Citi’s commodity research team just released a densely-packed note that breaks down the US oil transportation system reorganization currently underway and models potential market impacts associated with shifting crude and product flow patterns.
Global oil price benchmark crude West Texas Intermediate (WTI) traded at a slight premium to the world’s other major benchmark, Brent, for many years until late-2010, when the pricing relationship reversed. In summer 2011, the Brent-WTI spread blew out to an unprecedented $27 per barrel Brent premium, though it has since reeled back into a roughly $10/bbl trading range.
As of this morning, the July 2013 Brent futures contract traded at about $103/bbl and July 2013 WTI traded at around $93/bbl.
The research note, titled “The End of the Beginning,” sets the stage explaining,
“The disconnection of the two most traded oil price benchmarks beginning in late-2010 ushered in an era of feverish contemplation of the implications of WTI becoming a “broken benchmark” and slow realization that the shale revolution was indeed real and that the US and Canada could well be on the path to net self-sufficiency in hydrocarbons.”
The first reason for this shift was increased US and Canadian crude and natural gas liquids output from the oil sands and shale deposits that resulted in the well-publicized Cushing, Oklahoma storage glut.
However, the industry responded to changing production and transportation trends with a series of transformational infrastructure investments in rail capacity, pipeline reversals and new pipes that will come online in stages over the next several years, each substantially altering supply/demand fundamentals, and thus benchmark crude pricing dynamics.
“With continued growth in pipeline capacity out of the Bakken – the next one being the mid-2013 Plains Bakken North pipeline from Trenton, ND to Regina and Clearbrook to join the Enbridge Mainline – and ample rail capacity, there should now be more than enough to manage Bakken production growth, with perhaps more pipeline capacity alone than crude oil output by 2016-17.”
“…But the major source of growth of inflows into Cushing has been the Permian Basin in west Texas, which is why the debottlenecking of this producing region is particularly salient in its impact on Cushing balances.”
“Cushing is shifting into a structural surplus of takeaway capacity, and this should be exacerbated by the 700-k b/d TransCanada Keystone XL southern leg, expandable to 830-k b/d, expected to come online in 4Q’13, and the twinning of the Enbridge-Enterprise Seaway pipeline, which adds another 450-k b/d of capacity to bring the whole system to 850-k b/d nameplate, expected to come online in 1Q’14.”
One of the main questions the report grapples with is whether a Houston-based light sweet crude benchmark price is emerging as a substitute for Light Louisiana Sweet, which remains disconnected from the Western Gulf Coast. “The most visible Gulf Coast light sweet price is Louisiana Light Sweet (LLS), priced at St James, Louisiana on the eastern part of the Gulf Coast, but due to bottlenecks between Houston and St James, LLS has been pricing at a premium to Brent to attract light sweet crude; these bottlenecks should be resolved by the end of 2013; before then, the best USGC waterborne price marker would seem to be at Houston.”
So What Does this Mean for Prices?
The report argues, “the unprecedented scale of US pipeline infrastructure build-out and reconfiguration is about to credibly debottleneck the midcontinent crude glut.” This, along with changing pipeline flow dynamics along the Gulf Coast, Permian Basin to/from Cushing and from Western Canada, will narrow benchmark crude price spreads over the short term, then as pipeline capacities shift with new lines coming on over the medium term, spreads will again widen toward current levels, the analysts find.
“Citi thus sees Brent-WTI at $9 in 2Q, $6 in 3Q and $4 in 4Q’13, but then widening through 2014 as the USGC [US Gulf Coast] becomes increasingly glutted; combined with some increase in inflows to Cushing, the spread could target $7-9 by 2015, assuming no pipeline delays or disruptions; however, insufficient inflow additions to Cushing would mean the spread staying at $4-6. More exportability could narrow Brent-LLS.”
The risks to the outlook are particularly interesting, pointing out wildcards including aging infrastructure failures – like the recent Pegasus Pipeline spill – and rail accidents occurring more frequently as greater volumes of crude move via tank cars. Not only do these incidents alter physical flows – with knock-on pricing implications – but regulatory backlash also has the potential to profoundly impact oil markets.
