Navigating WTI

 | Jun 25, 2012 | 4:30 PM EDT
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For West Texas Intermediate (WTI) crude oil, the nearby price is currently around $80 a barrel, and the big question is where it will go from here. Some say prices are nearing a resistance and could turn around. Others believe they will continue to fall. The fact is the real market prices are actually much lower than WTI.

WTI prices don't tell the wholes story. There are more than 60 different prices for oil in 13 states -- and, with the exception of one delivery point, all posted prices are below the quoted WTI price.

Last Friday morning, as WTI's nearby was quoted at approximately $81, the following posting prices were posted for small producers. The difference between in the nation's low and high prices for the day was $41.73 per barrel, as seen below.


West Texas Intermediate, by State


Actually, producers will get even lower prices than these. Producers must pay additional fees in order to deliver their product to the trading point, and their product must meet specific quality specifications. Should the product fail to meet those specifications, there are predefined financial penalties, and those penalties can be substantial. For those wanting to take a deep dive in local pricing, check the RBN Energy website, which provides detailed explanations.

When it comes to energy, point of view always matters. From the standpoint of economic policymakers, for instance, low prices are favored. However, the viewpoint of the producer is dramatically different -- they need high prices. Depending on their geographic location, some producers need very high prices.

The point of view also changes when companies' production costs are taken into account.  The cost of production varies dramatically based on geographic conditions, as well as on production technologies. Canada's oil sands are said to have production costs between $50 and $75 per barrel, plus transportation costs.

Tight oil production requires fracking, and production costs are said to be in the neighborhood of $50 per barrel. The Williston Basin crudes in North Dakota (Bakken) and the Eagle Ford Formation in Texas have tight oil resources, and they will require fracking technologies in order to reach their crude oil.

For energy producers, local market prices establish gross margins. When local wellhead prices fall below market prices, companies' margins are crushed -- and that's what's happening to Bakken's small producers, according to Friday's price.

It's not just the small producers, either. All domestic oil producers are seeing lower margins. This includes the majors, such as Exxon Mobil (XOM), Marathon Oil (MRO) and EOG Resources (EOG). It also includes Whiting Petroleum (WLL), Continental Resources (CLR) and Canada-based Enerplus (ERF), all of which are working the Bakken formation.

This leaves us with an important lesson. The definition of "proven reserves" considers production economics and market prices. When prices are high, there's plenty of oil. When prices are low, there isn't quite so much. As market prices drift downward, so do reserves.

This may explain why the oil markets are caught between a rock and a hard place. Lower prices discourage production and encourage the economy, while higher prices discourage the economy and encourage production. So it appears Mr. Market will bounce oil futures between the rock and the hard place -- and, to complicated it further, the rock has also had a tendency of inching toward that hard place.

This provides a framework within which investors can win: They may succeed if they can correctly call WTI's lows and highs, and then ride the waves between the rock and the hard place. The key is to appreciate the market's fundamental and technical messages.

In my late-December piece, I reported that some analysts predicted that oil prices were "ready to turn down, possibly hard and soon." At the time, some other analysts disagreed with that view. Today, we are in the same position -- some analysis still offers conflicting forecasts.

For the longer-term investor, my advice is to hang tight. When WTI's technical been confirmed technically, wait longer. Seek macroeconomic confirmation. When it makes sense, go in.

While waiting, concentrate on the economy and oil markets. Be prepared to move in on the majors, as they can produce all the way down through the market's trough and up to the neighboring crest. Intermediates cannot reach the trough, and small producers can only profit in the white caps.

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