Crude Oil: California Crude Oil Price Fluctuations Are Consistent with Broader Market Trends
Published: 2007-01-19T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: California is the nation's fourth largest producer of crude oil and has the third largest oil refining industry (behind Texas and Louisiana). Because crude oil is a globally traded commodity, natural and geopolitical events can affect its price. These fluctuations affect state revenues because a share of the royalty payments from companies that lease state or federal lands to produce crude oil are distributed to the states. Because there are many varieties and grades of crude oil, buyers and sellers often price their oil relative to another abundant, highly traded, and high quality crude oil called a benchmark. West Texas Intermediate (WTI), a light crude oil, is the most commonly used benchmark in the United States. The price difference between a crude oil and its benchmark is commonly expressed as a price differential. In fall 2004, crude oil price differentials between WTI and California's heavier, and generally lower valued, crude oil rose sharply. GAO was asked to examine (1) the extent to which crude oil price differentials in California have fluctuated over the past 20 years and (2) the factors that may explain the recent changes in the price differential between California's crude oil and others. GAO analyzed historical data on California and benchmark crude oil prices and discussed market trends with state and federal government officials and crude oil experts.
section_title: What GAO Found
paragraphs: California crude oil price differentials have experienced numerous and large fluctuations over the past 20 years. The largest spike in the price differential began in mid-2004 and continued into 2005, during which the price differential between WTI and a California crude oil called Kern River rose from about $6 to about $15 per barrel. This increase in the price differential between WTI and California crude oils occurred in a period of generally increasing world oil prices during which prices for both WTI and California crude oils rose. Differentials between WTI and other oils also expanded in the same time period. The differentials have since fallen somewhat but remain relatively high by historical standards. Recent trends in California crude oil price differentials are consistent with a number of changing market conditions. First, beginning in mid-2004, Middle East producers began to increase the supply of heavy crude oils in the world marketplace, which helped depress prices for heavy crude oils, including those produced in California, and contributed to the expanding price differential between California crude oils and WTI. Second, the price differential of California crude oils to WTI increased when the rise in global crude oil prices caused prices of light crude oils to increase faster than the prices of heavier crude oils. This occurred because the petroleum products from heavy crude oils compete against other fuels, such as coal. Third, events that only impact regional crude oil markets or individual crude oils can also affect price differentials. For example, in September 2004, Hurricane Ivan disrupted crude oil production in the U.S. Gulf Coast region, resulting in decreases in the region's crude oil supply. The resulting scarcity of crude oil in the Gulf Coast region caused the prices of WTI and other regional oils to increase relative to crude oils produced outside the region. This also would have increased the price differentials between WTI and California crude oils. Finally, manipulation of crude oil prices could also affect price differentials, but experts and officials GAO interviewed generally believed that this was not a factor during this recent period.

section_title: Letter
paragraphs: California is the nation’s largest consumer of gasoline and consumes about  44 million gallons every day. California is also the nation’s fourth largest  producer of crude oil, behind Texas, Louisiana, and Alaska, and has the  third largest oil refining industry, behind Texas and Louisiana. Despite a  history of self-reliance in petroleum supplies, California crude oil  production has been declining since 1996, and California increasingly relies  on oil from other states and countries. California currently produces about  37 percent of the crude oil it uses, with the remainder coming largely from  Alaska, Saudi Arabia, Mexico, Ecuador, and Iraq. Crude oil is a globally  traded commodity, so natural and geopolitical events worldwide can affect  its prices. These fluctuations can affect state revenues because a share of  the royalty payments collected from companies that lease state or federal  lands to produce crude oil are distributed to the states. For example, in  fiscal year 2006, the Department of the Interior’s Minerals Management  Service (MMS), which collects royalties from federal lands, distributed  more than $303 million to the states, with California’s share totaling over  $44.7 million, or roughly 15 percent of the total state disbursements. States  rely on these revenues to fund education and infrastructure projects and to  assist local counties where the oil production occurs. Consequently, oil  producing states typically monitor crude oil price fluctuations and are  interested in ensuring that the crude oil produced in their state trades at a  fair price in the marketplace.
Crude oils produced from different regions and geologic structures vary in  important ways that also affect each crude oil’s value in the marketplace.  Specifically, the value of a given crude oil is determined by its inherent  quality and the amount and value of petroleum products that can be refined  from it. Crude oil is commonly classified according to two parameters:  density and sulfur content. Less dense crudes are known as “light,” while  denser crudes are known as “heavy.” Crudes with relatively low sulfur  content are known as “sweet,” while crudes with higher sulfur content are  known as “sour.” In general, heavier and more sour crudes require more  complex and expensive refineries to process the oil into usable products  but are less expensive to purchase than light sweet crudes. Because much  of the oil produced in California is heavy and sour, California refiners have  made significant investments in more technically complex equipment that  enables them to process these crudes into higher value products such as  gasoline, jet fuel, and diesel.
Because of the large number of grades of crude oils, buyers and sellers use  benchmark crude oils as a reference in pricing crude oil. A benchmark  crude oil is typically an abundantly produced and frequently traded crude  oil. There are currently three widely used crude oil benchmarks—West  Texas Intermediate (WTI), Brent, and Dubai. WTI is a very high quality light  crude oil produced in Texas and refined in the Midwest and Gulf Coast, and  it is typically the benchmark for crude oil produced in North and South  America. Other oils are often priced with reference to one of these  benchmark crude oils. The relationship between the prices of specific  crude oils and a benchmark crude oil is commonly expressed as a price  differential—calculated by subtracting the specific crude oil price from the  benchmark price. For example, if WTI is selling for $60 per barrel and Kern  River (a California crude oil) for $45 per barrel, the WTI-Kern River price  differential is $15.
Crude oil price differentials are generally not constant over time; they  reflect changes in world crude oil markets, as well as more local or crude  oil specific factors. When prices of the crude oil produced in a state fall to  an unusual degree relative to prices of benchmark oils or similar quality  oils, crude oil producers and state collectors of crude oil royalty revenues  become concerned. In fall 2004, crude oil price differentials in California  rose sharply when the price of WTI increased relative to California crude  oils. In this context, you requested that we provide additional information  on crude oil price differentials in California. As agreed with your office, this  report discusses (1) the extent to which crude oil price differentials in  California have fluctuated over the past 20 years and (2) the factors that  may explain the recent changes in the price differential between California  and other crude oils. To provide additional context for this report, we also  evaluated recent increases in the price differential between WTI and crude  oils produced in the Rocky Mountain region.
To determine the extent to which California crude oil price differentials  have fluctuated over time, we obtained historical data on California and  benchmark crude oil prices from Platts—a major provider of news and  information on energy commodities. We obtained data on three California  crude oils: two heavy crude oils (Kern River and Thums) and an  intermediate crude oil (Line 63). We used these data to calculate price  differentials by subtracting the price for California crude oils from  benchmark crude oils and analyzing these differentials for trends over  time. We also interviewed officials from the Energy Information  Administration (EIA), MMS, and the California Energy Commission (CEC).  To identify factors that may explain the recent changes in the California oil  price differentials, we interviewed officials from EIA, MMS, CEC, and the  California State Controller’s Office. In addition, we interviewed industry  experts from state, regional, and national trade organizations, such as the  California Independent Petroleum Association, the Western States  Petroleum Association, and the Independent Petroleum Association of  America; representatives from crude oil production and refining companies  in California and the Western United States; and independent energy sector  consultants. We also discussed the possibility of price manipulation with  numerous officials and experts to determine whether or not it was a  relevant factor in explaining recent changes in crude oil price differentials.  We conducted our work between May and December 2006 in accordance  with generally accepted government auditing standards.
subsections: section_title: Background
paragraphs: Two-thirds of all crude oil consumed in the United States is used by the  transportation sector, with gasoline accounting for two-thirds of that total.  The second largest consumer of crude oil is the industrial sector, including  refineries and petrochemical industries, which account for another 25  percent of that total. In the residential and commercial sectors, crude oil  consumption was as high as 15 percent of that total in 1970 but had since  fallen to 6.5 percent in 2004. Similarly, the burning of crude oil to generate  electricity peaked in 1975 at 8.6 percent, declining to 2.5 percent in 2004.
Crude oil is supplied through onshore and offshore domestic production  and international imports. In 2005, the United States produced 6.8 million  barrels per day (bpd), a 5.5 percent decrease from 2004. California is  currently the fourth largest oil producer (including onshore and offshore  production) in the United States, behind Louisiana, Texas, and Alaska,  respectively, but its production has declined at a rate of 2.4 percent per  year for the past 10 years. California produced 731,150 bpd in 2004 (the  most recent year for which numbers are available). Figure 2 shows the  decline in California crude oil production and the quantity of various  grades of crude oil produced in California.
In 2005, the United States imported 13.5 million bpd, or 27.1 percent of total  global oil imports. The EIA estimates that California imported 40.7 percent  of all crude processed by the state’s refineries, with the bulk of imports  coming from Saudi Arabia, Ecuador, Iraq, and Mexico. The remainder of  California’s crude oil was either produced in state, or transported by tanker  from Alaska. Figure 3 shows the sources of California’s crude oil and the  state’s major refining centers as of 2005, the last full year of data available,  and figure 4 shows the trend of California’s crude oil supply over the past  two decades.
WTI crude oil is a widely traded oil that is commonly used as a benchmark  for measuring crude oil prices in the United States. Prices for WTI are  collected at Cushing, Oklahoma. Crude oils delivered by pipeline generally  use WTI first month delivery (WTI crude oil delivered 1 month from a  specific date) as a price benchmark, and crude oils delivered by tankers  use WTI second month delivery (WTI crude oil delivered 2 months from a  specific date) as a price benchmark.
Crude oils are commonly classified by their density and sulfur content. The  gravity of a crude oil is specified using the American Petroleum Institute  (API) gravity standard, which measures the weight of crude oil in relation  to water, which has an API gravity of 10 degrees. As shown in table 1, crude  oil is generally classified as heavy (API gravity of 18 degrees or less),  intermediate (API gravity greater than 18 and less than 36 degrees), and  light (API gravity of 36 degrees or greater). In addition, crude oils vary by  their sulfur content—crude oil is classified as sweet when its sulfur content  is .5 percent or less by weight, and sour when its sulfur content is greater  than 1 percent. Other natural characteristics, such as the presence of heavy  metals and level of acidity, are also taken into account when classifying  crude oils. In general, heavier and more sour crude oils require more  complex and expensive refineries to process the oil into usable products  but are less expensive to purchase than light sweet crude oils. Based on the  API’s classification, California crude oils are almost all in the heavy and  intermediate range. WTI, on the other hand, is a very light oil with an API  gravity of just under 40. Table 1 shows the API classification and the API  gravity of California’s three primary crude oils.
The sale of crude oil primarily occurs through one of three types of  transactions: a spot transaction, a contract arrangement, or as a futures  contract. Spot transactions are agreements to sell or buy one shipment of  oil at a price agreed upon at the time of the arrangement. Spot transaction  prices in various regional markets are available through private publishers  that monitor and record market transactions and prices. Oil is often traded  in long-term contracts at prices that are tied to a market indicator, such as  the spot market or the futures market. While most contract prices are set in  reference to a market index or a benchmark crude oil, some domestically  produced crude oils are also sold using posted prices, which are usually set  by buyers, refiners, and gatherers, and apply to a particular crude stream (a  crude oil or blend of oils of standardized quality). International crude oils  sold through contract arrangements are generally priced using a formula  that includes a base price, which is referenced to a market indicator, plus  or minus a quality adjustment. A futures contract is a standardized  agreement that obligates the holder of the contract to make or accept  delivery of a specified quantity and quality of a crude oil during a specific  month at an agreed upon price. Futures contracts are bought and sold on a  commodities exchange, such as the New York Mercantile Exchange  (NYMEX). However, unlike spot transactions and contract arrangements,  futures contracts very rarely result in the delivery of physical barrels of oil.  Instead, the contract may be satisfied by a cash settlement prior to contract  expiration by selling or purchasing other contracts with terms that offset  the original contract or by exchanging a futures contract for the  commodity.
section_title: Price Differentials between California and Other Crude Oils Have Fluctuated Significantly over the Past 20 Years but Have Risen Significantly in Recent Years
paragraphs: From December 1987 to August 2006, price differentials between WTI and  California crude oils fluctuated significantly, generally increasing since  mid-2004 and reaching a high in January 2005. This recent increase in crude  oil price differentials coincided with a general increase in world crude oil  prices and reflected a more rapid increase in WTI prices relative to prices  of the three California crude oils we evaluated (Kern River, Thums, and  Line 63). Large price differentials also occurred in 2004, 2005, and 2006 for  heavier crude oils imported into California, such as Maya and Arab Heavy.  Since January 2005, the price differentials between WTI and these heavier  California and imported crude oils have fallen somewhat from their peak in  2005 but remain large by historical standards.
During the period from December 1987 through August 2006, all crude oil  prices we evaluated tended to follow similar patterns, rising and falling in  concert. However, the rate of increase or decrease in prices often varied by  crude oil type and, consequently, the price differentials between these  crude oils fluctuated. For example, California crude oil prices rose and fell  in relation to WTI during the same period, with the higher quality Line 63  mirroring the price of WTI more closely than the lower grade Kern River  and Thums. Specifically, the price differential between WTI and Kern River  ranged from a low of $3.20 in July 1995 to a high of $14.99 in January 2005.  Similar variable changes also occurred for the WTI-Thums price  differential, which fluctuated between a low of $2.47 in June 1995 and a  high of $13.92 in February 2005. For Line 63, the price differential was  lowest in September 2000 at $0.84 and highest in January 2005 at $9.57.  Fluctuations in prices for WTI, Kern River, Thums, and Line 63, as well as  price differentials between WTI and the three California crude oils can be  seen in figure 5.
While numerous fluctuations in crude oil prices and crude oil price  differentials have occurred over the 20-year period, global crude oil prices  rose precipitously in mid-2004, with the price of WTI rising from $40.79 in  July 2004 to $75.83 in August 2006––an increase of about 86 percent. This  general rise in oil prices also occurred in California crudes, where prices  for Line 63 rose from $41.44 in August 2004 to $70.72 in August 2006––an  increase of about 71 percent, followed by Kern River and Thums, which  rose from $40.45 and $41.41, respectively, in October 2004, to $63.32 and  $65.02, respectively, in August 2006 ––both increases of about 57 percent.  Because WTI rose faster than California crude oils, price differentials  between California crude oils and WTI also increased during this period.  The price differential for Line 63 rose from $6.54 in September 2004 to a  peak of $9.61 in December 2004––an increase of about 47 percent. The  price differential between Kern River and WTI rose from $5.95 in June 2004  to a peak of $14.99 in January 2005––an increase of about 152 percent. The  price differential for Thums and WTI followed a similar pattern, rising from  $7.13 in August 2004 to a peak of $13.92 in February 2005––an increase of  about 95 percent.
Crude oils imported into California, including Arab Heavy and Maya,  followed a similar pattern of fluctuating prices and increasing price  differentials during the same recent period. These intermediate crude oils  compete with Kern and Thums in the California marketplace because of  their similar quality and characteristics. Price differentials between WTI  and Arab Heavy increased from $7.84 in June 2004 to a high of $16.24 in  January 2005––an increase of about 107 percent. Price differentials for  Maya and WTI were $8.39 in June 2004 and rose to a peak of $18.68 in  March 2005––an increase of about 123 percent. Figure 6 provides an  overview of the rise in prices for WTI, Arab Heavy, and Maya and price  differentials between WTI and these imported crude oils from July 1988 to  August 2006.
Since mid-2005, price differentials for the three California crude oils and  the two imported crude oils have moderated somewhat but remain high by  historical standards. For example, the price differential for Kern River fell  to $12.17 in August 2006 (the last month for which data was available), a  decrease of about 19 percent from its high of $14.99 in January 2005. For  the lighter California crude oil, Line 63, the price differential fell to $5.11 in  August 2006, a decrease of about 47 percent from a peak of $9.61 in  December 2004. The price differentials for Arab Heavy and Maya followed  similar patterns. For example, the WTI-Arab Heavy price differential fell to  $12.56 in August 2006, a decrease of about 23 percent from its high of  $16.24 in January 2005. Nonetheless, all the crude oil price differentials  between WTI and the heavier crude oils we evaluated remain high by  historical standards.
section_title: Recent Increases in California Crude Oil Price Differentials Are Consistent with Other Market-Based Factors
paragraphs: According to EIA officials and other crude oil market experts we  interviewed, a range of market-based factors have affected recent crude oil  price differentials.  First, changing conditions and events in the global  crude oil market influenced the relative prices of light and heavy crude oils,  causing crude oil differentials between WTI and heavier crude oils to  increase.  Second, local and regional events that impacted specific regional  crude oil markets affected crude oil prices and affected the price  differential with WTI.  This was particularly evident in oil production in the  Rocky Mountain region in early 2006 when an increase in crude oil supplies  and a lack of crude oil transportation capacity caused a decrease in prices  and an increase in the price differential.  In addition, the state of California  has alleged in the past that crude oil producers in California manipulated  prices lower to avoid making royalty payments.  While most of the officials  and experts we interviewed did not believe that California crude oil  producers have recently engaged in this type of price manipulation, we  cannot rule out this possibility or other possible factors that we could not  observe that could explain some of the changes in price differentials.
subsections: section_title: Changing Conditions and Events in Global Crude Oil Markets Have Affected Price Differentials
paragraphs: EIA and other officials we interviewed told us that price differentials  between light and heavier crude oils are driven primarily by supply and  demand economics in the global crude oil and petroleum products markets  and stated that these factors have influenced recent trends in price  differentials between heavy California crude oils and the light crude oil  benchmark WTI.  For example, increases in the supply of light crude oil  result in lower prices for those crude oils, which would decrease the price  differential in comparison to heavy crude oil, such as those oils typically  produced in California.  Conversely, an increase in the supply of heavy  crude oil can result in lower prices for those crude oils, thus increasing the  price differential between heavy crude oils and WTI.  For example,  according to EIA officials, between January 2003 and January 2005, world  demand for crude oil increased substantially, in China and the United  States in particular and in response, crude oil producers in the Middle East  increased their production of heavy crude oil to meet the rising overall  demand for crude oils. EIA officials and others stated that this caused  prices of WTI to rise at a faster rate than heavy crude oils and contributed  to rising price differentials between WTI and heavier crude oils such as  those produced in California. EIA officials also told us that when crude oil  prices increase, as they have in recent years, prices of lighter petroleum  products, such as gasoline and diesel, rise faster than prices of residual fuel  oils and other heavier crude oils because the latter products face greater  competition from coal and natural gas, which are not initially affected by  increases in crude oil prices.  Because heavier crude oils typically generate  a greater proportion of heavier petroleum products than do lighter crude  oils, the value of the heavier crude oils falls relative to lighter crude oils.  This causes the price differentials between WTI and heavier oils to rise  further. Both of these factors helped push the price of heavy crude oils  lower in relation to light crude oils.  Specifically, between January 2003 and  January 2005, the price of WTI increased by about 42 percent, while the  price of Kern increased by about 16 percent. Consequently, the price  differential between these two crude oils expanded from about $6 to about  $15.
section_title: Local and Regional Events Have Affected Prices of Specific Crude Oils and Markets
paragraphs: Local and regional events, such as hurricanes off the U.S. Gulf Coast and  refinery outages, can cause fluctuations in the price of crude oils produced  in the region and benchmark crude oils.  Consequently, these events can  increase or decrease price differentials.  These events are tracked by  analysts in the private sector crude oil markets, financial markets, and the  federal government.  From 1970 through the end of 2005, EIA examined 72  different events and their effects on crude oil prices, such as the  Organization of Petroleum Exporting Countries oil embargo in 1973, the  terrorist attacks of September 11, 2001, and the multiple hurricanes that  struck the U.S. Gulf Coast in 2004 and 2005.  For example, when Hurricane  Ivan hit the Gulf of Mexico region in September 2004, oil tankers importing  crude oil into the Gulf were delayed, and oil producers were forced to  evacuate 3,000 employees from the region.  MMS estimated that Hurricane  Ivan caused crude oil production to decrease by 61 percent and resulted in  spikes in the price of WTI.  This would have increased the price differential  between WTI and other crude oils, including those California crude oils we  evaluated.
In addition, in early 2006, the price differential of local crude oils in the  Rocky Mountain region rose to an unusual extent.  The increase was most  pronounced with the price differential between WTI and Wyoming Sweet, a  regionally produced crude oil with a gravity and sulfur content very similar  to WTI.  From 1988 through mid-2005, the price of Wyoming Sweet was  roughly equal to WTI, with price differentials ranging between zero and $3.   However, beginning in January 2006, the price of Wyoming Sweet dropped  suddenly. Consequently, the price differential between Wyoming Sweet and  WTI increased from about $2 in the beginning of 2004 to over $24 in  February 2006.  In contrast to California, where crude oil prices and price  differentials to WTI have experienced regular fluctuations, there was no  historic precedent for crude oil price differentials of this magnitude  occurring in the Rocky Mountain region.  Although the Wyoming Sweet  price differential has since fallen to less than $10, this is still unusually high  for this region. Figure 7 shows prices for WTI and Wyoming Sweet and their  price differential between December 1987 and August 2006.
State officials and officials representing crude oil producers in the region  told us that the principal cause of the expanding Wyoming Sweet price  differential was inadequate crude oil transportation infrastructure.  In 2005,  crude oil production in this region increased, and Canadian producers also  increased imports into the region.  However, the existing pipeline, railroad,  and trucking infrastructure for transporting crude oil was insufficient to  move this large influx of crude oil out of the Rocky Mountain region to  other markets where it could have received a higher price.  The resulting  oversupply of crude oil in a region with comparatively low demand  prevented the price of the regional crude oils from increasing similar to  WTI prices, causing a large price differential. State officials we interviewed  predicted that, until transportation infrastructure can be expanded, price  differentials for oils produced in the Rocky Mountain region will continue  to be above the historical trends.
section_title: Manipulation of Crude Oil Prices Could Affect Price Differentials
paragraphs: Market manipulation is a final factor that could cause crude oil price  differentials to increase. In the past, the state of California alleged that  crude oil companies in California manipulated crude oil prices to lower  their royalty payments to the federal government. While we did not find any  evidence that any market players had manipulated crude oil prices in  California or elsewhere during the recent period of increasing crude oil  price differentials, we cannot rule out this or other possible factors or  events that we could not observe that could explain some of the changes in  price differentials.
The sales price of crude oil is an important variable in the equation that  determines the amount of royalties paid by oil companies who produce  crude oil on federal lands. Royalty revenues are calculated using the  following formula: Volume of Crude Oil Sold X Sales Price X Royalty Rate = Royalty  Revenues Consequently, changes in either the sale prices or the volume sold can  greatly affect the total amount of royalties oil companies pay and the states  receive.  Historically, posted prices were widely accepted as the true  market value and the measure that should be used in determining royalty  payments by crude oil producers, refiners, state governments, and the  federal government.
In litigation starting in 1975 and continuing through 1995, the state of  California and the city of Long Beach alleged that seven major oil  producing companies had conspired to keep posted prices low and that  their posted prices did not reflect the true market value of their crude oil,  thus illegally reducing the amount of royalties the oil companies paid. Six  of the companies eventually settled their cases, while the seventh went to  trial and was exonerated. Although MMS was not a party to this litigation, it  continued to independently evaluate whether posted prices reflected  market value. In June 1994, MMS formed an interagency task force with  some of the agencies that had previously reviewed the issue, including the  Departments of Energy, Justice, and Commerce, to evaluate documents  from the litigation and other data and determine whether the companies  had wrongfully undervalued crude oil to avoid paying royalties. In May  1996, the task force concluded, among other things, that (1) oil companies  in California typically received proceeds higher than posted prices and,  therefore, royalties were underpaid and (2) much of the crude oil produced  in California was not sold as contemplated in the royalty revenue formula,  but rather moved through various transfers or exchanges either within a  company that owned both the production and refinery operations, or  between two companies for purposes of reducing transportation costs.   Consequently, the reported sale price was frequently lower than actual  market prices.
In March 2000, MMS changed its regulations for valuing crude oil from  federal lands to address the conclusions of the task force. Among other  things, the regulations changed for determining the value of crude oil sold  in a “non-arms length” transaction––crude oil transferred within an oil  company between its production and refining affiliates. Currently, royalties  for these non-arms length transactions are calculated using a sales price  that is imputed based on the price of Alaska North Slope (in California) or  NYMEX (for the rest of the country) and adjusted for differences in quality.  In arms-length transactions––sales between two separate and unaffiliated  companies––the actual sale price, and not the posted price, is used to  calculate royalties.
In the course of our work, most of the officials and experts we interviewed  thought the new MMS regulations were effective in addressing this problem  and neither believed that crude oil producers were engaging in this sort of  price manipulation during the recent period of increasing crude oil price  differentials, nor did they provide any evidence of such manipulation.  However, we cannot rule out this or other possible factors or events that  we could not observe that could explain some of the changes in price  differentials.
As agreed with your offices, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 30 days from the  report date. At that time, we will send copies to interested congressional  committees and Members of Congress, the Secretary of Energy, and the  California State Controllers Office. We also will make copies available to  others upon request. In addition, the report will be available at no charge  on the GAO Web site at www.gao.gov.
If you or your staff have any questions about this report, please contact me  at (202) 512-3841 or wellsj@gao.gov. Contact points for our Offices of  Congressional Relations and Public Affairs may be found on the last page  of this report. GAO staff who made key contributions to this report are  listed in appendix II.
section_title: Objectives, Scope, and Methodology
paragraphs: The objectives of this review were to determine (1) the extent to which  crude oil price differentials in California have fluctuated over the past 20  years and (2) the factors that may explain the recent changes in the price  differential between California’s crude oil and others. As part of the second  objective, in order to provide additional context to the issue of price  differentials in California, we also evaluated the unusually high crude oil  price differentials that occurred in the Rocky Mountain region in late 2005.
To determine the extent to which California crude oil price differentials  have fluctuated over time, we obtained data on the spot prices of the North  American benchmark crude oil, West Texas Intermediate (WTI), and three  California crude oils: two heavy crude oils (Kern River and Thums) and an  intermediate crude oil (Line 63). We also obtained price data for two heavy  crude oils that are imported into California in large volumes: Arab Heavy, a  Saudi Arabian crude oil, and Maya, a crude oil imported from Mexico.  These data included prices from December 1987 through August 2006.  While most of the data we obtained listed a monthly average price, some  crude streams used daily or weekly averages. In these instances, we  calculated the monthly average price in order to make appropriate  comparisons. We used this data to calculate price differentials by  subtracting the price for the subject crude oil from the price of the  benchmark crude oil and analyzing these differentials for trends over time.  We interviewed officials from the Energy Information Administration  (EIA), Minerals Management Service (MMS), and the California Energy  Commission (CEC) to get background information on the major crude oils  produced in California and imported into the region.
To identify factors that may explain the recent changes in the California  price differentials, we (1) interviewed key officials and experts, (2)  reviewed studies on crude oil prices and price differentials, and (3)  reviewed historical studies and interviewed agency officials about the  history of crude oil price manipulation in California. To better understand  the key factors that affect crude oil price differentials in general and  specifically in California, we interviewed federal agency officials from EIA  and MMS; state agency officials from CEC and the California State  Controller’s Office; and experts from organizations representing crude oil  producers and refiners, including the California Independent Petroleum  Association (CIPA), the Western States Petroleum Association (WSPA), and  the Independent Petroleum Association of America. We reviewed studies,  reports, and presentations on crude oil pricing and differentials written by  or produced for EIA, MMS, CEC, CIPA, and WSPA. We also reviewed a  study prepared for the California State Controller’s Office on crude oil price  differentials in California, written by IIC Inc., and interviewed its author. To  evaluate the issue of crude oil price manipulation in California, we  reviewed documents, regulations, and studies from the 1980s and 1990s  regarding the history of allegations of oil producers manipulating prices to  avoid making royalty payments. We also interviewed officials with the  California State Controller’s Office, MMS, CIPA, and WSPA, regarding the  history of manipulation in California, and whether they believed or had  evidence that such price manipulation might have occurred in the recent  period of unusually high price differentials. We did not seek to acquire  proprietary records on the prices received for sales of crude oil from crude  oil producers or their buyers for this engagement.
To evaluate the unusually high price differentials in the Rocky Mountain  region, we obtained data on the spot price of Wyoming Sweet, a light sweet  crude oil similar in quality to WTI. We used this data to calculate price  differentials by subtracting the monthly average price for Wyoming Sweet  from the monthly average price of the WTI and analyzed these differentials  for trends over time. To understand the causes of the high price differential  in the Rocky Mountain region and to learn what stakeholders in the region  are doing to address the issue, we interviewed officials with the Wyoming  Pipeline Authority, the North Dakota Petroleum Council, the Interstate Oil  and Gas Commission, the Colorado Oil and Gas Commission, and oil  producers and refiners in the region.
We conducted our work between May and December 2006 in accordance  with generally accepted government auditing standards.
section_title: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the individual listed above, Frank Rusco, Assistant Director;  Jeffrey Barron; Casey Brown; Alison O’Neill; Kim Raheb; Barbara  Timmerman; and Wilda Wong made key contributions to this report.