I thought I'd start out by giving you a brief CV of my background. I graduated from McMaster University with a Bachelor of Chemical Engineering degree and a Master of Business Administration. I have worked in the petroleum industry for 32 years, 10 with Gulf Canada and 22 with Suncor. I've worked in both the upstream and downstream segments of the industry, including refining, supply, trading, wholesale marketing, crude marketing and logistics, strategic planning, and mergers and acquisition-type activities. I recently retired, on June 30, 2008, and the last position I held was vice-president, supply, distribution, and biofuels.
As for the purpose of the committee today, there have been significant concerns and questions recently that the run-up in price of crude and the associate products, gasoline and diesel, has been the result of speculation and not due to market fundamentals. I cannot answer the question around how much of the price rise is due to speculation and how much is due to fundamentals of supply and demand. I can try to help you understand various markets, price discovery and price-setting processes, and how they interact. My own personal belief is that it would be extremely difficult for speculators to drive the price against market fundamentals due to the size of the market, market liquidity, number of market players, and the complexity of the market, including such things as multiple locations, quality factors, refining configurations, and substitution effects.
So what I was planning to do is just walk through each of those sections, beginning with markets.
Crude oil is traded on a worldwide basis, whereas petroleum products tend to be traded more regionally. Major refining centres tend to be price-setting markets. Those include northwest Europe, the U.S. gulf coast, and the Far East, the Far East being represented usually by Singapore but may be switching to India as refining capacity in India grows. Prices for products tend to trade at the marginal cost of the high-cost refiner. Crude oil easily arbitrages between the three markets, whereas products usually are limited to trade in the Atlantic basin and the Pacific basin, logistics being the primary driver for the market segmentation.
In terms of price discovery, generally there are three means of price discovery: the futures markets in New York and London, what's termed the swap markets, and then the physical or cash markets.
Futures markets provide the highest level of price transparency limited to single highly liquid commodities with standard terms and conditions. Buyers and sellers put up margin and are protected by the exchange against default by counterparties. Markets are regulated.
Swaps are similar to futures but are not regulated and are usually between large highly sophisticated players. Risk of default is managed through the creditworthiness of the counterparties.
In physical markets, or cash markets, price discovery is limited somewhat to the major refining centres, such as the gulf coast. Buyers and sellers complete transactions on a daily basis and report these transactions to various industry publications such as Platts, Reuters, Opus, etc. These media then publish a list of crude and product prices for a range of qualities and different market locations. Contractual arrangements often use these publications to set transaction prices on a daily basis.
In terms of price setting, the price in any market is a function of the local supply and demand structure and the transportation cost to the major refining centre. In a supply-short market, price will be set at a transportation-plus basis. In other words, you take the price in the major refining centre and add the cost of transportation. In a supply-long market, price will be set on a transportation-minus basis, which is the reverse of the short market.
Added complexities include interactions between regional markets; regulatory requirements affecting quality; something I think you've probably heard, termed “boutique fuels”; structural product movements, where a company may own a pipeline to a particular market and will include the sunk cost of that pipeline in the pricing of their products—I would call that a structural product movement—and logistics barriers, such as the St. Lawrence Seaway being closed in the winter. All of these inhibit truck price transparency. Any of these factors make the price less transparent in that particular market.
To conclude, again I'll say that market size, complexity, and diversity all contribute to the unlikelihood of speculators driving prices contrary to fundamentals.
Thank you.