i o n s would symbolise changes
i n t h e market.
( i i ) Once t h e no rma l d i f f e r e n t i a l s f o r s e v e r a l c r u d e s were
e s t a b l i s h e d (al , a2....) then we could compare a c t u a l margins t o
see whether one was unusua l ly l a r g e r e l a t i v e t o another. This
t y p e of c a l c u l a t i o n h a s been s u g g e s t e d a s a g u i d e t o r e l a t i v e
p r o f i t a b i l i t y and hence t o demand pressure . It is important t o
r e c o g n i s e t h a t i f ut i s i ndeed random t h e n t h i s month's v a l u e s
c a n p r e d i c t only t h a t f o r n e x t month t h e marg in w i l l b e a t i t s
37
"normal" v a l u e . O v e r s h o o t i n g i n one p e r i o d d o e s n o t make it
more, o r l e s s l i k e l y t h a t t h e r e w i l l be overshoot ing i n t h e next
p e r i o d . I f s u c h p a t t e r n s e x i s t e d w i t h h i s t o r i c d a t a t h e n
e q u a t i o n s s u c h as ( 4 ) would t e n d t o show s e r i a l c o r r e l a t i o n
between success ive v a l u e s of ut.
A d i f f e r e n t p o i n t t o emerge f rom t h i s s t a t i s t i c a l
a p p r o a c h is t h a t t h e c o e f f i c i e n t of t h e s p o t p r i c e s h o u l d b e
u n i t y and t h a t t h e r e s i d u a l s h o u l d n o t b e c o r r e l a t e d w i t h the
s p o t p r i c e ( i e t h a t a l l s y s t e m a t i c i n f o r m a t i o n on t h e c u r r e n t
l e v e l of t h e netback is contained i n t h e spo t pr ice) . I f e i t h e r
of t h e s e r e s t r i c t i o n s d i d n o t h o l d t h e n t h e b a s i c way of u s i n g
t h e e q u a t i o n would h a v e t o change. Suppose , f i r s t l y , t h a t t h e
c o e f f i c i e n t on t h e spot p r i c e i s not u n i t y ( i e t h a t t h e two
s e r i e s a r e n o t i n a d o l l a r f o r d o l l a r r e l a t i o n s h i p ) :
Nt = a + ( 1 + b ) St + U (5)
I n t h i s case t h e margin is a f u n c t i o n of t h e s p o t p r i c e :
(Nt - St) = a + b S, + ut ( 6 )
Depending on t h e s i g n of b t h e marg in wou ld t e n d t o na r row o r
widen a t h i g h p r i c e s . T h i s would mean f i r s t l y t h a t a t t e m p t s
m e r e l y t o focus on t h e s i z e of t h e c u r r e n t margin as an i nd ica to r
of whether t h e market was d i s tu rbed would be mis l ead ing - a h igh
v a l u e of t h e marg in c o u l d m e r e l y b e a r e s u l t of t h e h i g h s p o t
p r i c e and n o t because of any d i s e q u i l i b r i u m between t h e two s i d e s
of t h e market. Futhermore, a s w e s h a l l see l a t e r , a r e l a t i o n s h i p
such as ( 6 ) would r a i s e problems of economic i n t e r p r e t a t i o n a s t o
how such a s i t u a t i o n could come about.
38
The second case (of an o m i t t e d v a r i a b l e ) c o u l d be
w r i t t e n :
Nt = a + ( 1 + b) St + cZt + ut ( 7 )
I f t h e e q u a t i o n i s e s t i m a t e d o r u s e d ( i n t h e fo rm o f t h e c u r e n t
margin) without a l l o w i n g for t h e i n f l u e n c e of v a r i a b l e 2 (what
ever t h a t might be) t hen aga in t h e a c t u a l margin cou ld seem t o be
most u n u s u a l e v e n though it would be c o m p l e t e l y e x p l i c a b l e i n
terms of t h e l e v e l of v a r i a b l e Z.
To summar ise , t h e u s e of t h e a c t u a l m a r g i n (N-S) t o
i n d i c a t e any form of market tendency i m p l i e s t h a t such a margin
has a normal value. This hypothes is p l a c e s s t rong r e s t r i c t i o n s
of a t e s t a b l e n a t u r e on t h e r e l a t i o n between the two s e r i e s . If
t h e r e s t r i c t i o n s can be shown not t o have he ld , t o a s i g n i f i c a n t
d e g r e e , i n t h e p a s t t h i s wou ld s u g g e s t t h a t u s e of t h e a c t u a l
margin as a guide t o i n d i c a t i n g abnormal behaviour i n t h e market
would have been i n c o r r e c t , and would s imul t aneous ly sugges t t h a t
a b e t t e r p r e d i c t o r of t h e no rma l r e l a t i o n s h i p b e t w e e n t h e two
s i d e s of t h e market could be found.
The tests of t h e b a s i c model have two f e a t u r e s . F i r s t ,
w e s h a l l j u s t e s t ima te t h e model as it s t a n d s i n order t o s ee how
w e l l i t f i t s t h e d a t a a n d , i n p a r t i c u l a r , w h e t h e r t h e
r e l a t i o n s h i p is s t a b l e ove r time. Secondly we compare t h e model
w i th more g e n e r a l models t o see whether they add ev idence a g a i n s t
t h e ex i s t ence of t h e s imple r e l a t i o n s h i p .
39
B.3.2 TEE GOODNESS OF FIT OF TEE BORHAL MARGIB MODEL
Given t h e l a r g e numbers of s e r i e s a v a i l a b l e f o r e a c h
c o n c e p t ( f o u r s e r i e s f o r s p o t c r u d e p r i c e s and s e v e n for
netbacks) i t i s n o t f e a s i b l e t o i n v e s t i g a t e eve ry combination i n
d e t a i l f o r e a c h c r u d e . The r e s u l t s of t h e p r e v i o u s s e c t i o n ,
compar ing t h e d i f f e r e n t c r u d e p r i c e s and n e t b a c k v a l u e s ,
suggested t h a t p r i c e s S S I and SSM would be very s i m i l a r (and that
SSP would a l s o be s imilar except for 1979). Since both of t h e s e
s e r i e s a r e a v a i l a b l e f o r t h e full l e n g t h of o u r p e r i o d it i s
n a t u r a l t o begin wi th them. The choice of which netback t o work
wi th i s more d i f f i c u l t . As between sources it seems t h a t t h e two
sources covering t h e l o n g e s t per iod (PIW and t h e indus t ry d a t a )
a r e most s t r o n g l y c o r r e l a t e d . It i s t h e n n e c e s s a r y t o c h o o s e
whether t o look a t complex or bas i c r e f i n i n g , and a l s o t o choose
wh ich r e f i n e r y l o c a t i o n t o d e a l w i t h . Complex r e f i n i n g became
i m p o r t a n t only i n t h e l a t e r p a r t of t h e p e r i o d , s o i t seems
d e s i r a b l e t o look f i r s t a t b a s i c r e f i n i n g . As f o r t h e l o c a t i o n
o f t h e r e f i n e r i e s , t h e d e c i d i n g f a c t o r i s t h a t U S d a t a i s for
complex r e f i n i n g . We t h e r e f o r e s t a r t w i t h b a s i c r e f i n i n g a t
Ro t t er d am.
This g i v e s two d a t a sources (SNPIWR and SNRBI) f o r t h e
netbacks and hence fou r combinations of r e g r e s s i o n t o be t r i e d .
Since t h e PIX d a t a s t o p s i n 1983.06 w e c a r r y out a l l t h e s e t e s t s
f o r t h e common p e r i o d 1976.01 t o 1983.06.
40
TABLE VIII: THE RoBlIBL M R G I R LICfDEL (1976.01-1983.06)
SNPIWR - SSM -1.08 2.02 0.36 (0.21)
SNPIWR - SSI -1.01 1 . 9 2 0.32 (0.20)
SNRBI - SSM -1.08 2.03 0 . 3 3 (0.21)
S N R B I - SSI -1.01 1.88 0.23 (0.20)
NNPIWR - NSM -0.40 1.76 0.52 (0.19)
NIPTWR - NSI -0.52 1.77 0.58 (0.19)
NMRBI - NSM 0.14 1.80 0.52 (0.19)
N N R B I - NSI 0.02 1.77 0.62 (0.19)
T a b l e VI11 g i v e s t h e r e s u l t s , which show a v e r y c l e a r p i c t u r e .
A l l t h e A r a b i a n d a t a show t h e n e t b a c k on a v e r a g e a round one
d o l l a r l o w e r t h a n t h e spot p r i c e f o r t h e p r i o d as a whole . The
v a r i a t i o n a r o u n d t h i s n o r m a l m a r g i n h a s a s t a n d a r d e r r o r of
around $1.90. This impl ies t h a t us ing a 95% confidence i n t e r v a l
t h e a c t u a l margin could be expected to be i n t h e range of -$4.80
t o +$2.80 95% of t h e t ime (-$6.70 t o $4.70 99% of t h e t ime) .
Thus f o r t h e Arab L i g h t c a s e , i f t h e no rma l m a r g i n h y p o t h e s i s
were t o be accepted as a long-run t r u t h , t hen the range of a c t u a l
margins between netback and s p o t p r i c e t h a t would be c o n s i s t e n t
w i th h i s t o r i c v a r i a t i o n would be very la rge .
41
For t h e N i g e r i a n c a s e t h e no rma l marg in depends on
w h e t h e r t h e PIW o r i n d u s t r y d a t a i s b e i n g used f o r t h e n e t b a c k .
The former impl ies a margin some $0.50 lower on average than t h e
l a t t e r . The sampling v a r i a t i o n of t h e margin i s again very wide
( a r a n g e o f abou t $7.2 i f a 95% i n t e r v a l i s t o b e used) .
The range of v a r i a t i o n of t h e a c t u a l margin c o n s i s t e n t
w i th t h e normal margin on t h e b a s i s of h i s t o r i c a l experience, i f
t h i s model i s c o r r e c t , is c l e a r l y t o o w i d e t o b e of any u s e at
a l l . However, two factors s u g g e s t t h a t t h e model is s e v e r e l y
mis-specif ied. F i r s t l y , i n a 1 1 cases t h e Durbin-Watson s t a t i s t i c
i s e x t r e m e l y l o w , i n d i c a t i n g s e r i o u s m i s - s p e c i f i c a t i o n .
Secondly, a p l o t of t h e a c t u a l v a l u e s (cent red on the es t imated
normal margin) of t h e a c t u a l margin shows very s t rong ev idence of
s t r u c t u r a l b r e a k s . For example w i t h t h e p a i r of s e r i e s SNPIWR
and SSM t h e a c t u a l d i f f e r e n t i a l between 1976.01 and 1978.10 has a
r a n g e of $-0.88 t o +$0.65 w i t h a n e a r z e r o mean and a s t a n d a r d
d e v i a t i o n of l e s s t h a n h a l f a d o l l a r . The n e t b a c k and s p o t
pr ices c l e a r l y moved c l o s e l y toge ther and were on average n e a r l y
e q u a l . For a few months a t t h e end of 1 9 7 8 and e a r l y 1979 t h e
netback margin was s t r o n g l y p o s i t i v e , and then from June 1979 t o
J u n e 1981 i t was a l w a y s such t h a t t h e n e t b a c k was more t h a n $ 2
below t h e spo t p r i c e (and w a s u s u a l l y more than $3 below). From
mid-81 t o mid-83 t h e m a r g i n f l u c t u a t e d a t a v a l u e of a b o u t $1
below. S imi l a r f i n d i n g s e x i s t f o r a l l fou r combinations based on
Arab Light.
42
For N i g e r i a n L i g h t t h e p o s i t i o n i s i n g e n e r a l v e r y
s i m i l a r . P r i o r t o t h e end o f 1978 t h e r e was a s m a l l n e g a t i v e
m a r g i n of a r o u n d $0.4. For l a t e 1 9 7 8 and e a r l y 1979 t h e m a r g i n
was s t r o n g l y p o s i t i v e , w h i l e from August 1979 t o January 1981 t h e
margin w a s c o n s i s t e n t l y n e g a t i v e w i t h t h e netback around $2 below
t h e spo t pr ice . After t h a t d a t e t h e margin narrowed t o around 70
cents. Again a l l s e r i e s show a s imilar p i c tu re .
These l a r g e and r a t h e r sudden s h i f t s r e j e c t t h e
h y p o t h e s i s t h a t t h r o u g h o u t t h e p e r i o d t h e r e h a s b e e n a normal
m a r g i n be tween t h e two s i d e s o f t h e marke t . The m a r g i n h a s
changed, and by s u f f i c i e n t l y l a r g e amounts t o r e q u i r e s e p a r a t e
e s t i m a t i o n f o r e a c h sub-pe r iod . The f i r s t check w e mus t run i s
t o s e e w h e t h e r our o t h e r s e r i e s c o n f i r m t h e s e s h i f t s . The OPAL
s e r i e s of n e t b a c k s , b e g i n n i n g i n 1980, c o v e r o n l y h a l f of t h e
t h i r d e p i s o d e and t h e w h o l e of t h e f o u r t h e p i s o d e and hence
c a n n o t be used. S i m i l a r l y , i n d u s t r y d a t a f o r complex r e f i n i n g
s t a r t s i n 1981 and hence cove r s o n l y t h e l a s t episode. Thus t h e
o n l y v a r i a t i o n s a r e w i t h t h e o t h e r two s o u r c e s for s p o t c r u d e
p r i c e s (SSP and SSO). The f o r m e r s t a r t s i n 1978 and t h e l a t t e r
i n 1979. Both s e r i e s show t h e same p a t t e r n f o r b o t h of t h e
n e t b a c k s and f o r b o t h of t h e c r u d e s . Hence we can c o n f i r m t h a t
t h e r e a r e a p p a r e n t l y fou r s e p a r a t e ep i sodes du r ing t h e e i g h t year
p e r i o d . The e x a c t d a t i n g of t h e b r e a k s i s f a i r l y c l e a r . For
Arab L i g h t e i g h t c o m p a r i s o n s show November 1978 a s t h e f i r s t
month a t which the margin increased s u b s t a n t i a l l y over prev ious
experience. The next break i s assigned e q u a l l y o f t e n t o May and
J u n e 1979. J u n e or July 1981 a p p e a r t o b e t h e b e g i n n i n g o f an
43
u n i n t e r r u p t e d r e c o v e r y i n t h e l e v e l of t h e m a r g i n ( a l t h o u g h
F e b r u a r y 1981 i s a n i s o l a t e d p r e c u r s o r of t h i s v a l u e ) . For
Nigerian t h e f i r s t break i s aga in c l e a r l y a f t e r October 1978, t h e
second is a f t e r J u l y 1979, and t h e t h i r d i s a f t e r May 1981 (with
some series showing June o r J u l y 1981). The f a c t t h a t t h e breaks
occur a t e x a c t l y t h e same pe r iods , n o t only f o r a l l measures of
t h e margin but a l s o f o r d i f f e r e n t crudes p o i n t s t o t h e e x i s t e n c e
of some i m p o r t a n t and s y s t e m a t i c f a c t o r t h a t is i g n o r e d by t h e
norma 1 margin" mode 1. I 1
The f i r s t e x t e n s i o n of our h y p o t h e s i s o f t h e "normal
margin" i s that a g i v e n m a r g i n is n o r m a l f o r a p e r i o d and t h e n
f o r some u n i d e n t i f i a b l e r e a s o n c h a n g e s t o a d i f f e r e n t l e v e l .
T h i s i s t e s t e d f o r adequacy of s t a t i s t i c a l e x p l a n a t i o n by
e s t i m a t i n g t h e margin f o r each ep i sode s e p a r a t e l y . The e x e r c i s e
i s c a r r i e d o u t s o l e l y f o r t h e PIW n e t b a c k and t h e MEPEP p r i c e
s e r i e s and t h e r e s u l t s a r e shown i n T a b l e I X . These r e s u l t s
confirm our p rev ious r e s u l t s - t h e margins s h i f t from near zero
p r i o r t o 1979, t o s t r o n g l y p o s i t i v e i n e a r l y 1979 and t h e n t o
s t r o n g l y n e g a t i v e u n t i l e a r l y 1981. F i n a l l y , t h e margin becomes
moderately n e g a t i v e for t h e rest of t h e period. The v a r i a b i l i t y
44
TABLE IX: ESTIMATED B W ZIBBGIBS FOB VARICHJS SUB-PKRImS
Depend en t v a r i a b l e s
SNPIWR - SSM
SNPIWR - SSM
SNPIWR - SSM S N P I W R - SSM
NWIWR - NSM
NNPIWR - NSM
NAPIWR - NSM
MNPIWR - NSM
Period
76.01 - 78.10
78.11 - 79.05
79.06 - 81.06
81.07 - 83.06 76.01 - 78.10 78.11 - 79.07 79.08 - 81.02 81.03 - 83.06
of t h e a c t u a l margin around
Const a n t S.E.E. D.W.S. ( S . E . )
-0.05 (0.06) 2.89 (0.76) -3.37 (0.27) -1.30 (0.15) -0 27 (0.09) 3.60 (0.72) -2.07
-0.70 (0.14)
(0.21)
0.32
2 .oo
1.36
0.73
0.53
2.16
0.93
0.73
1.15
1.71
1.21
1.36
0.39
2.13
1.24
1.45
t h e "normal margin" i s much g r e a t e r
during t h e very s h o r t per iod from November 1978 t o May 1979, and
i t seems l i k e l y t h a t t h i s p e r i o d c a n n o t b e r e p r e s e n t e d by a
s t a b l e "normal margin". A l l t h a t may be s a i d is t h a t , p e r h a p s
s u r p r i s i n g l y , a t t h e time when s p o t crude p r i c e s were undergoing
t h e v e r y s h a r p r i s e of t h e second o i l shock , t h e s p o t p r o d u c t
p r i c e s were r i s i n g even f a s t e r and hence i n c r e a s i n q t h e margin of
t h e n e t b a c k o v e r t h e c r u d e p r i c e by some t h r e e d o l l a r s . T h i s
e f f e c t p e r s i s t e d (on average) from November 1978 u n t i l May 1979
(by wh ich t i m e t h e s p o t c r u d e p r i c e r i s e was c o m p l e t e ) . A t a
t i m e when t h e p o t e n t i a l d i s r u p t i o n t o supply w a s occuring it i s
i n t e r e s t i n g t h a t f o r a s u b s t a n t i a l per iod product p r i c e s (having
r i s e n much f a s t e r than crude p r i c e s between October and November
1978, t h u s d r a m a t i c a l l y i n c r e a s i n g t h e margin) were then a b l e t o
keep pace w i t h crude p r i c e s d u r i n g t h e i r b ig r i s e (December 1978
t o February 1979) and on ly s t a r t e d t o f a l l behind i n May and June
45
1979. C l e a r l y t h e r e was i n i t i a l l y a f u l l pas s -on of t h e
a n t i c i p a t e d crude p r i c e rises. However, once t h e p r i c e s e t t l e d
a t t h e new h i g h e r l e v e l t h e m a r g i n c o l l a p s e d and was some $6
l o w e r t h a n in e a r l y 1979. A f t e r t h e b e g i n n i n g o f 1981 t h e
average margin increased by about $1, a l though netback was below
t h e s p o t p r i c e . The b r e a k i n e a r l y 1981 d o e s not c o r r e s p o n d t o
c l e a r l y i d e n t i f i a b l e f e a t u r e s , a s t h e e a r l i e r two did. The spot
p r i c e for Arab Light s t a r t e d t o f a l l i n December 1980 (but only
r e l a t i v e t o t h e except iona l l e v e l s of October and November). The
sharpes t permanent f a l l i n t h e spo t p r i c e appears t o have been in
F e b r u a r y 1 9 8 2 b u t n o movemen t i n t h e m a r g i n seems t o b e
a s s o c i a t e d w i t h t h e d a t a . The p i c t u r e is e x a c t l y t h e same for
N i g e r i a n L i g h t . As t h e p r i c e r o s e s h a r p l y f rom Oc tobe r 1978 t o
J u n e 1979 t h e p r o d u c t p r i c e s r o s e f a s t e r s t i l l and t h e "normal
margin" increased. Once p r i c e s were s t e a d i e r from July 1979 t h e
marg in f e l l by n e a r l y $6 . A f t e r e a r l y 1981 t h e a v e r a g e marg in
improved by more than $1 but t h e netback was s t i l l below t h e s p o t
p r i c e .
Not s u r p r i s i n g l y , g i v e n t h e s i g n i f i c a n t s h i f t s i n t h e
m a r g i n , t h e s t a n d a r d e r r o r s o f e s t ima tes ( r e s i d u a l v a r i a t i o n )
a round t h e m a r g i n i n t h e s u b - p e r i o d s a r e v e r y much l e s s t h a n
those f o r the whole per iod g i v e n i n T a b l e V I I . P a r t i c u l a r l y f o r
t h e pre-1979 p e r i o d t h e no rma l r a n g e of v a r i a t i o n e x p e c t e d f o r
t h e marg in would h a v e been be tween a b o u t +$0.55 and -$0.65.
These smal l e r v a r i a t i o n s made t h e concept of t h e "normal margin"
a much more u s e f u l t o o l i n h e l p i n g t o j u d g e t h e c u r r e n t m a r k e t
s i t u a t i o n . A t p resent t he re seems t o be an episode wi th a range
46
of j u s t under $3 i n which the a c t u a l margin might be expected t o
f a l l , wi thout being so unusual as t o a rouse s u s p i c i o n t h a t market
condi t ions were changing. Such a margin i s u s a b l e bu t c l e a r l y i t
would be d e s i r a b l e t o na r row i t f u r t h e r s t i l l . The m o d e l s , a s
judged by t h e Durbin-Watson s t a t i s t i c , a r e much improved on t h e
s i n g l e episode v e r s i o n s of Table VIII. However, t h e f i r s t sub-
period ( p a r t i c u l a r l y f o r Nigerian Light) s t i l l shows evidence of
mis-specif i c a t i o n .
S i m i l a r t e s t s a r e c a r r i e d o u t f o r o t h e r r e f i n i n g
c e n t r e s for t h e fou r sub-periods. The r e s u l t s shown in Table X
a r e r e m a r k a b l y c o n s i s t e n t . The f i r s t e p i s o d e shows a small
n e g a t i v e margin wi th a very c l o s e f i t . The second ep isode has a
v e r y l a r g e r e s i d u a l - t h e m a r g i n shows no s t r o n g p a t t e r n . The
t h i r d e p i s o d e a l s o h a s a poor f i t and a v e r y l a r g e n e g a t i v e
margin, w h i l e t h e f o u r t h per iod f i t s a lmost as w e l l as t h e f i r s t
p e r i o d and h a s a n e g a t i v e m a r g i n of be tween $1 and $ 2 (much
l a r g e r t h a n t h e 30 c e n t s of t h e f i r s t p e r i o d ) . The s h i f t s
between per iods a r e appa ren t ly s i m i l a r f o r a l l l o c a t i o n s .
A f i n a l check on t h e adequacy of t h e model i s c a r r i e d
o u t by r e g r e s s i n g a c t u a l m a r g i n s ( f o r a g i v e n e p i s o d e ) of one
crude on t h e same concept for t h e o t h e r crude. I f t h e d e v i a t i o n s
f rom t h e n o r m a l m a r g i n a r e p u r e l y random t h e n t hese c o n c e p t s
s h o u l d n o t b e c o r r e l a t e d . The i n t e r c e p t t e r m s h o u l d be
s i g n i f i c a n t ( b e i n g an e s t i m a t e o f t h e d i f f e r e n c e i n "normal
marg ins" f o r t h e p e r i o d ) , t h e slope term s h o u l d b e z e r o . T a b l e
X I g i v e s t h e r e g r e s s i o n s f o r t h e f o u r sub-periods.
47
Refinery Period Const ant S.E.E. D . W . S . Locat ion
Caribbean 76.09 - 78.10 -0.30 0.34 1.17
78.11 - 79.05 -0.10 2.40 1.61
79.06 - 81.06 -5.41 1.83 0.70
81.07 - 83.06 -2.10 0.65 1.48
...................................................................
(0.07)
(0.91)
(0.35)
(0.14)
Persian 76.09 - 78.10 -0.25 0.16 1.20 Gulf (0.03)
78.11 - 79.05 -0.97 2.37 1.65 (0.901
71.06 - 81.06 -3.72 1.98 1.23 ( 0 . 3 4 )
81.07 - 83.07 -1.16 0.90 1.55 (0.18)
--------------------__L_________________-------------------------
Singapore 71.09 - 78.10 0.08 0.20 1.02 ( 0 . 0 4 )
(0.92)
(0.37)
(0.22)
78.11 - 79.05 -0.39 2.44 1.75
79.06 - 81.06 -2.98 1.87 1.33
81.07 - 83.06 -0.93 1.10 1.58
.................................................................. I ta ly 76.09 - 78.10 -0.29 0.33 1.52
78.11 - 79.05 1.79 1.75 1.43
79.06 - 81.06 -3.81 1.40 0.96
81.07 - 83.06 -1.91 0.59 1.44
(0.06)
(0.66)
(0.28)
(0.12)
I'
48
WLE XI: BEGRESSIOB OF A U B LIGHT HARGIA OH BIGEBIAll LIGHT M E G I N
Dependent I n d e p e n d e n t P e r i od C o n s t a n t S 1 ope Sqd. SEE DWS Var iab le Variable (SE) (SE) Correl-
a t i o n
SNPIWR - SSM S N F I W R - SSM SWPIWR - SSM S N P I W R - SSM
NNPIWR - NSM NNPIWR - NSM NNPIWR - NSH NNPIWR - NSM
76.01 0.06 -78.10 ( 0 . 0 4 )
78.11 -1.06 -79.07 (1 .22 )
79.08 -2 .55 -81.03 (0.50)
81.03 -0.84 -83.06 (0.13)
0.44 0 .51 0.23 1.49
0.87 0.55 1.81 2.22
0.61 0.31 0.87 1.57
0 . 9 2 0 . 6 4 0.51 1 .21
(0.08)
(0.30)
( 0 . 2 2 )
(0.14)
The r e s u l t s i n T a b l e X I show v e r y c l e a r l y t h a t
d e v i a t i o n s from the normal margin a r e c o r r e l a t e d between crudes
f o r e a c h of t h e f o u r e p i s o d e s . T h a t i s , i f t h e n e t b a c k i s
p a r t i c u l a r l y high r e l a t i v e t o t h e s p o t p r i c e for a g i v e n crude it
is l i k e l y t h a t t h e n e t b a c k w i l l a l s o be h i g h r e l a t i v e t o t h e
spot-crudes f o r t h e o the r crude. The high c o r r e l a t i o n p o i n t s t o
a strong l i n k between markets which i t may be p o s s i b l e t o c a p t u r e
e x p l i c i t l y by some economic v a r i a b l e . If t h i s is t h e case , t hen
a sha rpe r p i c t u r e would emerge of t h e l i k e l y range of t h e margin
between t h e netback and i t s a s s o c i a t e d crude. However this must
be a l i n k s e p a r a t e from one l i n k i n g crude p r i c e s t o g e t h e r and t o
c o s t s . E f f e c t i v e l y i t m e a n s t h a t w h a t e v e r c a u s e s
' d i s e q u i l i b r i u m ' i n o n e c r u d e m a r k e t a l s o c r e a t e s
' d i s e q u i l i b r i u m ' i n o t h e r m a r k e t s s o t h a t t h e m a r g i n is
a b n o r m a l l y l a r g e ( s m a l l ) i n b o t h a t t h e same t i m e . T h i s i s an
i n t e r e s t i n g f i n d i n g , p a r t i c u l a r l y f o r t h e f i r s t sub-period where
t h e two s i d e s of t h e m a r k e t a r e v e r y c l o s e l y t i e d t o g e t h e r for
e a c h c r u d e v i ewed s e p a r a t e l y . However t h e s t u d y of r e l a t i o n s
49
between crudes i s a l a r g e s u b j e c t and i s n o t t r e a t e d any f u r t h e r
here .
I n summary, t h e s i m p l e view of a c o n s t a n t "normal
margin" between spo t netbacks and s p o t crudes i s n o t supported by
t h e d a t a . T h e r e h a v e b e e n a s e r i e s of e p i s o d e s i n which t h e
m a r g i n h a s s h i f t e d v e r y c o n s i d e r a b l y . T h i s p o i n t s t o t h e
i n e s c a p a b l e c o n c l u s i o n t h a t t h e m a r g i n must be a f f e c t e d by t h e
s t a t e of the market and hence t h a t i t s behaviour may be r e l a t e d
t o o b s e r v a b l e economic v a r i a b l e s .
Futher t es t s on t h e r e l a t i o n s h i p s between t h e margins
for d i f f e r e n t c r u d e s showed t h a t d e v i a t i o n s from t h e "normal
margin" f o r a g i v e n sub-period were s t r o n g l y c o r r e l a t e d between
crudes. This t o o p o i n t s t o t h e p o s s i b i l i t y t h a t t h e r e a r e o t h e r
sys t ema t i c v a r i a b l e s i n v o l v e d . It appears t h a t t h e use of t h e
m a r g i n t o a s s e s s t h e s t a t e o f t h e m a r k e t is c a p a b l e o f
c o n s i d e r a b l e ref inement , bu t t h a t t h i s must i n e v i t a b l y move t h e
d i s c u s s i o n away from a p u r e l y s t a t i s t i c a l d e s c r i p t i o n (which we
have shown t o be indadequate) t o a t e n t a t i v e economic a n a l y s i s of
t h e problem.
50
-2
- 3
-'t
c -2
I - 0
F i g u r e I
Netback Margin Inetback less spot) for A r a b L i g h t
I 1 1 I
1980
B . 4 ECORCMIC FACTORS DETRRMIBIHG THE =BA= TO CRUDE MARGIB
So f a r w e h a v e h y p o t h e s i s e d t h a t t h e p r i c e s on t h e
c r u d e and p r o d u c t s i d e s of t h e m a r k e t c a n be e x p e c t e d t o move
t o g e t h e r , w i th a cons t an t margin between them. However, s i n c e
w e h a v e s e e n t h a t t h e r e l a t i o n s h i p i s more complex t h a n t h i s ,
some t h e o r e t i c a l d i s c u s s i o n of t h e r e l a t i o n s h i p i s required. We
s t a r t w i th s imple a n a l y t i c a l models and then work towards more
r e a l i s t i c cases. F i n a l l y , w e t e s t some of t hose hypotheses f o r
which d a t a a r e a v a i l a b l e .
( a > S t a t i c equ i l ib r ium wi th a s i n a l e market of i d e n t i c a l buyers
and crude sold a t a s i n g l e p r i c e
The s t a r t i n g p o i n t for our a n a l y s i s is t h e s i t u a t i o n
where a l l c r u d e i s s o l d on a s i n g l e m a r k e t a t t h e same p r i c e ,
where a l l t h e buyers a r e i d e n t i c a l and where t h e market a d j u s t s
i n s t a n t a n e o u s l y t o e q u i l i b r i u m . I n s u c h a c a s e t h e (assumed)
p r o f i t maximising behaviour of t h e buyers of crude w i l l make them
pay a t t h e m a r g i n an amount e x a c t l y e q u a l t o what t h e c r u d e i s
w o r t h t o them a t t h e margin. T h i s M C = M R c o n d i t i o n is t h e
s t a r t i n g p o i n t f o r a l l OUT a n a l y s i s . Now t h e m a r g i n a l c o s t of
t h e c r u d e i s , of c o u r s e , not n e c e s s a r i l y e q u a l t o t h e p r i c e o f
t h e crude s i n c e the buyers may be b i g enough t o a f f e c t t h e p r i c e
( i e t h e l a r g e r t h e i r purchase t h e lower t h e p r i ce ) . However, w e
know t h a t t h e marginal c o s t of t h e crude i t s e l f w i l l be g r e a t e r
51
than or equal t o t h e p r i c e of crude:
MCC > Pc
To t h i s must be added t h e o t h e r cos t components and a t t h i s s t a g e
we make t h e same a s s u m p t i o n s a s a r e used i n c a l c u l a t i n g t h e
netback :
( i ) t h e r e i s no s u b s t i t u t i o n p o s s i b l e be tween i n p u t s ( i e
between crude, l abour , t r a n s p o r t e t c ;
I iil marginal c a p i t a l c o s t s a r e i r r e l e v a n t .
The f i r s t a s sumpt ion i s v e r y l a r g e l y t r u e e x c e p t t h a t some
f l e x i b i l i t y i s p o s s i b l e i n r e f k i n g techniques. However, i f w e
s t i c k t o t h e case of b a s i c r e f i n i n g for t h e moment then the ze ro
s u b s t i t u t a b i l i t y a s s u m p t i o n is s u s t a i n a b l e . This imp l i e s t h a t
t h e t o t a l m a r g i n a l c o s t i s t h e sum of t h e m a r g i n a l c o s t s of t h e
components which are i n f i x e d proport ions. Hence w e can d e r i v e
t h e t o t a l short-run marginal c o s t by adding marginal t r a n s p o r t ,
insurance and r e f k i n g cos t s :
SMCp = MCc + HCT + M% (8)
We n e x t t u r n t o t h e m a r g i n a l r e v e n u e t o b e o b t a i n e d f r o m t h i s
crude. The crude is r e f i n e d and ( a l lowing f o r r e f i n i n g l o s s e s )
t h e o u t p u t can b e sold. If t h e r e is demand e l a s t i c i t y f o r t h e
products (as t h e r e is) and i f t h e s e l l e r s a r e of s u b s t a n t i a l s i z e
(as they o f t e n a re ) then the marginal revenue from sales w i l l be
l ess then t h e pr ice of t h e sales:
pp MRP ( 9 )
5 2
Combining equat ions (8) and ( 9 ) we have:
Pp > PlRp = SMCp = MCC + MCT + MCR > Pc + MCT + M$ (10)
where t h e s u b s c r i p t s a r e
P = product
C = crude
T = t r a n s p o r t
R = r e f i n i n g
Pp - HCT - MCR = N > P c (11)
where N = netback
P = p r i c e
MC = marginal c o s t s
Hence t h e n e t b a c k s h o u l d be g r e a t e r t h a n t h e c r u d e p r i c e by
f a c t o r s r e l a t i n g t o t h e r e l a t i v e s i z e of t h e buyers of crude i n
t h e c r u d e m a r k e t and of s e l l e r s i n t h e p r o d u c t m a r k e t s , t o t h e
e l a s t i c i t y of t h e demand c u r v e and t h e c o l l u s i v e or non-col l u s i v e
behaviour of t h e agents . The reasons i n t h i s model for changes
i n t h e margin (N - Pc> r e l a t e d t o changes i n t h e s e t h r e e f a c t o r s .
This a n a l y s i s p r o d u c e s t h e s t r o n g p r e d i c t i o n t h a t t h e m a r g i n
( c o r r e c t l y c a l c u l a t e d ) s h o u l d be p o s i t i v e and s t a b l e e x c e p t
a g a i n s t s h i f t s in concen t r a t ion , t h e degree of c o l l u s i o n or t h e
e l a s t i c i t y of demand. I f t h e s e f a c t o r s change only slowly ( a s
seems p o s s i b l e ) t h e n t h e margin should b e s t a b l e .
W e n e x t n e e d t o r e t u r n t o t h e i s s u e of c a p i t a l c o s t s .
T h i s can be r e s o l v e d by r e f e r r i n g t o t h e s t a n d a r d a n a l y t i c a l
r e s u l t s t h a t e a c h p o i n t o n t h e l o n g - r u n m a r g i n a l c o s t c u r v e is
i n t e r s e c t e d by t h e short-run marginal c o s t cu rve corresponding t o
t h e ( f ixed ) amount of c a p i t a l g e n e r a t i n g t h a t output a t minimum
53
c o s t . Hence t h e s h o r t - r u n m a r g i n a l c o s t e q u a l s t h e long- run
m a r g i n a l c o s t i n e q u i l b r i u m ( a l t h o u g h t h e c o n t r i b u t i o n s f rom
va r ious f a c t o r s a r e d i f f e r e n t ) and s o i f w e a l l o w no s u b s t i t u t i o n
i n t e c h n i q u e t h e n i g n o r i n g c a p i t a l c o s t s i s c o r r e c t (and would
g i v e t h e same v a l u e a s i n c l u d i n g marginal c a p i t a l c o s t s , but a l s o
a l l o w i n g f o r marginal b e n e f i t s i n c o s t s from vary ing t h e input
mix i e us ing r e l a t i v e l y less crude t o produce t h e same v a l u e of
output). This s imple d i s c u s s i o n omits e x i t and e n t r y costs which
we r e t u r n t o below.
T h i s s i m p l e model i s c l e a r l y t h e p r o t o t y p e of t h e
However, as we c a n s ee i t f a i l s t o
a l l o w f o r two o b s e r v e d f a c t s . F i r s t l y , t h e m a r g i n i s o f t e n
n e g a t i v e and s e c o n d l y t h e m a r g i n v a r i e s i n a n a p p a r e n t l y non-
random d i s c r e t e f a s h i o n wh ich c o u l d s c a r c e l y b e r e l a t e d t o
d i s c r e t e changes i n concent ra t ion , e t c . A very important aspec t
of s u c h a model i s t h a t it d o e s n o t imply any c a u s a l i t y - e g
t h a t p r o d u c t p r i c e changes c a u s e c r u d e p r i c e changes ( o r v i c e
versa) . It m e r e l y s t a t e s what t h e r e l a t i o n would b e between them
i n an unchanging environment.
( b ) S t a t i c e q u i l i b r i u m w i t h a s i n g l e market of non- ident ica l
no rma l margin" approach . I f
buyers w i t h crude so ld a t a single pr i ce .
An o b v i o u s f e a t u r e of t h e r e f i n i n g i n d u s t r y (which w e
a r e t ak ing as t h e buyer of crude and s e l l e r of products ) i s t h a t
not a l l f i rms have i d e n t i c a l cos t s t r u c t u r e s . Some p l a n t s are
o l d e r t han o t h e r s and t e c h n o l o g i c a l advances of a g i v e n d a t e are
n o t i n c o r p o r a t e d i n p l a n t s b u i l t a t e a r l i e r d a t e s . Hence, w e
mus t examine t h e i m p l i c a t i o n s of h a v i n g a m a r k e t w i t h non-
54
i d e n t i c a l buyers.
T h e r e is, of c o u r s e , a n immedia t e and i m p o r t a n t
e m p i r i c a l c o n s e q u e n c e - i t i s no l o n g e r p o s s i b l e t o t a l k of a
s i n g l e c o s t b u t o n l y of some a v e r a g e o r r e p r e s e n t a t i v e c o s t .
T h i s l e a d s , f i r s t , t o t h e p o s s i b i l i t y of some fo rm of s a m p l i n g
e r r o r and, s e c o n d l y , i t r e q u i r e s a d e c i s i o n as t o t h e r e l e v a n t
c o s t f o r our theory.
I n a c o m p e t i t i v e e q u i l i b r i u m w i t h a d i s t r i b u t i o n of
c o s t s t h e h i g h e s t c o s t p r o d u c e r s a r e t h e o n e s who w i l l b e
squeezed out f i r s t , and so the r e l e v a n t marginal c o s t is t h a t of
2 t h e h ighes t c o s t buyer s t i l l l e f t i n t h e market.
I f t h e sequence of s t a t i c e q u i l i b r i a were such t h a t t h e
same p l a n t was always marg ina l , t h e n it would be c o r r e c t t o t a k e
f i x e d i n p u t / o u t p u t ( y i e l d ) c o e f f i c i e n t s t o c a l c u l a t e t h e
a p p r o p r i a t e margina 1 costs .
T h i s is i n d e e d what h a s b e e n done i n t h e p u b l i s h e d
d a t a (at l e a s t f o r v e r y l e n g t h y p e r i o d s ) . The u s e of f i x e d
y i e l d s t o c a l c u l a t e t h e n e t b a c k s o v e r t i m e l e a v e s u s w i t h two
ques t ions :
( i >
some average i n t r a - m a r g i n a l f i rm?
( i i ) d i d t h e t e c h n o l o g y o f t h e s e q u e n c e of m a r g i n a l
f i r m s remain cons t an t?
a r e t h e y i e l d s t h o s e of t h e m a r g i n a l f i r m o r of
I f t h e y i e l d s were f o r an i n t r a - m a r g i n a l p l a n t t h e n t h e m a r g i n
should be more s t r o n g l y p o s i t i v e , w h i l e i f t h e technology of t h e
s e q u e n c e of m a r g i n a l p l a n t s improved o v e r the p e r i o d , t h e gap
between t h e i n t r a - m a r g i n a l f i x e d y i e l d plant and t h e marginal and
5 5
c h a n g i n g y i e l d p l a n t s s h o u l d na r row. Hence t h e m a r g i n of t h e
f i x e d y i e l d p l a n t o v e r t h e c r u d e p r i c e would be e x p e c t e d t o
n a r r o w over t h e p e r i o d ( i e Of c o u r s e t h e m a r g i n s of
h ighe r but unchanging technology p l a n t s (complex r e f k i n g ) w i l l
be g r e a t e r than t h o s e f o r 8 f ixed y i e l d b a s i c r e f i n i n g p l a n t , but
bo th should f a l l o v e r time. Thus big s h i f t s i n demand o r supply
which changed t h e marginal p l a n t s u b s t a n t i a l l y would be expected
t o b e r e f l e c t e d i n t h e marg in for a f i x e d t e c h n o l o g y i n t r a -
marginal p l an t .
( c > S t a t i c equ i l ib r ium wi th many markets of non- iden t i ca l buyers
t o f a l l ) .
and crude s o l d a t a s i n g l e price.
An i m p o r t a n t f e a t u r e of t h e p r o d u c t m a r k e t is t h e
geographical d i s p e r s i o n of t h e r e f i n i n g c e n t r e s and hence of t h e
s p o t product markets. Data is a v a i l a b l e on product pr ices i n a
wide r a n g e of m a r k e t s . However, i n e q u i l i b r i u m t h e m a r g i n a l
revenue from r e f i n i n g a b a r r e l of crude i n a g i v e n l o c a l market,
w i t h l o c a l r e f i n i n g cond i t ions and s o l d a t l o c a l product p r i c e s ,
when n e t t e d back to t h e p o i n t of s a l e must e q u a l t h e m a r g i n a l
c o s t o f t h a t b a r r e l . Hence a l l n e t b a c k s f o r a g i v e n c r u d e , i f
c a l c u l a t e d c o r r e c t l y , would be equa l i n s t a t i c equ i l ib r ium. This
o b s e r v a t i o n i s t o b e d i s t i n g u i s h e d f rom a n a l y s i s o f what t h e
e q u i l i b r i u m p r i c e w i l l be. Such an a n a l y s i s would b r i n g i n t h e
r e l a t i v e s t r e n g t h s of demand i n e a c h g e o g r a p h i c m a r k e t . W e d o
not need t o consider such f a c t o r s in r e l a t i n g t h e v a r i o u s prices
i n equi l ibr ium.
The d a t a i n T a b l e V I showed c o r r e l a t i o n s , t h a t were
h i g h b u t c e r t a i n l y n o t p e r f e c t , for d i f f e r e n t c o u n t r i e s e g
56
SNPIWR and SNPIWU and SNRBI and SNRCI. However, i n b o t h c a s e s
t h e US d a t a a r e f o r complex r e f i n i n g w h i l e t h e R o t t e r d a m d a t a
a r e f o r b a s i c r e f i n i n g , so one is d e f i n i t e l y more in t ra -margina l
than t h e o ther . PIW does g i v e d a t a on f i v e c e n t r e s c a l c u l a t e d on
t h e assumption t h a t t h e y i e l d s a r e f o r b a s i c r e f in ing . However,
o n c e w e admi t t h e p o s s i b i l i t y t h a t c o s t c u r v e s d i f f e r w i t h i n
c o u n t r i e s , t h e n f o r t i o r i t h e y a r e l i k e l y t o d i f f e r be tween
coun t r i e s , I n e q u i l i b r i u m only t h e h ighes t c o s t remaining p l a n t
in t h e world i s marginal and a l l o t h e r s a r e in t ra -margina l . The
d i f f e r i n g degrees of in t ra -margina l i t y w i l l produce non-perf e c t
c o r r e l a t i o n s between t h e va r ious netbacks. This model does i m p l y
t h a t o n l y t h e r e l a t i o n of t h e l o w e s t v a l u e n e t b a c k t o t h e s p o t
p r i c e s h o u l d b e i n v e s t i g a t e d . T h e r e is n o t h i n g e x t r a i n t h i s
c a s e t o e x p l a i n why t h e marg in be tween the n e t b a c k for a g i v e n
refinery and t h e c r u d e p r i c e s h o u l d vary o v e r t i m e i n t h e way
observed. We p r e s e n t t h e ev idence on t h e varous PIW netbacks i n
o rde r t o f i l l ou t t h e p ic ture .
I d ) S t a t i c equ i l ib r ium with many markets of non- iden t i ca l buyers
and more t han one crude (each w i t h a s i n a l e p r i c e ) .
A s p e c i a l f e a t u r e of t h e o i l marke t (wh ich i t s h a r e s
w i t h most a g r i c u l t u r a l commodi t i e s ) i s t h a t c r u d e o i l f rom
d i f f e r e n t c o u n t r i e s has d i f f e r e n t t e c h n i c a l p r o p e r t i e s . This
means t h a t t h e mix of p r o d u c t s o b t a i n a b l e i s d i f f e r e n t . Of
c o u r s e r e f i n i n g t e c h n i q u e s may b e v a r i e d s o a s t o b r i n g y i e l d
p a t t e r n s t o g e t h e r b u t t h i s c o s t s money, and w e m u s t e n v i s a g e a
market w i th d i s t i n c t l y d i f f e r e n t y i e l d p a t t e r n s f o r each crude.
The p r i c e s o f t h e p r o d u c t s a r e of c o u r s e t h e same i n a g i v e n
57
market and so t h e crude p r i c e s r e f l e c t t h e d i f f e r e n t v a l u a t i o n s
p l a c e d upon t h e i r p r o d u c t s when t h e most e f f i c i e n t r e f i n i n g i s
b e i n g used ( i e where t h e m a r g i n a l b e n e f i t s f rom c h a n g i n g t h e
y i e l d s a t t hose p r i c e s a r e j u s t equa l t o t h e marginal c o s t s of so
do ing) . I f r e f i n e r i e s a r e c r u d e s p e c i f i c , as t h i s a n a l y s i s
sugges ts , t hen f o r each crude t h e r e w i l l be a marginal r e f i n e r y
and t h e m a r g i n a l r e v e n u e from t h i s r e f i n e r y w i l l e q u a l t h e
marginal c o s t s of t h e crude. Hence t o g e n e r a l i s e equat ion (11)
t o t h e case of two crudes w e would have:
Pp ( 1 ) - MCT (1) - MCR (1) = N (1) > Pc (1)
Pp ( 2 ) - MCT ( 2 ) - M$ ( 2 ) = N ( 2 ) > Pc ( 2 ) ( 1 2 )
The two margins r e f l e c t t h e concen t r a t ion on both s i d e s (of t h e
c r u d e b u y e r s and p r o d u c t s e l l e r s ) f o r t h e two c r u d e s . I n t h e
same product market w e would expect market power t o be i d e n t i c a l
- t h e p r o d u c t s a r e sold w i t h o u t r e f e r e n c e t o t h e c r u d e used. 3
Market power and concen t r a t ion a r e more l i k e l y t o vary between
purchasing l o c a t i o n s f o r d i f f e r e n t crudes. Hence even i f w e had
i d e a l d a t a f o r t h e t r u l y marginal p l a n t s t h e normal margins f o r
t h e two c r u d e s c o u l d b e d i f f e r e n t . However, t h e d i f f e r e n c e
between margins should be s t a b l e u n l e s s concen t r a t ion changes in
one market r e l a t i v e t o t h e other .
I f t h e d a t a a r e f o r f i x e d t e c h n o l o g y i n t r a - m a r g i n a l
p l a n t s t h e n b o t h m a r g i n s c a n be e x p e c t e d t o na r row, w h i l e t h e
d i f f e r e n c e be tween m a r g i n s s h o u l d remain s teady ( t e c h n o l o g i c a l
p r o g r e s s s h o u l d a f f e c t t h e r e f i n i n g o f a l l c r u d e s more o r less
equal ly . Geographical s e p a r a t i o n of p l a n t s should n o t compl ica te
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t h e i s s u e in t h e two c r u d e c a s e any d i f f e r e n t l y t h a n i n t h e
s i n g l e crude case.
( e ) S t a t i c equ i l ib r ium wi th many markets of non- iden t i ca l buyers
and more than one crude wi th each crude s o l d on a two-tier
p r i c e s y s t e m .
We begin w i t h t h e s i m p l e s t ca se of a s i n g l e crude w i t h
a s i n g l e r e f i n i n g market and i d e n t i c a l buyers. The crude is s o l d
a t two p r i c e s wh ich w e s h a l l d e n o t e " o f f i c i a l " and "spot". The
o f f i c i a l p r i c e i s t h a t of a government agency - i t i s p r e s e t and
which i s l i k e l y t o remain cons t an t for l eng thy per iods, w h i l e t h e
s p o t p r i c e i s t h e p r i c e d e t e r m i n e d by s u p p l y and demand on a
p a r t i c u l a r day.
So f a r our a n a l y s i s and p re l imina ry t e s t s have ignored
t h e o f f i c i a l p r i c e and i n s t e a d c o n c e n t r a t e d on t h e s p o t p r i c e .
If t h e s p o t m a r k e t w e r e p r e d o m i n a n t , t h a t i s i f a l l c r u d e were
s o l d s p o t , our approach would be s t r i c t l y c o r r e c t and would need
no f u r t h e r j u s t i f i c a t i o n . However, t h e b u l k of c r u d e oil is
p u r c h a s e d a t o f f i c i a l p r i c e s , w i t h t h e b e g i n n i n g of o u r p e r i o d
( 1 9 7 6 ) s e e i n g v i r t u a l l y a l l t r a n s a c t i o n s a t o f f i c i a l p r i c e s ,
w h i l e t h e end of t h e p e r i o d h a s s e e n a n i n c r e a s e i n s p o t and
spo t - r e l a t ed t r a n s a c t i o n s ( f i g u r e s of up t o 40% f o r s p o t - r e l a t e d
t r a n s a c t i o n s are o f t e n quoted). We must i n v e s t i g a t e t h e e f f e c t
of a t w o - t i e r p r i c e o n ou r r e l a t i o n s h i p s and a l s o t h e e x t r a
impact of t h e changing importance of t h e s p o t market.
S i n c e w e a r e d e a l i n g w i t h e q u i l i b r i u m s i t u a t i o n s w e
need a c l e a r v i e w o f how two d i f f e r e n t p r i c e s f o r t h e same
product can be s u s t a i n e d (with t r a d e con t inu ing a t both prices).
5 9
Here t h e r e a r e two c l e a r l y d i s t i n c t s i t u a t i o n s bu t both r e q u i r e
t h a t t h e s u p p l y a t t h e o f f i c i a l p r i c e i s l i m i t e d ( a n L-shaped
supply curve) . I f demand a t t h e o f f i c i a l p r i c e i s g r e a t e r than
t h e r a t i o n e d supply then t h e spo t p r i c e w i l l be forced above t h e
o f f i c i a l p r ice . I n such circumstances the s p o t p r i c e is t h e t r u e
marginal concept and t h e netback should be r e l a t e d s o l e l y t o t h e
spo t pr ice . This looks l i k e t h e c l a s s i c case of a d i sc r imina t ing
p r i c e s t r u c t u r e where by t h e producers of crude have market power
in t h e t i g h t marke t and c a n i n c r e a s e t o t a l p r o f i t s by u s i n g
quotas and two-part pricing.4 However, i t i s c l e a r t h a t much of
t h e s u p p l y on t h e spot m a r k e t d i d n o t come d i r e c t l y f rom t h e
producers bu t from buyers of crude who r e s o l d a t h ighe r pr ices .
Since o i l , u n l i k e e l e c t r i c i t y , is r e s a l e a b l e t h e r e is
then the f u r t h e r problem of how the p r i c e s were k e p t apar t . This
w a s done by t h e producers u s ing i m p l i c i t and e x p l i c i t means ( e g
d e s t i n a t i o n c l auses ) t o s t o p t h e buyers of c rude from r e s e l l i n g
it. C l e a r l y i n a t i g h t market t h e e f f e c t s of l o s s of goodwi l l on
being caught i n t h e act of r e s e l l i n g would b a l a n c e a s u b s t a n t i a l
p r i c e d i f f e r e n t i a l . Hence w h i l e t h e m a r k e t was t i g h t t h e
d i f f e r e n t i a l could pers is t .
In s u c h a s i t u a t i o n , a l t h o u g h a c t u a l s p o t c r u d e
t r a n s a c t i o n s were r e l a t i v e l y uncommon, t h e s p o t p r i c e was t h e
genuine ly marginal pr ice . I f a t y p i c a l company suddenly needed
more c r u d e i t would h a v e h a d t o buy i t o n t h e s p o t marke t .
However, the s e l l e r would ve ry l i k e l y have been another company
r a t h e r than a producer of crude. The normal margin between spot
products and s p o t crude c o u l d have been expected t o ho ld during
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t h i s p e r i o d of t i g h t n e s s ( d e f i n e d as one when t h e s p o t c r u d e
p r i c e was s u b s t a n t i a l l y and p e r s i s t e n t l y g r e a t e r t h a n t h e
o f f i c i a l p r i c e ) . The normal m a r g i n wou ld n o t b e d i s t u r b e d by
small changes i n quotas , o f f i c i a l p r i c e s o r demand ( even though
t h e s e would a l l a f f e c t t h e s p o t c r u d e p r i c e ) . T h i s is a n
important p i ece of a n a l y s i s s i n c e it shows why t h e product p r i c e
would n o t be e x p e c t e d t o f o l l o w t h e l o w e r o f i t s two p o s s i b l e
input p r i ces . C r i t i c a l l y f o r our purposes i t i s a l s o a t e s t a b l e
hypothesis .
However, l a r g e changes i n demand could and d i d r e s u l t
i n a s i t u a t i o n where t h e s u p p l y a t o f f i c i a l p r i c e s cou ld s a t i s f y
a l l t h e demand a t t h o s e p r i c e s . Wi th f u r t h e r r e d u c t i o n s i n
demand t h e r e wou ld b e e x c e s s s u p p l y , and i f a n o t h e r s o u r c e of
s u p p l y ( t h e s p o t m a r k e t ) emerged consumers would look a t t h a t .
Hence i f c r u d e were r e l e a s e d o n t o t h e spot m a r k e t t h e n i f t h e
r e s u l t i n g price were below t h e o f f i c i a l p r i c e a s i m p l i s t i c view
would i n f e r t h a t a l l c r u d e must h a v e b e e n bough t a t t h a t p r i c e
w i t h o u t d r i v i n g i t up t o t h e o f f i c i a l p r i c e , s i n c e i t wou ld b e
more p r o f i t a b l e f o r buyers t o purchase a t t h e lower p r i c e . The
empi r i ca l puzz le i s t h e o b s e r v a t i o n t h a t s i n c e 1982 s p o t p r i c e s
have been p e r s i s t e n t l y (and o f t e n s u b s t a n t i a l l y ) below o f f i c i a l
p r i c e s and y e t have n o t been bid up by demand switching en masse
f rom t h e o f f i c i a l to t h e s p o t market . As w e p o i n t e d o u t t h e r e
c e r t a i n l y h a s b e e n a growth i n t h e u s e of t h e s p o t m a r k e t i n
r e c e n t y e a r s , b u t s t i l l t h e b u l k o f o i l i s s o l d a t o f f i c i a l
p r i c e s .
There a r e a t l e a s t two r e a s o n s why a buyer might p r e f e r
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t o choose o f f i c i a l r a t h e r t h a n s p o t d e s p i t e t h e e x t r a mone ta ry
c o s t : ( i ) t h e r e are f i x e d c o s t s of t r a n s f e r r i n g t h e
source of purchase;
( i i ) t h e r e a r e " i n s u r a n c e " g a i n s t o be made i n
b u y i n g f rom o f f i c i a l s o u r c e s where t h e r e i s f u t u r e
supply uncer ta in ty .
So, i f i t t o o k t h e buy ing d e p a r t m e n t of a company some t i m e t o
overcome i t s adherence t o t h e t r a d i t i o n a l method of p u r c h a s i n g
( o f f i c i a l market) and t o l e a r n t h e d e t a i l s of u t i l i s i n g t h e spot
m a r k e t o n a r e g u l a r b a s i s , t h e r e s h o u l d be a g r a d u a l move t o
using t h e spot whenever t h i s w a s below t h e o f f i c i a l . Hence l a r g e
d i f f e r e n c e s i n p r i c e s s h o u l d become h a r d e r t o s u s t a i n . One
i m p l i c a t i o n of t h i s l i n e of a rgument must be t h a t t h e s p o t
m a r k e t , once i t h a s grown i n i m p o r t a n c e , w i l l c o n t i n u e t o b e
i m p o r t a n t . The b u y e r s will n o t f o r g e t how to u s e it when it
would be t o t h e i r advantage t o do so.
However, we do not n e c e s s a r i l y expect t h e d i f f e r e n t i a l
be tween s p o t and o f f i c i a l p r i c e s t o d i s a p p e a r a l t o g e t h e r o v e r
t i m e . Our second reason , t h a t of buying o f f i c i a l a s an insurance
premium, w i l l s t i l l b e v a l i d even when buyers a r e p e r f e c t l y
f a m i l i a r w i th t h e spo t market. When t h e r e i s s t i l l u n c e r t a i n t y
about f u t u r e p r i c e s and hence about the p o s s i b i l i t y of be ing a b l e
t o o b t a i n c r u d e when r e q u i r e d , i t m a y a p p e a r a d v a n t a g e o u s t o a
buyer n o t t o d e s e r t h i s t r a d i t i o n a l sou rce of supply for a l i t t l e
e x t r a p r o f i t . Hence w h i l e memories of excess demand s i t u a t i o n s
a r e s t i l l f r e s h o f f i c i a l crude may command a s u b s t a n t i a l premium
62
o v e r s p o t c r u d e , However, as s u c h e p i s o d e s r e c e d e and t h e
1 i k e l i h o o d of s u p p l y s h o r t a g e seems weak t h e s i t u a t i o n w i l l
r e v e r s e . The s e l l e r s h o u l d b e p r e p a r e d t o o f f e r a d i s c o u n t t o
r e g u l a r c u s t o m e r s ( n o t t o a1 1 p u r c h a s e r s ) t o a t t e m p t t o r e d u c e
h i s r e v e n u e u n c e r t a i n t y . T h i s would t e n d t o push t h e o f f i c i a l
p r i c e down r e l a t i v e t o t h e s p o t pr ice .
A s a f i n a l p o i n t w e s h o u l d t o u c h on t h e i s s u e of why
t h e s e l l e r i s prepared t o s e l l a t two p r i c e s (hav ing seen why t h e
buyer may be prepared t o buy a t both pr ices) . A f i r s t reason f o r
t h e p e r s i s t e n t e x i s t e n c e of s u p p l y o n b o t h m a r k e t s is t h a t t h e
s a l e s on spo t a r e pu re ly by d i s t r e s s purchasers who have bought
t o o much o f f i c i a l . The second p o s s i b i l i t y is t h a t t o o 'high" an
o f f i c i a l p r i c e may mean l o s t s a l e s (and r e v e n u e ) and t h e
t e m p t a t i o n f o r one of t h e c a r t e l t o ' ' ch i se l ' ' i n a d i s c r e t e
f a s h i o n , by s e l l i n g some e x t r a a t a l o w e r p r i c e , may be v e r y
s t rong .
For o u r p u r p o s e s t h e i n t e r e s t i n g a s p e c t i s t h e
r e l a t i o n s h i p between t h e ne tback and t h e purchase p r i c e of o i l i n
t h e s i t u a t i o n where t h e spo t p r i c e i s below t h e o f f i c i a l p r ice .
C l e a r l y t h e s i m p l e s t a rgument would be t h a t t h e lower p r i c e
( spot ) is t h e marginal cos t and hence t h e ne tback should aga in be
r e l a t e d s o l e l y t o t h e s p o t p r i c e . However, o u r a rgument t h a t
b u y e r s a l w a y s buy m a i n l y a t o f f i c i a l for i n s u r a n c e p u r p o s e s ,
would imply t h a t a p o r t f o l i o t y p e d e c i s i o n was invo lved . Under
u n c e r t a i n t y t h e r e a r e two s o u r c e s of s u p p l y w i t h d i f f e r e n t
a v e r a g e c o s t s and d i f f e r e n t v a r i a n c e s of c o s t s ( r e l a t e d t o t h e
f u t u r e b e n e f i t s of b e i n g a r e g u l a r cus tomer f o r t h e c r u d e a t
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o f f i c i a l p r i c e s ) . The m a r g i n a l p u r c h a s e i n a p o r t f o l i o model
i n c l u d e s b o t h components ( w i t h s h a r e s a d d i n g u p t o one hundred
p e r c e n t ) . I f t h e p e r c e i v e d i n s u r a n c e gain changed t h e n the
c o m p o s i t i o n of t h e p o r t f o l i o would a l t e r . The outcome o f this
l i n e of a n a l y s i s i s t h a t i n t h e c a s e of a s i n g l e c r u d e t h e
n e t b a c k s h o u l d be r e l a t e d t o a w e i g h t e d a v e r a g e of spot and
o f f i c i a l p r i c e s whenever t h e spo t p r i c e f a l l s below t h e o f f i c i a l
p r i c e . This is a l s o a t e s t a b l e hypothesis , s i n c e the pe r iods of
o f f i c i a l p r i c e i n f l u e n c e are i d e n t i f i a b l e from t h e data.
The i s s u e o f t w o - t i e r p r i c i n g r a i s e s f u r t h e r
p o s s i b i l i t i e s when t h e r e i s more than one v a r i e t y of crude. If
t h e s p o t p r i c e s f o r b o t h c r u d e s were b e l o w t h o s e of t h e i r
r e s p e c t i v e o f f i c i a l p r i c e s then w e cou ld appea l t o t h e p o r t f o l i o
a rgumen t f o r b o t h c r u d e s . However, s i n c e t h e u n c e r t a i n t i e s on
t h e two s o u r c e s of s u p p l y might w e l l b e d i f f e r e n t i t would b e
r a t i o n a l t o t r y t o keep i n w i t h b o t h s u p p l i e r s , e v e n a t some
e x t r a r e f i n i n g c o s t s . A p o r t f o l i o wou ld t h e n i n c l u d e a l l
o f f i c i a l p r i c e s a s w e l l a s one s p o t p r i c e ( i n e q u i l i b r i u m s p o t
pr ices a r e d r i v e n t o a p o i n t where buyers are i n d i f f e r e n t between
them, s i n c e t h e r e a r e no f a c t o r s i n v o l v e d i n t h e i r choice except
r e l a t i v e pr ices) . The netback would a l s o have t o be a d j u s t e d t o
inco rpora t e t h e mix tu re of y i e l d s . We do n o t a t t e m p t t o f o l l o w
up t h i s complex idea b u t merely acknowledge i t s exis tence.
The p o r t f o l i o p u r c h a s i n g a rgumen t g i v e s a r e a s o n why
t h e netback w i l l n o t always be r e l a t e d s o l e l y t o t h e s p o t p r i ce .
A t c e r t a i n times i t w i l l a l s o be r e l a t e d t o t h e o f f i c i a l p r i c e -
s i n c e t h i s i s p red ic t ed t o happen when t h e s p o t crude p r i c e f a l l s
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below t h e o f f i c i a l p r i c e it f o l l o w s t h a t the l a r g e r t h i s gap t h e
h i g h e r s h o u l d b e t h e m a r g i n of t h e n e t b a c k o v e r t h e s p o t c r u d e
p r i ce . T h i s e s t a b l i s h e s a n a rgument € o r a m a r g i n l a r g e r t h a n
t h a t d u e s o l e l y t o t h e c o m p e t i t i v e s t r u c t u r e , and a l s o a n
argument f o r a v a r y i n g margin . The l a t t e r c e r t a i n l y a c c o r d s
roughly wi th t h e empi r i ca l evidence presented e a r l i e r , t h a t t h e
marg in improved a f t e r 1981, and t h i s was a l s o t h e t i m e a t which
t h e spo t p r i c e moved below t h e o f f i c i a l p r ice . These arguments
w i l l be t e s t e d more r i g o r o u s l y in t h e f o l l o w i n g s e c t i o n of t h e
paper.
(f) S t a t i c Equi l ibr ium w i t h a s i n g l e crude and wi th products
so ld t o more t h a t one c l a s s of u se r
So f a r t h e a n a l y s i s has concent ra ted on t h e case where
t h e r e f i n e d products a r e s o l d t o a ' f inal ' buyer.
However t h e r e a r e two important i n s t i t u t i o n a l f e a t u r e s
of t h e marke t t h a t h a v e changed over t h e p e r i o d and which a
s i m p l e a n a l y s i s does n o t b r ing out.
(1) Some products are s o l d as i n t e rmed ia t e i n p u t s t o r e f i n e r i e s t h e m s e l v e s (eg n a p t h a f o r f i n i s h e d g a s o l i n e ) and as a p ropor t ion of t h e market t h i s can vary.
Some companies a r e f u l l y i n t e g r a t e d (upstream and downstream) s o t h a t some c r u d e i s b e i n g conver ted i n t o products wi thout going through an a c t u a l market.
( 2 )
The f i r s t c a s e where t h e a v e r a g e p r o d u c t mix i s n o t
s o l d onto t h e market but some is f u r t h e r conver ted does sugges t
t h a t t h e r e i s an e x t r a p r o f i t t o be made on t h i s second r e f i n i n g
s tage . However, i n a compe t i t i ve model, t h e w i l l i n g n e s s t o buy
product whatever i t s use i s t o be and however much p r o f i t can be
65
t h e r e b y o b t a i n e d w i l l make t h e r e v e n u e f rom a l t e r n a t i v e uses
equa l so t h a t t h e spo t p r i c e is s t i l l a marginal revenue. It i s
of c o u r s e t r u e t h a t t h e p r o d u c t s p o t m a r k e t w i l l be t h i n a t
c e r t a i n t i m e s bu t t h i s shou ld n o t d i s t o r t t h e a n a l y s i s .
S i m i l a r l y i f some r e f i n e r s a r e f u l l y i n t e g r a t e d and for
i n t e r n a l company r e a s o n s u s e t r a n s f e r p r i c i n g , t h a t d o e s n o t
v a l u e products a t spot market v a l u e s , t h i s may a f f e c t t h e t o t a l
ou tpu t of products i e a group of non-profi t maximisers may l e a v e
a 'smaller' market f o r o t h e r f i rms. N e v e r t h e l e s s f o r t h e s e non-
i n t e g r a t e d firms t h e v a l u a t i o n a t t h e margin shou ld s t i l l d r i v e
marginal revenue equal t o marginal c o s t ( i t w i l l m e r e l y be a t a
d i f f e r e n t o u t p u t ) . We see t h a t i f p r o f i t m a x i m i s i n g b e h a v i o u r
r u l e s o v e r p a r t of t h e market we then would expect t o observe t h e
normal MC=MR r e l a t i o n s h i p .
F i n a l l y w e consider t h e f a c t t h a t some product is s o l d
a t c o n t r a c t p r i c e s r a t h e r t han o n t h e spot market. C l e a r l y t h e
s p o t m a r k e t i s t h e c o r r e c t m a r g i n a l c o n c e p t i f s p o t p r o d u c t
p r i c e s a r e a b o v e c o n t r a c t p r o d u c t p r i c e s . However i f t h e
c o n t r a c t p r i c e were e v e r h i g h e r t h e n i t wou ld be m a r g i n a l
( a l l o w i n g f o r t h e e x t r a c o s t s of b e i n g t i e d t o a c o n t r a c t ) . It
migh t b e a r g u e d t h a t i n s u c h c i r c u m s t a n c e s t r a d i n g on s p o t
p r o d u c t s wou ld d r y up u n t i l t h e p r i c e e q u a l i s e d t h e a d j u s t e d
c o n t r a c t p r i c e so t h a t a p a r t from short-run f l u c t u a t i o n s t h e s p o t
p r o d u c t p r i c e i s a l w a y s t h e m a r g i n a l c o n c e p t . However t h e r e
c o u l d be a p o r t f o l i o s e l l i n g a rgument f o r p r o d u c t s j u s t a s for
b u y i n g c rude . S i n c e t h e a d v a n t a g e s f o r a c o n t r a c t a r e n o t j u s t
t h e p r i c e r e c e i v e d but a l s o a measure of c e r t a i n t y , a s e l l e r (who
6 6
i s not a r i s k l o v e r ) should be w i l l ing to se1 1 a f r a c t i o n on s p o t
and a f r a c t i o n o n c o n t r a c t w i t h t h e e q u i l i b r i u m c o n t r a c t p r i c e
b e i n g b e l o w t h e s p o t p r i c e (by t h e r i s k premium). T h i s would
imp ly t h a t i f t h e s p o t p r o d u c t p r i c e were a b o v e t h e c o n t r a c t
p r i c e t h e s p o t p r o d u c t p r i c e o v e r s t a t e s t h e r e v e n u e o n a u n i t
s a l e basis . C l e a r l y t h i s argument p r e s e n t s no r eason t o e x p l a i n
a spo t product p r i c e being p e r s i s t e n t l y below t h e s p o t c o n t r a c t
p r i c e . However i f t h i s d i d happen t h e n t h e s p o t p r o d u c t p r i c e
would u n d e r s t a t e r e v e n u e a t t h e m a r g i n were s e l l e r s a b l e t o
o b t a i n t h i s p r i c e . J u s t a s when s p o t c r u d e p r i c e s a r e a b o v e
o f f i c i a l p r i c e s but a r e y e t marginal because buyers cannot o b t a i n
o f f i c i a l , w e n e e d t o a r g u e t h a t s p o t p r o d u c t p r i c e s c o u l d f a l l
be low a c o n t r a c t p r i c e i f s e l l e r s a r e n o t a b l e t o o b t a i n a
c o n t r a c t a t t h e c u r r e n t c o n t r a c t p r i c e . Thus if t h e m a r k e t
switches away from t h e l e v e l a t which e x i s t i n g c o n t r a c t s were s e t
t h e n t h e s p o t p r o d u c t p r i c e c o u l d t e m p o r a r i l y f a l l b e l o w t h e
c o n t r a c t p r i c e . S i n c e c o n t r a c t s t h e m s e l v e s a r e p o t e n t i a l l y
f l e x i b l e and s e n s i t i v e t o market f o r c e s it i s n o t expected t h a t
t h i s s t a t e of a f f a i r s would p e r s i s t . N e v e r t h e l e s s during t h i s
phase s p o t product p r i c e s a r e t h e r e l e v e n t marginal revenue. To
summarise we have argued t h a t i f s p o t product i s below c o n t r a c t
p r i c e t h e n t h e f o r m e r i s m a r g i n a l w h i l e i f t h e s p o t p r o d u c t i s
above c o n t r a c t p r i c e s t h e t r u e marginal revenue may be o v e r s t a t e d
by t h e s p o t p r o d u c t p r i c e s ( b e c a u s e o f t h e d i v e r s i f i c a t i o n of
se1 l i n g ) . N e i t h e r case s u g g e s t s an a n a l y t i c a l r e a s o n why t h e
n e t b a c k (wh ich is based on spot p r o d u c t p r i c e s ) c o u l d be
unde r s t a t ed and hence why t h e r e is an observed n e g a t i v e margin.
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(g ) Short-run dynamics wi th a s i n g l e crude t raded a t a s i n g l e
p r i c e .
While we d i s c u s s t h e model i n equi lbr ium w e do n o t have
t o spec i fy anyth ing about t h e mechanisms of supply o r demand f o r
c r u d e oil, o r how t h e t w o s i d e s of t h e marke t a r e b r o u g h t i n t o
equi l ibr ium. However, it is n o t n e c e s s a r i l y t r u e t h a t the market
i s a l w a y s i n e q u i l b r i u m and indeed i t may t a k e t i m e t o move
towards e q u i l i b r i u m i n a s y s t e m a t i c f a s h i o n . I f t h e r e i s some
form of p a r t i a l adjustment i n t h e market t hen t h e c u r r e n t netback
margin w i l l n o t n e c e s s a r i l y be on average a good r e p r e s e n t a t i o n
of t h e e q u i l i b r i u m or normal margin (but r a t h e r w i l l r e f l e c t t h e
s e r i e s of i n c o m p l e t e a d j u s t m e n t s b r o u g h t a b o u t by demand o r
s u p p l y s h i f t s i n t h e p e r i o d ) . Even w i t h o u t a t t e m p t i n g t o
i d e n t i f y t h e c a u s e s o f t h e s e demand and s u p p l y s h i f t s we can
r e c o g n i s e t h a t t h e i r e x i s t e n c e w i l l p r o d u c e a d y n a m i c
r e l a t i o n s h i p between product p r i c e s and crude p r i ces .
We b e g i n by l o o k i n g a t t h e t e m p o r a l s e q u e n c e i n t h e
t ransformat ion of crude i n t o products . Once t h e crude i s s o l d ,
i t w i l l need t o be t r a n s p o r t e d f rom t h e p o i n t of s a l e t o t h e
r e f i n i n g cent re . For Saudi crude bought a t o f f i c i a l p r i c e s and
b e i n g r e f i n e d a t Ro t t e rdam t h i s m a y t a k e up t o s i x weeks. The
l a g on spot purchases is more p r o b l e m a t i c a l , s i n c e it depends on
t h e l o c a t i o n of t h e cargo a t t h e p o i n t of s a l e . Remembering t h a t
o u r p r i c e d a t a i s l a r g e l y " i n t h e month" we c a n e x p e c t a l a g of
be tween z e r o and s i x weeks, g i v i n g a mean lag of up t o a month.
Once t h e crude a r r i v e s a t t h e r e f i n e r y i t w i l l be added t o stocks
and only g r a d u a l l y used t o produce products. There w i l l be some
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inventory of products which produces a f u r t h e r d e l a y before t h a t
crude i s a c t u a l l y sold a s a product a t t h e r e f i n e r y gate.
T h i s p r o d u c t i o n l a g i n t r o d u c e s a p r o b l e m n o t o f t e n
f a c e d i n e l e m e n t a r y economics , t h a t o f t h e t i m i n g of t h e
passing-on of p r i c e increases . Whatever p r i n c i p l e of p r i c ing i s
used, whether p e r f e c t l y c o m p e t i t i v e , mark-up or 01 i g o p o l i s t i c ,
t h e firm h a s a r a n g e o f o p t i o n s be tween LIFO and FIFO p r i c i n g
r u l e s . I f FIFO p r i c i n g i s used p r i c e s r e s p o n d w i t h a l a g e q u a l
to t h a t of t h e per iod of product ion ( i n c l u d i n g t h e two inventory
h o l d i n g p e r i o d s a s p a r t of t h e p e r i o d of p r o d u c t i o n ) . A t t h e
o t h e r ex t r eme , i f LIFO p r i c i n g i s used t h e n c o s t of c r u d e
i n c r e a s e s a r e i m m e d i a t e l y r e g i s t e r e d i n p r i c e of p r o d u c t
i n c r e a s e s . The s p i r i t of a rgumen t s u sed t o d e s c r i b e p e r f e c t
c o m p e t i t i o n s u g g e s t s t h a t FIFO would b e u s e d , with f i r m s
r e l u c t a n t t o push up pr ices because of l o s t demand u n t i l t h e loss
on p r o f i t s from t h e h igher c o s t s forced them (and competi tors) t o
do so. O l i g o p o l i s t i c p r i c i n g p r a c t i c e s may vary from t h i s (as i n
t h e e x a m p l e of f i r m s m a r k i n g u p s t o c k i m m e d i a t e l y a f t e r l a r g e
c o s t i nc reases , eg d e v a l u a t i o n s , a r e announced) but i t does not
seem t h a t L I F O w i l l b e a t t r a c t i v e i n n o n - c o l l u s i v e marke t s .
A c c o r d i n g l y w e e x p e c t t h e r e t o be some l a g i n t h e p a s s i n g on o f
c o s t s (crude p r i ces ) t o r evenues (product p r i c e s ) when the re a r e
s h i f t s i n t h e c o s t curves .
In a w o r l d w h e r e c o s t s a r e c h a n g i n g c o n s t a n t l y , o r a t
l e a s t f a i r l y o f t e n , t h e r e may b e some d e s i r e t o r e d u c e
v a r i a b i l i t y i n p r o d u c t p r i c i n g and s o p r o d u c t p r i c e s m i g h t
a t tempt t o smooth ou t s h i f t s in cos ts . This f a c t o r would perhaps
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a l l o w l o n g e r l a g s be tween changes i n c r u d e p r i c e s and t h e
a s s o c i a t e d changes i n product p r i c e s than a s i m p l e FIFO r u l e .
So f a r w e h a v e c o n c e n t r a t e d on s h i f t s coming on t h e
supply s i d e , which produce changes in crude p r i c e s and which are
t hen t r ansmi t t ed t o product p r i ces . However, much of t h e s h o r t
r u n d i s t u r b a n c e (as w e l l a s some o f t h e l o n g e r run e f f e c t s ) t o
t h e c r u d e o i l m a r k e t comes f rom the demand s i d e . I f t h e demand
f o r p r o d u c t s s u d d e n l y d r o p s ( b e c a u s e of a f a l l i n t h e g e n e r a l
l e v e l of economic a c t i v i t y ) t h e n p r o d u c t p r i c e s a r e l i k e l y t o
f a l l u n l e s s :
(i) p r i c i n g i s e n t i r e l y done on a mark-up b a s i s ;
( i i > p r i c i n g i s designed t o change r a t h e r more smoothly than demand, and i n v e n t o r i e s are used t o absorb t h e s h i f t s .
I n a l l cases t h e f a l l i n s a l e s o r p r o f i t s w i l l tend t o l e a d t o a
r educ t ion i n t h e quan t i ty of crude purchased. Most of t h i s w i l l
b e f e l t o n t h e o f f i c i a l marke t b u t i t w i l l a l s o s p i l l i n t o t h e
m a r g i n a l s p o t marke t . Hence 8 f a l l i n s p o t p r i c e s w i l l come
a b o u t . Again t h e r e i s t h e p o s s i b i l i t y of a l a g from p r o d u c t
p r i c e s t o crude p r i c e s because of t h e w i l l i n g n e s s of producers t o
l i v e wi th some v a r i a t i o n i n demand.
Hence c a u s a l i t y and l a g s c a n r u n in b o t h d i r e c t i o n s .
Furthermore t h e two s i d e s of t h e market may i n t e r a c t i n a dynamic
f a s h i o n . Suppose demand f o r p r o d u c t s f a l l s - t h i s l e a d s t o a
f a l l i n p r i c e s a t e x i s t i n e , c o s t s . The f i r m s a l s o d e c i d e t o
reduce t h e i r purchases of crude, which lowers t h e crude p r i c e and
w i l l a f f e c t t h e product p r i c e , magnifying i ts i n i t i a l f a l l .
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Hence a l t h o u g h w e need n o t s p e c i f i c a l l y model t h e f a c t o r s
s h i f t i n g t h e s u p p l y and demand c u r v e s w e c o u l d model t h e
a d j u s t m e n t p r o c e s s . The g e n e r a l s t r u c t u r e would be a p a i r of
dynamic equat ions:
S t f (Nt, N t - l ..... > Nt = f ( S t + st,2 .... 1 (13)
where t h e l a g s a r e long enough to c a t c h a l l t h e de layed response
f rom a s h i f t o n one s i d e of t h e m a r k e t t o t h e d i r e c t e f f e c t s on
t h e o t h e r s ide. The feedback e f f e c t s would of course be captured
by t h e s u b s t i t u t i o n of one e q u a t i o n i n t o t h e o t h e r . The e r r o r
terms i n these equat ions would be t h e supply and demand s h i f t i n g
v a r i a b l e s . The problem wi th these equat ions is one of e s t ima t ing
s t r u c t u r a l parameters without exogenous v a r i a b l e s . I f t h e t a s k
s e t were l e s s a m b i t i o u s i e e s t i m a t i o n of t h e a v e r a g e l a g s on
e i t h e r s i d e of t h e market then t h e r e is some way forward.
These dynamic m o d e l s show c l e a r l y t h a t t h e a c t u a l
margin w i l l no t n e c e s s a r i l y be a good e s t ima to r f o r t h e "normal
e q u i l i b r i u m " marg in b e c a u s e of t h e o m i s s i o n of t h e l a g g e d
v a r i a b l e s which r e l a t e t h e two concepts.
(h) Shor t run dynamics w i t h a s i n g l e crude t raded a t two prices.
I f t h e spot p r i c e were always above t h e o f f i c i a l p r ice ,
b e c a u s e o f r a t i o n e d demand, t h e n t h e dynamic a n a l y s i s wou ld
c o n t i n u e t o r e l a t e n e t b a c k s and s p o t c r u d e p r i c e s as i n t h e
p r e v i o u s s e c t i o n . Even i f t h e o f f i c i a l p r i c e changed t h e
r e l a t i o n be tween t h e two would be u n a l t e r e d a c c o r d i n g t o t h e
arguments put forward ( a l though t h e l e v e l of t h e spot p r i c e would
change). THe matter i s obv ious ly less s i m p l e i f t h e spot p r i c e
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were below t h e o f f i c i a l pr ice . Both lagged p r i c e s should a f f e c t
t h e n e t b a c k , b u t t h e l a g s be tween t h e two c o u l d b e d i f f e r e n t i f
s p o t were purchased i n a d i f f e r e n t l o c a t i o n from o f f i c i a l . Given
t h a t f o r some crudes t h e o f f i c i a l w a s changed r a t h e r i n f r e q u e n t l y
( r e l a t i v e t o m o n t h l y d a t a ) t h e l a g f rom o f f i c i a l p r i c e s t o
netbacks may be d i f f i c u l t t o s e p a r a t e from t h e c u r r e n t e f f e c t .
( i> Short run dynamics with more than one crude.
A l t h o u g h t h e a d j u s t m e n t p r o c e s s f o r a g i v e n c r u d e i s
f a i r l y easy t o fo rmula t e , t h e problem becomes much more d i f f i c u l t
when a second crude i s introduced. I n p a r t i c u l a r we may wish t o
d i s t i n g u i s h between supply shocks t h a t a r e crude s p e c i f i c or a r e
gene ra l . Demand shocks apply t o products and hence ( i n a g i v e n
l o c a t i o n ) w i l l a f f e c t a l l netbacks very s i m i l a r l y i n t h e s h o r t
run. Shocks which a r e p r o d u c t s p e c i f i c w i l l a f f e c t t h o s e
netbacks which are most i n t e n s i v e i n t h e product concerned. Thus
w e have fou r cases :
(i) g e n e r a l demand s h i f t s wh ich a f f e c t a 1 1 n e t b a c k s e q u a l l l y ;
( i i ) produc t - r e l a t ed demand, s h i f t s which w i l l a f f e c t netbacks d i f f e r e n t i a l l y ;
( i i i ) gene ra l supply s h i f t s which w i l l tend t o push up a l l crude p r i c e s evenly;
( i v ) c r u d e - s p e c i f i c s u p p l y s h i f t s w h i c h p u s h up one crude most.
While t h e new se t of e q u i l i b r i u m p r i c e s and netbacks a r e emerging
w e w i l l f i n d t h a t s h i f t s i n one m a r k e t w i l l show p a r t i a l
adjustments i n o t h e r markets a s w e l l a s own markets. This type
o f a d j u s t m e n t i s p o s s i b l e t o m o d e l , b u t w i t h o u t a n a r t i c u l a t e d
t h e o r y of t h e e q u i l i b r i u m r e l a t i o n s h i p between crude p r i c e s it
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would be d i f f i c u l t t o implement an i n t e r - r e l a t e d p r i c e adjustment
model.
S i m i l a r l y , demand shocks i n a s p e c i f i c g e o g r a p h i c a l
m a r k e t would g r a d u a l l y s p i l l o v e r i n t o o t h e r m a r k e t s , b u t t h e
formal adjustment p rocess would be t r i c k y t o hand le because of
t h e p o s s i b i l i t y of t r a d e i n t h e products.
(j) A s i n g l e crude when t h e r e a r e e x i t and e n t r y c o s t s and when
t h e r e a r e o m i t t e d c o s t s .
The p e r s i s t a n c e of a n e g a t i v e m a r g i n i e of n e t b a c k s
b e i n g be low c r u d e p r i c e s f o r a p e r i o d u p f o u r y e a r s r a i s e s a n
important p o i n t of i n t e r p r e t a t i o n . Since, as w e have argued, t h e
marg ina l r e f i n e r y might w e l l show an even g r e a t e r marginal loss
w e need t o d i s c u s s whether such a r e s u l t is compatible w i t h t h e
5 t ype of p r o f i t maximising behaviour t h a t we have so f a r assumed . One i n t e r p r e t a t i o n of t h e p e r s i s t a n c e of ( a v e r a g e )
l o s s e s of t h i s phenomenon i s t h a t t h e r e a r e l a r g e e x i t c o s t s
which persuade r e f i n e r s t h a t it is b e t t e r t o s t a y i n and o p e r a t e
t h e p l a n t even though t h i s shows a paper l o s s . The types of cos t
t h a t w o u l d e n t e r t h i s c a l c u l a t i o n a r e t h e s h u t down o r
m o t h b a l l i n g c o s t s . I f firms e x p e c t t h e m a r k e t t o expand a t a
l a t e r d a t e , having j u s t experienced a f a l l i n demand, t h e n t h e r e
is a l s o a r e - e n t r y c o s t t o c o n s i d e r ( b r i n g t h e p l a n t o u t of t h e
m o t h b a l l s e t c ) . However i n b o t h t h e case of a f a l l i n demand
t h a t i s seen as permanent and t h e f a l l t h a t i s seen a s temporary
( s h o r t to medium r u n ) i t i s s t i l l n e c e s s a r y t o c o n s i d e r t h e
cond i t ions under which exit would s t i l l be t h e b e s t po l i cy . We
can t a k e t h e f i r s t c a s e t o i l l u s t r a t e t h e arguments. Demand has
73
f a l l e n from a l e v e l a t which t h e market was i n e q u i l i b r i u m t o a
l o w e r l e v e l , wh ich i s s e e n a s permanent . The e x i t r u l e of
elementary economics sugges t s t h a t i f average r evenue does not
cover average v a r i a b l e c o s t s t h e n t h e r e should be immediate e x i t
- o t h e r w i s e e x i t s h o u l d t a k e p l a c e once t h e f i x e d c o s t e l e m e n t
has become v a r i a b l e . However i f t h e opportuni ty c o s t s i t u a t i o n
must i n c l u d e a s u b s t a n t i a l e l e m e n t f o r s h u t down c o s t s t h e n a
discounted cash f l o w c a l c u l a t i o n i s r e l e v e n t . This needs t o ask
f o r which f u t u r e y e a r i t i s loss m i n i m i s i n g t o s h u t down.
Suppose t h e s h u t down c o s t s v a r y i n r e a l terms w i t h t h e y e a r of
t h e shut down and t h a t t h e y e a r l y ope ra t ing l o s s is cons tan t (and
i s t h e minimum t h a t can be obtained) . Then t h e DCF is c a l c u l a t e d
for a series of hypo the t i ca l s h u t down years. I f i n t h e c u r r e n t
per iod t h e minimising year f o r s h u t down i s g r e a t e r t h a n zero t h e
whole process i s taken forward one year with t h e p l a n t k e p t open.
The c a l c u l a t i o n is r e p e a t e d t h e n e x t y e a r and so o n u n t i l i t s
m i n i m i s i n g v a l u e i s z e r o and t h e p l a n t i s s h u t down ( i f t h e r e
were n o r e d u c t i o n i n s h u t down c o s t s t h e p l a n t w o u l d e i t h e r be
c l o s e d down immediately or never). Hence i f t h e s h u t down c o s t
i s l a r g e r e l a t i v e t o running l o s s e s and i f it f a l l s s l o w l y then
t h e market can o p e r a t e a t a book-keeping loss f o r s e v e r a l years
( t h e l o s s being even bigger i f i t s h u t down immediately).
Clearly i f we g e n e r a l i s e t h i s t o t h e c a s e where demand
i s expected t o pick up again and t h e r e a r e r e -en t ry c o s t s (which
probably i n c r e a s e t h e longer t h e p l a n t i s i d l e ) t h e n t h i s should
extend t h e per iod du r ing which a l o s s would be s u s t a i n e d wi th t h e
p 1 a n t running.
74
However t h e r e is s t i l l t h e d i f f i c u l t y of e x p l a i n i n g why
t h e M C = M R c o n d i t i o n i s a p p a r e n t l y v i o l a t e d f o r such a l o n g
period. I f t h e p l a n t i s t o be ope ra t ed i t should s t i l l be run t o
m i n i m i s e l o s s e s and t h i s would b e where MC=HR - i e e x i t c o s t s
can e x p l a i n t h e p e r s i s t e n c e of ave rage l o s s e s but not marginal
10s ses . It i s a t t h i s p o i n t t h a t we must a l s o c o n s i d e r o t h e r
r e a s o n s for d e c i d i n g on t h e optimum o p e r a t i o n of a p l a n t .
S t r a t e g i c o r p o l i t i c a l f a c t o r s may d e t e r m i n e t h e c h o i c e of
o p e r a t i n g size f o r s e v e r a l p l a n t s a t a l e v e l which may not r e l a t e
t o c u r r e n t prof i t a b i l i t y issues . However t h i s would m e r e l y put
more p r e s s u r e on o t h e r r e f i n e r s to a d j u s t output (and hence would
a f f e c t p r i c e s on b o t h s i d e s of t h e marke t ) . Only a g e n e r a l
w i l l i n g n e s s t o s a c r i f i c e c u r r e n t p r o f i t s t o o t h e r g a i n s would
p e r m i t t h e p r i c e s t o s t a y a p a r t i n t h i s fashion. Hence w e c a n
n o t a p p e a l t o s e l e c t i v e non-prof i t maximis ing b e h a v i o u r t o
e x p l a i n t h e p e r s i s t e n c e of marginal l o s ses .
75
B . 5 FIIII'PHBB STATISTICAL TESTS ON THE RELBTIONSEIPS BETUEEA PRODUCT AND CRUD3 PRICES
B I 5 I 1 AlU UBCORSS1BBIl!lED BEIATIOHSEIP
The s t a t i s t i c a l a n a l y s i s so f a r has r e l a t e d t h e netback
t o t h e spo t crude pr ice w h i l e t h e t h e o r e t i c a l s e c t i o n has l a r g e l y
d i scussed t h e r e l a t i o n s h i p between marginal r evenue and marginal
cost . Given t h a t t h e netback i s a p u r e l y cons t ruc t ed series it
i s i m p o r t a n t t o c o n s i d e r w h e t h e r i t c a n be u s e d a s a m e a s u r e o f
marginal revenue (with c e r t a i n c o s t s deducted). The problems of
a c t u a l measurement h a v e b e e n d e a l t w i t h a t l e n g t h i n s e c t i o n
B.2.2 - i f t h e concept is c o r r e c t t hen w e have shown a very g r e a t
deg ree of concordance on t h e measurement of t h e s e r i e s from very
d i f f e r e n t sources. The problem, if it exists, is more l i k e l y t o
be c o n c e p t u a l - w e h a v e a l r e a d y d i s c u s s e d t h e d i f f i c u l t i e s
a s s o c i a t e d wi th cho ice of r e f i n e r y , measuring s h o r t or long-run
m a r g i n a l c o s t e l e m e n t s and t h e i m p o r t a n c e o f t h e a s s u m p t i o n o f
f i x e d c o e f f i c i e n t t e c h n o l o g y . We c a n n o t a s s e r t t h a t w e h a v e
measu red m a r g i n a l r e v e n u e s and c o s t s b u t m e r e l y t h a t we h a v e
obtained t h e b e s t estimates a v a i l a b l e a t present . A l l i n f e r e n c e s
w i l l be c o n d i t i o n a l on p o s s i b l e mis-specif i c a t i o n a t t h i s s t e p of
t h e a n a l y s i s . To a n t i c i p a t e t h e r e s u l t s w e n o t e t h a t when t h e
n e t b a c k i s b e l o w t h e c r u d e p r i c e t h e n i f t h i s i s a measurement
e r r o r a r i s i n g f o r c o n c e p t i o n a l m i s - s p e c i f i c a t i o n t h e n e i t h e r
r e v e n u e i s t o o low o r c o s t s a r e t o o h i g h . The r e v e n u e f i g u r e s ,
76
being based on product v a l u e s and average y i e l d s can s c a r c e l y be
too low f o r t h e marginal r e f i n e r y (even though they a r e c l e a r l y
lower t h a n f o r t h e i n t r a - m a r g i n a l r e f i n e r y ) . The c o s t f i g u r e s
a r e p e r h a p s v u l n e r a b l e i n t h e t r a n s p o r t c o s t o r r e f i n i n g c o s t
e l e m e n t s b u t t h e s e a r e r a t h e r s m a l l and i n o r d e r t o p roduce a
p o s i t i v e margin would need t o a lmos t disappear . C l e a r l y t h e r e i s
a l s o l i t t l e room in this approach t o a l l o w f o r o t h e r c o s t s t h a t
may have been omitted. Bearing these concept ional d i f f i c u l t i e s
i n mind we u s e t h e f i g u r e s a s o u r b e s t a v a i l a b l e e s t i m a t e s of
c o s t s and revenues.
Before we in t roduce any e x t r a v a r i a b l e s w e e s t i m a t e t h e
r e l a t i o n s h i p between t h e netback and t h e spot crude p r i c e i n i t s
leas t r e s t r i c t e d form ie:
Nt = a + bSt + ut (14)
G i v e n t h a t w e found t h e p a r a m e t e r s t o be v a r i a b l e be tween
e p i s o d e s i t is s e n s i b l e t o s t a r t w i t h t h e m o d e l s e s t i m a t e d for
sub-periods. To o b t a i n t h e longes t runs of d a t a w e h a v e f o r Arab
L i g h t t h e two n e t b a c k s ( S N R B I and SNPIWR) and t h e two p r i c e
s e r i e s (SSM a n d SSI) w h e r e t h e d a t a is f e l t t o b e m o r e
acceptab le . The r e s u l t s a r e shown i n Table X I I .
77
TABLE XII: Relations between Hetbacks and Spot Crude Prices For Arab Light
Dependent Independent Period Constant S 1 ope SEE DWS Var i a b l e Variable
SNPIWR SPJPIWR SNRBI SNRBI SNPrWR SWPIWR SNRBI SNRB I SNPIWR SNP IWR SNRBI SNRBI SNPIWR SNPIWR SNRBI SNRBI
S SM S SM SSI s SI S SM S SM SSI ssz S SM S SM SSI SSI S SM SSM s SI SSI
76.01-78.10 76.01-78.10 76.01-78.10 76 .01-79.10 78.11-79.05 78.1 1-79.05 78.11-79.05 78.1 1-79.05 79.06-81.06 79.06-81.06 79.06-81.06 79.06-81.06 81.07-83.06 81.07-83.06 81.07-83 06 81.07-83.06
-3.0(2.5) 1.2( 12.6) 0.30 1.44 0.996(220) 0.33 1.14
-0.9(0.7) 1.08(10.8) 0.30 0.96 1.009( 239) 0.30 0.92
6.7(3.0) O.gO(8.5) 2.1 1.59 1.06(25.7) 2.9 0.93
5.1(2.6) 0.84(10.2) 1.7 1.36 1.04(32) 2.3 0.76
5.0(1.5) 0.79(8.4) 1.22 1.18 0.90(129) 1.26 1.23
-0.3(0.1) O.gl(9.4) 1.13 0.77 0.90(146) 1.11 0.77
-0.3(0.1) 0.97(12.6) 0.74 1.32 0.96(203) 0.72 1.31
1.16(2.1) 0.93(13.7) 0.64 1.41 0.97I236) 0.63 1.45
The r e s u l t s of t h e unconstrained model are u s e f u l l y
compared wi th t h e cons t r a ined model :
f o r wh ich t h e r e s u l t s w e r e g i v e n i n T a b l e I X . The d i f f e r e n c e
between these two models is the r e s t r i c t i o n on t h e c o e f f i c i e n t of
t h e s p o t p r i ce . The unconstrained model a l l o w s t h e movements t o
be o t h e r than d o l l a r for d o l l a r responses. Since i n many c a s e s
t h e i n t e r c e p t term becomes i n s i g n i f i c a n t l y d i f f e r e n t f rom z e r o
t h e model is then cons t r a ined i n a d i f f e r e n t way:
The f i r s t comparison w e make is t h a t between t h e d i f f e r e n t d a t a
s o u r c e s . When t h e c o n s t r a i n t i s o m i t t e d t h e r e s u l t s a r e v e r y
s i m i l a r , i n gene ra l t h e indus t ry sources g i v e t h e b e t t e r fit .
Once we t u r n t o t h e a n a l y s i s of t h e s e p a r a t e pe r iods w e
c a n s e e t h a t f o r any g i v e n model t h e r e a r e s u b s t a n t i a l s h i f t s
78
be tween p e r i o d s in t h e c o e f f i c i e n t s . Hence t h e i n s t a b i l i t y w e
n o t e d w i t h t h e b a s i c "normal marg in" model i s n o t removed by
g e n e r a l i s i n g t o t h e "spot - re la ted margin" model. In p a r t i c u l a r
the short e p o s i d e 1978.11 t o 1979.05 is v e r y d i f f e r e n t from t h e
o t h e r p e r i o d s . It may w e l l n o t b e p o s s i b l e t o d e s c r i b e t h i s
t u r b u l e n t p e r i o d i n a s i m p l e m o d e l , and w e s h o u l d n o t be t o o
c o n c e r n e d by f a i l u r e t o f i t i t . E v e n t h e o t h e r t h r e e p e r i o d s
show v a r i a t i o n , and i n g e n e r a l t h e r e is l i t t l e e v i d e n c e f o r a
non-zero i n t e r c e p t when t h e "mark-up" is n o t c o n s t r a i n e d t o
uni ty . We can c i t e as a t y p i c a l r e s u l t t h e model u s i n g indus t ry
d a t a w i t h o u t a n i n t e r c e p t . I n t h e p e r i o d 1976.01 t o 1978.10 t h e
netback increased $1.01 f o r e v e r y d o l l a r r ise i n s p o t p r i c e s ; i n
1979.06 t o 1981.06 t h i s margin w a s down to $0.90; and f o r 1981.07
i t had r ecove red t o $0.97. Given t h e v e r y s m a l l s t anda rd e r r o r s
these c o e f f i c i e n t s a r e s i g n i f i c a n t l y d i f f e r e n t f r o m each o t h e r ,
and s o t h e r e i s some s t r u c t u r a l s h i f t b e i n g shown in t h e "spot -
r e l a t e d margin". The s t a n d a r d e r r o r s of e s t ima tes for t h e s e
t h r e e sub-periods vary a g r e a t d e a l , and add f u r t h e r ev idence f o r
s h i f t s .
When we r e p e a t t h e same e x e r c i s e for Niger i a we o b t a i n
very s imilar r e s u l t s (Table XIII).
7 9
TABLE XZII: Relations betveen Betbacks and Spot Prices for l iger ia .
NNP IWR NWPIWR NNRBI NNRB I
NNPIWR NNPIWR NNRB I NNRB I
NNP IWR MNPIWR NNRB I NNRB I
NNPIWR NNP IWR NNRB I NNRB I
ISM N SM MSI N S I
N SM NSM NSI MSI
MSM NSM NSI NSI
NSM NSM N S I NSI
76.01-78.10 -0.82(0.4) 1.04(7.1) 76.01-78.10 0.98( 149 76.01-78.10 1.20(0.6) 0.93(5.9) 76 .O 1-78.10 1.01(144)
78.1 1-79.07 6.5( 2.7) 0.88(9.6)
78.1 1-79.07 0 -8 9( 8 - 2) 78.11-7 9 -07 1.1 Z(31)
78.11-79.07 1.13(29) 6.5( 2 3)
79.08-81.02 5.86(2.44) 0.79(13)
79.08-81.02 -1.08(0.4) 0.98( 14) 79.08-81.02 0.95(187)
79.08-81.02 0.95(222)
81.03-83.06 0.40(0.2) 0.97(18) 81.03-83.06 0.98( 23 1 1 81.03-83.06 -0.95(0 - 6 ) 1.03(23) 81.03-83.06 1.00(298)
0.53 0.53 0.57 0.56
2 .08 2.80 2.50 3.10
0.75 0.84 0.74 0.72
0.91 0.70 0.56 0.55
0.40 0.39 0.40 0.42
2.38 1.47 2.18 1.44
1.09 1.24 2.54 2.47
1.61 1.62 1.59 1.57
As b e f o r e , t h e r e s u l t s €or t h e two d a t a s o u r c e s a r e
ve ry s i m i l a r , w i th those from t h e indus t ry source being s l i g h t l y
b e t t e r . The second episode (78179) is much less w e l l exp la ined
by t h e mode l , w i t h v e r y d i f f e r e n t c o e f f i c i e n t s and a l a r g e r
s t anda rd e r r o r of e s t ima te . The o t h e r episodes do n o t g e n e r a l l y
suppor t t h e presence of a constant a s w e l l a s a s l o p e term. When
t h e r e s t r i c t e d " spo t - r e l a t ed margin" model is considered the mark
u p on a d o l l a r i n c r e a s e in s p o t p r i c e s v a r i e s f rom $1.01 i n t h e
f i r s t per iod, t o $0.95 in t h e t h i r d , and r e c o v e r s to $1.00 i n t h e
f o u r t h . F o r N i g e r i a t h e m a r g i n s v a r y l e s s ( b u t s t i l l
s i g n i f i c a n t l y ) , and i n t e r e s t i n g l y i n two of t h e fou r ep i sodes a r e
in a d o l l a r f o r d o l l a r r e l a t i o n . The s t anda rd e r r o r of estimate
is much c l o s e r between per iods than f o r Arab Light.
80
B . 5 . 2 OFFICIAL PRICES AS EXPURATOBY VARIABLES
Raving o n l y p a r t i a l l y succeded i n p r o v i d i n g a s t a b l e
e s t i m a t e of t h e r e l a t i o n s h i p between netbacks and crude p r i c e s by
g e n e r a l i s i n g on t h e "normal margin" model it i s necessary t o go
on t o add e x t r a explanatory v a r i a b l e s . The f i r s t candidate is
t h e " o f f i c i a l p r i c e " . In S e c t i o n B.5.1 w e a r g u e d t h a t when t h e
o f f i c i a l p r i c e i s below t h e s p o t p r i c e t h e r e must be r a t i o n i n g ,
and so t h e s p o t i s marginal and t h e netback shou ld be r e l a t e d t o
t h e s p o t and not t o t h e o f f i c i a l p r i c e . For Arab L i g h t we p l o t
t h e t h r e e s e r i e s ( f i g u r e 111). From t h e beginning of t h e per iod
u n t i l 1 9 7 8 t h e two p r i c e s e r i e s a r e s o c l o s e t h a t t h e y would b e
i n t e r c h a n g e a b l e i n any r e g r e s s i o n . A f t e r t h i s d a t e t h e s e r i e s
d i f f e r s u b s t a n t i a l l y , w i th t h e o f f i c i a l series being t h e l a r g e r
from mid 1981 u n t i l t h e end of our period. Given t h a t t h e second
episode i s so u n r e p r e s e n t a t i v e w e r e a l l y have two pe r iods worth
t e s t i n g . The p e r i o d f rom 1979.06 u n t i l 1981.06, f o r which s p o t
i s g r e a t e r t h a n o f f i c i a l , and t h e 1981.07 t o 1983.06 p e r i o d €or
which o f f i c i a l i s g r e a t e r . It i s e x t r e m e l y s t r i k i n g t h a t t h e
switchover i n t h e r e l a t i o n s h i p between s p o t and o f f i c i a l crude
p r i c e s i s a t e x a c t l y t h e same p o i n t t h a t t h e r e l a t i o n between t h e
spo t p r i c e and t h e netback changes. According t o t h e hypothesis
p r e s e n t e d e a r l i e r i n t h e p a p e r b o t h s p o t and o f f i c i a l p r i c e s
should be r e l a t e d t o t h e netback i n t h e f i n a l pe r iod (when s p o t
i s b e l o w o f f i c i a l ) , b u t i n t h e t h i r d p e r i o d o n l y t h e s p o t p r i c e
81
should be r e l a t e d t o t h e netback. Tests on these r e l a t i o n s h i p s
p r i o r t o 1980 a r e u n l i k e l y t o show a c l e a r p i c t u r e because of t h e
v e r y s t r o n g c o r r e l a t i o n be tween s p o t and o f f i c i a l p r i c e s ( f o r
Arab Light between 1976.01 and 1978.10 t h e c o r r e l a t i o n is +0.866,
w h i l e be tween 1979.06 and 1983.06 t h e c o r r e l a t i o n i s +0.244).
The r e s u l t s a r e shown i n Table X I V .
TABLE XIV: The Impact of Spot and O f f i c i a l Prices on Hetbacks for Arab Light.
Dependent Independent Per iod Spot O f f i c i a l DWS SEE Var iab le Var i ab le C o e f f i c i e n t C o e f f i c i e n t
SNPIWR SSM, SO 79.08-81.06 0.90(23) O.OOl(0.02) 1.23 1.28 SNRBI SSI,SO 79.08.81.06 0.90(26) 0.006(0.14) 0.77 1.13
....................................................................
SNPIWR SSM,SO 81.07-83.06 0.88(9) O.OS(O.9) 1.17 0.73 SNRB I* SSI,SO 81.07-83.06 0.83(10) 0.13(1.6) 1.23 0.60 SNRB I SSI,SO 81.07-83.06 0.77(9) 0.19(2.2) 1.67 0.58 SNPIWR" SSM,SO 81.07-83.06 0.78( 7) 0.17( 1.7) 1.68 0.68
* Estimated by Cochrane - Orcut t procedure.
We see t h a t f o r t h e t h i r d pe r iod , when t h e o f f i c i a l was
l o w e r t h a n t h e s p o t p r i c e , the o f f i c i a l p r i c e i s c o m p l e t e l y
i n s i g n i f i c a n t while t h e s p o t p r i c e is s i g n i f i c a n t . This confirms
our f i r s t important hypothesis t h a t when t h e spo t is t h e higher ,
i t is s t i l l t h e marginal cost .
For t h e f i n a l per iod, when s p o t w a s lower than o f f i c i a l ,
we s e e some ev idence t h a t both s p o t and o f f i c i a l are r e l a t e d t o
t h e n e t b a c k o n c e s e r i a l c o r r e l a t i o n is a l l o w e d f o r i n t h e
r e g r e s s i o n . The p r e s e n c e of s e r i a l c o r r e l a t i o n p o i n t s t o some
s y s t e m a t i c s p e c i f i c a t i o n e r r o r . The g o o d n e s s of f i t i m p r o v e s
s l i g h t l y o n t h o s e shown i n T a b l e XI1 and it would p r o b a b l y b e
wrong t o emphasise t h e s e r e s u l t s too much. Again i t can be seen
82
t h a t the sum o f t h e c o e f f i c i e n t s i s j u s t l e s s t h a n u n i t y ,
suggest ing less than complete pas s ing on a t t h e margin.
The r e s u l t s f o r Nigerian Light a r e shown i n T a b l e XV and
t h e d a t a i n f i g u r e IV.
WL3 XV: The Impact of Spot and Official Prices on the Hetback for Nigerian Light.
NNPIWR NSM,NO 79.08-81.02 0.97(35) 0.03(0.9) 1.46 0 -85 NNPRBI NSI,NO 79.08-81.02 0.97(43) -0.02(0.7) 2.60 0.73
NMPIWR NSM,NO 81.03-83.06 l.OO(16) -0.02(0.03) 1.51 0.73 NNRBI NSI,NO 81.03-83.06 1.18( 16) -0.18(2.5) 1.32 0.75
For t h e t h i r d p e r i o d , when t h e s p o t w a s a b o v e t h e
o f f i c i a l p r i c e w e a g a i n f i n d no ev i d e n c e t h a t the l o w e r of t h e
two p r i c e s w a s r e l a t e d t o t h e n e t b a c k . However, for t h e fourth
period when t h e s p o t was lower t h a n t h e o f f i c i a l p r i c e t h e r e i s
no evidence of a p o s i t i v e r e l a t i o n between the o f f i c i a l p r i c e and
t h e n e t b a c k . The i n d u s t r y d a t a shows a s i g n i f i c a n t n e g a t i v e
e f f e c t but t h i s does not f i t any t h e o r e t i c a l e x p l a n a t i o n and must
b e r e j e c t e d . Adjust ing t h e equa t ions f o r s e r i a l c o r r e l a t i o n does
n o t a f f e c t t h e s e conc 1 us ions.
The sample s e p a r a t i o n has so f a r been made a t t h e po in t
where i n s p e c t i o n of t h e d a t a suggested t h a t t h e netback t o s p o t
p r i c e d i f f e r e n t i a l changed. I t i s l a r g e l y t r u e t h a t this d a t e
c o i n c i d e s w i t h t h e t i m e when s p o t p r i c e s changed f rom b e i n g
higher than the o f f i c i a l p r i c e t o being lower. However t h e r e are
a few months w h i c h do n o t confo rm to t h i s p a t t e r n . Fo r S a u d i
83
1981.08, 1 9 8 1 . 1 1 , 1981.12 and 1982.01 a l l saw spot a b o v e
o f f i c i a l . For Nigerian t h e r e were some months w i t h spot below
o f f i c i a l (1980.01, 1980.08, 1980.09, 1980.12) and then there were
some months w i t h s p o t above o f f i c i a l (1981.10, 1981.11, 1 9 8 1 . 1 2
and 1982.01). Regressions were tried for Nigerian for just those
months i n which the spot was below the o f f i c i a l b u t this too gave
no e v i d e n c e f o r any i n f l u e n c e of t h e o f f i c i a l pr ice on t h e
netback.
84
45
40
35
30
25
m cc < A J 0 0.
20
i 5
10
F i g u r e 111
Netback , Spot and O f f i c i a l Prices f o r A r a b L i g h t
NETBACK
1P76 1977 I 978 i 0753 i 9 8 0 1 9 B i 1982 1983 9A T ES
F i s u r e IV
45
40
35
30
25
rr, rx < -I J 0 a
20
I S
i Q
Netback, Spot a n d O f f i c i a l Prices for N i g e r i a n L i g h t
NETBACK
1
! I ! !
I
I
I OFF IC I AL
1 - J
I I
I
U
I I
I I
I 1 I I I i i I
1970 1 P77 1073 1979 1985, 1?61 1 PB2 1 sa3 DATES
B . 5 . 3 DYHBMC WUATIOAS
The a n a l y s i s s o f a r h a s b e e n c o n d u c t e d o n t h e
a s s u m p t i o n t h a t m a r k e t s d o n o t t a k e t i m e t o come i n t o
equ i l ib r ium. We have o u t l i n e d c e r t a i n r e a s o n s why netbacks might
l a g behind spo t p r i c e s ( i f FIFO p r i c i n g were used and t h e r e were
long d e l i v e r y times and h igh inventory l e v e l s ) . Clear ly shocks
c a n a l s o o r i g i n a t e o n t h e p r o d u c t side of t h e m a r k e t , b u t o n l y
s t o c k s of p r o d u c t s and c r u d e s c o u l d s t o p t h i s b e i n g p a s s e d o n
immediately t o higher input p r i c e s (which have t o be spo t pr ices
s i n c e o f f i c i a l p r i c e s a r e changed i n f r e q u e n t l y ) .
A s e r i e s of t e s t s w a s c a r r i e d o u t t o check f o r l a g s
between t h e two s e t s of p r i ces . It on ly seemed necessary to t e s t
f o r a l a g of one month o r less i n i t i a l l y . Given t h a t even t h i s
l a g ( w i t h one i m p o r t a n t e x c e p t i o n ) was n e v e r found t o be
s i g n i f i c a n t it seemed n e i t h e r necessary nor s e n s i b l e t o look f o r
e v e n l o n g e r l a g s . The t e s t s were c a r r i e d o u t f o r t h e t h i r d and
f o u r t h sub-periods p r e v i o u s l y i d e n t i f i e d , u s i n g b o t h t h e netback
and s p o t p r i c e s as d e p e n d e n t v a r i a b l e . As w e l l as t h e l a g g e d
independent v a r i a b l e t h e o f f i c i a l p r i c e was a l s o included i n a l l
r e g r e s s i o n s t o check f o r i t s i n f l u e n c e . T a b l e XVI g i v e s t h e
r e s u l t s f o r Arab Light - and Tab le XVII f o r N ige r i an Light. Two
se t s of d a t a a r e used t o g i v e a check on t h e f ind ings .
85
TABLE XVI: Lags between Spot Prices and Hetbacks for Arab Light
SMRB I
S SM
S N P m 79.10-81.06 SSM 0.80 (7.6) 0.81
( 7 . 8 ) s SI 0.89
( 7 . 2 ) 0.91 (7.6)
S S I
SNF'IWR 81.09-83.06 SSM 1 .oo
( 9 . 0 ) 0.91 (7.4)
S SM
SNRBI 81.09-83.12 SSI 0.96 (10) 0.89 (9)
SSI
0.10 (0.90) 0.03 (0.3)
0.01 (0.08) -0.08 (0.6)
-0.04 (0.4) -0.12 (1 . O )
0 .or (0.1)
SMPIWR 1.04
(8.8) 1.05 (8.8)
SNRB I 1 .oo
(8.3) 1.01
( 8 . 4 )
SNPIWR 0.81 (7.5) 0.81 (6.6) 1.04 (190)
-0.06 (0.6)
SNRBI 0.85 (8.9) 0.86
( 7 . 9 ) 1.03
(262)
0.06 (1.2)
0.09 (1.6)
0.07 (0.6) 0.11 -0.06
( 0 . 9 ) ( 0 . 9 )
0.11 ( 0 . 9 ) 0.15 -0.07 (1.2) (1.0)
0.16 (1.5)
0.23 (2 .2 ) 0.23 -0.0 (1.7) (0.02)
0.14 (1.6)
0.18 (1.9) 0.18 -0.01 (1.7) (0.07)
1.01 1.29
1.00 1.31
1.04 0 .84
1.00 0.89
1.13 1.18
1.14 1.19
1.14 0.68
1.14 0.71
0.76 1.32
0.74 1.14
0.73 1.18
0.77 1.30
0.61 1.45
0.59 1.23
0.59 1.27
0.61 1.26
0.73 1.17
86
TABLE XVII: Lags Between Spot Prices and Betbacbs for l i g e r i a n Light
Dependent P e r i o d Spot Lagged Netback Lagged O f f i c i a l SEE DWS V a r i a b l e spot Netback
NNPIWR 7 9 .10-81.02 NSM 0.85 (13) 0.85 (13)
0.91 (10) 0.91 (10)
NNRBI NSI
p1 SM
NSI
NNPIWR 81 .O5-83.06 MSM 1.07
1.07 (12)
(1 1)
N SM
NNRBI 81.05-83.12 MSI 1.10 (10) 1.17 (10)
N S I
0.09 (1.4) 0.10 (1.4)
0 .04 (0.5) 0.06 (0.6)
-0.08 (0.9) -0.08 (0.9)
NNP IWR 1.10 -0.03 (12) ( 0 . 3 ) 1.10 -0.05 (11) (0.5) NNRB I 0 . 9 4 0.11 (11) (1.3) 0 . 9 4 0.10 (11) (1.1)
NNPIWR 0.80 0.22 (10) (2.9) 0.77 0.19 1.02 (230)
-0.10 (0.9) -0.04 ( 0 . 4 )
NNRB I 0.81 0.19 (9.4) (2.2) 0.71 0.11
( 9 . 4 ) (1.5)
0.69 1.53
-0.01 0.71 1.59 (0.5)
0.71 1.95
-0.01 0.73 1.96 (0 .5)
0.77 1.81
0.01 0.80 1.87 (0.4)
0.71 1.61
0.01 0.73 1.61 (0.3)
0.73 1.54
0.00 0.75 1.54 (0.01)
0.66
0.06 0.65 0.74 1.47
0.76 0.85
-0.13 0.72 1.10 (1.9)
0.72 0.63
0.18 0.59 1.01 (4.0)
1.01 ( 244)
0.76 0.86
87
Neither Tab le XVI nor Tab le XVII show any evidence of
l a g g e d r e l a t i o n s h i p s i n t h e t h i r d p e r i o d o r e v i d e n c e f o r t h e
i n f l u e n c e of t h e o f f i c i a l p r i c e when l a g s a r e i n c l u d e d . T h e s e
f i n d i n g s a r e t h e same when n e t b a c k s a r e r e l a t e d t o l a g g e d s p o t
pr ices and when s p o t p r i c e s a r e r e l a t e d t o lagged netbacks. For
t h e f i n a l per iod t h e r e i s no evidence that netbacks a r e r e l a t e d
t o l a g g e d s p o t p r i c e s ( w h e t h e r or n o t o f f i c i a l p r i c e s a r e
inc luded a s suggested by t h e previous r e s u l t s ) . However,the d a t a
f o r both c o u n t r i e s , according t o both sources , shows a r e l a t i o n
between spo t p r i c e s and lagged netbacks. In one case t h e c u r r e n t
o f f i c i a l p r i c e a l s o has a c o e f f i c i e n t s i g n i f i c a n t l y d i f f e r e n t
from z e r o b u t w i t h a n u n e x p e c t e d p o s i t i v e s i g n . Hence w e f i n d
t h a t i n t h e f i n a l p e r i o d , when s p o t p r i c e s were be low o f f i c i a l
p r i c e s , netbacks had a lagged e f f e c t on s p o t p r i ces . The ave rage
l a g l e n g t h i n b o t h c a s e s i s around one week. O b v i o u s l y f o r
sha rpe r t e s t s of t h e l a g s t r u c t u r e i t would be necessary t o use
d a t a based on a s h o r t e r t i m e i n t e r v a l t h a n one month. Moreover
t h e p o s s i b l y s i g n i f i c a n t c o e f f i c i e n t of t h e o f f i c i a l p r i c e a s a
determinant of t h e netback sugges t s t h a t a s y s t e m of equat ions i s
p r e s e n t ( t h e r e be i n g a p p a r e n t 1 y two s e p a r a t e r e l a t i o n s h i p s
be tween t h e s p o t p r i c e and t h e n e t b a c k ) . R e - e s t i m a t i o n of t h e
Arab L i g h t e q u a t i o n s by TSLS d o e s n o t change t h e c o e f f i c i e n t s
very much but does dec rease t h e "t" s c o r e t o below s ign i f i cance .
G i v e n t h e l a c k o f good i n s t r u m e n t s ( t h e c o n s t a n t and o f f i c i a l
p r i c e were used) t h i s l a c k of f i t i s not s u r p r i s i n g .
There i s a l s o a t h e o r e t i c a l problem i n e x p l a i n i n g t h e
lagged e f f e c t of netbacks on spo t p r i c e s which on ly occurs when
88
s p o t p r i c e s a r e be low n e t b a c k s . The l a c k of l a g g e d e f f e c t s of
s p o t p r i c e s o n n e t b a c k s would h a v e t o b e p r o v i s i o n a l l y
i n t e r p r e t e d a s i n d i c a t i n g t h a t s h i f t s i n supply are immediately
t r a n s l a t e d i n t o p r o d u c t p r i c e s whe the r or n o t t h e r e is "excess
supply' ' ( i e spot i s less than o f f i c i a l ) , w h i l e s h i f t s i n demand
have no l a g when t h e r e i s "excess demand" ( spot above o f f i c i a l )
b u t d o show a s h o r t l a g when t h e r e i s e x c e s s s u p p l y ( s p o t b e l o w
o f f i c i a l ) . Rowever, t h e change i n "goodness o f f i t " due t o t h e
lagged v a l u e s i s very s l i g h t i n n e a r l y a l l cases , so t h a t adding
a l a g is appa ren t ly o n l y a minor adjustment t o t h e equation.
Experiments w i th l a g s longer than one month all f a i l t o
show s i g n f i c a n c e f o r t h e l o n g e r l a g (and o f t e n make e v e n t h e
s i n g l e l a g i n s i g n i f i c a n t ) .
The r e s u l t s of t h e s e t e s t s s u g g e s t t h a t t h e two s i d e s
of t h e market a d j u s t t o shocks i n t h e o t h e r s i d e very qu ick ly and
t h a t i f i t is d e s i r e d t o i n v e s t i g a t e t h e speed of a d j u s t m e n t a t
a l l a c c u r a t e l y then it would be necessary t o u s e d a t a bssed on a
t i m e per iod of one week a t longes t .
89
B .5.4 VARIATIOHS B-I BEFIHEEIES
So f a r a l l t h e f o r m a l s t a t i s t i c a l t e s t s h a v e b e e n
c a r r i e d o u t f o r n e t b a c k s c a l c u l a t e d f o r a b a s i c r e f i n e r y a t
Ro t t e rdam. As T a b l e s V I , VII, and VI11 showed, t h e v a r i o u s
c e n t r e s a n d t y p e s o f r e f i n e r y u s e d a s t h e b a s i s f o r t h e
c a l c u l a t i o n produce s e r i e s t h a t are n o t p e r f e c t l y c o r r e l a t e d wi th
one another. The d i f f e r e n c e s a r e n o t just i n t h e month by month
f l u c t u a t i o n s but i n t h e g e n e r a l l e v e l s of t h e ser ies , as Table
VI11 showed.
A s w e a r g u e d i n S e c t i o n B.4, i n a n e q u i l i b r i u m
s i t u a t i o n wi th i d e n t i c a l r e f i n e r i e s a l l netbacks should be t h e
same. Once improvements i n t e c h n o l o g y a r e i n t r o d u c e d t h e n w e
move t o t h e v i e w t h a t t h e h i g h e s t c o s t p l a n t i s g o i n g t o be
marginal. I t s "output" p r i c e w i l l be l i nked t o t h e crude p r i c e
w h i l e a l l o t h e r p l a n t s w i l l be intra-marginal . This o b s e r v a t i o n
s u g g e s t s t h a t t h e s p o t p r i c e should be r e l a t e d t o t h e l o w e s t
n e t b a c k i n t h e v a r i o u s t e s t s used. The e s t i m a t i o n of no rma l
m a r g i n s p e r i o d by p e r i o d f o r Arab L i g h t a t d i f f e r e n t l o c a t i o n s
shows t h a t t h e n e t b a c k f r o m R o t t e r d a m i s not t h e l o w e s t a s
between t h e d i f f e r e n t sources. The Caribbean netback appears t o
be t h e lowest and should perhaps be taken a s t h e marginal market.
However, s i n c e n e t b a c k s a r e h i g h l y c o r r e l a t e d ( b e c a u s e t h e
v a r i a t i o n i s c a u s e d by t h e same v a r i a b l e s , a l b e i t w e i g h t e d
90
d i f f e r e n t l y ) we should n o t be s u r p r i s e d i f t h e g e n e r a l p a t t e r n of
r e s u l t s were r epea ted f o r a l l series. Accordingly w e re-estimate
t h e "standard" models f o r t h e t h i r d and f o u r t h pe r iods , viz. t h a t
i n t h e t h i r d p e r i o d t h e n e t b a c k i s r e l a t e d t o t h e s p o t , and i n
t h e f o u r t h per iod t h e netback is r e l a t e d t o both spo t and o f f i c a l
for Arab Light. Tab le s X V I I I and XIX show the r e s u l t s .
91
SWPIWI 79.08-81.06 SSM 0.89 151 1.02 0.83 0.84 91 1.61 0.55 SNPIWC 0.90 99 1.57 0.72 SNPIWP 0.91 123 1.29 1 .ll SNPIWS 0.92 88 1.81 0.81 SWIWU 0.89 139 1.11 0.78 S NP IW6
II f I I t
I 1 f l I 1
I 1 II I f
I t *I II
I 1 I 1 T I
0.90 157 1.00 1.35 II 11 tf SNPIWR
TABLE XIX: Relation Between Wetback and Spot and Official Prices for Arab Light for Various Refineries for the Fourth Episode ...........................................................................
Dependent Spot Period Spot Spo t O f f i c i a l O f f i c i a l SEE DWS Var iab le Var i ab le C o e f f i c i e n t 't' C o e f f i c i e n t 't'
SNPIWI SSM 81.07-83.06 0.84 11 0.10 1.3 0.57 1.17 SNPIWC I t I t I' 0.87 10 0.06 0.7 0.65 1.39
It 0.64 6.8 0.31 3.5 0.70 1.49 SNPIWP I' 0.50 4.8 0.45 4.4 0.79 1.70 SNPIWS I' 1.07 7.1 -0.09 0.6 1.14 0.87 " 0.83 5.7 0.14 1.0 0.92 1.85 I' 0.78 7 .O 0.17 1.7 0.68 1.68 SNPIWR I T
SNRCI* SSI 81.07-83.12 0.93 8 .O 0.12 1.05 0.90 0.70 SNRCI* 11 lf 0.80 6.7 0.24 2.09 0.74 1.59 SMUCI* s SI 'I 0.74 6.5 0.24 2.19 0.71 1.59
" 0.78 9.3 0.18 2.3 0.55 1.72 SNRBI
'I 0.76 9.1 0.18 2.2 0.52 1.62 11 'I 0.83 8.8 0.10 1.1 0.63 1.70
SNPIWP* f I f l " 0.59 5.7 0.36 3.7 0.67 2.00 S NP IW S* I f f I 'I 0.48 4.2 0.47 4.4 0.78 1.99
" 0.74 9.5 0.21 2.8 0.51 1.76 S N P I W 6
----------------------------------------------------------,------------------
I 1 I 1
11 I 1
II SNPIWv* I T
sNPIwu* I t 11
I!
II
t l
II t l
sNPIW1; I1 f I
SNPIWC* 11
f I I f
* = Estimated by Cochrane-Orcutt t echn ique .
The r e s u l t s for t h e t h i r d ep i sode ( s t a r t i n g i n 1978.08
t o conform t o t h e t e s t s f o r lags) show very u n i f o r m r e s u l t s .
The Rotterdam s e r i e s i s ( just) t h e most s t r o n g l y c o r r e l a t e d wi th
t h e spot price. I n a l l cases the margin is l e s s than 1002, w i th
t h e C a r i b b e a n b e i n g t h e l o w e s t . The US and C a r i b b e a n n e t b a c k s
92
seem to be t h e l e a s t r e l a t e d t o t h e Arab Light s p o t p r i ce . This
r e f l e c t s p e r h a p s t h e l a c k of p e r f e c t a d j u s t m e n t i n t h e m a r k e t
t o g e t h e r w i th a l o c a l higher dependence on o the r crudes.
For t h e f o u r t h episode t h e r e s u l t s a r e very s i m i l a r i n
p a t t e r n . Once s e r i a l c o r r e l a t i o n i s t a k e n i n t o a c c o u n t t h e
n e t b a c k is s t r o n g l y r e l a t e d t o t h e s p o t p r i c e and t h e o f f i c i a l
p r i c e f o r a l l a r e a s e x c e p t t h e C a r i b b e a n and t h e US when PIW
n e t b a c k s a r e u s e d . F o r i n d u s t r y d a t a t h e U S a l s o shows
c o r r e l a t i o n of both s p o t and o f f i c i a l p r i c e s . F u r t h e r , b o t h
complex and b a s i c r e f i n i n g a t R o t t e r d a m show t h e i n f l u e n c e of
both p r i ces . The goodness of f i t i s f a i r l y s i m i l a r f o r a l l cases
and t h e X m a r g i n is v e r y s i m i l a r f o r a l l t h e PIW s e r i e s - o n l y
t h e i n d u s t r y complex r e f i n i n g s e r i e s f o r R o t t e r d a m shows a
netback higher t h a n t h e weighted sum of t h e input prices.
The g e n e r a l congruity of t h e r e s u l t s sugges t s t h a t t h e
v a r i o u s markets a re c l o s e l y t i e d t o g e t h e r , and t h a t t h e arguments
used t o e x p l a i n t h e i n t e r - r e l a t o n s h i p s of p r i c e s i n t h e two
p e r i o d , h a v e some g e n e r a l v a l i d i t y . A t t h e same t i m e t h e r e i s
s u f f i c i e n t v a r i a t i o n i n t h e r e s u l t s t o s u g g e s t t h a t t h e
d i f f e r e n c e s c a n n o t be a s c r i b e d s o l e l y t o d i f f e r e n c e s i n
technology b u t r a t h e r t o imper fec t ions i n t h e market.
93
Data Appendix : Kev t o Abbreviations
SNPIWR - PIW‘s n e t b a c k f rom R o t t e r d a m t o S a u d i A r a b i a ( b a s i c r ef i n ing ) .
SNPIWC - PIW’s n e t b a c k f r o m t h e C a r i b b e a n t o S a u d i A r a b i a ( b a s i c r e f i n i n g ) .
SNPIWP - PIW’s n e t b a c k f rom t h e P e r s i a n G u l f t o S a u d i Arabia ( b a s i c r e f i n i n g ) .
SNPIWI - PIW’s n e t b a c k f rom I t a l y t o S a u d i A r a b i a ( b a s i c r e f i n i n g ) .
SNPIWS - PIW‘s n e t b a c k f rom S i n g a p o r e t o S a u d i A r a b i a ( b a s i c r e f i n ing ) .
SNFIWU - PIW’s n e t b a c k f rom US t o S a u d i A r a b i a ( complex r e f i n i n g ) .
SNpIW6 - Average of above s i x series.
SMRBI - I n d u s t r y n e t b a c k f rom R o t t e r d a m t o S a u d i A r a b i a ( b a s i c r e f i n e r y ) .
SNRCI - I n d u s t r y n e t b a c k f rom R o t t e r d a m t o S a u d i A r a b i a (complex r e f i n i n g ) .
SNUCI - Industry netback from US t o Saudi Arabia (complex r e f i n i n g ) .
SNOPAB - OPAL netback from Rotterdam t o Saudi Arabia ( b a s i c r e f i n i n g ) .
SNOPAC - OPAL n e t b a c k f rom R o t t e r d a m t o S a u d i A r a b i a (complex r e f i n i n g ) .
s so - Spot p r i c e for Arab Light by OPEC B u l l e t i n .
S SM - Spot p r i c e f o r Arab Light by MEPEP, MEES.
S S I - Spot p r i c e for Arab L i g h t g i v e n by i n d u s t r y source.
s SP - Spot p r i c e for Arab Light g i v e n by PIW.
9 4
so
NNPWR
NNPIW5
NNRB I
N N R C I
NNUCI
NNOPAB
NNOPAC
NSM
NSI
NPO
NSP
NO
O f f i c i a l pr ice of Arab Light.
PIW n e t b a c k f rom R o t t e r d a m t o N i g e r i a ( b a s i c r e f i n i n g ) . PIW 5 c e n t r e a v e r a g e n e t b a c k t o N i g e r i a (bas i c r e f i n i n g ) .
Industry netback from Rotterdam t o Niger ia ( b a s i c r e f i n i n g ) . I n d u s t r y n e t b a c k f r o m R o t t e r d a m t o N i g e r i a (complex r e f i n i n g ) .
I n d u s t r y n e t b a c k f rom U S t o N i g e r i a (complex r e f i n i n g ) . OPAL n e t b a c k f r o m Rot t e rdam t o N i g e r i a ( b a s i c r e f i n i n g ) . OPAL n e t b a c k from R o t t e r d a m to N i g e r i a ( complex r e f i n ing . Spot p r i c e for Nigerian Light by MEES.
S p o t p r i c e f o r N i g e r i a n L i g h t g i v e n by i n d u s t r y source . Spot p r i c e f o r Niger ian Light by OPEC Bul l e t in.
Spot p r i c e f o r Nigerian Light by PIW.
O f f i c i a l p r i c e of Nigerian Light.
9 5
1 . The v a r i a n c e of t h e v a r i a b l e s f o r t h e f u l l p e r i o d 1 9 7 6 t o 1983 i s a b o u t 1 0 0 w h i l e t h e v a r i a n c e of the e r r o r be tween t h e ser ies exc luding 1979 and 1980 is about 0.05.
2. In a s i t u a t i o n where u n p r o f i t a b l e p l a n t s a r e m o t h b a l l e d r a t h e r t h a n s c r a p p e d t h e same argument a p p l i e s and t h e r e l e v a n t c o s t i s t h a t of t h e h i g h e s t c o s t p l a n t s t i l l i n p r oduc t ion.
3 . D i f f e r e n t marke t power f o r d i f f e r e n t products c o u l d mean d i f f e r e n t e f f e c t i v e power f o r t h e b u n d l e o f p r o d u c t s produced by one crude r e l a t i v e t o those of t h e o t h e r crude.
4. The ana logue w i t h m u l t i - p a r t p r i c i n g , o f t e n adopted by power supp ly i n d u s t r i e s is c l e a r .
5. O f c o u r s e temporary l o s s e s m i g h t be i n c u r r e d i n o r d e r t o r e a p l a r g e r l ong- t e rm r e w a r d s eg p r o d u c i n g t o stock a p r o d u c t f o r which demand was v e r y s e a s o n a l . However t h i s can n o t exp la in long-term l o s s e s .
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