Sandy Fielden, RBN Energy
Next Year’s Super Bowl (February 3, 2013) will provide the usual mix of brawn and hokey consumer advertising. RBN is betting that the WTI discount to Brent will fall well below its current $22.76 /Bbl before then. Early next year new pipeline pathways out of the Midwest and West Texas to the Gulf Coast and growing railcar traffic out of the Bakken will put an end to the Cushing Supply glut. Important signals today suggest the WTI discount should narrow sooner, but prices for the two crudes remained stubbornly far apart last week. Today we explain why the spread hasn’t narrowed already and the fundamental pressures that will overwhelm it come the spring.
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. Historically, 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 has averaged over $16/Bbl this year.
We last reported on the much followed Brent/WTI crude oil price relationship in July (see A Bridge Too Far). Back then we pondered the fate of the WTI discount to Brent that has had market watchers and traders busy polishing their crystal balls since last November (2011). That is when Enbridge and Enterprise announced their project to reverse the Seaway pipeline between Cushing, OK and Houston, TX and thereby begin to relieve a stockpile of crude at Cushing.
You can see the whole story in the chart below. The blue line is the WTI discount to Brent against the left axis in $/Barrel. The red line is the Cushing crude oil stock position (reported by the Energy Information Administration – EIA) in million barrels against the right axis. Back in July 2010, WTI was trading at a slight premium to Brent that reversed to a discount in August 2010. Since then the WTI discount to Brent widened out to stay above $10/Bbl except for a brief period in December 2011 (after the first Seaway reversal announcement). For the past week (starting Monday October 8, 2012) the WTI discount has been trading above $20.00/Bbl. Between January and July 2012, Cushing inventories surged to record levels. The opening of the Seaway pipeline to the first crude flows in June 2012 did not result in a decline in the stockpile until July 2012. Since that time, Cushing stocks have fallen by 3 MMBbl (7 percent) to 44.2 MMBbl although the pace of the fall has slowed in the past two weeks and Cushing stocks rose last week (October 6, 2012 data). As you can see from the green circle on the chart, the fall in Cushing stocks since July appears to have coincided with a widening of the WTI discount to Brent when logically we might have expected it to narrow in the face of the Seaway pipeline opening and the reduction in Cushing stocks. Instead the WTI discount to Brent for prompt delivery crude has widened to more than $20/Bbl again this week.
Source: EIA Stocks Data and CME Futures Data from Morningstar
This counter intuitive behaviour in the WTI discount has certainly been helped along by the strengthening of Brent relative to WTI as a result of two factors. First security concerns over Iran’s nuclear arsenal have led to tightening of oil sanctions against Iran and threats from the latter to blockade vital sea routes out of the Arab Gulf. Iran tensions in the Middle East have been added to by the pseudo war between Turkey and Syria that threatens an important route to the Meditterranean via Turkey for Iraqi crude. Since the majority of Middle East crude is priced against Brent, these tensions inflate Brent prices. Second there has been a physical scarcity of Brent crude in the North Sea because of seasonal production maintenance and an overall decline in production levels from 40 year old North Sea oil fields. Since WTI is currently disconnected from world markets in the absence of sufficient outlets to US coastal refining markets, international events have far less impact on WTI than they do on Brent, causing the two crudes to trade further apart when Brent prices rise.
All the same, the WTI discount to Brent should be declining in the face of a number of fundamental indicators that the end is in sight for the Cushing stockpile. The first of these is the expected early 2013 Seaway pipeline expansion from 150 Mb/d to 400 Mb/d. That will increase flows out of Cushing direct to the Gulf Coast. Before then there have already been a couple more important indications that the flow of crude past Cushing and down to the Gulf Coast is increasing. The first such indication is a dramatic increase in rail tank car traffic out of the Bakken to just about anywhere but Cushing. We described the build out of rail terminals in North Dakota and expansion of rail receiving facilities at market centers on the East and Gulf Coasts in “Railing Against The Pipelines”. Bakken crude is being railed to the West Coast as well. There has also been an expansion in the use of barges to move crude down the Illinois and Mississippi rivers to the Gulf Coast. All of these domestic barrels reaching the coast relieve the Cushing stockpile because they would otherwise have added to the Midwest supply glut. Crucially these cheaper domestic barrels also exert downward pressure on the price that coastal refiners are paying for imported crude. Since imported crudes are priced against Brent, the WTI discount to Brent should be narrowing. The second important indication that the Cushing logjam is unwinding came from Enbridge Inc announcing last week that capacity on the Spearhead pipeline that links the Chicago area with Cushing will not be rationed in November as requests for shipping space have reduced below the capacity of the pipeline. The Spearhead pipeline has previously been pro-rated (rationed) for months because demand to move crude to Cushing through Chicago from Canada exceeded capacity. The immediate impact of available capacity on Spearhead is that 20 Mb/d less crude will ship to Cushing. Perhaps more important is the psychological signal that producers now have better options than to ship barrels to Cushing if they want the best price. (We read an excellent Reuters article on this topic last week that you can link to here).
Certainly the futures markets appear to believe that the WTI discount to Brent will narrow in the coming months. The chart below shows the forward curve of the WTI discount to Brent as of October 12, 2012. The discount falls quite rapidly from $22/Bbl to $15/Bbl in July 2013 and then more slowly to $10/Bbl in November 2014 and $5.75/Bbl by December 2019.
Source: CME Futures Data from Morningstar
So why isn’t the WTI discount to Brent narrowing in today’s spot market? One big culprit is the huge (403 Mb/d) BP Whiting refinery in Indiana – that makes up 11 percent of PADD 2 refining capacity. This refinery is in the midst of a 5-year expansion project that will come to an end in the middle of 2013. The multi billion dollar project consists of reconfiguring the refinery to process larger quantities of heavier Canadian crude. To complete the upgrade BP will next month (November) close down the main crude distillation unit that has a current capacity of 250 Mb/d. The refinery will not return to full capacity until the upgrade is complete – BP says that will be the “middle” of 2013. Why does that matter? That means Midwest crude demand will fall by 250 Mb/d in November and for at least 6 months following. That means 250 Mb/d of oil back on the open market looking for a way out of the Midwest – weighing on the Cushing stockpile.
Ironically when the Whiting refinery reduces capacity by 250 Mb/d that will exactly match the increase in Seaway pipeline capacity (from 150 Mb/d now to 400 Mb/d in early 2013). The result will be an additional 250 Mb/d crude flowing out of the Midwest through Cushing and 250 Mb/d crude added to Midwest supply i.e. no net change. So because of the refinery outage, the market believes the end to the Cushing logjam is not yet in sight and that WTI prices will continue to be discounted heavily against Brent. For the moment. The fact that the forward curve is pointing to a reduced WTI discount indicates that today’s prices are being driven higher by current supply concerns that could easily evaporate if it turns out the Whiting refinery turnaround has less impact than expected.
With all eyes on the Seaway expansion and BP refinery, another important factor may have escaped the attention of market watchers. That is the potential impact of additional takeaway pipeline capacity – due online in early 2013 out of the Permian Basin - that we reported a couple of weeks ago in “The New Adventures of Good Ole Boy Permian – The Race to the Gulf Coast”. Expansions to the West Texas Gulf pipeline will allow 80 Mb/d of Permian crude to flow to the Gulf Coast in early 2013. The first phase reversal of the Longhorn pipeline will send up to 135 Mb/d of Permian crude to Houston in the same timeframe and Phase 1 of the Permian Express pipeline will provide another 90 Mb/d of capacity into Port Arthur. These additions provide a route to the Gulf Coast for 305 Mb/d of crude that can currently only be shipped by pipeline out of the Permian Basin to Cushing or to the Midwest via the Mid Valley pipeline. Although all of that capacity will not immediately transfer from the Midwest to the Gulf Coast, the additions will further relieve the pressure on Cushing by providing shippers with options they did not previously have, to avoid Cushing and achieve a better price at the Gulf Coast.
Our bet is that the $20 plus/Bbl WTI discount to Brent will not survive the Super Bowl on February 3, 2013. The market is holding its breath to see what happens during the BP refinery turnaround in November and December and as soon as that becomes clearer, the Seaway expansion and increased takeaway out of Permian will be upon us early in 2013. Together with the growing railcar traffic out of the Bakken, these events should tip the balance in favor of a lower WTI discount. Then later next year the Keystone Gulf Coast project will add a further 700 Mb/d to flows out of the Midwest into the Gulf Coast and surely end any remaining influence that Cushing stocks exert on the market. Then we can get the crystal ball back out to start worrying about how narrow the discount will get and how quickly.
About the author
Sandy Fielden serves as Director Energy Analytics for RBN Energy LLC and is an internationally accomplished professional with 25 years of management and communication experience in the European and North American energy industry, including ten years as a vice president at industry leading firms. He is a widely recognized expert at analyzing, processing, and communicating the value of a wide range of information in the energy industry.
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