WTI/Brent Spread - The Cushing Glut; fact or fiction?
By: Aaron Fennell
Date: August 23, 2011
The WTI/Brent crude oil spread has been thrust into the field of public attention as it has reached extreme levels. The spread compares the two most important oil benchmarks in the world. West Texas Intermediate (WTI) crude oil is light sweet crude oil locating in Cushing Oklahoma and has historically been the American oil benchmark. The Brent crude oil is light sweet oil located in the North Sea and it is the most important European benchmark.
For many decades the two oil prices tracked each other fairly closely. Prior to 2011 a difference of $5.00 was considered extreme. In the winter of 2011 the price difference between the two oils started to widen. This divergence was initiated by the Egyptian revolution and the Libyan civil war as oil production from Libya came to a halt. This happened concurrently with the recognition of a developing crude oil glut at the Cushing Oklahoma pricing hub. The spread widened at a breathtaking rate first moving out to $10.00 then $15.00 then over $20.00 reaching a high level of nearly $25.00 per barrel. Currently analyst projections for the spread are all over the map and traders have become polarized in their expectations for the spread. Some traders believe that the price relationship is permanently broken, while others believe it is a market aberration bound to correct over time.
The Libyan civil war appears to be drawing to a close. It is still unclear how long it will take for oil to start flowing out of Libya once again, but the situation is improving each week. Expectations are that oil export from Libya will resume within the week with oil production around 160,000 barrels per day. The Organization of Petroleum Exporting Countries recently stated that Libyan oil production could reach 1 million barrels per day within 6 months. Given that Libya is a single industry economy everybody within the country has an incentive to get the oil moving once again.
The Cushing glut still appears to be the more significant contributing factor driving the wide spread. When one compares the WTI (Cushing) price to other North American benchmarks we see a spread of similar magnitude. Louisiana Light Sweet crude oil has been trading $15.00 higher than WTI Light Sweet with only 600 miles physically separating the two pricing points. The lion's share of the WTI/Brent spread has been caused by depressed WTI prices rather than exceptionally high Brent prices.
The Cushing glut developed because Canadian crude oil production has increase significantly in recent years. Most of this production is exported south into the United States via pipeline to the Cushing hub. At the same time the Bakken oil field has been expanding north of Cushing. Currently there is plenty of transport capacity into the hub and plenty of oil available for delivery, but there is a bottleneck exiting the hub to deliver oil into refineries on the Gulf Coast. Further, more oil storage facilities at the Cushing hub had been constructed so that oil traders could speculate in the physical markets while keeping their oil near the important pricing hub. Through the winter of 2011 oil inventories at the hub accumulated to high levels raising concerns of a glut. That said, economics has a remarkable way of rebalancing the flow of commodities from where they are cheap to where they are expensive. Pipelines are clearly the most efficient way to move oil if capacity is available, but without capacity there are other alternative transport methods. Oil can move by rail, truck, or barge down the Mississippi river. Even though the Mississippi does not directly access Cushing the river is still used to transport oil from the boarder Mid-West to the Mississippi Delta.
The data shows that crude oil movements from the Mid West to the Gulf Coast have been increasing. The Department of Energy statistics indicate that the oil transport from the Mid-west to the Gulf Coast has increased four times over the past 5 years. Further, the Department of Energy numbers exclude crude oil shipments by rail and truck. In a recent report on the subject the DOE stated that some estimates indicate the actual total figure may be at least twice that of pipeline shipments alone. "However, EIA surveys exclude truck and rail shipments, which some third party sources estimate may be as large, or even larger, than the most recent pipeline shipment estimates. Thus, crude shipments from PADD 2 to PADD 3 are likely substantially higher than the EIA data indicate."
The data also shows that the shipping alternatives are in fact resolving the Cushing glut. Cushing oil storage peaked in April 2011 at 41.9 million barrels, but by September 2011 the storage levels had been drawn down 22% to 32.7 million barrels, a level common in 2009 before a glut at Cushing was ever considered a problem.
In the long term more permanent solutions are required to resolve the oil transport imbalances. Projections are for continued growth in Canadian oil production. Canadian oil needs to be redirected away from or out of the Cushings hub for markets to permanently rebalance. Here again economics will ultimately find these solutions with a few major strategies already on the table.
Enbridge Line 9 Solution:
In early August 2011 Enbridge submitted an application to reverse the flow of a portion of the Line 9 crude oil pipeline from Montreal to Sarnia. Currently the pipeline brings oil from eastern Canada into refineries in Ontario and into the northern edge of the U.S. pipeline network. If reversed Ontario refineries that currently rely on oil from eastern Canada would instead rely on oil from western Canada. This in turn would free eastern Canadian oil to be either exported into the north eastern United States or loaded on tankers bound for the global marketplace. If approved this solution could be implemented by the fall of 2012 and could have an impact of 125,000 BPD.
Northern Gateway Pipeline:
Enbridge is working towards the construction of the Northern Gateway Pipeline from Northern Alberta to the Pacific Coast. This would be a critical supply line to fill oil tankers bound for Asian markets. It would truly be an important strategic piece of infrastructure in the longer term. The pipeline would have a capacity of 525,000 BPD and would be a good start in bringing Canadian oil to markets beyond North America. Unfortunately pipelines take time to approve and construct so this pipeline will not reach completion until 2016 at the earliest. Though controversial the case for this pipeline has gotten much stronger as the Cushing glut has become so evident by the price of WTI. Currently Canada is a price taker in the crude oil market because most of her oil is land locked. Canada must establish access to alternative markets so that local oil logistical problems do not position Canada at an economic disadvantage.
Keystone XL pipeline:
The Keystone XL pipeline expansion is a solution that cuts to the heart of the problem in a meaningful way. This pipeline would bring Canadian oil 1600 miles from the Canadian oil sands to refineries on the Gulf Coast. The pipeline also transitions through both the Bakken oil field and the Cushing hub. The pipeline will not only provide a direct route for Canadian oil to reach the final customer, but it will also give Cushing oil better access to the refineries on the Gulf Coast. The 36 inch pipeline would increase the Keystone system capacity to 1.3 million barrels per day. This project is tremendously controversial leading up to an important U.S. election year and there are still some political hurdles to overcome. If approved promptly it could be operational by late 2013.
http://www.transcanada.com/keystone_pipeline_map.html
Traders can still have a tremendous opportunity to profit from a potential normalization of the WTI/Brent Crude price relationship. The spread still remains above $20.00 per barrel. Traders who would like help implementing a trading strategy that profits from a narrowing WTI/Brent spread can contract the Fennell Thompson Group at 416-862-3945. To see more of our trading ideas please visit www.fennellthompson.ca.
Disclaimer: Opinions expressed are subject to change without notice. This report should not be construed as a request to engage in any transaction involving the purchase and sale of a futures contract and/or commodity options thereon. The risk of loss in trading futures contracts or commodity options can be substantial, and investors should carefully consider the inherent risks of such an investment in light of their financial condition.
