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Over the past year or two, something strange has happened in the oil & gas markets. Oil is becoming less fungible; gas more fungible.

Natural Gas
In the past, when a gas field was developed, there was usually a long-term supply contract with a power company or other large user. For example, Japan will sign up to buy 50% of the LNG production from a new plant in Qatar at a fixed rate for 25 years. This rate can be wildly different from what natural gas trades for in Texas.

Most of the natural gas market continues to function that way, with wildly varying prices on a regional basis. However, the massive increase in LNG from Qatar and Australia, combined with massive new production from Russia and former Soviet republics like Kazakhstan and Turkmenistan, have created a flood of natural gas on global markets. This has created more uncontracted gas on the market, providing natural gas users around the world with more options--thus lower prices.

And natural gas should be an ultimate fungible commodity. It is basically methane. Scrub the H2S out of the gas and gas from Norway is easily substituted by of for gas from Australia or Qatar or Russia.

Within this sea of fungible natural gas lies the U.S., now swimming in a flood of natural gas due to massive shale development in the past few years. This gives domestic gas users a big advantage in global markets. The beneficiaries are companies that use natural gas for their base stocks or power generation:
* Petrochemical companies (DOW, Celanese)
* Fertilizer companies (Agrium)
* Power companies with a large natural gas fired portfolio
* Aluminum producers who rely on cheap power
* My favorite (and a large personal holding), natural gas pipeline companies like Kinder Morgan

Meanwhile, oil is not nearly as fungible as it once was. Sure, there were always differences in crude slates from light, sweet crude to heavy, sour crude. However, over the past 10 years, the price differentials for crude have become far more volatile, not just based on the crude quality, but based on the location of production.

Part of this is the actual reality of Peak Oil. As a brief review, Peak Oil is the theory that oil production follows an inverted parabolic curve where once you hit the peak you will have irrevocable decline. In 2000--2008, there was a lot of fear in the market that we were at or near that point.

However, Peak Oil theory really only applies to liquid oil that comes out of the ground like a bubblin crude Jed Clampett style. It doesn't apply to the millions of barrels per day coming out of the tar sands, it doesn't account for the 700,000 bpd that will be flowing from the Barnett Shale, it doesn't account for millions of barrels of deepwater oil, it doesn't account for the 500,000 bpd of gas to liquids fuels being exported from Qatar, hundreds of thousands of barrels per day of biofuels, it doesn't account for wide swaths of current production around the world.

In a way it does--it says that the tougher oil will be more expensive to produce, and it is. What the theory did not forsee was that all of these unconventional production methods would allow overall production to keep rising.

However, what you now see is actually a much more diverse set of products both in the crude slates and finished fuel markets. There are multiple types of biodiesel, for example. Some of the new designer fuels are cleaner and better than traditional fuels. At current prices, they are cheaper. Some things also occur at a regulatory level with "boutique" fuels for different regions for air quality reasons within the U.S.--meaning that fuel made for the Midwest cannot be "exported" to the East Coast.

However, nothing is quite as extreme as the inverted U.S. crude market. The pipelines are all set up to export finished products from the Gulf of Mexico north to the middle of the country. Even 5 years ago, no one was talking about a glut of crude being stuck in North Dakota and the Midwest. Few people were talking about how even though Canadian tar sands were more expensive to produce, they would fetch a lower price on the market because they don't have the transportation infrastructure to make the product fungible.

Who benefits here? Refining companies in the Midwest.
* Tesoro has the only refinery in North Dakota
* Holly and Frontier have refineries in Oklahoma and Kansas to use the crude stuck in Cushing
* BP finished a Canadian crude pipeline deal a few years ago and their Whiting Refinery is making huge profits.
* I believe the same pipeline extends to the Husky Oil in Lima, Ohio

In Europe, meanwhile, lower taxes on diesel have been far too successful. Something like 75% of new cars sold are now diesels, up from only 25% 25-30 years ago. European refineries are not set up to produce such a high % of diesel, so they are stuck with a shortage of diesel and excess gasoline exports.

This is why East Coast refineries have been crushed. Sunoco is on life support because cheap European gasoline is flooding the import terminals on the Eastern Seaboard. (They were also set up for light, sweet crude and the Libyan conflict was just about the coup de grace.)

I don't know who will benefit in Europe. There will be more pain, like the bankruptcy of Petroplus, before any clarity returns to the market. If stability is ever achieved in the European economy, there will likely be several projects for diesel hydrotreaters to upgrade refineries to higher yield.

In any case, these changes are 5-10 years away. In the meantime, crude oil, gasoline, and biofuels are no longer the fungible products they used to be.

Conclusion: To know whether a specific company will make money from high or low oil prices, you now have to know what kind of oil they use, where they are getting it from, and whether or not the infrastructure exists for them to obtain a substitute.
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