I take exception to the article by Karl R. Pavlovic, titled "Gravity and sulfur-based crude valuations more accurate than believed" (OGJ, Nov. 22, 1999, p. 51).
Mr. Pavlovic is taking your readers down a dangerous path, one that has been traversed before at considerable expense.
In the early 1990s, I worked for a major oil company that had spent millions of dollars on reserves of high-sulfur, low-gravity crude. They were mystified that the crude differentials to West Texas Intermediate (WTI) they had originally assumed when valuing and buying the reserves had not held. The initial margins became much wider, on both an absolute and percentage basis. Suddenly their high-sulfur, low-gravity crude was worth far less than they had paid for it.
At their request, I constructed a detailed model to project differences in relative crude prices, one of the simplest being West Texas Sour (WTS) to WTI. The model was ultimately sufficiently comprehensive and useful that we were also able to test absolute oil price scenarios.
Before the company dedicated resources to the project, I was asked to show, in some simple ways, that uniform sulfur-gravity differentials did not apply. Examining the period 1988-93-a time prior to the one Mr. Pavlovic has chosen-we saw, for example, a WTI-WTS differential that varied between less than $1/bbl up to $4/bbl. The difference was not a function of the absolute price level. The variation in the differential between the company's heavy crude and light crude was even more striking.
In a nutshell, we determined not only were product prices key to crude oil prices, but refining capacity limits-particularly in heavy-crude upgrading units and sulfur-handling capacity-can explode the heavy-light and sweet-sour differentials.
Thus, when predicting oil prices for crudes other than WTI, ignoring product prices and existing or potential refining constraints is expensive folly.
Laura Starks Dannenmaier
Dallas
