Economic analysis

Jeff Rubin puzzles me

I don’t understand this at all. As far as I can make out, this is Jeff Rubin‘s argument:

  1. Refineries’ margins are paper-thin, and have been so for decades; that’s why North American oil companies stopped building them long ago and have been shutting them down. This is true.
  2. The West Texas Intermediate (WTI) crude oil price set in Cushing, Oklahoma is currently trading at a significant discount from the Brent price set in the North Sea and which is used as the reference price everywhere where supplies are available by tanker, such as Eastern Canada. This is also true.
  3. Refineries buying WTI oil are more profitable than those buying Brent oil. Market pressures being what they are in the market for gasoline, this is also true.

From this, Rubin concludes that the path to prosperity is for Canadians to get in on the business of refining WTI-priced oil – namely, the oil produced in Canada.

This makes no sense to me:

  1. If refining WTI-priced crude was the path to long-term prosperity, oil companies would be building refineries without any encouragement from Ottawa (or Washington, come to that).
  2. The WTI-Brent spread opened up sometime around January 2011. The economics of refining have been dodgy for decades.
  3. The WTI-Brent spread is an opportunity for arbitrage: buying in the low-price market and selling in the high-price market. Ordinarily, arbitrage is a cheap and riskless way of making money. As long as the price differential exists, demand will increase in the low-price market, and supply will increase in the high-price market. The reason why the Brent-WTI differential has persisted is that it was difficult and costly to buy oil in Cushing and transport it to the Gulf Coast, where the Brent price prevails.
  4. Unsurprisingly, the private sector is falling over itself to take advantage of this arbitrage opportunity. The Seaway pipeline reversal has already begun to ship oil from Cushing to Houston, and the southern part of the Keystone XL project is under way. It makes no sense at all to make policy based on the assumption that the WTI-Brent spread is an immutable constant.
  5. It won’t be long — a few years — before the WTI-Brent spread is arbitraged away, and we’ll revert to a world where refining is everywhere a marginal business with razor-thin margins, and in which oil production is lucrative – which probably explains why the private sector doesn’t see much point in investing in Jeff Rubin’s business plan.

Diverting capital and labour away from a lucrative industry towards a marginal one isn’t creating “value-added.” It’s creating value subtraction.

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