Back in December, I suggested that the Brent-WTI spread
would likely narrow in the New Year due to the completion of the key Seaway
pipeline as well as increases in refinery demand. Back then, the spread was at
$22.6 and indeed narrowed considerably to reach $15.6 on 17th
January. Since then however, operators of the Seaway Pipeline have announced
that flow has been restricted due to new bottlenecks building up at the
delivery point in Texas, and markets have come to realise that not only is
Seaway not the miracle cure to the inventory build-up, but that the key factor
affecting the Brent-WTI spread may not be logistics, but rather overwhelming
supply. In the wake of these realisations, the spread has more than reversed,
closing at $21.8 on Friday as the chart shows.
The announcement from Seaway came on January 23rd,
when Enterprise announced storage at the final terminal in Jones Creek, TX, had
reached full capacity and thus no more crude could flow into the terminal. The
reason for this is that the terminal has just two outlets; a further pipeline
to Texas City and Phillip 66’s Sweeny refinery. With the refinery under
maintenance, demand from Jones Creek was reduced by up to 247,000 b/d, and the 2.6
Mb available in storage was not enough to absorb the surplus supply.
While the Brent-WTI spread widened significantly on the
news, many analysts still expect a narrowing of the spread in the coming
quarters because of additional infrastructure projects that are coming online.
The range of these estimates varies widely; Goldman Sachs expects a spread of $7.50
in Q2, while the writers at Econblog believe $12 would be more realistic and
analysts at Deutsch Bank don’t expect the spread to narrow until the second
half of 2013. To understand the reasoning behind these differing forecasts,
let’s take a look at some of the additional projects that will help change the
current structure of the US crude market.
Pipeline from Jones
Creek to ECHO
The first project should complete Seaway’s original purpose
of moving crude from Cushing to a place of greater demand and greater storage
capacity. Enterprise are currently in the process of building a lateral
pipeline between Jones Creek and Enterprise’s crude storage terminal in
Houston, called ECHO. The terminal, which currently has a storage capacity of
750,000 barrels (that will someday be 6 mbls), is connected to refiners in the
Texas Gulf area with a total refining capacity of 3.8 Mb/d, as well as having water
access to move crude to other refineries on the Gulf coast. Furthermore, with NYMEX
considering implementing a new benchmark for US crude at the ECHO terminal,
Enterprise will be doing all they can to ensure the terminal features as a
major future hub no matter what the structure of the oil market. Given this, additional
pipelines out of the terminal are already planned; by 2014 there should be a pipeline
connecting ECHO to the 1.84 million bbls Beaumont/Port Arthur refinery complex.
Enterprise and its customers are confident this lateral
connection is what the oil supply chain needs; earlier this month transporters
provided the long-term commitment needed for the company to build a twin Seaway
Pipeline, which is expected to increase total capacity to 950,000 b/d by 1Q2014
from the current 450,000 b/d.
While the market has had Seaway tunnel-vision in the past
month, focus has also moved on to other projects expected to relieve the glut
at Cushing. One of the reasons cited by Goldman Sachs’ Jeffrey Currie for his
belief that the spread will fall to $7.50 is the implementation of Magellan’s
Longhorn pipeline reversal, allowing an initial 75,000 b/d flow from the WTI
producing Permian basin to Houston in Q1, expanding to 150,000 in Q2 and eventually 225,000 b/d. Additionally Sunoco Logistics is also
implementing a reversal of two pipelines which will take crude from the Permian
basin area to the Gulf coast, with an eventual capacity of around 200,000 b/d.
The combined changes mean at least
280,000 barrels can avoid Cushing in Q2.
Another project to reduce the crude flow through Cushing is
a major expansion to the Keystone pipeline, which currently runs from Canada to
Cushing through an indirect route, but will soon allow a direct route from
Canada to Texas and thereby providing another route for crude flows out of
Cushing. On the flip-side, this will also mean much more crude in the Gulf
area.
It’s not just pipelines that will transport extra production;
Rail is now the preferred transportation method from oil plays in North Dakota.
The total amount of crude carried on railways in the US is 350,000 b/d and the
main carrier, Burlington Northern, expects the 240,000 b/d it transported in
2012 to increase by 40% this year. Much of this will be to refiners on the Gulf
coast.
While these pipelines will help reduce the glut at Cushing,
they will only be effective in decreasing the Brent-WTi spread if excess crude
in the Houston area can find its way to points of demand. The reversal of
Shell’s Houston to Houma, LA, pipeline should also be finished by Q1/Q2. This
pipeline, with a capacity of 250-350,000 b/d will allow crude to flow from
Houston to the Louisiana Gulf refinery area in which there is a potential 3.2
MMb/d of refining capacity.
Will there be enough crude demand?
While there are plenty of projects that will help alleviate
various bottlenecks in the oil supply chain, none of these will actually
increase the price of oil if demand at the final destination is overwhelmed by
the new supply. However with different refiners set up to process different
types of crude, it’s not just a case of total crude supplied matching total
crude demand. Indeed, with the boom in tight oil coming only recently, refiners
have actually spent the last few years investing to process heavy crude rather
than domestic light crude. Furthermore the country cannot just export excess
light crude in return for heavy imports, as the US limits exports for political
reasons. With the current administration unlikely to permit increases in
outright exports before the country reaches its energy self-sufficiency targets,
US produced crude prices would have to fall before the government acquires the
political mandate to allow exports, or before refiners have the incentive to
convert back to processing light crude.
Will the spread
narrow this year?
Seaway tunnel-vision reined in the market earlier this year,
and the consequences of such a view is that many have been hurt on bets on the Brent-WTI
narrowing that didn’t materalise. There are now three main camps with regard to
the Brent-WTI spread; those who believe the spread will narrow in Q2, those who
believe it will not narrow until later this year or 2014, and those who don’t
believe it will narrow at all, and that WTI pricing will be completely
overwhelmed by excess supply.
Given the current outlook, it looks as if a combination of
these views will prevail; a narrowing of the spread in Q2 and 2H followed by a
widening again in 2014. In this process, WTI will see gains as infrastructure
comes online which will result in sweet crude imports being priced out and the
WTI-Brent spread will narrow. However as US production increases, storage will
fill up and bottlenecks will be seen in weak points of the supply chain, which
would result in the Brent and WTI again beginning to diverge. It’s likely this
process will be more gradual than the rapid narrowing seen at the beginning of
January, as those burnt from the reversal take more caution.
One of two things would then have to happen to prevent the
wide spread remaining; a reversal of export policy or refiners switching to
processing light crude. Due to the political attractiveness of energy independence,
a change in export policy would have to have clear benefits for the US economy
which means the administration may have to wait for prices to fall before it
gains support. The same applies to the refinery conversion process; sweet crude
prices need to be sustainably lower than imported heavy crude for the capital
expenditure to be justified. Both of these things will take some time, and thus
the spread is likely to widen further before complete price convergence between
WTI and Brent is achieved.
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