Product Quality and Business Contracts: Intermediary Crude Oil Pricing in a Southwest-US Regional Market

By Chowdhury, S. M., De, O. & Martin, S

We study upstream and downstream prices and the profit margin of crude oil in a Southwest-US regional crude oil intermediary market, where oil is transported by motor vehicle. We analyze a proprietary data set that permits a unique account of intermediation in a regional market. This contrasts with existing empirical studies, which rely on national/international level crude oil data that is heavily influenced by macroeconomic and political factors. We estimate panel hedonic models to analyze the effects of geographic variables, the characteristics of bilateral business deals between an intermediary and the upstream and downstream trading partners, and the quality components of the crude oil on prices and margins. Selection bias involving crude oil posted price is accounted for using a standard instrumental variable approach and a Hausman-Taylor instrumental variable approach. Results show that in this market, the characteristics of bilateral business deals and logistic issues have significant effects on oil prices and the profit margin, independent of oil quality. In line with existing results, we find significant effects of quality components such as basic sediment and water, sulfur content, and specific gravity on buying and selling prices and on the profit margin, but only effects of gravity is non-linear.