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    Untitled Document

    The 2014 Brent/WTI crude relationship

    Sandy Fielden, RBN Energy

    After tracking within $1/Bbl or so of each other for years, international benchmark Brent crude suddenly began to trade at a higher premium to US benchmark West Texas Intermediate (WTI) in 2010. The Brent premium widened out as far as $28/Bbl in November 2011 and averaged $18/Bbl in 2012. But during 2013 the relationship calmed down some to average $11/Bbl and in 2014 so far has averaged $8.11/Bbl – closing lower at $5.17/Bbl yesterday (June 10, 2014). Today we provide an update on the Brent/WTI crude price relationship.

    Current US crude production is over 8.4 MMb/d – up 50% since the start of 2011 (see Like A Bat Out of Hell). The rapidly changing dynamics of the US crude market over the past three years as a result of this surge in production have caused upsets and volatility in crude oil price relationships. None more so than between the two most widely traded crudes in the world – US benchmark and CME NYMEX futures delivery grade West Texas Intermediate (WTI) and its international rival North Sea benchmark Brent.

    WTI and Brent are both light sweet crudes with similar refining qualities that should be priced about the same if they are trading in the same market.  Historically that was the case before 2010 and WTI and Brent prices tracked closely - with WTI generally having a slight premium over its international rival – reflecting the freight cost to ship Brent to the US. At this time, Brent and similar light sweet crude grades were regularly imported at the US Gulf Coast since domestic production did not meet local refinery needs. But a little over three years ago in August 2010, WTI began to trade at a discount to Brent because of a build up of crude inventory at the Midwest Cushing, OK trading hub. Growing crude production in North Dakota and Western Canada overwhelmed Midwest refinery needs and got caught in a Cushing glut because of inadequate pipeline transport capacity to Gulf Coast refineries. The WTI discount to Brent widened out as far as $28/Bbl in November 2011 and averaged $18/Bbl in 2012. In effect US domestic crude was landlocked at Cushing and its price was heavily discounted versus coastal grades.

    Then during 2013 the Brent premium to WTI collapsed to less than $1/Bbl in July as surging Midwest and Texas crude production began to bypass Cushing and reach Gulf Coast refineries – ending the market disconnect. But from mid-September to the end of last year Brent prices took off on their own track, leaving WTI behind as the spread surged back to $19/Bbl at the end of November (see Why 2013 Was The Year of Daft Punk for the Brent/WTI Spread). This time the disconnect was caused by a glut of domestic light sweet crude at the Gulf Coast that pushed out imported supplies and severed the trading ties between Brent and WTI. This new situation was confirmed by the behavior of a third crude, Light Louisiana Sweet (LLS) – the Gulf Coast light sweet crude benchmark. Instead of tracking Brent – as they had during the past three years, LLS prices began to track WTI (see Goodbye Stranger) meaning that the Gulf Coast market for light crude had become domestic instead of international. From that point forward the relationship between LLS and WTI assumed more importance for the US crude market than that between Brent and WTI.

    So far in 2014 the dominant story in the US crude market has been a continued flow of crude towards the Gulf Coast as more pipeline capacity opened up from Cushing in the shape of the 700 Mb/d Cushing Marketlink southern leg of the Keystone XL pipeline. The impact on crude inventories has been quite dramatic. The two charts in Figure #1 below tell the story using data from the Energy Information Administration (EIA). On the left is crude oil inventory at Cushing, OK showing that stocks this year have drained significantly (red line) versus the 5 year range (gray shading) and the 5-year average (blue line). Since the end of January Cushing stocks have fallen nearly 50 percent from 42 MMBbl to under 22 MMBbl – their lowest level since October 2008. The right hand chart shows where most of those crude supplies headed to – the Gulf Coast region. There crude inventories this year (red line) have risen from 166 MMBbl in January to an all time record 216 MMBbl in mid-May before dropping back to 207 MMBbl last week (May 30, 2014) an increase of 41 MMBbl or 25 percent so far this year.

    Figure #1

    Source: EIA data from Morningstar

    The implications of this oversupply situation at the Gulf Coast have been magnified by the Federal ban on crude exports that dates back to the 1970’s - restricting the export of US crude to anywhere except Canada. That ban means producers cannot simply export excess light-sweet crude supplies to overseas markets (see Imagine There’s No Export Ban). The result is that crude prices at the Gulf Coast (i.e. LLS) have come under downward pressure from the weight of excess inventory.

    The red line in Figure #2 below shows the LLS premium over WTI since the start of 2014. As crude inventory levels at the Gulf Coast increased this year, LLS prices weakened against WTI – reaching a low under $2/Bbl in early May (purple dashed circle). The LLS premium has now hovered around the $2/Bbl level for two months since the start of April.  As we have suggested before, if the crude glut at the Gulf Coast continues, it would not be a surprise if WTI prices at Cushing traded above LLS at the Gulf Coast (see Crudes on the Run). That likelihood is increased by the sucking sound out of Cushing as more barrels empty out of tanks there. Indeed low supplies at Cushing are now strongly supportive of WTI prices because supplies there could reach a low point where Midwest refineries run short of feedstock. But there are yet more new pipelines opening up this year to send crude to Houston instead of Cushing – starting with the 300 Mb/d Magellan/Oxy BridgeTex expected online from the Permian Basin at the end of this month (June 2014) and joined by the 450 Mb/d Seaway Twin pipeline later this year that will open more capacity between Cushing and Houston. Expect LLS premiums over WTI to stay under pressure for the balance of the year (unless there is a change to the crude export regulations).

    Figure #2

    Source: CME data from Morningstar

    Meantime – since the start of the year the price of Brent crude has traded independently of the US Gulf Coast market. The premium of Brent over WTI (blue line in Figure #2) drifted down from $15/Bbl in mid-January to less than $4/Bbl in mid-April (green dashed circle) before recovering to around $8/Bbl through mid-May. Since then Brent prices have drifted down versus a stronger WTI to their present level at $5.17/Bbl (June 10, 2014).  With only a trickle of light sweet crude now imported at the Gulf Coast, Brent prices seem to have little influence over WTI or LLS. The Brent market has been more influenced by factors specific to the European market such as concerns over North Sea crude production and whether or not Libya will return to producing typical Gaddafi era volumes of 2 MMb/d of crude or be limited to current output around 160 Mb/d. The Ukraine crisis is also underpinning European crude prices since Russia provides as much as 35 percent of European supplies. In the last two weeks these supply concerns have eased and the Brent premium to WTI has narrowed by about $1.90 since May 28, 2014.

    We should also note that both WTI and Brent futures are in backwardation – meaning that expectations for prices for crude delivered in the future are lower than prices today. This condition makes sense in the US since the market is oversupplied and production continues to increase. In the international market the Brent backwardation is likely reflective of expectations that rising US crude production will replace more imports – pushing those supplies back onto the world market and weighing on forward prices.

    In summary the Brent/WTI crude price spread in 2014 so far is far less volatile than it was in 2012 or 2013 but the two crudes are now trading in separate arenas with Brent the “Queen Bee” outside the US and WTI only exerting domestic influence. Rising US production is flooding the Gulf Coast region with supplies, keeping crude prices under pressure there, while the empty tanks at Cushing are supportive of higher WTI levels. The international market is disconnected from the Gulf Coast and having a minimal impact on  WTI and LLS prices. Brent prices have drifted lower recently as European supply fears have eased. The biggest threat to what has been a relatively stable crude market would be a change to the US regulations on crude exports. We’ll save that story for another blog.

     

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