U.S. Solves Its Oil Glut Dilemma

For the first time in nearly three years, the price of crude oil is higher in the U.S. than in Europe. And, believe it or not, that's great news.

For the first time in nearly three years, the price of crude oil ishigher in the U.S. than in Europe. And, believe it or not, that's great news.

Energy investors closely track the difference, or spread, between the so-called West Texas Intermediate spot price in the U.S. and the Brent price in Europe. The spread has vanished over the past few months.

Source: Bloomberg.

Historically, oil has traded at a slight premium in the U.S. over Europe. Then, in 2010, North American oil production grew much more quickly than anyone expected -- including companies that manage oil pipelines and transportation. Domestic demand also remained surprisingly weak.

American prices dropped $20 below world levels because it became impossible to get all the oil out of the middle of the country quickly and cheaply.

Does the end of that spread mean slightly higher prices for American drivers? Probably not. U.S. gasoline prices are determined by world oil and gasoline prices (as well as the cost of transporting gas from refineries). The fact that U.S. oil is now flowing more freely from what had been a midcontinent bottleneck should be a good thing for American drivers.

Oil trades on a world market, where a $20-a-barrel discount simply should not exist. It costs a fraction of that amount to transport oil across thousands of miles by pipeline, by rail, and maybe even by truck, according to Jim Hamilton, an economics professor at University of California San Diego. The U.S. hadn't been making the most productive use of its oil bounty.

The lack of enough transportation for oil production was a de-facto interstate trade barrier, preventing the flow of oil across the country, which had to continue oil imports. That barrier is beginning to come down, and the inventory glut is shrinking quickly.

Oil producers have turned to railcars to transport crude from North Dakota, in one major change, as railways have expanded their capacity more quickly than have pipelines.

Pipelines, too, are expanding and re-routing. Many new ones are now under construction as oil producers ink long-term contracts with pipeline firms. Data from the U.S. Energy Information Administration show that the volume of oil going from the Midwest to the Gulf Coast has grown threefold since 2005.

Clearly, the markets think the U.S. is taking care of its oil glut.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.