Buying High and Selling Low

The 2011 price gap between the West Texas Intermediate and Brent crude oil benchmarks was caused primarily by the lack of pipeline infrastructure connecting the American Midcontinent to the Gulf Coast. An analysis of the profit-maximization function for a crude oil refiner with control of an inter-regional pipeline shows that by shipping crude oil from a high-price to a low-price region, a refiner can lower the cost of its inputs sufficiently to offset the trading loss on pipeline flows. This paper then explains how transporting crude oil to the low price region enabled the price gap to remain for most of 2011 and why the price gap ultimately shrank again. † University of Michigan