WTI for prompt delivery closed $10.94/Bbl below Brent on Wednesday (October 23, 2013). Brent prices are disconnected from WTI and Light Louisiana Sweet because the Gulf Coast is awash with light sweet crude. West Coast crude prices on the other hand are supposed to march to a different tune – isolated from new shale and Canadian crude supplies and thus expected to continue tracking international Brent. But ANS prices on the West Coast have fallen to more than $5/Bbl below Brent in the past 2 weeks and seem to be tracking WTI. Is this just a temporary aberration or could it be signaling another step change in the road to US crude independence? Today we take a closer look at what’s going on.
US crude oil market analysis tends to be dominated by the spread between US domestic benchmark West Texas Intermediate (WTI) crude and international benchmark Brent – aka “The Spread”. However, the West Coast market is more concerned with pricing for the dominant grade consumed there - Alaska North Slope (ANS) crude. ANS is shipped to refineries in Washington State and California from the Valdez Marine Terminal at the southern end of the Trans Alaska Pipeline (TAPS). We have previously documented the decline in ANS crude production from its heyday 2MMb/d in the 1980’s to 520 Mb/d in 2012 (see After the Oil Rush). ANS production has actually improved to average 528 Mb/d so far in 2013 but it remains on a slow downward trend. Without changes to existing regulations and increased production, ANS is destined to be a dwindling resource supplied only to West Coast refineries (see Anchored Down in Anchorage).
In the past three years the US crude market East of the Rockies has been dominated by the disconnect between WTI and Brent prices that arose because new crude production from North Dakota and Canada got caught up in pipeline congestion in the Midwest. That disconnect led to WTI discounts to Brent getting up to $28/Bbl in 2011, averaging $18/Bbl in 2012 and then falling back to parity in the first half of this year (see Reunited). During that whole saga, ANS prices stayed more or less level with Brent crude. That is because the West Coast oil market is insulated from the Midwest – where crude prices were discounted – since there are no US pipelines across the Rockies. West Coast refiners had only limited access to lower priced US domestic grades (by pipeline from Canada and limited rail shipments from North Dakota) and had to pay international prices for their diet of ANS, Californian crude and imports from Latin America and Asia.
And it has been the prevailing sentiment among many analysts that even as the WTI discount to Brent narrowed sharply this July, ANS crude would continue to price close to Brent until sufficient quantities of lower priced crude from North Dakota and Western Canada made their way to West Coast refineries to compete with the flagship Alaska grade. That has not happened yet as we shall see. But in the meantime, as we described earlier this week, prices for Brent crude recently began to increase their premium to the Gulf Coast Louisiana Light Sweet (LLS) grade as well as WTI (see Goodbye Stranger?). Although the Gulf Coast disconnect could be attributed to a temporary surplus and high crude inventory levels during maintenance season, the surging Brent premium to LLS and WTI was also repeated unexpectedly on the West Coast against ANS. The chart below shows Brent (red line), WTI (blue line) and ANS (green line) since the start of 2013. Until the beginning of October ANS tracked pretty closely with Brent – following its historic pattern. In the past three weeks however Brent prices have increased while both WTI and ANS fell – moving in opposite directions (black dotted arrows on the chart). If continued, this trend would suggest that ANS prices are being driven more by US domestic crude rather than by competition from imports. That would be a startling development given West Coast fundamentals that still point to limited and falling production of ANS and very little competition so far from cheaper domestic US and Canadian crude.
Source: CME data from Morningstar and Alaska Department of Revenue
In fact supplies of crude from North Dakota and Western Canada have barely begun to flow to West Coast refineries although there are plenty of plans underway to increase those volumes. The major projects completed or underway so far to that end are for crude by rail deliveries to Washington State refineries from North Dakota. Earlier this month we completed a two part series on West Coast rail unload terminals that described limited progress on these plans so far (see Coast Bound Train). Refiner Tesoro has led the pack - delivering 50 Mb/d of Bakken crude since the end of 2012 to its 120 Mb/d refinery at Anacortes, WA and starting deliveries to its Martinez, CA refinery in September of this year. Smaller refiner US Oil and Refining Co is also supplying 39 Mb/d of Bakken crude by rail to its Tacoma, WA refinery. Phillips 66 was supplying 30 Mb/d of Bakken crude by rail to its 100 Mb/d refinery at Ferndale, WA via an agreement with Targa that ended in September and is awaiting completion of its own rail unloading terminal at the end of this year or early 2014 to resume supplies. The other two refiners in Washington State – Shell and BP will have to wait until 2014 at least for their crude by rail unload terminals to be permitted and built. In short, during this year, about 90 Mb/d out of the total Washington State refining capacity of 638 Mb/d has been supplied consistently from the Bakken with Phillips adding 30 Mb/d for some period up until September.
Washington State refineries would also be well placed geographically to pick up crude sent by pipeline to the West Coast from Western Canada - if more of it was available – which is not the case. The only operating pipeline – the Kinder Morgan TransMountain Express (TMX) that currently delivers 300 Mb/d to Vancouver is at capacity. Plans to expand the TMX by 575 Mb/d are delayed until at least 2017 (if they are approved) and another Canadian West Coast pipeline project - the Enbridge Northern Gateway - is also delayed by possibly insurmountable permit issues (see West Coast Pipe Dreams for more on these projects). So incremental deliveries of Canadian crude to displace ANS volumes processed in Washington State have to be by rail in the short term. Those deliveries are constrained by the same lack of refinery unload capacity as Bakken crude – although by the end of 2014 it is expected that new terminals will be completed to ease that constraint.
What about California? Despite a large number of merchant and refinery unload terminal projects on the drawing board that we documented in Coast Bound Train, California refineries have been less successful than Washington State in getting access to crude supplies from North Dakota and Canada. These supplies would have to come by rail (at least until when or if the Canadian West Coast pipelines are built after 2017) – either direct to refineries or via terminals in California or on the Oregon Coast (rail to barge facilities that would ship crude down the coast to California). The chart below shows data provided by the California Energy Commission on crude oil imports into the State by rail since the start of 2011. The total crude by rail imports (red area) tops out at a pretty meager 17 Mb/d in February 2013 and the latest data for June 2013 is just under 7 Mb/d. Of those totals, crude from the Bakken (blue area) averages out at under 3 Mb/d – a trickle compared to California crude refinery capacity of 1.8 MMb/d. The rail constraints in California are similar to Washington – a lack of completed receiving terminal capacity. Once that barrier is down plenty of producers have their eye on delivering crude to the West Coast by rail – from the Niobrara in the Rockies (see Bananarama in the Rockies), from the Uinta Basin in Utah (see Do You Think I’m Waxy?) and from the Permian Basin in West Texas. A Kinder Morgan pipeline proposal to ship crude from the Permian to the West Coast failed due to lack of shipper interest in part because Producers preferred to wait for rail options (see The Price of Freedom).
Source: California Energy Commission
So given that ANS crude is not yet under any serious pressure from cheaper North Dakota or Canadian supplies, why have prices been retreating relative to Brent this month? The answer to this question is not by any means clear. As best we can tell from Energy Information Administration (EIA) inventory data, stocks in Petroleum Administrative Defense District (PADD) 5 – the area that include West Coast States as well as Alaska, Nevada and Hawaii – are not unusually high. So there is no apparent stockpile exerting downward pressure on ANS prices.
In fact the dip in ANS prices towards WTI and away from Brent is most likely caused by oversupply in the sour crude market at the US Gulf Coast. That oversupply has had a knock-on effect on the West Coast, particularly in California where most refineries process heavy and sour crudes that are either produced locally or imported. The Gulf Coast heavy sour crude surplus has caused prices for the benchmark US domestic sour grade West Texas Sour (WTS) to tumble $7/Bbl or more below WTI. Lower sour crude prices are also affecting pricing for imported sour crudes such as Mexican Maya. Those lower domestic and imported sour crude prices have been reflected in lower prices for Californian sour crude production – grades like Thums and Kern River – that are also sharply down in price this month.
In this situation where sour crude prices are down sharply, ANS is more likely to come under pressure than Brent because ANS is a medium sour crude with an API gravity of 31.5 and 0.96 percent sulfur content whereas Brent is a light sweet crude. So ANS crude is competing at California refineries with sour crude imports that are also influenced by Gulf Coast sour crude prices. Brent on the other hand is a light sweet crude that does not compete directly against sour crude on the West Coast. And just as Brent has lost its influence on the Gulf Coast market at the moment – drifting away from LLS and WTI, so its “pull” on ANS prices is weakened by the sour crude price collapse.
To sum up, the price of ANS is being pressured towards WTI and LLS instead of keeping level with Brent (as many expected) because of an oversupply in the sour crude market at the Gulf Coast that is impacting import prices at the West Coast. ANS prices should move closer to Brent once the sour crude oversupply at the Gulf Coast is corrected. In the longer term, however, ANS prices will come under greater pressure from domestic crude grades as they begin to be delivered in greater quantities to West Cost refineries by the end of 2014.