OXFORD

Ns-nrn
=
FOR-

ENERGY
STUDIES

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 p a p e r 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 n o t
r e p r e s e n t t h e v i e w s of the Oxford I n s t i t u t e
for Energy Studies or any of its members.

C o p y r i g h t 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

I1

111

IV

V
VI

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

27

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

27

Months w i t h Extreme Disagreements

Between S e r i e s

28

R e l a t i o n s h i p s Between Netbacks f o r
Arab Light

34

R e l a t i o n s h i p s Between Netbacks f o r
Nigerian Light

35

C o r r e l a t i o n s f o r Saudi Netbacks

(1981.01-1983.06)
VI1

VI11

IX
X

XI
XI1
XI11

XIV
XV

36

C o r r e l a t i o n s f o r N i g e r i a n Netbacks

(1981.01-1983.06)

36

The Normal Margin Model (1976.01-1983.06)

41

Estimated Normal Margins f o r Various

Sub-Per i o d s

45

Estimated Normal Margins a t D i f f e r e n t

R e f i n e r y Centres

48

R e g r e s s i o n of Arab L i g h t Margin on
N i g e r i a n Light Margin

49

R e l a t i o n s Between Netbacks and Spot Crude

P r i c e s for Arab Light

78

R e l a t i o n s Between Netbacks and Spot P r i c e s

f o r Nigeria

80

The I m p a c t of Spot and O f f i c i a l P r i c e s

o n Metbacks for Arab L i g h t

82

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 N i g e r i a n L i g h t

83

TABLE OF CORTEldS

INTRODUCTION

B.l

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 S p o t Product Values

17

B.2

The Data

B.2.1

Spot Crude P r i c e s

23

B.2.2

Netback Data

30

8.3

A Simple Model R e l a t i n g S p o t Product Values

and Spot Crude Prices

B.3.1

The Model

37

B.3.2

The Goodness of F i t of t h e Normal Margin Model

40

B.4

Economic F a c t o r s Determining t h e Netback t o

Crude Margin

51

B.5

F u r t h e r 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

B.5.1

An Unconstrained R e l a t i o n s h i p

76

B.5.2

O f f i c i a l P r i c e s as Explanatory V a r i a b l e s

81

B.5.3

Dynamic Equation6

85

B.5.4

V a r i a t i o n s B e tween Ref i n e r i e s

90

DATA APPENDIX:

94

NOTES

KEY TO ABBREVIATIONS

96

XVI

XVII

XVIII

XIX

Lags Between Spot P r i c e s and Netbacks

of Arab Light

86

Lags Between Spot P r i c e s and Netbacks

f o r Nigerian Light

87

R e l a t i o n Between Netback and Spot P r i c e

for Various R e f iner i e s f o r Arab Light f o r
t h e Third Episode

92

R e l a t i o n Between Netback and Spot and

O f f i c i a l P r i c e s f o r Arab Light f o r Various
R e f i n e r i e s f o r the Fourth Episode.

92

I ATBODU CTIOH
This paper

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 c r u d e o i l p r i c e s and t h e p r i c e s of the p r o d u c t s 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 f o c u s

o n a m e a s u r e of t h e d i f f e r e n c e b e t w e e n t h e " v a l u e " of t h e o i l
o n c e 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
itself.

There has been v e r y l i t t l e p u b l i s h e d work on t h e 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 s u m m a r i s i n g 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 p r o d u c t s

h a v e 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 t o 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 b e t w e e n t h e t w o s e 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 ( a n d t h e i r
associated

product

N i g e r i a n L i g h t (37.7

Arabian

values),

OAPI).

Light

(33.9

'API)

and

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 c r u d e s i s t h a t d a t a i s a v a i l a b l e for l o n g p e r i o d s and
t h a t t h e i r p r i c e behaviour is n o t t o o s i m i l a r ( a s would be Arab
and I r a n i a n L i g h t f o r example).

A p a r t i c u l a r problem w i t h studying t h e s e concepts 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
concepts.

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 r o d u c e d by

v a r i o u s p r i v a t e a g e n c i e s and t h i s l e a d s t o t h e u n u s u a l s i t u a t i o n
of h a v i n g mu1 t i p l e o b s e r v a t i o n s ( e s t i m a t e s ) 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 d e v o t e d t o comparison

of t h e s e v a r i o u s d a t a sources.
The p a p e r

is divided

Part A

into two s e c t i o n s .

d e s c r i b e s t h e main r e s u l t s , b o t h a n a l y t i c a l and s t a t i s t i c a l ,
This s e c t i o n i s self-contained

t h e study.

of

but does n o t i n c l u d e

any d i s c u s s i o n of how t h e r e s u l t s were d e r i v e d .

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 c o v e r s t h e same m a t e r i a l b u t a t much

greater

length.

S e c t i o n B.l

The a r r a n g e m e n t of

presents

the basic

p a r t B i s a s follows.

c o n c e p t s t o be u s e d

i n the

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 c e s ) .

S e c t i o n B.2

is concerned w i t h t h e d a t a used, w i t h t h e v a r i o u s s o u r c e of d a t a
a n d w i t h a c o m p a r i s o n b e t w e e n d i f f e r e n t s o u r c e s f o r t h e same
concept.

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 w h i c h 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 f r o m 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
p r o d u c t i o n 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 w i t h
t h e spot c r u d e p r i c e a t t h e p o i n t of
hypothesis

sale.

is n o t s u p p o r t e d by t h e d a t a .

This simple

S e c t i o n B.4

then

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 o f
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 c o n c e n t r a t i o n on a

s i m p l e 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

i n c o r p o r a t e prob 1e m s r a i s e d by c e r t a i n i m p o r 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

g e o g r a p h i c a 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

a two t i e r c r u d e p r i c e s y s t e m , a n d t h e e x i s t e n c e of r e f i n e r i e s
with d i f f e r e n t cost structures.
themselves

tested

and

Some of t h e s e new hypotheses a r e

the r e s u l t s presented

i n B.5.

The

c o n c l u s i o n 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 s o 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

h a n d 1 i n g a v e r y c o m p l e x m a r k e 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 p r o d u c t s ) 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 t e s t s on t h e o p e r a t i o n of t h e market.

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 b a c k t o t h e p o i n t of s a l e of t h e c r u d e , s h o u l d
b e 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 crude.

The

d i f f e r e n c e b e t w e e n t h e two c o n c e p t s , w h i c h 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",

has been used as a

m e a s u r e 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 a s a t o o l t o d e c i d e
w h e t h e r t h e m a r k e t i s s u b s t a n t i a l l y o u t of e q u i l i b r i u m .

There

h a s 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 s h o w t h a t ,

indeed,

i f there is

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 c o m p e t i t i v e s t r u c t u r e
then t h e netback c o r r e c t l y c a l c u l a t e d f o r a marginal r e f i n e r y
would b e expected t o b e s l i g h t l y above 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 h y p o t h e s i s of t h e "normal" margin d a t a on
b o t h n e t b a c k s and s p o t c r u d e is r e q u i r e d .

There i s no " o f f i c i a l "

d a t a on e i t h e r concept b u t 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 s e r i e s of
data.

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 o n a m o n t h l y

b a s i s o v e r 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 a n d
important findings.

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 .

For crude d a t a f o u r s o u r c e s were used:

( i > OPEC B u l l e t i n
(ii)
(iii)
(iv)

Petroleum I n t e l l i g e n c e Weekly
Middle East Petroleum and Economic P u b l i c a t i o n s
An i n d u s t r y e s t i m a t e .

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 a v e r a g e t h a n t h e o t h e r s o u r c e s o v e r t h e
p e r i o d (by b e t w e e n o n e 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 s o u r c e s a r e c l o s e b u t vary between e a c h o t h e r by an amount

e q u a l t o about 65 cents.

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 s o u r c e s i s o f t e n v e r y g r e a t

f o r Arab Light

the maximum d i f f e r e n c e r e a c h e s $6 w h i l e for N i g e r i a n t h e maximum

d i f f e r e n c e i s $3.

T h i s "measurement e r r o r " i n t h e s p o 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 s h o u l d i n c l u d e t h i s period.
For n e t b a c k d a t a t h r e e s o u r c e s were u t i l i s e d :

( i ) Petroleum I n t e l l i g e n c e Weekly
(ii)

OPAL

( i i i ) An i n d u s t r y e s t i m a t e .
Netback d a t a d i s t i n g u i s h e s n o t o n l y t h e crude used b u t 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 s o u r c e s 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
s o u r c e s f o r b o t h crudes.

b u t w i t h OPAL below b o t h o t h e r

Again t h e d i f f e r e n c e s between s o u r c e s

a r e a t t h e i r g r e a t e s t i n 1979.

R a t h e r s u r p r i s i n g l y t h e agreement

between s o u r c e s i s c l o s e r f o r n e t b a c k s t h a n f o r crudes.
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

However,

nor a s u f f i c i e n t

c o n d i t i o n f o r t h e s e r i e s to b e a c c u r a t e , e v e n t h o u g h i t d o e s

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

i n c r e a s e confidence
independently.

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 w h i c h 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 .

is a n 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

However it

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 t o t h o s e a c t u a l l y u s e d by a n a n a c t u a l
agent.

The d e t a i l e d k n o w l e d g e of t h e m a r k e t d o e s n o t p r o d u c e

noticeably d i f f e r e n t figures.
Given t h e amount of measurement e r r o r t h a t t h e s e s e r i e s
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 .

There

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 h e
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 s p o t c r u d e p r i c e s o v e r t h e l e n g t h y p e r i o d 1976 t o 1983 makes

it c l e a r t h a t t h e r e is a v e r y 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 market, i e

b e t w e e n p r o d u c t s and c r u d e .

However, t h e

e x a c t n a t u r e of t h e r e l a t i o n s h i p r a i s e s 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 been a p p a r e n t s o l e l y from a p r i o r i
t h e o r i s i n g or from e m p i r i c a l a n a l y s i s of s h o r t r u n s of d a t a .
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 s p o t product n e t b a c k s and s p o t

crude prices 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 is formulated).
The s h i f t i n g i n t h e
r e l a t i o n s h i p d o e s n o t appear t o b e continuous,
i n d i c a t i n g t h e o m i s s i o n o f some c o n t i n u a l l y v a r i a b l e
f a c t o r , but is rather discontinuous, indicating the e f f e c t
of a factor vhich changes a t d i s c r e t e i n t e r v a l s .
(ii)

The r e l a t i o n s h i p between t h e two s e r i e s 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 o f t h e

market i f the period of adjustment t o change i s slow

and/or there are large fixed cost elerents involved in
adjustment to large s h i f t s 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 p a r t i c u l a r the persistence of t h 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
invest i g at 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 c r u d e 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 from 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 c h a n g e s 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 (prof i t o r l o s s ) p o s i t i o n of firms.

The "normal

margin" h y p o t h e s i s has t o be d i s c a r d e d for two s e p a r a t e reasons.

Firstly,
changes.
are.

over long periods,

t h e average or t y p i c a l margin

F i g u r e s I and I1 make i t c l e a r how s h a r p t h e s e changes

The s e c o n d r e a s o n f o r a b a n d o n i n g t h e "normal

margin"

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 t h e d o l l a r o r
d o l l a r r e s p o n s e 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 margin t h a t v a r i e s continuously w i t h t h e g e n e r a l o i l p r i c e

level.

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 r o m 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
c h a n g e s b e t w e e n 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 b e 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 ) from 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 1 9 7 8 t o l a t e summer 1 9 7 9 ; ( c >

from l a t e summer

1979 t o s p r i n g 1981; (d) from s p r i n g 1981 t o t h e end of 1983.

I n t h e first episode

( J a n 1 9 7 6 - l a t e 1978) s p o t p r i c e s

and t h e netback a r e a l m o s 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
( 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 A r a b and 50
c e n t s f o r Nigerian).

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 the industry 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 n e t b a c k is s l i g h t l y h i g h e r t h a n

t h e spot price.

T h i s would be q u i t e c o n s i s t e n t w i t h a n MC=MR

c o n d i t i o n f o r p r o f i t maximisation, w i t h a f a 1 l i n g demand c u r v e
h a v i n g a l o w e r M R 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 w i t h a h i g h e r M C t h a n t h e c o s t of r e f i n i n g a v e r a g e b a r r e l .
Both e f f e c t s would be expected t o b e 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 o v e r s p o t i s n o t s u r p r i s i n g .

The

v e r y t i g h t f i t f o r t h i s p e r i o d s u g g e s t s t h a t i t is u n l i k e l y t h a t
other

v a r i a b l e s would have a s i g n i f i c a n t r o l e t o play

( 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 a l m o s t i d e n t i c a l t o
the spot price).

This p e r i o d , f o r Rotterdam product p r i c e s , i s

c o n s i s t e n t w i t h t h e "normal margin" h y p o t h e s i s 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 a n g e f i n d i n g (common t o a l l p e r i o d s ) i s t h a t t h e

margin f o r Arab Light is c o r r e l a t e d w i t h t h e margin f o r N i g e r i a n

Light.

I n e q u i l i b r i u m t h e r e would be no such c o r r e l a t i o n and s o

t h i s s u g g e s t s 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 i n c e 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 episode,

t h e f i n d i n g cannot be s i m p l y a t t r i b u t e d t o

specification error.
The second episode, f r o m l a t e 1 9 7 8 t o mid 1 9 7 9 , 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 i c e 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
s u s p e c t ) and a l l a t t e m p t s t o do s o 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 o n e 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 a s b e i n g d o m i n a t e d b y
t h e s u p p l y d i s r u p t i o n of

the

Iranian revolution)

is that

on averaRe netbacks were some 5 % h i g h e r than s p o t f o r Arab L i g h t

and 12% h i g h e r 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 e p i s o d e s netbacks h a v e been on

a v e r a g e below s p o t p r i c e s .

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

could

e s t a b l i s h any f i r m conclusion.
The t h i r d episode, s t r e t c h i n g f r o m l a t e i n 1979 t o
e a r l y in 1981, corresponds to a p e r i o d 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 c e .

This can be

i n t e r p r e t e d as a p e r i o d of e x c e s s demand ( a t the g i v e n o f f i c i a l
p r i c e s ) w h e r e l i m i t e d s u p p l i e s m e a n t 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 .

For

t h i s p e r i o d t h e "normal m a r g i n " 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 L i g h t and $2 f o r Nigerian).

There has been a

t e m p t a t i o n t o suggest t h a t t h i s i n d i c a t e s producers o p e r a t i n g 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 b e t w e e n m a r g i n a l a n d

average concepts.

S i n c e most c r u d e was b o u g h t a t o f f i c i a l

prices,

below t h e s p o 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 c o u l d

w e l l h a v e been below t h e t o t a l r e v e n u e e v e n though t h e m a r g i n a l

c o s t f o r t h e r e f i n e r y chosen was above m a r g i n a l r e v e n u e a c c o r d i n g
t o the data.
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 h a n t h e a b s o l u t e margin model, and g i v e s a S a u d i
netback a t 90% of s p o t p r i c e and a N i g e r i a n netback of 95% of t h e
spot price.

The accuracy of t h e e q u a t i o n s i s s u b s t a n t i a l l y l e s s

than t h o s e f o r t h e f i r s t p e r i o d

f o r Arab L i g h t , s u g g e s t i n g t h a t

some o t h e r v a r i a b l e may be i n v o l v e d .

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 i n d i n g .
f o r i n c l u s i o n i n t h e equations.

There a r e two c a n d i d a t e s

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 might be expected t h a t t h e lower p r i c e would
determine product prices, a t l e a s t i n part.

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 i n c l u d e d a s e x p l a n a t o r y v a r i a b l e s f o r t h e
netback

then

the

spot

variable

continued

to

be

strongly

s i g n i f i c a n t , b u t t h e o f f i c i a l p r i c e was c o m p l e t e l y i n s i g n i f i c a n t
and a d d e d 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 .

This i s strong

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 w a s 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 a n a v e r a g e c o s t b a s i s .

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

netbacks leading spot prices.

No

evidence f o r lagged r e l a t i o n s h i p s (with o r without o f f i c i a l

p r i c e s ) c o u l d be found f o r t h i s episode.
Hence f o r t h e p e r i o d of e x c e s s 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 r o m e i t h e r s i d e of t h e m a r k e t .

The one f e a t u r e

which cannot be so simply e x p l a i n e d is t h e d e g r e e t o which t h e

netback i s p e r s i s t e n t l y below t h e s p o t p r i c e .

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 m i g h 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 price significant.

The d a t a from a l l s o u r c e s confirms

t h i s n e g a t i v e margin and f o r a g e n u i n e l y m a r g i n a l 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 .

In order t o argue t h a t

m a r g i n a l r e v e n u e 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 w o u l d b e 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 m a r g i n a l concepts and were lower
t h a n t h e t r u e m a r g i n a l revenues from p r o d u c t s , 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 etc.) were t o o l a r g e .

Since

t h e s e c o s 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 c o u l d n o t 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 .

It 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 confirm it.

E v e n 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 e a s i l y e x p l a i n e d i f t h e r e a r e l a r g e e x i t and

re-entry

costs (mothballing costs).

C l e a r l y i t can o f t e n be

b e t t e r t o r u n a t a s m a l l l o s s t h a n t o i n c u r t h e s e l a r g e shutdown
costs.

However t h e p e r s i s t e n c e of m a r a i n a l l o s s e s cannot be so

e a s i l y explained.

S e c t i o n B4 of t h e paper a n a l y s e s a s e r i e s 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 could e x p l a i n t h i s finding.

It i s argued 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 e x p l a n a t i o n f o r t h i s phenomenon.
t h a t the t h i r d episode presents a puzzle

Thus w e must conclude

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 m a r g i n a l l o s s on t h e
data a s calculated.
The final episode, w h i c h 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 r e s e n t s a complex p i c t u r e .

The p e r c e n t a g e 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 s p o t p r i c e f o r Arab L i g h t , w i t h N i g e r i a n Light
showing a l m o s t 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 .
fit

The goodness of

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 a n d a s good a s t h e

f i r s t e p i s o d e f o r N i g e r i a n ( b u t n o t f o r Arab L i g h t ) .

The period

of t h e f i n a l e p i s o d e w a s o n e i n w h i c h t h e s p o t p r i c e was l o w e r
S i n c e t h i s phenomenon is d i f f i c u l t t o

than t h e o f f i c i a l price.
e x p l a i n i n a two-tier

market

system u n l e s s

p o r t f o l i o t y p e c h o i c e e v e n a t t h e margin ( i e
e v e n though i t is more e x p e n s i v e t h a n s p o t ) ,

buyers

take

buy some o f f i c i a l
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 t h e s p o t p r i c e
a f f e c t e d t h e netback.

There was c o n f i r m a t i o n of t h i s h y p o t h e s i s

for Arab L i g h t but not f o r N i g e r i a n Light.

be e x p l a i n e d

if

buyers

i n s u r a n c e of

purchasing

felt

it

Such a f i n d i n g c o u l d

l e s s i m p o r t a n t t o pay

Nigerian

at

official

prices

the
than

p u r c h a s i n g Saudi a t o f f i c i a l p r i c e s .
A second, u n u s u a l ,

f e a t u r e of t h e l a s t e p i s o d e i s t h a t

f o r t h e f i r s t time e v i d e n c e of

lagged r e a c t i o n s was found.

The

s p o t p r i c e was r e l a t e d t o b o t h t h e c u r r e n t and one month lagged

netback f o r b o t h Arab and N i g e r i a n crudes.

I t i s n o t o b v i o u s 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 p r i c e .

The e f f e c t was small ( w i t h an

a v e r a g e 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

p e r i o d s c o u l d a p r o p e r dynamic a n a l y s i s be undertaken.
Even f o r t h e f i n a l e p i s o d e when n e t b a c k s 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 ( a n d 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 l e s s t h a n u n i t y ,
a l o s s a t t h e margin.

indicating

S i n c e t h e 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 a c c o r d i n g t o t h e s e f i g u r e s .

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 w h i c h 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 m a r k e 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 on 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 n o t t o prof it maximise because continued p r o d u c t i o n
s e r v e s o t h e r ends.

These f i n d i n g s must be looked a t i n t h e

c o n t e x t of t h e wider range of d a t a on r e f i n i n g .

The s t a t i s t i c a l

a n a l y s i s h a s c o n c e n t r a t e d l a r g e l y o n 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 .
a l l o w e d t h e l o n g e s t r u n of data.

Firstly,

it

Secondly, i f markets are i n

e q u i l i b r ium t h e n t h e netback s h o u l d be t h e same everywhere except

f o r random f l u c t u a t i o n s .

T h i r d l y , on a m a r g i n a l i s t argument i t

would 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 w h i c h s h o u l d t h e r e f o r e b e 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 netback 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 of t h e f i n a l
p e r i o d under study.

T h i s of c o u r s e 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 r o 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
sometimes h i g h e r

s t i l l ) but

d o e s w a r n a g a i n s t t h e u s e of

13

g e n e r a 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 a s
d i f f e r e n t i a t e d by l o c a t i o n ( a n d by t e c h n o l o g y ) shows t h a t a s
between c e n t r e s t h e r e s u l t s a r e very s i m i l a r .

Netbacks a r e

r e l a t e d t o s p o t p r i c e s when t h e r e i s " 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 b o t h s p o 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 s u p p l y . "

The

weakest l i n k between netbacks and crude p r i c e s a p p e a r s 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 n e t b a c k s

and c r u d e p r i c e s f o r Arab L i g h t i s a s c l o s e a s f o r any o t h e r

centre.
The a n a l y s i s of

t h e r e l a t i o n s between t h e product

p r i c e s , a s 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 v e r y c l o s e l y I inked on a month by
month b a s i s .

The n a t u r e of t h e l i n k h a s 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 e p i s o d e s ) ,

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
appears t o be unpredictable.

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 95%confidence 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 b e p r e d i c t e d w i t h i n p l u s o r m i n u s $1 ( a n d
v i c e versa).

I t 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 m a r k e t .

I t is 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 i m p r o v e t h e f i t of t h e m o d e l and i n d e e d t h e

14

s h i f t i n g margin has

itself

t o 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 w o u l d p r o b a b l y b e of a n o r d e r o f m a g n i t u d e
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 r o m any a p r i o r i
m o d e l 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 m a r g i n 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 u s e

of n e t b a c k s

o u t of l i n e .

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
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 netback/off 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 crudes.

Those

w h i c h 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" ( A r a b L i g h t ) i n d i c a t e w h e t h e r a n 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 i g h ) .

Symbolical l y

we calculate for

example :

(MN

NO)

(SA

SO>

(1)

where :

NN

= N i g e r i a n netback

NO = O f f i c i a l p r i c e of N i g e r i a n Light
SN = Saudi netback

SO

= O f f i c i a l p r i c e of Arab L i g h t .

If t h i s i s z e r o t h e o f f i c i a l p r i c e s a r e s a i d t o b e i n
l i n e w i t h market r e a l i t i e s

i f it i s p o s i t i v e the o f f i c i a l price

of N i g e r i a n i s r e l a t i v e l y t o o l o w , w h i l e i f i t i s n e g a t i v e t h e
official

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 high.

This

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 measure 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 a n d t h a t t h e m a r g i n i s a b s o l u t e
and n o t r e l a t i v e .

The measurement e r r o r s i n t h e n e t b a c k t o g e t h e r

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 do n o t measure 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 o f s p o t
d i f f e r e n t i a 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 h y p o t h e s i s 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 from t h e crude are s y s t e m a t i c a l l y

related.

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 " t y p i c a l "

refinery.

The sum o f 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 v a l u e " (worth) and i s

t h e r e v e n u e 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 of 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 t h e r r e f i n i n g costs.
analysis then

I f we c o n c e n t r a t e on a s h o r t - r u n m a r g i n a l

t h e r e i s no e x t r a c a p i t a l c o s t

involved in

r e f i n i n g a n o t h e r b a r r e l of o i l (below f u l l c a p a c i t y ) b u t 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 w o u l d 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 d e f i n e d ) f o b , a d d i n g on t r a n s p o r t
and i n s u r a n c e c o s t s t o o b t a i n t h e c i f

o i l p r i c e and t h e n 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

the revenue figure.

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 r e v e n u e 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" o f t h e 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
17

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 h e ''spo t product e q u i v a 1e n t v a 1uel' ( i n d u s t r y t e r m i n o 1ogy).

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 " n e t b a c k " 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 " n e t b a c k

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 w a y s :

margin".
(i)

" G e n e r a l l y , t h e s p o 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
l o a d i n g p o r t i s compared w i t h

producer's

.... c r u d e

prices to

d e t e r m i n e p r o f i t o r l o s s " (PIW(supp) 7 March 83 p4).

( i i ) D i f f e r e n c e s between s p o t product v a l u e s of t h e major

crude 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

variations or

" d i f f e r e n t i a l s " among t h e o f f i c i a l c r u d e 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, i b i d ) .

I n a l l such 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 between t h e
r e l a t e d s e r i e s h a v e 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
o f a 'normal'

a b s o l u t e margin between t h e series.

In fact, there

a r e f o u r d i s t i n c t t y p e s of netback margin t h a t can be c a l c u l a t e d

a n d 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 m u s t b e a l l o w e d f o r .
The p l u r a l i t y arises because c r u d e 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 contract prices.

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 b a c k by s t a r t i n g w i t h t h e
I'

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 a n d s u b t r a c t i n g d u t i e s a n d

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 p r o d u c t market) c o n c e n t r a t e s on u s i n g 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 s p o 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 c e s .
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 w h i c h of t h e s e two
,

m a r g i n s t o examine we m u s t 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 n e t b a c k 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;

( i i ) t h e t y p e of r e f i n i n g p r o c e s s b e i n g u s e d ;

( i i i ) 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 a k e n 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
crudes,
refinery.

they

t h e y i e l d s vary between

a l s o d e p e n d on t h e t y p e a n d l o c a t i o n of

the

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

Nigerian Light,

but these have d i s t i n c t l y different y i e l d

p e r c e n t a g e s a s t h e 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 crude w i l l vary between l o c a t i o n s , because
r e f i a e r i e s 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 .

There 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
(ii)
(iii)
(iv)

(v)
(vi)

US Gulf Coast

Caribbean
P e r s i a n Gulf
Singapore
Italy.

Other s o u r c e s c o n c e n t r a t e on Rotterdam and/or t h e US G u l f .

The t e c h n i q u e s 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
s o u r c e s 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 i m p l e t o p p i n g l r e f o r m i n g t y p e 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 i m a r y 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 .
T h e s e 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 t h o u g h t h e 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 w h i c h 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
costs.

This l a s t i s c a l c u l a t e d o n a m a r g i n a l b a s i s u s i n g

W o r l d s c a l e 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 b e i n g e v a l u a t e d .
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 i v e n crude, t h e n e t b a c k and c r u d e p r i c e a r e
related.

Given t h a t we have decided

v a l u a t i o n s w e must

d e c i d e which

t o use

crude p r i c e

spot

product

t o use.

The

c a l c u l a t i o n s a r e e x p l i c i t l y on a m a r g i n a l b a s i s , as t h e e x c l u s i o n

20

of c a p i t a l c o s t e l e m e n t s 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 b e 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 m a r g i n a l ,

We m u s t

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 .

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 ( a n d d r i v i n g i t u p u n t i l t h e two meet).

If

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

situation the spot price

such a

in

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
official.

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 r e a s o n 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 p o i n t l a t e r and assume f o r t h e p r e s e n t t h a t spot crude i s

t h e m a r g i n a l s o u r c e of s u p p l y w h e r e s p o t p r i c e s a r e a b o v e

or

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) p r i c e :

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 h a s c e n t r e d on t h e margin between t h o s e
two

magnitudes so t h a t w e c o u l d 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)

S i n c e 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 =

+ 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 period.

The t e r m

should

21

exhibit

systematic behaviour

no

if

it

does then the

r e l a t i o n s h i p between t h e netback and t h e s p o t c r u d e p r i c e would

n o t b e just on a v e r a g e a c o n s t a n t .

Hence i t w o u l d n o t b e

p o s s i b l e t o d e c i d e 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 d e c i d e d r e l a t i v e t o t h e o t h e r

f a c t o r s d e t e r m i n i n g 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
m a r g i n was u n u s u a l l y h i g h o r l o w t h e v a r i a n c e of t h e random
fluctuation

(U>

e x p l a i n p a r t of

i s a c r i t i c a l component.
U

I f we were a b l e t o

by 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 of

randomness for t h e margin would d e c r e a s e and we should b e a b l e t o

s p o 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 purely mechanistic hypothesis
t o test.

Although w e h a v e i m p l i c i t l y suggested t h a t t h e concepts

used a r e m a r g i n a l r e v e n u e s and c o s t s w e h a v e n o t y e t s p e l l e d o u t
t h e e c o n o m i c a s s u m p t i o n s w h i c h w o u l d 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 w h i c h a h y p o t h e s i s of how t h e y a r e l i n k e d c a n n o t b e
constructed.

22

T h i s deeper q u e s t i o n is t a k e n up i n s e c t i o n B.3.

B.2
B.2.1

THE DATA

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 s p o t 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 n o o f f i c i a l s e r i e s .

Instead interested

p a r t i e s , s u c h a s 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 i m a t e s f o r t h e same concept,

caused i n p a r t by t h e l a c k of

a n 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 n o t t r a d e d 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 w h i c h 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 .

I n s t e a d 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 a g e n t s who a r e s p r e a d worldwide.

Hence d a t a must b e c o l l e c t e d by some f o r m of s u r v e y a p p r o a c h .
T h i s l e a d s t o a f i r s t s o u r c e of
particular

variation

an a g e n t a t a

t i m e m a y b e a b l e t o p r o v i d e a p r i c e done ( i e

a c t u a l l y t r a n s a c t e d ) or m e r e l y a p r i c e Ioffered.

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 p e r i o d s u g g e s t t h a t

a t p r e s e n 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

are very close.

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 .

This short-coming

is l i k e l y t o b e more

s e r i o u s i n t h e f i r s t p a r t of our p e r i o d , when t h e s p o t market was

v e r y t h i n a n d 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 s e c o n d 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
the contract.

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 " i n t h e month" o r p r i c e s " f o r t h e

month".

The f o r m e r r e f e r s t o c o n t r a c t s made i n December w h i c h

w i l l a c t u a l l y b e i m p l e m e n t e d 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

b e f o r e December t h a t w i l l be p a y a b l e 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 b e much more l a b o r i o u s t o b u i l d up o n a

time

series basis.

These

two

concepts

also

suggest

that

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.

In fact,

s i n c e t h e r e i s no c l e a r

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 ,

s t a t e m e n t of

the

it i s not possible

t o come t o any d e c i s i o n as t o w h i c h 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 n e e d 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 o b t a i n e d 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 r o m t h i s s o u r c e S S O and NSO.

This s o u r c e , w h i c h 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 o u r 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 i g u r e .
(2)

Middle E a s 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 from t h e

b e g i n n i n g of our p e r i o d ( w h i c h s t a r t s at J a n u a r y 1 9 7 6 ) .
w e e k l y 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 .

24

The

We denote

t h e s e by SSM and NSM.

(3)

I n d u s t r y 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 c o m b i n i n g a l l t h e

k n o w l e d g e a v a i l a b l e t o them.

We h a v e o n e such s o u r c e ( S S I and

N S I ) f r o m 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 7 6 ) t o t h e end o n

a monthly b a s i s .

This a g a i n is a mid-month average.

( 4 ) Petroleum I n t e l l i g e n c e Weekly (PIW)

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 r e s e n t f o r t h e t w o crudes i n q u e s t i o n (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

o n e s e r i e s 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
both) without
identical

introducing

the regression

constant.

If

the

c o e f f i c i e n t would

s e r i e s were

be unity,

the

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 T a b l e 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
ranging from 1 t o 2 percent).

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 c e n t s

a b a r r e l h i g h e r t h a n o t h e r series.

(ii) The o t h e r t h r e e s e r i e s a r e a l l v e r y c l o s e t o each

o t h e r and i n g e n e r a l do n o t d i f f e r s i g n i f i c a n t l y .

However,

the

s t a n d a r d e r r o r of estimate f o r a l l s i x c a s e s , e x c l u d i n g t h e OPEC
Bulletin,

i s between 50 c e n t s and 80 cents.

Hence a l t h o u g h t h e

25

c o r r e l a t i o n i s v e r y h i g h t h e a v e r a g e e r r o r i s t h e same o r d e 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 b e t w e e n t h e s e s e r i e s a n d t h e 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 f e w m o n t h s when t h e r e s i d u a l s a r e many
t i m e s t h e s t a n d a r d e r r o r of e s t i m a t e .

Since the 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 a p p r o x i m a t e l y one i n

a hundred would be more t h a n t h r e e times as l a r g e as t h e s t a n d a r d

e r r o r of e s t i m a t e .

T a b l e 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 e x c e e d e d .

It i s n o t

s u r p r i s i n g t h a t t h e only p e r i o d 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 m o n t h s of 1979, when t h e s p o t p r i c e w a s m o v i n g

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 market.

F o r t h e c a s e of A r a b L i g h t t h e s p o t p r i c e f o r M a y

1 9 7 9 r a n g e s f r o m $28.35 f o r SSI, t o $28.95 f o r S S O , t o $30.67 f o r

SSM and up t o $34.25 for SSP.

The extreme d i v e r g e n c e 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

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 e x t r e m e " 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 picture t o a great extent.

By c o m p a r i s o n t h e r a n g e o f

p r i c e s for N i g e r i a n 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 .
l a r g e , but o n l y h a l f

t h a t of Arab Light.

T h i s r a n g e o f $3 i s
The p e r i o d of extreme

disagreement f o r Arab Light i s s h o r t e r b e i n g j u s t May,

J u n e 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 A u g u s t 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: RELATIOIMIPS BETWEEB SPOT PRICE MEASURES

FOB ARAB LIGHT

R e g r e s s i o n Dependent
Equation
var iabl e
No.

Independent
var iab 1e

Period

C o e f f i c i e n t Sqd.
SEE
(SE)
correla t ion

DWS

........................................................................
(R1)

SSI

S SM

(R2)

s SP

SSI

(R3)

s SP

S SM

(R4)

s SP

sso

(R5)

sso

SSI

(R6)

sso

S SM

(RI 3)

SSI

S SM

76.0183.12
78.0183.12
78.0183.12
79.0183.12
79.0183.12
79.0183.12
76.0178.12
81.0183.12

0.997
(0.002)
1.000
(0.003)
0.997
(0.003)
0.985

0.997

0.51

1.59

0.991

0.81

2.21

0.992

0.71

2.72

0.954

1.01

2.01

0.989

0.51

1.19

0.984

0.61

1.61

0.999

0.22

0.79

(0.004)
1.015
(0.002)
1.011
(0.002)
1.00
(0.001)

TABLE 11: BELBTIOASHIPS BETWEEB SPOT PRICE LIRASWES

FOR HIGEEFA% LIGHT

(R7)

NSI

NSM

(R8)

NSP

NSM

(R9)

NSP

NSI

(R10)

NSP

NSO

(R11)

NSO

MSI

(R12)

NSO

NSM

(R14)

NSI

NSM

76.0183.12
78.0183.12
78.0183.12
79.0183.12
79.0183.12
79.0183.12
76.0178.12
81.0183.12

1.004
(0.002)
0.998
(0.003)
0.994
(0.002)
0.981
(0.003)
1.012
(0 .003>
1.017
(0.004)
1.0037
(0.0013)

0.996

0.63

1.90

0.993

0.70

1.97

0.995

0.59

1.56

0.972

0.81

1.16

0.973

0.79

1.81

0.960

0.96

1.76

0,999

0.30

1.37

27

MOHTHS WITH EXTBEHE DISBC;BKEMENTS* BETWEEH SERIES

TABLE 111:
(a)

Arab Light

s SP

SSI
+SSM

s SP
S SM

SSP

sso

sso

SSI

sso

SSI

SSM

7 9 . 0 5 4.3

79.05 7 . 3

7 9 . 0 5 5.2

79.05 5.7

79.05 3 . 4

79.06 3 . 4

79.07 5 . 0

(b)

Nigerian L i g h t

NSI
NSM

NSP

NSP

NSI

NSM

79.01
3.8

81.06
3.5

7 9 . 0 7 3.7

NSP
NS 0

NSO
NSI

79.06

79.02

3.2

3.2

79.05 79.05
3.3
4.1

NSO
NSM

79.08
3.7

An extreme d i v e r g e n c e i s a r e s i d u a l g r e a t e r t h a n t h r e e times
t h e s t a n d a r d e r r o r of estimate.
It is measured i n m u l t i p l e s of
t h e SEE.

l o n g e s t p e r i o d , we re-ran

t h e r e g r e s s i o n s o m i t t i n g t h e two y e a r s

1 9 7 9 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) a n d (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 e x t r e m e l y 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 1 9 7 9 a n d 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 a b b r e v i a t e d p e r i o d i s n o t
non-existent

but is v e r y small and s h o u l d n o t b i a s t h e r e s u l t s t o

any g r e a t e x t e n t . 1

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 i n d u s t r y 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 ,

p a r t i c u l a r l y i f some months during 1979 are d e l e t e d from whatever

s t a t i s t i c a l t e s t s are t o be run.

T h e OPEC B u l l e t i n s e r i e s i s

s i g n i f i c a n t l y greater than the other s e r i e s and its use could be

expected t o lead t o d i f f e r e n t r e s u l t s from the others.

29

B.2.2

HETBBCK DATA

The c o n s t r u c t i o n of netback s e r i e s r e q u i r e s i n f o r m a t i o n
on f o u r elements:
(i)

t h e s p o t product p r i c e s i n a p a r t i c u l a r market;

( i i ) t h e r e f i n e r y y i e l d s i n t h a t market ;
(iii)
(iv)

t h e running c o s t s p e r b a r r e l f o r t h e r e f i n e r y ;
t h e t r a n s p o r t and i n s u r a n c e c o s t s between t h e r e f i n e r y
and t h e e x p o r t p o i n t of t h e crude under c o n s i d e r a t i o n .
Given t h e s e r e q u i r e m e n t s and t h e absence of any o f f i c i a l

a g e n c y 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
refinery location.

Given t h e complexity of t h e c a l c u l a t i o n s

r e q u i r e d it is n o t s u r p r i s i n g t h a t t h e r e should be s u s p i c i o n of
f i g u r e s produced by a g e n c i e s n o t i n v o l v e d i n r e f i n i n g .

However,

p u b l i s h e d f i g u r e s are a n important s o u r c e of common i n f o r m a t i o n

which must be i n v e s t i g a t e d .
We have used t h r e e s o u r c e s of d a t a b u t f o r each s o u r c e
t h e r e i s more t h a n one n e t b a c k s o t h a t t h e t o t a l number of s e r i e s
a v a i l a b l e is rather

large.

Each s o u r c e i d e n t i f i e s e i t h e r more

t h a n o n e 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 o n e 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 s o u r c e p u b l i s h e s d a t a on Saudi n e t b a c k s 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 r o m t h e b e g i n n i n g of o u r p e r i o d
(SNPIWR).

Four

other centres,

t h e C a r i b b e a n (SNPIWC),

the

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 c o n t i n u o u s l y p u b l i s h e d from t h e beginning of 1977.

Similar

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 U S n e t b a c k s ,

assume t h e r e f i n i n g t o b e 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 b e t w e e n summer and w i n t e r months
b u t a p a r t f r o m 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 a n d t h i s i n c r e a s e d t h e Gross

Product Value by approximately Z X ,

with

conversion

p o s s i b i l i t i e s (upgrading heavier products i n t o

l i g h t e r ) is

at

that

date.

For

t h e US

g i v i n g a sharp d i s c o n t i n u i t y
refinery

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 i s 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 .
Errors i n these elements a r e not l i k e l y t o a f f e c t t h e netback
very g r e a t l y .
It

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 w i d e

g e o g r a p h i c a l c o v e r a g e 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

runs

31

of d a t a on a c o n s t a n 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 p u b l i s h e d 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 r o m
R o t t e r d a m for b o t h b a s i c hydroskimming a n d 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 c e n t s and 45 c e n t s f o r t h e two t y p e s

of r e f i n e r i e s .
( i i i ) I n d u s t r y Data

As w i t h s p o 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 n d u s t r y t o c a l c u l a t e t h e v a l u e of n e t b a c k s 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
typical refinery.

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 f r o m 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 b o t h 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 s e r i e s (between l o c a t i o n s , between t y p e s
of r e f i n e r y and b e t w e e n d a t a s o u r c e ) .
become a p p a r e n t ,

For r e a s o n s t h a t w i l l

it i s s e n s i b l e t o c o n c e n t r a t e on t h o s e f i g u r e s

w h i c h a r e f o r t h e same l o c a t i o n a n d t h e same t y p e of r e f i n i n g
process.

W e b e g i n 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

three sources g i v e data.

T a b l e s I V and V

( 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 s e r i e s (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 p e r i o d s a v a i l a b l e .
We can s e e from t h e t a b l e s t h a t t h e d a t a a v a i l a b l e f o r
t h e l o n g e s t p e r i o d (PIW and i n d u s t r y b a s i c r e f i n e r y a t Rotterdam)

32

a r e i n c l o s e a g r e e m e n t ( E q u a t i o n s (Et151 and (R20)).

data,

for basic refining,

The OPAL

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 t a n d a r d e r r o r of e s t i m a t e , for b o t h Arabian and

Nigerian.

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 ) .

is just

significantly

F o r N i g e r i a n t h e OPAL f i g u r e

l e s s t h a n t h e PIW f i g u r e b u t

s u b s t a n t i a l l y less than the industry data.

it

is

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 v e r y l a r g e measure of agreement

between t h e s e r i e s , w i t h s t a n d a r d e r r o r s much l e s s t h a n t h o s e f o r
e q u a t i o n s l i n k i n g t h e v a r i o u s s p o 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 N i g e r i a n 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 u s i n g complex r e f i n i n g t h e PIW and
i n d u s t r y d a t a a r e a l m o s t 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
o b s e r v a t i o n s f o r which t h e r e s i d u a l is g r e a t e r t h a n t h r e e times
t h e s t a n d a r d e r r o r of e s t i m a t e .

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 J a n u a r y 1981 f o r SNPIWU and SNUCI ( i n

b o t h c a s e s t h e margin was o n l y j u s t o v e r t h r e e s t a n d a r d e r r o r s ) .
The c a s e of May 1 9 7 9 i s n o t s u r p r i s i n g

the turbulence in the

c r u d e spot m a r k e 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 procedures a t s u c h a time 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 n e t b a c k s e r i e s a r e i n c l o s e r agreement

t h a n 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 i g h e 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 e x t r e m e l y 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:

(a)

BELBTIOBSBIPS BETWEEN BETBACKS

FOE ARAB LIGHT

Basic Refining a t Rotterdam

(RI51

SNIWR

SNRBI

76.0183.06

1.001
(0.002)

0.997

0.47

1.04

(R16)

SNPIWR

SNOPAB

1.016
(0.001)

0.985

0.30

1.39

(RI7 )

SNRBI

SNOPAB

80.0183.06
80.0183.12

1.020

0.977

0.37

0.45

0.985

0.32

0.35

0.955

0.53

1.50

(b)
(RI81
(c)

(R19)

Complex Refining a t Rotterdam

SNOPAC

SNRCI

81.0183.12

0.954
(0.002)

Complex Refining i n US
SNPIWU

SNUCI

81.01-

83.06

34

(0.002)

0.995
(0.003)

TABLE V: RELBTIOHSEIPS BKTWIZElU HETBACKS FOR BIGERIBlP LIGHT

(a)

B a s i c RefininE a t Rotterdam

(R20)

NNPIWR

(R21)

NNPIWR
NNRB I

(R22)

(b)

NNRBI

76.01-

NMOPAB

83.06
80.0183.06

NNOPAB

0.981
(0.002)
1.003

80.0183.12

(0.002)
1.020
(0.002)

81.0183.12

1.030
(0.002)

0 .998

0.43 1 . 1 2

0.985

0.34 0 . 9 4

0.986

0.36 0.74

0.984

0.42

Complex R e f i n i n g a t Rotterdam

(R231

NNRCI

NNOPAC

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 w i t h t h e o t h e r two s o u r c e s

and a r e below them on average.
the natural

This is an important r e s u l t g i v e n

tendency t o t r u s t i n d u s t r y d a t a more i n t h i s case.

Finally,

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

(unsquared) c o r r e l a t i o n m a t r i x between 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 w h i c h 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 from 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 o c c u r b e t w e e n 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 h a v e i d e n t i c a l d e f i n i t i o n s .

Corr e 1a t i o n s b e tween s e r i e s

f o r s i m p l e and complex r e f i n i n g or between Rotterdam and t h e US

a r e a p p r e c i a b l y lower even when t h e d a t a s o u r c e 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 of d a t a which match 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 periods.

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 r o v e s 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 be

35

0.52

correct i t does not c o n s t i t u t e 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 p a r t o f 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

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

SNRBI

1.000

TABLE V I I : COBBELBTIORS FOB HIG'HtIAH HETBAmS (1981.01-1983.06)

NNPIWR

NNRB I

NNOPAB

NNOPAC

NNPIWR

1.000

NNRB I

0.989

1 .ooo

NNOPAB

0.993

0.993

1 .ooo

NNOPAC

0.983

0.976

0.990

1 .ooo

NNRCI

0.976

0.973

0.980

0.990

36

NNRCI

1 .ooo

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 of t h i s paper w e argued
t h a t t h e netback and s p o 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 w e r e 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 t h e n

i t s v a l u e s h o u l d on a v e r a g e be z e r o and s u c c e s s i v e v a l u e s of t h e
random term s h o u l d 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 1i 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 )
compared w i t h t h e "normal
abnormality derived.

could b e

m a r g i n " a n d a m e a s u r e m e n t of

Extreme d e v i a t i o n s would s y m b o l i s e changes

i n t h e market.
( i i ) Once t h e n o r m a 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 w e r e
e s t a b l i s h e d (al,

a2....)

t h e n we c o u l d compare a c t u a l margins t o

see whether one was u n u s u a l l y 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 b e e n 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 p r e s s u r e .

I t is i m p o r t a n t t o

r e c o g n i s e t h a t i f ut i s i n d e e d r a n d o m t h e n t h i s month's

values

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 m a r g i n 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 o n e 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 o v e r s h o o t i n g i n t h e next
period.

If

such 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 ) w o u l d 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 s u c c e s s i v e 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 r o m 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
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

spot price ( i e

l e v e l of t h e netback is c o n t a i n e d i n t h e s p o t p r i c e ) .

If either

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 o n t h e s p o t 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 not i n a d o l l a r for d o l l a r relationship):

Nt

= a

+ ( 1 + b ) St +

(5)

I n t h i s c a s e 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)

D e p e n d i n g on t h e s i g n of b t h e m a r g i n w o u l d t e n d t o n a r r o w o r
widen a t h i g h p r i c e s .

T h i s w o u l d 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 f o c u s on t h e s i z e of t h e c u r r e n t margin as an i n d i c a t o r
of whether t h e market was d i s t u r b e d would be m i s l e a d i n g

a high

v a l u e of t h e m a r g i n 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 c o u l d come about.

38

The s e c o n d c a s e (of

an o m i t t e d v a r i a b l e ) c o u l d b e

written:
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 used ( i n t h e form of t h e c u r e n t
margin) w i t h o u t 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 h e n a g a i n t h e a c t u a l margin c o u l d seem t o be

most u n u s u a l e v e n t h o u g h i t w o u l d b e 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 s u m m a r i s e , t h e u s e of t h e a c t u a l m a r g i n (N-S)

to

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

h a s a normal value.

This hypothesis p l a c e s strong 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 .

t h e r e s t r i c t i o n s can be shown n o t t o have h e l d ,
degree, i n the

If

t o a significant

p a s t t h i s w o u l d 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 g u i d e t o i n d i c a t i n g abnormal b e h a v i o u r i n t h e market

would have been i n c o r r e c t , and would s i m u l t a n e o u s l y s u g g e s 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 n o r m a 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 c o u l d be found.
The t e s t s of t h e b a s i c model have two f e a t u r e s .

First,

w e s h a l l j u s t e s t i m a t e t h e model as i t s t a n d s i n order t o s e e how

w e l l

it

f i t s t h e d a t a and,

r e l a t i o n s h i p i s s t a b l e o v e r time.

in particular,

whether t h e

Secondly we compare t h e model

w i t h more g e n e r a l models t o see whether they add e v i d e n c e a g a i n s t

t h e e x i s t e n c e of t h e s i m p l e 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

G i v e n 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
concept

(four

series

for

spot crude p r i c e s

and

s e v e n for

n e t b a c k s ) 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 e v e r y combination i n
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 ,

d e t a i l f o r each crude.
comparing t h e d i f f e r e n t

crude

prices

and

netback

values,

suggested t h a t p r i c e s S S I and SSM would be v e r y s i m i l a r (and that

SSP would a l s o be s i m i l a r except for 1979).

S i n c e 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 w i t h them.
w i t h i s more d i f f i c u l t .

The c h o i c e of which netback t o work

As between s o u r c e s it seems t h a t t h e two

s o u r c e s c o v e r i n g t h e l o n g e s t p e r i o d (PIW and t h e i n d u s t r y 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 is t h e n n e c e s s a r y t o choose
whether t o look a t complex or b a s i c r e f i n i n g , and a l s o t o choose
which r e f i n e r y l o c a t i o n t o d e a l with.

Complex r e f i n i n g became

i m p o r t a n t o n l y i n t h e l a t e r p a r t of t h e p e r i o d ,
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 .

s o i t seems

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
c o m p l e x 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 s o u r c e s (SNPIWR and SNRBI) f o r t h e
n e t b a c k s and hence f o u r combinations of r e g r e s s i o n t o b e t r i e d .
S i n c e 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
(0.21)

2.02

0.36

SNPIWR

SSI

-1.01

1.92

0.32

2.03

0.33

1.88

0.23

1.76

0.52

-0.52
(0.19)

1.77

0.58

(0.20)
SNRBI

-1.08

SSM

(0.21)
SNRBI

- SSI

-1.01

(0.20)
NNPIWR

NSM

-0.40
(0.19)

NIPTWR

NSI

NMRBI

NSM

0.14
(0.19)

1.80

0.52

NNRBI

NSI

0.02
(0.19)

1.77

0.62

T a b l e V I 1 1 g i v e s t h e r e s u l t s , w h i c h 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 o n a v e r a g e a r o u n d o n e
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 a s a w h o l e .

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.

T h i s i m p l i e s t h a t u s i n g a 95% c o n f i d e n c e i n t e r v a l

t h e a c t u a l margin c o u l d be expected to be i n t h e r a n g e of -$4.80

t o +$2.80

9 5 % o f t h e t i m e (-$6.70

t o $4.70 9 9 % of t h e t i m e ) .

Thus f o r t h e Arab L i g h t c a s e , i f t h e n o r m a l m a r g i n h y p o t h e s i s

were t o be a c c e p t e d as a long-run t r u t h , t h e n the r a n g e 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 b e c o n s i s t e n t
w i t h h i s t o r i c v a r i a t i o n would be v e r y l a r g e .

41

For t h e N i g e r i a n c a s e t h e normal margin 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 u s e d f o r t h e n e t b a c k .
The former i m p l i e s a margin some $0.50 lower on a v e r a g e t h a n t h e
latter.

The sampling v a r i a t i o n of t h e margin i s a g a i n v e r y wide

( a r a n g e o f a b o u t $7.2

i f a 95% i n t e r v a l i s t o b e u s e d ) .

The r a n g e 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 t h 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 e x p e r i e n c e , i f
t h i s m o d e l i s c o r r e c t , i s c l e a r l y t o o w i d e t o b e of any u s e at
all.

However, two factors s u g g e s t t h a t t h e m o d e l is s e v e r e l y

mis-specif ied.

is extremely

F i r s t l y , i n a 1 1 c a s e s t h e Durbin-Watson
low,

indicating

statistic

s e r i o u s mis-specification.

Secondly, a p l o t of t h e a c t u a l v a l u e s ( c e n t r e d on t h e e s t i m a t e d
normal margin) of t h e a c t u a l margin shows very s t r o n g e v i d e n c e of
s t r u c t u r a l breaks.

For e x a m p l e 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 h a s 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

p r i c e s c l e a r l y moved c l o s e l y t o g e t h e r and were on a v e r a g e n e a r l y

equal.

F o r a f e w m o n t h s a t t h e end of 1 9 7 8 and e a r l y 1 9 7 9 t h e

n e t b a c k margin was s t r o n g l y p o s i t i v e , and t h e n from June 1979 t o

J u n e 1 9 8 1 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 s p o t p r i c e (and w a s u s u a l l y more than $3 below).
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
below.

a t a v a l u e of a b o u t $1

S i m i l a r f i n d i n g s e x i s t f o r a l l f o u r combinations based o n

A r a b Light.

42

From

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
P r i o r t o t h e end o f 1 9 7 8 t h e r e was a s m a l l n e g a t i v e

similar.

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 1 9 7 9 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 spot price.
cents.

After t h a t d a t e t h e margin narrowed t o around 70

Again a l l s e r i e s show a s i m i l a r p i c t u r e .
These

large

and

rather

sudden

s h i f t s reject

the

h y p o t h e s i s t h a t throughout t h e p e r i o d t h e r e has been a normal

m a r g i n b e t w e e n t h e two s i d e s o f t h e m a r k e t .

The m a r g i n h a s

c h a n g e d , 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 each sub-period.

T h e f i r s t c h e c k w e m u s 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 1 9 8 0 , 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 h e n c e
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 c o v e 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).
i n 1979.

The f o r m e r s t a r t s i n 1 9 7 8 a n d t h e l a t t e r

B o t h 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 c a n 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 four s e p a r a t e episodes during t h e e i g h t year

period.

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 i n c r e a s e d s u b s t a n t i a l l y over p r e v i o u s
experience.

The n e x t b r e a k i s a s s i g n e d 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 J u l y 1 9 8 1 a p p e a r t o b e t h e b e g i n n i n g o f a n

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 1 9 8 1 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 a g a i n 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 ( w i t h

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 p e r i o d s , n o t only f o r a l l measures of

t h e margin b u t a l s o f o r d i f f e r e n t c r u d e s 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 i s i g n o r e d by t h e
I1

norma 1 margin" mode 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

m a r g i n " i s that a g i v e n m a r g i n i s 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 e p i s o d e 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 .
confirm our p r e v i o u s r e s u l t s

These r e s u l t s

t h e margins s h i f t from n e a r z e r o

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 r e s t of t h e period.

44

The v a r i a b i l i t y

TABLE IX: ESTIMATED B

W ZIBBGIBS FOB VARICHJS SUB-PKRImS

Depend en t
variables

Period

Const a n t

SNPIWR - SSM

76.01

78.10

S.E.E.

D.W.S.

0.32

1.15

2 .oo

1.71

1.36

1.21

0.73

1.36

0.53

0.39

2.16

2.13

0.93

1.24

0.73

1.45

(S.E.)

SNPIWR

SSM

78.11

79.05

SNPIWR

SSM

79.06

81.06

SNPIWR

SSM

81.07

83.06

NWIWR

NSM

76.01

NNPIWR

NSM

78.11

NAPIWR

NSM

79.08

81.02

MNPIWR

NSM

81.03

83.06

78.10
79.07

-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
(0.21)
-0.70
(0.14)

of t h e a c t u a l margin around t h e "normal margin" i s much g r e a t e r

d u r i n g t h e v e r y s h o r t p e r i o d 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 b e 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 s e c o n d o i l s h o c k , 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 .

This

e f f e c t p e r s i s t e d (on a v e r a g e ) from November 1978 u n t i l May 1979

(by w h i c h 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 ) .

At 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 s u p p l y w a s o c c u r i n g 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 period 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 t h e n 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 i g r i s e (December 1978
t o February 1979) and o n l y 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 p a s s - o n

a n t i c i p a t e d crude p r i c e rises.

of

the

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

a v e r a g e margin i n c r e a s e d by about $1, a l t h o u g h n e t b a c k was below

t h e spot price.
clearly

The b r e a k i n e a r l y 1 9 8 1 d o e s not c o r r e s p o n d t o

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 e x c e p t i o n a l l e v e l s of October and November).

The

s h a r p e s t permanent f a l l i n t h e s p o t p r i c e a p p e a r s t o h a v e been in
F e b r u a r y 1 9 8 2 b u t n o m o v e m e n t i n t h e m a r g i n seems t o b e
associated w i t h t h e data.
Nigerian Light.

The p i c t u r e i s e x a c t l y t h e same for

As t h e p r i c e r o s e s h a r p l y f r o m O c t o b e 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" i n c r e a s e d .

Once p r i c e s were s t e a d i e r from July 1979 t h e

m a r g i n 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 margin

improved by more t h a n $1 but t h e n e t b a c k was s t i l l below t h e s p o t

price.
Not s u r p r i s i n g l y ,

given the significant s h i f t s i n the

margin, t h e s t a n d a r d e r r o r s of estimates ( r e s i d u a l v a r i a t i o n )
around t h e margin i n t h e sub-periods

a r e v e r y much l e s s t h a n

t h o s e f o r t h e whole p e r i o d g i v e n i n T a b l e V I I .

Particularly for

t h e p r e - 1 9 7 9 p e r i o d t h e n o r m a 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 m a r g i n w o u l d h a v e b e e n b e t w e e n 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
situation.

46

A t p r e s e n t t h e r e seems t o be an e p i s o d e w i t h a range

of j u s t under $3 i n which t h e a c t u a l margin might b e expected t o

f a l l , w i t h o u t b e i n g s o u n u s u a l as t o a r o u s e s u s p i c i o n t h a t market
c o n d i t i o n s were changing.

Such a margin i s u s a b l e b u t c l e a r l y i t
The m o d e l s , a s

would be d e s i r a b l e t o narrow i t f u r t h e r s t i l l .
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 e p i s o d e v e r s i o n s of T a b l e VIII.

However,

t h e f i r s t sub-

p e r i o d ( p a r t i c u l a r l y f o r N i g e r i a n L i g h t ) s t i l l shows e v i d e n c e of
mis-specif i c a t i o n .
Similar tests are carried out for other refining
c e n t r e s for t h e f o u r sub-periods.
a r e remarkably c o n s i s t e n t .

The r e s u l t s shown in T a b l e X

The f i r s t e p i s o d e shows a s m a l l

n e g a t i v e margin w i t h a very c l o s e f i t .
very large r e s i d u a l

The second e p i s o d e has a

t h e m a r g i n shows n o 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 p o o r 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 p e r i o d f i t s a l m o s t 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 b e t w e e n $1 a n d $ 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 p e r i o d s a r e a p p a r e n t l y 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 c h e c k o n t h e a d e q u a c y of t h e m o d e l 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 o n e
c r u d e on t h e same concept for t h e o t h e r crude.

If t h e deviations

f r o m 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 h e s e c o n c e p t s
should not

be

correlated.

The

intercept

term

should

be

s i g n i f i c a n t ( b e i n g a n 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
m a r g i n s " f o r t h e p e r i o d ) , t h e s l o p e term s h o u l d b e z e r o .

Table

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
Locat ion

Period

Const ant

Caribbean

76.09

78.10

78.11

79.05

79.06

81.06

81.07

83.06

76.09

78.10

78.11

79.05

71.06

81.06

81.07

83.07

S.E.E.

D.W.S.

...................................................................

Persian
Gulf

-0.30
(0.07)
-0.10
(0.91)
-5.41
(0.35)
-2.10
(0.14)

-0.25
(0.03)
-0.97
(0.901
-3.72
(0.34)
-1.16
(0.18)

0.34

1.17

2.40

1.61

1.83

0.70

0.65

1.48

0.16

1.20

2.37

1.65

1.98

1.23

0.90

1.55

--------------------__L_________________-------------------------

Singapore

71.09

78.10

0.20

1.02

78.11

0.08
(0.04)

79.05

2.44

1.75

79.06

81.06

-0.39
(0.92)
-2.98
(0.37)
-0.93
(0.22)

1.87

1.33

1.10

1.58

-0.29
(0.06)
1.79
(0.66)
-3.81
(0.28)
-1.91
(0.12)

0.33

1.52

1.75

1.43

1.40

0.96

0.59

1.44

81.07

83.06

..................................................................
Italy

I'

48

76.09

78.10

78.11

79.05

79.06

81.06

81.07

83.06

WLE XI: BEGRESSIOB OF A U B LIGHT HARGIA OH BIGEBIAll LIGHT M E G I N

Dependent
Variable

Independent
Variable

SNPIWR

76.01
-78.10
78.11
-79.07

NNPIWR
NSM
NNPIWR

SSM

SNFIWR

- SSM
SWPIWR
- SSM

NSM

79.08

NNPIWR
NSH
NNPIWR
- NSM

SNPIWR

Per iod

SSM

-81.03
81.03

-83.06

The r e s u l t s

in

Constant
(SE)

S 1ope

(SE)

0.06

0.44

(0.04)
-1.06
(1.22)
-2.55
(0.50)
-0.84
(0.13)

(0.08)

Table X I

SEE

DWS

0.51

0.23

1.49

0.55

1.81

2.22

0.31

0.87

1.57

0.64

0.51

1.21

Sqd.
Correlation

0.87
(0.30)
0.61
(0.22)
0.92

(0.14)

show v e r y

clearly

that

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

the four episodes.

That is,

i f the netback i s

p a r t i c u l a r l y h i g h 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 b e 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 t h e r crude.

The h i g h 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 c a s e , t h e n

a s h a r p e 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

costs.

Effectively

'disequilibrium'
'disequilibrium'

in

it

means

one

crude

that

whatever

market

also

causes
creates

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
each crude viewed 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 s p o t n e t b a c k s and s p o t c r u d e s i s n o t supported by
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 w h i c h t h e

the data.

margin has s h i f t e d very considerably.

This points t o

the

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 b e 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 b e h a v i o u r 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 .

F u t h e r t e s 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 f r o m t h e "normal

margin" f o r a g i v e n sub-period
crudes.

were s t r o n g l y c o r r e l a t e d between

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

systematic variables involved.

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 of
c o n s i d e r a b l e refinement,

t h e market

is c a p a b l e o f

b u 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

Figure

N e t b a c k Margin Inetback l e s s spot)

for A r a b L i g h t

1980

-2

-3

-'t

-2

-0

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 b e e x p e c t e d t o move
together, with a

c o n s t a n t margin between them.

However,

since

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 c o m p l e x 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 r e q u i r e d .

We

s t a r t w i t h s i m p l e a n a l y t i c a l models and t h e n 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 h o s e 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 e q u i l i b r i u m w i t h 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

w h e r e 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
instantaneously t o equilibrium.

I n s u c h a c a s e t h e (assumed)

p r o f i t maximising b e h a v i o u r 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 w h a t t h e c r u d e i s
w o r t h t o them a t t h e m a r g i n .
s t a r t i n g point for a l l

OUT

T h i s MC=MR

analysis.

c o n d i t i o n is t h e

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 t h e buyers may b e b i g enough t o a f f e c t t h e p r i c e

(ie

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 c e ) .

However, w e

know t h a t t h e m a r g i n a l 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

t h a n or e q u a l 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 c o s 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 u s e d 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 b e t w e e n i n p u t s ( i e
between crude, l a b o u r , 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 s u m p t i o n 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 we

s t i c k t o t h e c a s e of b a s i c r e f i n i n g for t h e moment t h e n the z e r o

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 i m p 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 p r o p o r t i o n s .

Hence w e can d e r i v e

t h e t o t a l s h o r t - r u n m a r g i n a l c o s t by adding m a r g i n a l t r a n s p o r t ,
i n s u r a n c e and r e f k i n g c o s 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 l o w i n g 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 i s demand e l a s t i c i t y f o r t h e

p r o d u c t s (as t h e r e i s ) 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
( a s they o f t e n a r e ) t h e n the m a r g i n a l r e v e n u e from s a l e s w i l l b e

l e s s t h e n t h e p r i c e of t h e sales:
pp

52

MRP

(9)

Combining e q u a t i o n s (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 = transport
R = refining
Pp

- HCT - MCR

where

N > Pc

(11)

N = netback
P = price
MC = m a r g i n a l c o s t s

Hence t h e n e t b a c k s h o u l d b e 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 c r u d e 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
b e h a v i o u r of t h e a g e n t s .
i n t h e margin (N

The r e a s o n s i n t h i s model for changes

- 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 b e 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 c o n c e n t r a t i o n , t h e d e g r e e 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 c h a n g e 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 c a n b e 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 s h o r t - r u n m a r g i n a l c o s t c u r v e c o r r e s p o n d i n g t o
t h e ( f i x e d ) amount of c a p i t a l g e n e r a t i n g t h a t o u t p u t a t minimum

53

cost.

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 l o n g - r u n

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 from
v a r i o u s 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 m a r g i n a l c a p i t a l c o s t s , b u t a l s o
a l l o w i n g f o r m a r g i n a l b e n e f i t s i n c o s t s from v a r y i n g t h e i n p u t
mix i e
output).

u s i n g r e l a t i v e l y l e s s crude t o produce t h e same v a l u e of

T h i s s i m p l e d i s c u s s i o n o m i t s 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 m o d e l 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
If

normal margin" approach.

However, as we c a n s e e 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 margin i s o f t e n

n e g a t i v e a n d 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 nonrandom d i s c r e t e f a s h i o n w h i c h 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 c o n c e n t r a t i o n , e t c .

A very important aspect

of s u c h a m o d e l i s t h a t i t d o e s n o t i m p l y a n y c a u s a l i t y

eg

t h a t p r o d u c t p r i c e changes c a u s e crude 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 n o n - i d e n t i c a l
b u y e r s w i t h crude s o l d a t a single p r i c e .

A n 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 ( w h i c h w e
a r e t a k i n g as t h e buyer of c r u d e and s e l l e r of p r o d u c t s )

not a l l f i r m s have i d e n t i c a l c o s t s t r u c t u r e s .

is that

Some p l a n t s are

o l d e r t h a n o t h e r s and t e c h n o l o g i c a l a d v a n c e s of a g i v e n d a t e a r e
not incorporated i n p l a n t s b u i l t a t e a r l i e r dates.

Hence, w e

m u s t e x a m i n e 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.
There

is,

of

e m p i r i c a l consequence

course,

an

i m m e d i a t e and

important

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 f o r m 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
t h e h i g h e s 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 m a r g i n a l , t h e n it would b e c o r r e c t t o t a k e

fixed

input/output

( y i e l d ) coefficients t o calculate the

a p p r o p r i a t e margina 1 c o s t s .
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
questions:
( i > 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
some a v e r a g e i n t r a - m a r g i n a l f i r m ?
( 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 c o n s t a n t ?

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
s h o u l d 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 i m p r o v e d o v e r the p e r i o d , t h e g a p
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 m a r g i n a l and

55

changing y i e l d p l a n t s s h o u l d narrow.

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 w o u l d be e x p e c t e d t o
narrow over t h e p e r i o d ( i e

to fall).

Of c o u r s e t h e m a r g i n s of

h i g h e 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

fixed y i e l d b a s i c r e f i n i n g p l a n t , but

b o t h should f a l l o v e r time.

Thus big s h i f t s i n demand o r s u p p l y

which changed t h e m a r g i n a l p l a n t s u b s t a n t i a l l y would b e expected

t o b e r e f l e c t e d i n t h e m a r g i n for a f i x e d t e c h n o l o g y i n t r a marginal plant.
(c>

S t a t i c e q u i l i b r i u m w i t h many m a r k e t s of n o n - i d e n t i c a l buyers
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
g e o g r a p h i c a l 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.

w i d e r a n g e of m a r k e t s .

Data i s a v a i l a b l e on product p r i c e s i n a

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

r e v e n u e from r e f i n i n g a b a r r e l of c r u d e 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 c o n d i t i o n s and s o l d a t l o c a l p r o d u c t p r i c e s ,
when n e t t e d b a c k t o t h e p o i n t of s a l e m u s t e q u a l t h e m a r g i n a l
c o s t of 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 e q u a l i n s t a t i c e q u i l i b r i u m .

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 from a n a l y s i s of 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 .

We do

not need t o c o n s i d e r 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 p r i c e s

i n equilibrium.

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

high but certainly not perfect,

56

for d i f f e r e n t c o u n t r i e s e g

S N P I W R and S N P I W U and S N R B I and SNRCI.

t h e US

However, i n b o t h c a s e s

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

are for basic refining,

than the other.

so one is d e f i n i t e l y more i n t r a - m a r g i n a l

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 i n i n g .

However,

once w e admit 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
countries, then

f o r t i o r i they a r e l i k e l y t o d i f f e r between

countries, I n e q u i l i b r i u m only t h e highest c o s t remaining p l a n t

in t h e world i s m a r g i n a l and a l l o t h e r s a r e i n t r a - m a r g i n a l .
differing

The

d e g r e e s of i n t r a - m a r g i n a 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 v a r i o u s netbacks.

T h i s 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
price should be investigated.

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 m a r g i n b e t w e e n the n e t b a c k for a g i v e n

r e f i n e r y 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 e v i d e n c e on t h e v a r o u s PIW n e t b a c k s i n

order t o f i l l out the picture.

Id)

S t a t i c e q u i l i b r i u m with many m a r k e t s of n o n - i d e n t i c a l buyers

and more t h a n one crude ( e a c h 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 m a r k e t ( w h i c h 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 c o m m o d i t i e s ) i s t h a t c r u d e o i l f r o m
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

m e a n s t h a t t h e m i x 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 t h 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 e a c h 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 m o s t 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 from c h a n g i n g t h e

y i e l d s a t t h o s e p r i c e s a r e j u s t e q u a l t o t h e m a r g i n a l c o s t s of s o

If r e f i n e r i e s a r e crude s p e c i f i c ,

doing).

as t h i s a n a l y s i s

t h e n f o r e a c h crude t h e r e w i l l b e a m a r g i n a l r e f i n e r y

suggests,

and t h e m a r g i n a l r e v e n u e f r o m t h i s r e f i n e r y w i l l e q u a l t h e
m a r g i n a l c o s t s of t h e crude.

Hence t o g e n e r a l i s e e q u a t i o n (11)

t o t h e case of two c r u d e s w e would have:

Pp ( 1 )

MCT (1)

- MCR

(1) = N (1)

> Pc (1)

Pp ( 2 )

MCT ( 2 )

(2) = N (2)

> Pc ( 2 )

M$

(12)

The two margins r e f l e c t t h e c o n c e n t r a t i o n on b o t h s i d e s (of t h e

c r u d e b u y e r s a n d 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 .

In the

same product market w e would e x p e c t 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 c o n c e n t r a t i o n a r e more l i k e l y t o v a r y between

p u r c h a s i n g l o c a t i o n s f o r d i f f e r e n t crudes.

Hence e v e n 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 s h o u l d be s t a b l e u n l e s s c o n c e n t r a t i o n changes in

one market r e l a t i v e t o t h e o t h e r .
If t h e data a r e f o r fixed technology intra-marginal

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 n a r r o w , w h i l e t h e
d i f f e r e n c e b e t w e e n m a r g i n s s h o u l d remain s t e a d y ( 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 l e s s
equally

.
Geographical s e p a r a t i o n of p l a n t s s h o u l d n o t c o m p l i c a t e

58

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 e q u i l i b r i u m w i t h many markets of n o n - i d e n t i c a l buyers

and more t h a n one crude w i t h each crude s o l d on a two-tier
p r i c e system.
We begin w i t h t h e s i m p l e s t c a s e 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 w h i c h w e s h a l l d e n o t e " o f f i c i a l " and "spot".

o f f i c i a l p r i c e i s t h a t of a government agency

The

i t i s p r e s e t and

which i s l i k e l y t o remain c o n s t a n t for l e n g t h y p e r i o d s , 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 r e l i m i n a r y t e s t s h a v e 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 o i l 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
(1976) 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 a n d
spot-related

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 o u 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.
Since w e a r e d e a l i n g with e q u i l i b r i u m s i t u a t i o n s w e
n e e d 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
p r o d u c t can be s u s t a i n e d ( w i t h t r a d e c o n t i n u i n g a t b o t h prices).

59

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 b u t b o t h 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 t h a n

t h e r a t i o n e d supply t h e n t h e s p o t p r i c e w i l l b e f o r c e d above t h e
o f f i c i a l price.

I n such c i r c u m s t a n c e s t h e s p o t p r i c e is t h e t r u e

m a r g i n a l concept and t h e n e t b a c k should be r e l a t e d s o l e l y t o t h e

spot price.

This looks l i k e t h e c l a s s i c case of a d i s c r i m i n a t i n g

p r i c e s t r u c t u r e where by t h e p r o d u c e r s of crude h a v e market power

in t h e t i g h t m a r k e 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
q u o t a s 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 o n t h e s p o t m a r k e t d i d n o t come d i r e c t l y f r o m t h e
p r o d u c e r s b u t from b u y e r s of c r u d e who r e s o l d a t h i g h e r p r i c e s .
S i n c e o i l , u n l i k e e l e c t r i c i t y , i s r e s a l e a b l e t h e r e is
t h e n t h e f u r t h e r problem of how the p r i c e s were k e p t a p a r t .

This

w a s done by t h e producers u s i n g 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 a u s e s ) t o s t o p t h e buyers of c r u d e 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 g o o d w i l l on

being c a u g h t i n t h e a c t 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
price 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 persist.

In s u c h a s i t u a t i o n ,

although actual

spot crude

t r a n s a c t i o n s w e r e r e l a t i v e l y uncommon, t h e s p o t p r i c e w a s t h e
genuinely marginal price.

I f a t y p i c a l company suddenly needed

more c r u d e i t w o u l d h a v e h a d t o buy i t o n t h e s p o t m a r k e t .
However,

the s e l l e r would v e r y l i k e l y h a v e b e e n a n o t h e r company

r a t h e r t h a n a producer of crude.

The normal m a r g i n between s p o t

p r o d u c t s and s p o t crude c o u l d h a v e been expected t o h o l d d u r i n g

60

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 o n e 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
o f f i c i a l price).

than the

The n o r m a l m a r g i n w o u l d n o t b e d i s t u r b e d by

small changes i n q u o t a s , o f f i c i a l p r i c e s o r demand ( e v e n 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 e c e of a n a l y s i s s i n c e i t shows why t h e p r o d u c t p r i c e

w o u l d n o t b e 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 prices.

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 c o u l d 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 .

With 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 w o u l d b e e x c e s s s u p p l y , a n d 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 c o n s u m e r s w o u l d 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
w o u l d 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 b o u g h 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 w o u l d 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

e m p i r i c a l p u z z l e 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
h a v e 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 h a v e n o t been b i d up by demand s w i t c h i n g e n masse
from t h e o f f i c i a l t o 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 g r o w t h 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 of o i l i s s o l d a t o f f i c i a l
prices.
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

61

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 monetary
cost:
(i)

t h e r e a r e 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

s o u r c e of purchase;
(ii)

t h e r e a r e " i n s u r a n c e " g a i n s t o b e made i n

b u y i n g f r o m 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 uncertainty.

So, i f i t t o o k t h e b u y i n g d e p a r t m e n t of a company some t i m e t o

overcome i t s a d h e r e n c e 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 s p o t
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 b e a g r a d u a l move t o

using t h e s p o t 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 .
i m p l i c a t i o n of

One

t h i s l i n e of a r g u m e n t m u s t b e t h a t t h e s p o t

m a r k e t , o n c e 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
important.

The b u y e r s w i l l n o t f o r g e t how t o u s e i t when i t

would be t o t h e i r a d v a n t a g e t o do so.
However, we do n o t 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
between 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
time.

Our second r e a s o n , t h a t of buying o f f i c i a l a s a n i n s u r a n c e

premium, w i l l s t i l l b e v a l i d e v e n when b u y e r s a r e p e r f e c t l y
f a m i l i a r w i t h t h e s p o 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

a b o u t 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 b e i n g 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 s o u r c e of s u p p l y for a l i t t l e
extra profit.

Hence w h i l e memories of e x c e s s 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 crude,

However,

a s 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
reverse.

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 customers (not t o a11 purchasers) t o attempt t o reduce

his revenue uncertainty.

T h i s would tend 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 p r i c e .

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 o n 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 ( h a v i n g seen why t h e
buyer may be prepared t o buy a t b o t h p r i c e s ) .

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 i s t h a t t h e
s a l e s on s p o t a r e p u r e l y by d i s t r e s s p u r c h a s e r s who have bought
t o o much o f f i c i a l .
official

The second p o s s i b i l i t y is t h a t t o o 'high" an

p r i c e may mean

l o s t s a l e s ( a n d r e v e n u e ) and

t e m p t a t i o n f o r o n e of t h e c a r t e l t o ' ' c h i s e l ' '

the

in a discrete

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 b e v e r y
strong.

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 n e t b a c k and t h e p u r c h a s e 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 s p o t p r i c e i s below t h e o f f i c i a l p r i c e .
C l e a r l y t h e s i m p l e s t argument would be t h a t t h e lower p r i c e
( s p o t ) is t h e m a r g i n a l c o s t and hence t h e n e t b a c k s h o u l d a g a i n be
r e l a t e d s o l e l y t o the spot price.

However, o u r a r g u m e n t 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 i n v o l v e d .

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 a n d 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 c u s t o m e r f o r t h e c r u d e a t

63

o f f i c i a l prices).

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 c o m p o n e n t s ( w i t h s h a r e s a d d i n g u p t o one h u n d r e d
per cent).

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 t h e

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 b e 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 s p o t a n d
o f f i c i a l p r i c e s whenever t h e s p o t p r i c e f a l l s below t h e o f f i c i a l
price.

This is a l s o a t e s t a b l e h y p o t h e s i s ,

s i n c e t h e p e r i o d s 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

issue

of

two-tier

pricing

raises

further

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.

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

If

their

respective o f f i c i a l prices then we could appeal t o the p o r t f o l i o

argument f o r b o t h crudes.

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 m i g h t 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 k e e p 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
extra refining costs.

A p o r t f o l i o would 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 spot p r i c e ( i n e q u i l i b r i u m s p o t
p r i c e s a r e d r i v e n t o a p o i n t where buyers a r e 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 c h o i c e e x c e p t
r e l a t i v e prices).

The netback would a l s o h a v e t o be a d j u s t e d t o

i n c o r p o r a t e t h e m i x t u r e 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 i d e a b u t merely acknowledge i t s e x i s t e n c e .

The p o r t f o l i o p u r c h a s i n g a r g u m e n 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 c e .
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 r e d i c t e d t o happen when t h e s p o t crude p r i c e f a l l s

64

below t h e o f f i c i a l p r i c e i t 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
price.

This e s t a b l i s h e s a n argument o r a margin l a r g e r t h a n

t h a t due s o l e l y t o t h e competitive s t r u c t u r e ,
argument f o r a v a r y i n g margin.

and a l s o a n

The l a t t e r c e r t a i n l y a c c o r d s

roughly with t h e empirical evidence presented e a r l i e r ,

that the

m a r g i n i m p r o v e d 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 w h i c h

t h e s p o t p r i c e moved below t h e o f f i c i a l p r i c e .

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 E q u i l i b r i u m w i t h a s i n g l e c r u d e and w i t h p r o d u c t s
s o l d t o more t h a t one c l a s s of u s e r
So f a r t h e a n a l y s i s has c o n c e n t r a t e d on t h e c a s e where

t h e r e f i n e d products a r e s o l d t o a 'final'

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 m a r k e t t h a t h a v e c h a n g e d o v e r t h e p e r i o d a n d w h i c h a

s i m p l e a n a l y s i s does n o t b r i n g out.
(1)

(2)

Some p r o d u c t s a r e s o l d as i n t e r m e d i a t e i n p u t s
naptha f o r
t o r e f i n e r i e s t h e m s e l v e s (eg
f i n i s h e d g a s o l i n e ) and as a p r o p o r t i o n 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
a n d d o w n s t r e a m ) s o t h a t some c r u d e i s b e i n g
c o n v e r t e d i n t o p r o d u c t s w i t h o u t going through
a n a c t u a l market.

The f i r s t c a s e w h e r e 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 o n t o t h e market b u t some is f u r t h e r c o n v e r t e d does s u g g e s 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 b e made on t h i s second r e f i n i n g
stage.

However, i n a c o m p e t i t i v e model, t h e w i l l i n g n e s s t o buy

p r o d u c t whatever i t s u s e i s t o b e 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 r o m a l t e r n a t i v e u s e s
e q u a l s o t h a t t h e s p o t p r i c e is s t i l l a m a r g i n a l 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 b e t h i n a t
c e r t a i n t i m e s but t h i s should not d i s t o r t the analysis.
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 p r o d u c t s 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
o u t p u t of p r o d u c t s i e
a 'smaller'

a group of n o n - p r o f i t

market f o r o t h e r f i r m s .

maximisers may l e a v e

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 s h o u l d s t i l l d r i v e
m a r g i n a l r e v e n u e e q u a l t o m a r g i n a l 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 output).

We s e e 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 o b s e r v e 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 c o n s i d e r 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 h a n o n t h e spot market.

Clearly the

spot market is the c o r r e c t marginal concept i f spot product

prices a r e above c o n t r a c t product p r i c e s .

However

if

the

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 would 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

m i g h 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 w o u l d 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
product p r i c e i s always t h e marginal concept.

However t h e r e

c o u l d b e a p o r t f o l i o s e l l i n g a r g u m e n t f o r p r o d u c t s j u s t a s for
buying crude.

Since t h e advantages f o r a c o n t r a c t a r e not j u s t

t h e p r i c e r e c e i v e d b u t a l s o a measure of c e r t a i n t y , a s e l l e r (who

66

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

i m p l y 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 product p r i c e o v e r s t a t e s t h e revenue on 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 e a s o n t o e x p l a i n

a s p o 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

price.

However i f t h i s d i d h a p p e n 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 w e r e s e l l e r s a b l e t o
obtain t h i s price.

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 b u t 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 need t o argue t h a t spot product p r i c e s could f a l l
below a c o n t r a c t p r i c e i f s e l l e r s are 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 price.

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 product 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 below t h e
contract price.

Since contracts themselves 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 i t 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 w o u l d 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 p r o d u c t p r i c e s a r e t h e r e l e v e n t m a r g i n a l revenue.

To

summarise we have argued t h a t i f s p o t p r o d u c t i s below c o n t r a c t

p r i c e t h e n t h e former i s marginal w h i l e i f t h e s p o t product i s
above c o n t r a c t p r i c e s t h e t r u e m a r g i n a l r e v e n u e 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

se1l i n g ) .

N e i t h e r c a s e s u g g e s t s a n 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 ( w h i c h is b a s e d

on spot p r o d u c t

prices)

could

u n d e r s t a t e d and hence why t h e r e is a n observed n e g a t i v e margin.

67

be

(g)

Short-run dynamics w i t h a s i n g l e crude t r a d e d a t a s i n g l e

price.
While we d i s c u s s t h e model i n e q u i l b r i u m w e do n o t have

t o s p e c i f y a n y t h i n g about t h e mechanisms of s u p p l y 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 m a r k e t a r e b r o u g h t i n t o
equilibrium.

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 i n d e e d 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 fashion.

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 h e n 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 o n a v e r a g e 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 ( b u t 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
supply

shifts

i n t h e period).

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 c a n
recognise that

their

existence w i l l

produce a dynamic

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 c e s .

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 r a n s f o r m a t i o n of c r u d e i n t o p r o d u c t s .

Once t h e c r u d e i s s o l d ,

i t w i l l n e e d t o b e t r a n s p o r t e d f r o m 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 centre.

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 R o t t e r d a m t h i s m a y t a k e u p t o s i x weeks.

The

l a g on spot p u r c h a s e s 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 c a r g o 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
b e t w e e n z e r o a n d s i x weeks, g i v i n g a mean l a g of u p 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 o n l y g r a d u a l l y used t o produce products. There w i l l be some

68

i n v e n t o r y of p r o d u c t s which produces a f u r t h e r d e l a y b e f o r e 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.
This production l a g i n t r o d u c e s a problem not o f t e n
faced

i n elementary

economics,

passing-on of p r i c e i n c r e a s e s .

t h a t of

t h e t i m i n g of

the

Whatever p r i n c i p l e of p r i c i n g 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 01i 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 b e t w e e n LIFO and F I F O p r i c i n g
rules.

I f FIFO p r i c i n g i s u s e d 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 p e r i o d of p r o d u c t i o n ( i n c l u d i n g t h e two i n v e n t o r y

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 ) .
o t h e r extreme,
increases are
increases.

i f LIFO p r i c i n g i s u s e d
immediately

registered

in

t h e n c o s t of
price

At the
crude

of p r o d u c t

The s p i r i t of a r g u m e n t s u s e d t o d e s c r i b e p e r f e c t

competition suggests t h a t

FIFO w o u l d 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 p r i c e s 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 i g h e r c o s t s f o r c e d them (and c o m p e t i t o r s ) 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 v a r y 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
cost increases,

eg

d e v a l u a t i o n s , a r e announced) b u t i t does n o t

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 m a r k e 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 b e some l a g i n t h e p a s s i n g o n o f
c o s t s ( c r u d e p r i c e s ) t o r e v e n u e s (product p r i c e s ) when t h e r e 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
least f a i r l y often,

t h e r e may b e s o m e 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 t e m p t t o smooth o u t s h i f t s in c o s t s .

This f a c t o r would perhaps

69

allow longer

l a g s b e t w e e n c h a n g e s 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 t h a n 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

s u p p l y s i d e , which produce changes in c r u d e p r i c e s and which are

t h e n t r a n s m i t t e d t o product p r i c e s .

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 ( a s w e l l a s some o f t h e l o n g e r r u n 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 r o m 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 e c o n o m i c 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 unless:

( 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 t h a n
demand, and i n v e n t o r i e s a r e used t o a b s o r b 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 e d u c t i o n i n t h e q u a n t i t y of crude purchased.

Most of t h i s w i l l

be f e l t on t h e o f f i c i a l market 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
marginal s p o t market.
about.

Hence

f a l l i n s p o t p r i c e s w i l l come

A g a i n 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 p r o d u c e r s t o
l i v e w i t h 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
fashion.

S u p p o s e demand f o r p r o d u c t s f a l l s

f a l l i n prices a t existine, costs.

t h i s leads t o a

The f i r m s a l s o d e c i d e t o

r e d u c e t h e i r purchases of crude, which lowers t h e c r u d e p r i c e and

w i l l a f f e c t t h e p r o d u c t p r i c e , magnifying i t s i n i t i a l f a l l .

70

Hence a l t h o u g h w e n e e d 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 a n d demand
adjustment process.

c u r v e s w e c o u l d model

the

The g e n e r a l s t r u c t u r e w o u l d b e a p a i r of

dynamic e q u a t i o n s :

.....>
st,2
....1

f (Nt, N t - l

St

Nt = f ( S t +

(13)

where t h e l a g s a r e l o n g enough to c a t c h a l l t h e d e l a y e d r e s p o n s e
f r o m a s h i f t o n o n e 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 o n
t h e o t h e r side.

The feedback e f f e c t s would of c o u r s e be c a p t u r e d

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 t h e s e e q u a t i o n s would be t h e s u p p l y and demand s h i f t i n g

variables.

The problem w i t h t h e s e e q u a t i o n s is one of e s t i m a t i n g

s t r u c t u r a l parameters w i t h o u t exogenous v a r i a b l e s .

s e t were l e s s a m b i t i o u s i e

If the task

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 o n

e i t h e r s i d e of t h e market t h e n t h e r e is some way forward.

T h e s e 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 n o t n e c e s s a r i l y be a good e s t i m a t o r f o r t h e "normal
e q u i l i b r i u m " margin because

of

t h e o m i s s i o n of

the

lagged

v a r i a b l e s which r e l a t e t h e two concepts.

(h)

S h o r t r u n dynamics w i t h a s i n g l e crude t r a d e d a t two prices.

I f t h e s p o t p r i c e were always above t h e o f f i c i a l p r i c e ,

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 d y n a m i c a n a l y s i s w o u l d
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 a s i n t h e
previous section.

Even i f

t h e o f f i c i a l p r i c e changed

the

r e l a t i o n b e t w e e n t h e two w o u l d b e u n a l t e r e d a c c o r d i n g t o t h e
arguments p u t forward ( a l t h o u g h t h e l e v e l of t h e s p o t p r i c e would
change).

THe matter i s o b v i o u s l y l e s s s i m p l e i f t h e s p o t p r i c e

71

were below t h e o f f i c i a l p r i c e .

Both lagged p r i c e s s h o u l d 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 b e t w e e n 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 c r u d e s 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 monthly d a t a ) t h e l a g from o f f i c i a l p r i c e s t o
netbacks may b e 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 > S h o r t r u n dynamics w i t h more t h a n one c r u d e .

Although t h e adjustment process f o r a given crude is

f a i r l y easy t o f o r m u l a 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

general.

Demand shocks a p p l y t o p r o d u c t s 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 n e t b a c k s very s i m i l a r l y i n t h e s h o r t
run.

Shocks w h i c h a r e p r o d u c t

specific w i l l

affect

netbacks which a r e most i n t e n s i v e i n t h e product concerned.

those

Thus

w e have four cases:

( i ) g e n e r a l demand s h i f t s w h i c h a f f e c t a 1 1 n e t b a c k s
equallly ;
( ii)

p r o d u c t - r e l a t e d 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 ;

(iii)

g e n e r a 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 e v e n l y ;

(iv)

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 o n e
crude most.

While t h e new s e t of e q u i l i b r i u m p r i c e s and n e t b a c k s 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 market 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

of adjustment i s p o s s i b l e t o model, 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

72

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 s h o c k s i n a s p e c i f i c g e o g r a p h i c a l
market 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 r o c e s s would be t r i c k y t o h a n d l e 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

there are o m i t t e d costs.
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

being below crude p r i c e s f o r a p e r i o d up 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

m a r g i n a l r e f i n e r y might w e l l show a n e v e n g r e a t e r m a r g i n a l 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

t y p e of p r o f i t maximising behaviour t h a t we h a v e so f a r assumed 5

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 t y p e s of c o s 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
mothballing costs.

I f f i r m s 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

i s 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
mothballs etc).

However i n b o t h t h e c a s e of a f a l l i n demand

t h a t i s s e e n 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
c o n d i t i o n s under which exit would s t i l l b e t h e b e s t p o l i c y .
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.

We

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 , which i s s e e n a s permanent.

The e x i t r u l e of

elementary economics s u g g e s t s t h a t i f a v e r a g e r e v e n u e does n o t

c o v e r a v e r a g e v a r i a b l e c o s t s t h e n t h e r e s h o u l d be immediate e x i t

otherwise 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 element

has become v a r i a b l e .

However i f t h e o p p o r t u n i t y 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 .

f o r which f u t u r e y e a r

it

is

T h i s needs t o ask

l o s s 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 o p e r a t i n g l o s s is c o n s t a n t (and

i s t h e minimum t h a t can be o b t a i n e d ) .

Then t h e DCF is c a l c u l a t e d

f o r a series of h y p o t h e t i c a l s h u t down years.

If i n the current

p e r i o d 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 z e r o t h e

whole p r o c e s s i s t a k e n forward one y e a r w i t h 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
w e r e 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 b e
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 t h e n
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 y e a r s

( t h e l o s s being even b i g g e r i f i t s h u t down immediately).

C l e a r l y 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 p i c k up a g a i n and t h e r e a r e r e - e n t r y

c o s t s (which

probably i n c r e a s e t h e l o n g e r 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 p e r i o d d u r i n g which a l o s s would be s u s t a i n e d w i t h t h e
p 1a n t running.

74

However t h e r e i s 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 MC=MR 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

I f t h e p l a n t i s t o be o p e r a t e d i t should s t i l l be r u n t o

period.

m i n i m i s e l o s s e s and t h i s w o u l d b e w h e r e M C = H R

ie

exit costs

can e x p l a i n t h e p e r s i s t e n c e of a v e r a g e l o s s e s but n o t marginal

10sses

.
I t 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 plant.

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 n o t 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 i s s u e s .

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 o u t p u t (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 m a r k e 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 prof 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 it maximising 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 m a r g i n a l l o s s e s .

75

B.5

FIIII'PHBB STATISTICAL TESTS ON THE RELBTIONSEIPS BETUEEA

PRODUCT AND CRUD3 PRICES

B 5 1 AlU UBCORSS1BBIl!lED BEIATIOHSEIP

I

The s t a t i s t i c a l a n a l y s i s so f a r h a s r e l a t e d t h e n e t b a c k
t o t h e s p o t crude p r i c e 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 s c u s s e d t h e r e l a t i o n s h i p between m a r g i n a l r e v e n u e and m a r g i n a l
Given t h a t t h e netback i s a p u r e l y c o n s t r u c t e d series it

cost.

is important t o c o n s i d e r whether i t can be used a s a measure of

m a r g i n a l revenue ( w i t h 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 h e n w e h a v e shown a v e r y g r e a t

d e g r e e of concordance on t h e measurement of t h e s e r i e s from v e r y

d i f f e r e n t sources.
be c o n c e p t u a l

The problem,

if it e x i s t s , is more l i k e l y t o

we have already discussed the d i f f i c u l t i e s

a s s o c i a t e d w i t h c h o i c e 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 of t h e a s s u m p t i o n of
fixed coefficient technology.

We c a n n o t a s s e r t t h a t w e h a v e

m e a s u r e d 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
o b t a i n e d t h e b e s t estimates a v a i l a b l e a t p r e s e n t .

A l l inferences

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
the analysis.

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 below 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 conceptional mis-specif i c a t i o n then 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 .

76

The r e v e n u e f i g u r e s ,

b e i n g based on product v a l u e s and a v e r a g e y i e l d s can s c a r c e l y be

t o o low f o r t h e m a r g i n a l r e f i n e r y ( e v e n though t h e y a r e c l e a r l y

lower than 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

are perhaps 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 r o d u c e a
p o s i t i v e margin would need t o a l m o s t d i s a p p e a r .

Clearly there 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 c o n c e p t i o n a l 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 r e v e n u e s .
B e f o r e we i n t r o d u c e 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 s p o t crude p r i c e i n i t s

l e a s t r e s t r i c t e d form ie:
Nt = a + bSt + ut

(14)

Given 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 between

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 l o n g e s t r u n s 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
acceptable.

The r e s u l t s a r e shown i n T a b l e X I I .

77

TABLE XII: Relations between Hetbacks and Spot Crude Prices

For Arab Light

Dependent
Var i a b l e

SNPIWR
SPJPIWR
SNRBI
SNRBI
SNPrWR
SWPIWR
SNRBI
SNRB I
SNPIWR
SNP IWR

SNRBI
SNRBI
SNPIWR
SNPIWR
SNRBI
SNRBI

Period

Constant

S 1o p e

SEE

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)
0.996(220)
1.08(10.8)
1.009( 239)
O.gO(8.5)
1.06(25.7)
0.84(10.2)
1.04(32)
0.79(8.4)
0.90(129)
O.gl(9.4)
0.90(146)
0.97(12.6)
0.96(203)
0.93(13.7)
0.97I236)

0.30
0.33
0.30
0.30
2.1
2.9
1.7
2.3
1.22
1.26
1.13
1.11
0.74
0.72
0.64
0.63

Independent
Variable

S SM
S SM

SSI

s SI
SSM
S SM
SSI

ssz
S SM
SSM
SSI

SSI
S SM
SSM
s SI
SSI

-0.9(0.7)
6.7(3.0)
5.1(2.6)
5.0(1.5)
-0.3(0.1)
-0.3(0.1)
1.16(2.1)

DWS

1.44
1.14
0.96
0.92
1.59
0.93
1.36
0.76
1.18
1.23
0.77
0.77
1.32
1.31
1.41

1.45

The r e s u l t s of t h e unconstrained model a r e u s e f u l l y

compared w i t h t h e c o n s t r a i n e d model :

f o r which t h e r e s u l t s were g i v e n i n T a b l e IX.

The d i f f e r e n c e

between t h e s e 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

the spot price.

The u n c o n s t r a i n e d 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.

S i n c e 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 r o m z e r o
t h e model is then c o n s t r a i n e d 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

sources.

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 general t h e industry 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 p e r i o d s 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

b e t w e e n 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 m a r g i n " m o d e l i s n o t r e m o v e d by
generalising t o the "spot-related

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 i s v e r y d i f f e r e n t from t h e

other periods.

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 model, 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 .

Even 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 , a n d 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
unity.

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

We c a n 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 i n d u s t r y

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
n e t b a c k i n c r e a s e d $1.01 f o r e v e r y d o l l a r r i s e i n s p o t p r i c e s ;

1979.06 t o 1981.06 t h i s margin w a s down to $0.90;

i t had r e c o v e r e d t o $0.97.

in

and f o r 1981.07

Given t h e v e r y s m a l l s t a n d a r d 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 ,
a n d 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 " s p o t 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 i m a t e s for t h e s e

t h r e e sub-periods v a r y a g r e a t d e a l , and add f u r t h e r e v i d e n c e f o r

shifts.
When we r e p e a t t h e same e x e r c i s e for N i g e r i a we o b t a i n
v e r y s i m i l a r r e s u l t s ( T a b l e XIII).

79

TABLE XZII: Relations betveen Betbacks and Spot Prices f o r

ligeria.

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

76.01-78.10 -0.82(0.4)
76.01-78.10
76.01-78.10
1.20(0.6)
76 .O 1-78.10

1.04(7.1)
0 . 9 8 ( 149
0.93(5.9)
1.01(144)

0.53
0.53
0.57
0.56

0.40
0.39
0.40
0.42

78.1 1-79.07 6.5( 2.7)

78.11-7 9 -07
78.1 1-79.07 6.5( 2 3)
78.11-79.07

0.88(9.6)
1.1 Z(31)
0 -8 9( 8 2)
1.13(29)

2 .08
2.80
2.50
3.10

2.38
1.47
2.18
1.44

NSI

79.08-81.02 5.86(2.44)
79.08-81.02
79.08-81.02 -1.08(0.4)
79.08-81.02

0.79(13)
0.95(187)
0.98( 14)
0.95(222)

0.75
0.84
0.74
0.72

1.09
1.24
2.54
2.47

NSM
NSM
NSI
NSI

81.03-83.06
0.40(0.2)
81.03-83.06
81.03-83.06 -0.95(0 - 6 )
81.03-83.06

0.97(18)
0.98( 23 1 1
1.03(23)
1.00(298)

0.91

1.61

0.70
0.56
0.55

1.62
1.59
1.57

ISM
N SM

MSI
NSI
N SM
NSM

NSI
MSI
MSM
NSM
NSI

A s 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
v e r y s i m i l a r , w i t h t h o s e from t h e i n d u s t r y source being s l i g h t l y
better.

The second e p i s o d e (78179) is much less w e l l e x p l a i n e d

b y t h e m o d e 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
s t a n d a r d e r r o r of e s t i m a t e .

a larger

The o t h e r e p i s o d e s do n o t g e n e r a l l y

s u p p o r t t h e p r e s e n c e 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 " s p o t - r e l a t e d 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 r o m $1.01 i n t h e
f i r s t p e r i o d , 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 the

less (but

still

fourth.

For

Nigeria t h e margins

vary

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 f o u r e p i s o d e s a r e

in a d o l l a r for d o l l a r relation.

The s t a n d a r d e r r o r of estimate

is much c l o s e r between p e r i o d s t h a n 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 n e c e s s a r y t o go

on t o add

The f i r s t c a n d i d a t e is

e x t r a explanatory v a r i a b l e s .

t h e " o f f i c i a l price".

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 s h o u l d be r e l a t e d t o
t h e s p o t a n d not t o t h e o f f i c i a l p r i c e .
t h e t h r e e s e r i e s ( f i g u r e 111).

For A r a b L i g h t we p l o t

From t h e beginning of t h e p e r i o d

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 w o u l d 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 .

After t h i s date the series

d i f f e r s u b s t a n t i a l l y , w i t h t h e o f f i c i a l series b e i n g t h e l a r g e r
from mid 1981 u n t i l t h e end of our period.
episode
testing.

Given t h a t t h e second

i s s o u n r e p r e s e n t a t i v e w e r e a l l y h a v e two p e r i o d s worth
The p e r i o d f r o m 1979.06 u n t i l 1981.06, f o r w h i c h 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 o r

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

s w i t c h o v e r 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
s p o t p r i c e and t h e netback changes.

According t o t h e h y p o t h e s i s

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 p e r i o d (when s p o t

i s below o f f i c i a l ) , but i n t h e t h i r d period o n l y t h e spot p r i c e

81

Tests on t h e s e r e l a t i o n s h i p s

s h o u l d be r e l a t e d t o t h e netback.

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 b e t w e e n 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 b e t w e e n 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 T a b l e X I V .
TABLE X I V : The Impact of Spot and O f f i c i a l Prices on Hetbacks
for Arab Light.

Dependent
Variable

Independent
Variable

Per iod

SNPIWR
SNRBI

SSM, SO
SSI,SO

79.08-81.06
79.08.81.06

SNPIWR
SNRB I*
SNRB I

SNPIWR"

SSM,SO
SSI,SO
SSI,SO
SSM,SO

81.07-83.06
81.07-83.06
81.07-83.06
81.07-83.06

*Estimated

by Cochrane

Official
DWS
Coefficient

SEE

0.90(23)
0.90(26)

O.OOl(0.02)
0.006(0.14)

1.23
0.77

1.28
1.13

0.88(9)
0.83(10)
0.77(9)
0.78( 7)

O.OS(O.9)
0.13(1.6)
0.19(2.2)
0.17( 1.7)

1.17
1.23
1.67
1.68

0.73
0.60
0.58
0.68

Spot
Coefficient

....................................................................

O r c u t t procedure.

We see t h a t f o r t h e t h i r d p e r i o d , when t h e o f f i c i a l was

lower than 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 .

T h i s confirms

our f i r s t important h y p o t h e s i s t h a t when t h e s p o t is t h e h i g h e r ,

i t is s t i l l t h e m a r g i n a l cost.
For t h e f i n a l p e r i o d , when s p o t w a s lower t h a n o f f i c i a l ,

we s e e some e v i d e n c e t h a t both s p o t and o f f i c i a l a r e 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
regression.

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

systematic specification error.

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 a n d i t w o u l d 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.

82

Again i t can b e s e e n

that

the sum o f

the coefficients

is just

less than unity,

s u g g e s t i n g l e s s than complete p a s s i n g on a t t h e margin.

The r e s u l t s f o r Nigerian L i g h t 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.

0.03(0.9)
-0.02(0.7)

NNPRBI

NSM,NO
NSI,NO

79.08-81.02
79.08-81.02

0.97(35)
0.97(43)

NMPIWR
NNRBI

NSM,NO
NSI,NO

81.03-83.06
81.03-83.06

-0.02(0.03)
l.OO(16)
1.18( 16) -0.18(2.5)

NNPIWR

For t h e t h i r d p e r i o d ,

2.60

0 -85
0.73

1.51
1.32

0.73
0.75

1.46

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 n o e v i d e n c e t h a t t h e 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

p e r i o d 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 e v i d e n c e 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 netback.

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 n o t 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

be rejected.

A d j u s t i n g t h e e q u a t i o n s 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 1us 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 p o i n 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 n e t b a c k 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 c h a n g e d f r o m b e i n g
h i g h e r 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 f e w months w h i c h do n o t c o n f o r m to t h i s p a t t e r n .

For Saudi

83

1981.08, 1 9 8 1 . 1 1 , 1981.12 and 1982.01 a l l saw s p o t a b o v e

official.

For N i g e r i a n t h e r e were some months w i t h s p o t b e l o w

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 a b o v e o f f i c i a l ( 1 9 8 1 . 1 0 , 1981.11, 1 9 8 1 . 1 2

and 1982.01). Regressions were tried f o r Nigerian f o r just those

months i n which the s p o t was below the o f f i c i a l b u t this too g a v e
no e v i d e n c e f o r any i n f l u e n c e o f t h e o f f i c i a l p r i c e o n t h e
netback.

84

F i g u r e 111

Netback,

Spot and O f f i c i a l P r i c e s f o r A r a b L i g h t

45

40

35

30

25

m
cc
<

NETBACK

A
J
0
0.

20

i5

10
1P76

1977

I 978

i 0753

i9 8 0

9A T ES

19Bi

1982

1983

F i s u r e IV

N e t b a c k , 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

45

40

35

30

!
I

NETBACK

25

!
I

OFF IC IAL

1-J

rr,
rx
<
-I
J

I
I

a
20

IS

iQ

1970

1 P77

1073

1979

1985,

DATES

1?61

1 PB2

1 sa3

DYHBMC WUATIOAS

B.5.3

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
do n o t

take

on t h e

assumption

that markets

equilibrium.

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

time

t o come i n t o

l a g behind s p o 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

l o n g d e l i v e r y times and h i g h i n v e n t o r y l e v e l s ) .

C l e a r l y 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 s i d e 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 a n d 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 h i g h e r i n p u t p r i c e s (which h a v e t o be s p o t p r i c e s
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 c h e c k f o r l a g s
between t h e two s e t s of p r i c e s .

It o n l y seemed n e c e s s a r y to t e s t

f o r a l a g of one month o r l e s s i n i t i a l l y .

Given t h a t e v e n t h i s

l a g ( w i t h one i m p o r t a n t

never

e x c e p t i o n ) was

s i g n i f i c a n t it seemed n e i t h e r
even longer lags.

found

to

be

necessary nor s e n s i b l e t o look f o r

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 a n d

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
a n d 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 a s 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 i n c l u d e d 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 .
r e s u l t s f o r Arab L i g h t

T a b l e XVI g i v e s t h e

and T a b l e XVII f o r N i g e r i a n Light.

Two

s e t s of d a t a a r e used t o g i v e a check on t h e f i n d i n g s .

85

TABLE XVI:

S N P m

Lags between Spot Prices and Hetbacks for Arab L i g h t

79.10-81.06

SSM
0.80
(7.6)
0.81
(7.8)

0.10
(0.90)
0.03
(0.3)

(7.2)

(0.08)

0.91
(7.6)

-0.08
(0.6)

s SI
0.89

SMRB I

SMPIWR
1.04

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

0.16
(1.5)

0.74

1.14

-0.0

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

0.07
(0.6)
0.11

-0.06

(0.9)

(0.9)

SNRB I

SSI

1 .oo

81.09-83.06

SSM
1 .oo
(9.0)
0.91

(7.4)

(8.3)

0.11
(0.9)

1.01
(8.4)

0.15
(1.2)

-0.04
(0.4)
-0.12
(1 . O )

S SM

-0.07
(1.0)

SNPIWR

0.81
(7.5)
0.81
(6.6)
1.04
(190)
81.09-83.12

SSI
0.96
(10)

0.89
(9)

0.23
(2.2)

0.23
(1.7)

0 .or
(0.1)
-0.06
(0.6)

(0.02)

0.14
(1.6)
SNRBI

0.85
(8.9)
0.86
(7.9)

1.03
(262)

86

1.31

0.09
(1.6)

1.05
(8.8)

SSI

1.00

0.06
(1.2)

(8.8)

SNRBI

1.29

0.01

S SM

SNF'IWR

1.01

0.18
(1.9)
0.18
(1.7)

-0.01
(0.07)

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
Variable

NNPIWR

7 9 .10-81.02

Spot

Netback

0.09
(1.4)
0.10
(1.4)

1.53

0.71

1.59

0.71

1.95

0.73

1.96

0.77

1.81

0.01 0.80
(0.4)

1.87

0.71

1.61

0.73

1.61

0.73

1.54

0.00 0.75
(0.01)

1.54

-0.01
(0.5)
NNP IWR

1.10
-0.03
(12)
(0.3)
1.10
-0.05
(11)
(0.5)
NNRB I
0.94
0.11
(11)
(1.3)
0.94
0.10
(11)
(1.1)

NSI

81 .O5-83.06 MSM
1.07
(12)
1.07
(1 1)

0.01
(0.3)

-0.08
(0.9)
-0.08

(0.9)

N SM

NNPIWR
0.80 0.22
(10) (2.9)

0.77
1.02
(230)

NSI

DWS

0.69

-0.01
(0.5)

0.04
(0.5)
0.06
(0.6)

p1 SM

NNRBI

SEE

NSI

0.91
(10)
0.91
(10)

NNPIWR

Lagged O f f i c i a l
Netback

NSM

0.85
(13)
0.85
(13)
NNRBI

Lagged
spot

81.05-83.12

MSI
1.10
(10)
1.17
(10)

0.19

0.66
0.65
0.74

1.47

0.76

0.85

0.72

1.10

0.72

0.63

0.18 0.59
(4.0)

1.01

0.76

0.86

0.06

-0.10
(0.9)

-0.04

-0.13

(0.4)

(1.9)

NNRB I
0.81
0.19
(9.4) (2.2)
0.71
0.11
( 9 . 4 ) (1.5)
1.01
( 244)

87

N e i t h e r T a b l e XVI nor T a b l e XVII

show any e v i d e n c e of

lagged r e l a t i o n s h i p s i n t h e t h i r d period o r evidence f o r the

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 .

These

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
p r i c e s 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 p e r i o d t h e r e i s no e v i d e n c e that n e t b a c k s a r e r e l a t e d
to

lagged

spot prices

( 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

i n c l u d e d a s suggested by t h e p r e v i o u s 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 , a c c o r d i n g t o both s o u r c e s ,

shows a r e l a t i o n

between s p o t p r i c e s and lagged netbacks.

In one c a s e 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 w e r e b e l o w o f f i c i a l
p r i c e s , n e t b a c k s had a lagged e f f e c t on s p o t p r i c e s .
l a g l e n g t h i n b o t h c a s e s i s a r o u n d o n e week.

The a v e r a g e

Obviously f o r

s h a r p e 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 b e necessary t o u s e
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
d e t e r m i n a n t of t h e netback s u g g e s t s t h a t a s y s t e m of e q u a t i o n s i s
p r e s e n t ( t h e r e b e i n g a p p a r e n t 1y two s e p a r a t e r e l a t i o n s h i p s
b e t w e e n 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 b y TSLS d o e s n o t c h a n g e t h e c o e f f i c i e n t s
v e r y much b u t does d e c r e a s e t h e "t" s c o r e t o below s i g n i f i c a n c e .
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 n o t 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 n e t b a c k s on s p o t p r i c e s which o n l y occurs when

88

s p o t p r i c e s a r e below netbacks.

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 on 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 s u p p l y a r e 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 w h e t h e r or n o t t h e r e is " e x c e s s
supply'' ( i e

s p o t i s less t h a n o f f i c i a l ) , w h i l e s h i f t s i n demand

h a v e no l a g when t h e r e i s "excess demand" ( s p o t 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
official).

Rowever, t h e c h a n g e i n " g o o d n e s s o f f i t " d u e t o t h e

lagged v a l u e s i s v e r y s l i g h t i n n e a r l y a l l c a s e s , s o t h a t adding
a l a g is a p p a r e n t l y o n l y a minor a d j u s t m e n t t o t h e equation.
Experiments w i t h l a g s l o n g e r t h a n one month a l l 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 lag insignificant).

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 v e r y q u i c k l y 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 s p e e d 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 t h e n it would be n e c e s s a r y t o u s e d a t a bssed on a

t i m e p e r i o d of one week a t l o n g e s 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

carried out f o r netbacks c a l c u l a t e d f o r a b a s i c refinery a t

As T a b l e s V I , VII, a n d V I 1 1 showed, t h e v a r i o u s

Rotterdam.

c e n t r e s and t y p e s of 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 a r e n o t p e r f e c t l y c o r r e l a t e d w i t h
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

one another.

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 s e r i e s , as T a b l e

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 an equilibrium

s i t u a t i o n with 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 i m p r o v e m e n t s 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 b e
marginal.

I t s "output" p r i c e w i l l b e l i n k e d 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 i n t r a - m a r g i n a l .

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 n o r m a l

m a r g i n s p e r i o d b y 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 n e t b a c k appears t o

be t h e l o w e s t and s h o u l d perhaps be t a k e n a s t h e m a r g i n a l market.

However,

since netbacks a r e highly c o r r e l a t e d (because t h e

v a r i a t i o n i s c a u s e d b y t h e same v a r i a b l e s ,

90

a l b e i t weighted

d i f f e r e n t l y ) we s h o u l d 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 e p e a t e d 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 p e r i o d s , 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 p e r i o d t h e n e t b a c k is r e l a t e d t o b o t h s p o t and o f f i c a l

for Arab Light.

T a b l e s X V I I I and XIX show t h e r e s u l t s .

91

SWPIWI
SNPIWC
SNPIWP

79.08-81.06

SSM

fI

It

II

fl

I1

I1

SNPIWS

If

I1

II

SWIWU

It

*I

II

SNP IW6

I1

I1

TI

SNPIWR

II

11

tf

0.89
0.84
0.90
0.91
0.92
0.89

151
91
99
123
88
139

1.02
1.61
1.57
1.29
1.81
1.11

0.83
0.55
0.72
1 .ll
0.81
0.78

0.90

157

1.00

1.35

TABLE XIX: Relation Between Wetback and Spot and Official Prices for
Arab Light f o r Various Refineries for the Fourth Episode

...........................................................................
Dependent S p o t
Period
Variable Variable

Spot
S p o t O f f i c i a l O f f i c i a l SEE
C o e f f i c i e n t 't
C o e f f i c i e n t 't'

DWS

----------------------------------------------------------,------------------

SNPIWI
SNPIWC
SNPIWP
SNPIWS
SNPIWv*
sNPIwu*
SNPIWR

SSM

SNRCI*
SNRCI*
SMUCI*
SNRBI

SSI

sNPIW1;
SNPIWC*
SNPIWP*
S NP IW S*
SNPIW6

It

81.07-83.06

I1

It
I1

11

I1

II

IT

I'

It
I'

It

11

I!

IT

I'

"
I'

81.07-83.12

II

11

lf

0.84
0.87
0.64
0.50
1.07
0.83
0.78
0.93
0.80
0.74
0.78

11
10
6.8
4.8
7.1
5.7
7 .O

9.1
8.8
5.7
4.2
9.5

s SI

tl

II

tl

I1

fI

'I

0.76

11

11

'I

fI

fl

"

If
fI

fI
If

'I

0.83
0.59
0.48
0.74

'I

"

"

= Estimated by Cochrane-Orcutt

8 .O

6.7
6.5
9.3

0.10
0.06
0.31
0.45
-0.09
0.14
0.17
0.12
0.24
0.24
0.18

0.18
0.10

0.36
0.47

0.21

1.3
0.7
3.5

4.4
0.6

1.0
1.7
1.05
2.09
2.19
2.3
2.2
1.1
3.7

4.4
2.8

0.57
0.65

1.17
1.39
0.70 1.49
0.79 1.70
1.14 0.87
0.92 1.85
0.68 1.68
0.90 0.70
0.74 1.59
0.71 1.59
0.55 1.72
0.52
0.63
0.67
0.78
0.51

technique.

The r e s u l t s for t h e t h i r d e p i s o d e ( s t a r t i n g i n 1978.08

t o c o n f o r m t o t h e t e s t s f o r l a g s ) 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 ( j u s t ) t h e most s t r o n g l y c o r r e l a t e d w i t h

t h e spot p r i c e .

I n a l l c a s e s the margin is l e s s t h a n 1002, w i t h

t h e Caribbean being t h e lowest.

92

The US and C a r i b b e a n n e t b a c k s

1.62
1.70
2.00
1.99
1.76

seem to be t h e l e a s t r e l a t e d t o t h e Arab L i g h t s p o t p r i c e .

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 t h a l o c a l h i g h e r dependence on o t h e r crudes.
For t h e f o u r t h e p i s o d e t h e r e s u l t s a r e very s i m i l a r i n
pattern.

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 a n d 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 U S when PIW
netbacks a r e used.

F o r i n d u s t r y d a t a t h e US a l s o shows

c o r r e l a t i o n of b o t h s p o t and o f f i c i a l p r i c e s .

Further, both

c o m p l e x 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 prices.

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 c a s e s

a n d 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

only

t h e i n d u s t r y c o m p l e x 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 h i g h e r t h a n t h e weighted sum of t h e i n p u t prices.
The g e n e r a l congruity of t h e r e s u l t s s u g g e s t s t h a t t h e
v a r i o u s markets a r e 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
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 .

of p r i c e s i n t h e two

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 suggest t h a t the
d i f f e r e n c e s cannot be a s c r i b e d

solely to differences in

technology b u t r a t h e r t o i m p e r f e c t i o n s i n t h e market.

93

Data Appendix : Kev t o Abbreviations

SNPIWR

PIWs n e t b a c k f r o m 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 i n g ) .

SNPIWC

PIWs 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
(basic r e f i n i n g ) .

SNPIWP

PIWs n e t b a c k f r o m t h e P e r s i a n G u l f
Arabia ( b a s i c r e f i n i n g ) .

SNPIWI

PIWs n e t b a c k f r o m I t a l y t o S a u d i A r a b i a ( b a s i c
refining)

SNPIWS

SNFIWU

PIWs n e t b a c k f r o m US t o S a u d i A r a b i a ( c o m p l e x
refining)
Average of above s i x series.

SMRBI

SNRCI

I n d u s t r y netback from Rotterdam t o Saudi Arabia

(complex r e f i n i n g ) .

SNUCI

I n d u s t r y netback from US t o Saudi A r a b i a (complex

refining)

SNOPAB

OPAL netback from Rotterdam t o Saudi Arabia ( b a s i c

refining)

SNOPAC

OPAL n e t b a c k f r o m R o t t e r d a m
(complex r e f i n i n g ) .

s so

Spot p r i c e for Arab L i g h t by OPEC B u l l e t i n .

SSM

Spot p r i c e f o r Arab L i g h t by MEPEP, MEES.

SSI

Spot p r i c e
source.

s SP

Spot p r i c e for Arab Light g i v e n by PIW.

SNpIW6

94

t o Saudi

PIWs n e t b a c k f r o m S i n g a p o r e t o S a u d i A r a b i a
(basic r e f i n ing).

I n d u s t r y netback from Rotterdam t o Saudi Arabia

(basic r e f i n e r y ) .

to

Saudi Arabia

for Arab L i g h t g i v e n by

industry

so

O f f i c i a l p r i c e of Arab Light.

NNPWR

PIW n e t b a c k
refining)

NNPIW5

PIW 5 c e n t r e a v e r a g e
(basic r e f i n i n g ) .

NNRB I

Industry netback from Rotterdam t o N i g e r i a ( b a s i c

refining)

NNRCI

Industry netback from Rotterdam t o Nigeria

(complex r e f i n i n g ) .

NNUCI

Industry netback
refining)

NNOPAB

OPAL 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 ( b a s i c
refining)

NNOPAC

OPAL 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 ( c o m p l e x
r e f i n ing

NSM

Spot p r i c e for N i g e r i a n Light by MEES.

NSI

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

NPO

Spot p r i c e f o r N i g e r i a n L i g h t by OPEC Bul l e t in.

NSP

Spot p r i c e f o r N i g e r i a n Light by PIW.

NO

O f f i c i a l p r i c e of N i g e r i a n Light.

from Rotterdam t o N i g e r i a ( b a s i c

netback

to

Nigeria

.
.

from U S t o N i g e r i a (complex

95

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 t h e e r r o r b e t w e e n
t h e s e r i e s e x c l u d i n g 1979 and 1980 is about 0.05.

2.

In a s i t u a t i o n w h e r e 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 m a r k e 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 t h o s e of t h e o t h e r crude.

4.

The a n a l o g u e 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 a d o p t e d by power
s u p p l y 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 t e m p o r a r y 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 o n g - t e r m 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 w h i c h demand was v e r y s e a s o n a l . However t h i s
can n o t e x p l a i n long-term l o s s e s .

96

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