What makes some types of oil better than others?
In the last article I introduced API gravity as a measurement of the density of oil. To recap, heavy oil is roughly 10-22° API, medium oil is about 22-31° API and light oil is everything above that. What does that mean for investors?
Refiners' favourite crudes are around 40-45°API. Tapis from Malaysia is at the top of that range and is the most valuable of the major international oils. It typically trades at $1-2/barrel premium to North Sea crudes such as Brent (which is 38° API).
The US government's Energy Information Administration (EIA) tracks the prices of different crudes on their website. Above about 25° API it doesn't make a lot of difference, the oil will trade for only a dollar or two below Brent, but heavy oil can trade at 30% or more below Brent.
Sticky oil is bad
API gravity is most important to investors as a proxy for the "stickiness" of oil. The relationship varies a bit depending on the oil, but you usually start having problems below 22° API and particularly below about 18° API.
It starts in the rock -- heavy oil "sticks" to the rock leading to low recovery rates, you may get as little as 10% of the oil out by natural flow. This can be improved by injecting hot (and expensive!) steam down the hole just to get the oil to flow out of the reservoir.
This is one technique used in Canadian tarsands, and is common in places like Colombia. Thus the economics of heavy oil development may be critically dependent on the availability of gas or other sources of heat for steam production -- Sefton Resources (LSE: SER) has been battling with this in California.
Even once the oil is on the surface, it won't flow down a pipeline unless you add special chemicals, heat the entire pipeline, mix it with lighter crude or "upgrade" it by partially refining it into something lighter. Upgrading is common in the Canadian tarsands; Cairn (LSE: CNE) India will have to heat over 400 miles of pipeline between their Mangala field and the refinery.
So if the oil is too viscous then much less of the oil will make it out of the ground and it will cost more to produce and more to transport to market. And as we saw above, the market will then pay you a lower price for it.
These are all good reasons to pay close attention to the API gravity as a proxy for viscosity, particularly once it starts going below 25° API. Some companies such as Nautical Petroleum (LSE: NPE) and Bankers Petroleum (LSE: BNK) embrace the challenges of heavy oil, but often the media may gloss over the poor economics in all the excitement of a new discovery, and some companies don't hurry to correct them.
Oil chemistry matters
It's worth emphasising that refiners are interested in the chemical composition of the oil and not the API gravity per se. For instance, some North Sea fields such as Captain produce heavy oils of 19° API or less, but they contain a lot of the napthenes demanded by certain specialist refineries, and those oils trade at just $5 or so below Brent.
Geographical location also makes a difference. Minas is an Indonesian crude that at 36° API is a little heavier than Brent, but usually trades at a premium to Brent because (among other reasons) it has lower shipping costs than most crudes available to Asian refineries.
Refiners are also interested in things like the nickel and vanadium content of the oil as they mess up refinery catalysts; the huge Manifa field is on hold until the Saudis build dedicated refineries that can cope with its high vanadium content, but it's not something the average investor will come across.
You may occasionally see company announcements mention TAN (Total Acid Number), a measure of acidity, but again I wouldn't worry about it.
Wax is bad
However you should watch out for references to wax in the oil, which can bung up pipelines if it's not treated and/or heated. Waxy crude increases operating costs and is a problem faced by Tullow (LSE: TLW) in Uganda, for instance.
Platts are the main information providers in the industry and they list specifications for many of the major crude oils including API gravity, TAN, vanadium and nickel content. If a company is producing from the same rocks as a benchmark oil, their oil will probably be similar but it's always worth asking questions such as :
1) What API is your oil?
2) If it's <25° API: a) Will you try to enhance recovery by steaming or similar? b) Are there problems transporting it?
3) Is it waxy?
4) Does it have any other "goodies" or "nasties" in it?
In the next article, I discuss the main "nasty" in oil and gas -- sulphur.
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