Sandy Fielden, RBN Energy
Back in October we posted a blog forecasting that the Brent/WTI price spread (at that time $22.76/Bbl) would narrow by the time of the Super Bowl (see Place Your Bets on Narrow Brent /WTI Spread for the Super Bowl). That turned out to be true (it is now $18.99/Bbl) but no Lambeau Leap for the RBN team. A $19 differential is still a big number, and the crude supply congestion in the Midwest that led to a wide WTI discount to Brent in the first place continues. Last week the congestion showed every sign of moving to Houston and staying there at least until the end of the year. Today we present our post-Super Bowl Brent/WTI spread analysis.
The Brent/WTI price spread is less important to US advertising revenues than the Super Bowl and has no halftime spectacular involving Beyonce but it does have an enthusiastic following among energy analysts. Welcome spread fans – you are among wonks. [Follow the Brent/WTI spread daily via RBN’s Spotcheck.]
Basics for new crude oil spread fans
Before we get going on the post-bowl analysis we’ll return to basics for a minute to allow any new spread fans to catch up – skip to the next paragraph if you are already a Brent/WTI wonk. West Texas Intermediate crude (WTI), the US domestic benchmark and Brent crude, the benchmark for crude sold in Europe, Africa and the Middle East are both light sweet crudes with similar refining qualities. WTI has a gravity of 39.6 API degrees and sulfur content of 0.24 percent. Brent has a gravity of 38.06 API degrees and sulfur content of 0.37 percent. That means the crudes are just about equal in quality, and therefore should be priced about the same if they are trading in the same market. Historically that was the case, and WTI and Brent prices tracked closely, with WTI generally having a slight premium over Brent. Since August 2010 WTI has traded consistently at a discount to Brent that ballooned out to $27.68 /Bbl in October 2011 and averaged $17.50/Bbl during 2012. It is generally accepted that the large WTI discount to Brent came about because they no longer trade in the same market. In effect, the market has split geographically with the oversupply of new crude production from Canada and US domestic shale plays such as the Bakken field in North Dakota hitting transportation constraits south of the Cushing, OK hub. In effect, the combination of new production backed up supplies at the Cushing hub where WTI is traded, and the constraints on capacity to move those barrels out of Cushing and to the Gulf Coast has caused the rice of WTI fall relative to barrels in the Gulf market, including international crudes that are linked to Brent.
The current WTI discount to Brent is $18.99/Bbl as of Friday February 1, 2013. So our prediction back in October that the spread would narrow by the Super Bowl was correct.
Fortunately since October our wisdom in matters spread has deepened. Instead of just calling the spread direction one way or the other like a halftime commentator we matured. In our most recent post covering the Brent/WTI spread we changed our approach to appeal to the legitimate fears of the adult trading community (see The Seven Gates of Hell for WTI Crude Traders).
In that post we talked down what we called the “simple theory” of WTI price recovery. That (debunked) theory says that all it will take to end the WTI discount to Brent is for new pipeline infrastructure to open up and let the Cushing crude glut flow out of the Midwest -where it is not needed - down to the Gulf Coast where there is greater refinery demand. At that point, theoretically WTI prices will resume parity with Brent, the clouds will part and the sun will shine on Downton Abbey.
Instead (we continued) the US crude oil market is going through a complex transition that involves more factors than just Cushing inventories and WTI/Brent prices. We then listed seven variables (the “Gates of Hell” in our title) that we believe influence the WTI/Brent spread and help explain what is happening to domestic US crude price relationships. Since we did the Super Bowl story back in October and there have been strange goings on in the Brent/WTI spread world during the past week we felt duty bound to update you on the current alignment of the seven variables. [For newbie Brent/WTI spread wonks – what follows will make more sense if you read “The Seven Gates of Hell for WTI Crude Traders” first.]
Gate #1 - Midwest Refinery Demand
The BP Whiting refinery expansion project that we referred to last time is still keeping 250 Mb/d of refining capacity out of the Midwest market that will not be returning until the middle of 2013. That means 250 Mb/d less demand for crude in the Midwest, increasing the pressure on the stockpile of crude at Cushing. Another sign that inventory levels in the Midwest remain under pressure was pipeline owner Enbridge apportioning February 2013 deliveries on their 193 Mb/d Spearhead line from Chicago to Cushing. As we reported recently the pipelines carrying crude production out of Western Canada into the Midwest are packed to the gunnels - forcing Enbridge to reduce shipper volumes by apportionment (see West Coast Pipe Dreams). That means more crude is coming into the Midwest than is being consumed by refinery demand or flowing to the Gulf Coast – putting downward pressure on the price of Midwest crudes – including WTI.
Gate # 2 – The Crude Stockpile at Cushing
The Cushing crude stockpile still remains stubbornly high according to Energy Information Administration (EIA) data. Although down this past week (January 21, 2013) from a record high of 52 MMBbl on January 7, 2013 the stockpile is still only 187 MBbl lower than that record. There are two likely culprits for the continuing record stockpile. The first is Midwest refinery demand (see above) and the second is the strange goings on with the Seaway Pipeline.
The strange goings on came to the attention of spread fans last week (January 23, 2013). We learned then that the Seaway pipeline capacity between Cushing and Houston - increased from 150 Mb/d to 400 Mb/d earlier in January - had to be scaled back to 175 Mb/d by operator Enterprise. The company posted a notice to shippers stating that because of “unforeseen constraints in outbound takeaway…. the Jones Creek delivery point has reached maximum capacity”.
The constraint on the Seaway pipeline was caused by congestion at the Houston end of the system that the operator Enterprise says will potentially continue until late in 2013. The constraint will only be relieved once Enterprise completes a lateral pipeline from Jones Creek to its ECHO terminal (see ECHO and the Blending Men), Hard core spread conspiracy theorists are skeptical that this congestion was not predictable and is therefore clear evidence of strange goings on. We at RBN Energy prefer to accept that what happened is part of the teething process as new infrastructure comes online to move crude supplies into the Gulf Coast region (see Gulf Coast Crude Oil Flood Preparations). In any case the news on Seaway is a setback to flows from Cushing to reduce the Midwest crude glut. That means the WTI discount to Brent, that had reduced from $19/Bbl at the end of 2012 to less than $16/Bbl on January 17, 2013 in anticipation of increased flows on Seaway, has now moved back to $18.99/Bbl and will likely stay at that level until Cushing stocks start to decline again.
Gate #3 - Permian and Eagle Ford volumes to Houston
Next up on our list of variables is the impact that the flow of new crude from the Eagle Ford and Permian basins in Texas into the Houston area will have on crude price relationships. The market is waiting for new pipeline capacity to open up between the Permian Basin and Houston starting with the 135 Mb/d Longhorn reversal due online sometime in March 2013. Crude production in the Permian basin is booming but most of the takeaway capacity now ends up in the already crowded Midwest market. That has caused WTI prices at Midland, TX close to the producing basin to be discounted by as much as $20/Bbl last November against WTI delivered to Cushing (pipeline tariff between Midland and Cushing is $1.69/Bbl). The prospect of increased takeaway capacity in March 2013 caused the WTI Midland to WTI Cushing discount to decline last week to $3.25/Bbl as the pipeline began scheduling March deliveries.
Eagle Ford crude volumes reaching Houston by pipeline and by barge along the coast from Corpus Christi are increasing. Last week we calculated that 420 Mb/d of Eagle Ford crude and condensate are being delivered to Houston (see Too Much Too Soon). Deliveries on the Enterprise Eagle Ford crude pipeline into Houston will hit the same constraint at Jones Creek that we mentioned earlier has impacted Seaway pipeline capacity. The greater the volume of crude coming into Houston by pipeline the greater the potential congestion. Look for Eagle Ford producers to try and avoid the Houston congestion and deliver further along the Gulf Coast at St. James, LA.
Gate #4 - Flows to St. James
Which brings us neatly to the next in our list of variables – deliveries of crude to St. James. While Houston is rapidly becoming a crowded marketplace for crude the only logical alternative (on the Gulf Coast at least) is to deliver to refineries in the Louisiana Gulf Coast region via the St. James trading hub. Accomplishing that feat via Houston is going to be difficult for a while at least. The planned reversal of the Shell 200 Mb/d Houston-Houma (Ho-Ho) pipeline is only partially completed. That means there are no commercially accessible pipelines running from Houston to St. James until Ho-Ho is finished later in 2013.
Until then, crude can reach St. James by barge or tanker from Corpus Christi (Eagle Ford) or by barge from Houston. As we learned recently in our series on Gulf Coast terminals, Bakken crude is also reaching St. James at the rate of more then 100 Mb/d by rail from North Dakota (see Back to the Delta). At the moment the rewards for moving crude from Houston or from North Dakota to St. James are still attractive. That is because crude prices at St. James are still being set by the local benchmark, light Louisiana sweet (LLS) crude. The price of LLS is still tracking closely with Brent (both crudes were priced at $114.90/Bbl on January 30, 2013). So if producers can transport crude from the Eagle Ford to St. James (via barge or tanker along the Gulf Coast from Corpus Christi) then they can achieve prices about $1/Bbl below LLS. That is roughly $13/Bbl more than marketers are paying for Eagle Ford barrels at the wellhead in South Texas. Similarly Bakken crude from North Dakota delivered by pipeline into the Midwest is priced close to WTI (recently at a slight premium) but can be sold for $18.99/Bbl more (at a slight discount to LLS) if delivered by rail to St. James (we detailed these movements recently in Back to the Delta – the rail transport cost is ~$11/Bbl).
Gate #5 - Crude quality
Part of the reason for the crude price difference between Houston and St. James is the crude logjam in the Midwest that keeps WTI prices discounted and LLS more expensive because it competes against imported crudes priced against Brent. Another factor in this equation is that new domestic US production from the Bakken, Eagle Ford and Permian basins is light and sweet crude that the majority of refineries in the Houston and Texas Gulf Coast area are not optimally configured to process. The Gulf Coast refineries configured to run light sweet crudes are mostly in the Louisiana Gulf Coast region. That means Eagle Ford producers in South Texas find a better market for their crude in Louisiana and that will also likely be the case for Permian basin crude coming into Houston from West Texas on new pipelines later this year. We explained the challenge that refiners face with these new domestic crudes in Turner Mason and the Goblet of Light and Heavy. The crude quality issue further complicates Gulf Coast logistics because the infrastructure is not yet in place to smoothly distribute the right crude to the right refinery (see Gulf Coast Crude Oil Flood Preparations).
[Another crude quality question taxing the minds of senior traders across Houston these days is: “What are we going to do with all that condensate?” Not technically a “spread” question though so we’ll punt that to another blog soon].
Gate #6 - Seaway light or heavy
If more light sweet crudes come into Houston than local refineries are able to digest and if the excess cannot be blended with heavier crude or shipped further east to Louisiana then the Houston market will be saturated with supplies before too long. The result will be downward pressure on light sweet crude prices. Heavier sour crudes could then attract a premium to light sweet crudes – turning traditional refinery economics upside down. Heavy sour crudes require more expensive refinery configurations and processing and they yield less of the lighter valuable refined products such as gasoline and diesel. If heavy crudes are scarce refiners will pay more to secure their supplies since they have already sunk their investment cost in heavy crude processing units.
If more heavy crude from Western Canada makes its way to Houston this year then that will help reduce the chances of a glut of light sweet crude. Some of that heavy crude can be blended with light sweet crude to make it more palatable for Houston refinery configurations. However not all Canadian crude is suitable for blending since much of it is already diluted with condensates to make dilbit (see It’s a Kinder Magic). At the moment the constraint on Seaway flows will reduce the volume of heavier crudes coming to Houston from Cushing. Canadian crude is being shipped by rail to the US but primarily to the East and West Coasts or St. James where crude prices are more attractive. The Keystone XL Gulf Coast extension expected online in late 2013 will provide an additional 700 Mb/d of capacity from Cushing to Texas that will likely be mostly heavy Canadian crude.
Gate# 7 - Crude exports
Crude exports from the US are restricted under Department of Commerce regulations (see Fifty Shades Lighter). As the expected flood of new domestic crude washes up at the Gulf Coast over the next two years the mismatch of light and heavy crude supplies with refinery configurations – means that exporting some of the excess light sweet supplies in return for imports of heavier crude would make a lot of sense. At the moment that “common sense” rationale runs up against political concerns about the security of US supplies. There has been some discussion of instituting a “swap” system where exporters of light crudes would import an equal amount of heavy crude but it is unclear if these will gain traction. As a result the only exports likely this year at least will be to Canada – because US shippers have been granted waivers to export crude there. Exports of crude from the South Texas Eagle Ford to Eastern Canada are expected to grow – helped in part by lower shipping costs. Those lower costs are because of the Jones Act that increases the cost of shipping between domestic US ports by regulating the construction and operation of vessels used for those voyages (see The Sea and Mr. Jones).
The expected exports to Canada will not likely reduce the flood of crude at the Gulf Coast significantly. As a result prices for domestic light sweet crude will face downward pressure as the market is oversupplied. Expect political pressure to relieve the ban on crude exports but with no effect this year.
To sum up, spread fans, the WTI discount to Brent is still close to $20/Bbl. The simple dream that the Seaway pipeline expansion would bring about reconciliation between these two separated crudes is shattered for the moment. The price of LLS is still tracking close to Brent and new domestic and Canadian production crude is being pulled towards the Louisiana Gulf Coast by those higher prices. The next big hurdle we will cross is the impact of the Longhorn reversal bringing Permian barrels into Houston sometime in March 2013. Until then the Brent/WTI spread is likely going to drift along in a range between $17 and $20/Bbl. The wild card to watch in this saga is the likely oversupply of light sweet crude into Houston and the downward pressure that will exert on WTI prices. Finally – as always in this market - keep an eye out for strange goings on. May the spread be with you.