The rapid pace of new US crude production has traders scrambling to assess constantly moving crude differentials as supporting infrastructure grows and changes the dynamics.
Not long ago, there was too much crude in Cushing, Oklahoma, the delivery point of the NYMEX sweet crude futures contract.
This had traders constantly eyeing the spread, or price difference, between US benchmark WTI and North Sea Brent, pushing WTI from its traditional premium over Brent to a discount where it has held for several years.
The flip in relationships between the two benchmark crudes was due to the lack of pipeline capacity to carry crude out of the oil hub of Cushing to refineries along the US Gulf Coast, which is home to about half the nation's refinery capacity.
Many traders expected Brent to keep a double-digit premium to WTI as barrel upon barrel of crude from Canada and Midcontinent producing fields like the Bakken kept flowing into Cushing. Midstream companies barely kept up with building storage tanks to hold the flow, let along building pipelines to alleviate the glut.
But instead the spread started to narrow and one of the biggest issues for traders was trying to get back on the right side of their position.
"So many traders were convinced that the Brent premium was not going to ever come back now have to do major damage control," Carl Larry, president of Oil Outlooks, said Tuesday.
"This has put a lot of pressure on them to make up [what] was lost to start the new year," Larry said. "Trading volumes are better now for funds, but trading houses and spec traders have been scared to put too much risk on in the market. We think this is why trading remains sideways with no direction."
Brent was trading at a $21.09/b premium to WTI on March 15. By May 15, the premium had narrowed more than half, to $8.96/b. On May 21, the spread was valued under $8/b.
MIDSTREAM COMPANIES RE-EVALUATING
By the beginning of this year, it was considered almost a certainty that TransCanada's Keystone XL would be carrying 800,000 b/d from Alberta and North Dakota through Cushing and down to the Gulf. Since that project is still in political limbo, there is a growing glut in Cushing.
Pipelines carrying Cushing crude out to Gulf Coast refineries are not equal to the amount of crude flowing into Cushing, a ratio that has sent many midstream companies back to the drawing board.
Between 2013 and 2014, government data shows an expected 1.4 million barrels of crude takeaway capacity from Cushing while new inbound pipeline capacity will be about 1.3 million b/d. While that is likely to help siphon off Cushing stocks, it will not be an immediate move due to high stocks marooned there.
The amount of crude sitting in Cushing storage tanks was more than 50 million barrels at the beginning of 2013 -- a record high. It has tapered off a bit to 49.7 billion barrels for the week ended May 10.
"There is a lot of crude leaving Cushing and the crude into Cushing has not gotten bigger so it's constructive for WTI and the arbs," said one hedge fund trader. "It doesn't get any better than that."
Last spring, Enbridge and Enterprise reversed the Seaway pipeline to carry as much as 400,000 b/d of crude out of Cushing and down to the Gulf refineries, but it was not enough to make much difference. The Seaway phase three plan will carry an additional 450,000 b/d out of Cushing by 2015.
As Seaway and other pipeline plans emerged, and new production came on from old reworked fields like the Permian and new fields like the Bakken, crude price differentials responded. Various crude grades moved as each pipeline or alternative mode of transportation like rail or barge began operation.
The West Texas Permian, one of the nation's first oil fields, was rejuvenated by the new techniques used for drilling tight shale formations like the Bakken and the Eagle Ford. It has increased production from the region and the pipelines used to move it to the Gulf refineries completely bypass Cushing.
The spot price of WTI out of the West Texas city of Midland was recently trading at around $96.69/b while West Texas Sour, also out of Midland and popular among Gulf refiners looking for heavier, more sour barrels, at $96.64/b, showing the value heavier crudes are commanding at the Gulf. This spread had blown out to as much as 20 cents earlier this year.
The spot price of both Midland grades rose after Magellan said it started with 75,000 b/d of crude line fill on its 225,000 b/d Longhorn pipeline in Texas, which will bypass Cushing and carry the crude directly to the Gulf, with easier access to the Gulf Coast refineries giving it greater value.
But the price difference between WTI ex-Midland and WTS ex-Midland, usually a difference of several cents, has flattened out as traders jumped in to take the opportunity to trade the spread. Some say the Permian arb trade is over for the moment.
'BULL MARKET CORRECTION'
Cushing is also getting some relief by not receiving as much oil from the North. More Bakken and Canadian crude is being sent directly to East, West and Gulf coast terminals. On May 22, the WTI-Brent spread ended the day around $7.73/b, in from more than $20/b in 2012.
A number of traders don't expect the narrower WTI-Brent spread to last.
"I look at this as a bull market correction. I am not entertaining a more bearish scenario," Brian Larose, senior analyst at United-ICAP, said Tuesday. Larose says the key technical level to breach is for WTI to move to $13.45 below Brent and show a clear change in direction.
Several traders Tuesday said they though there was still too much crude in Cushing and they expect the spread to widen.
"But as the US continues on the road to recovery, US demand is going to lead the drive. In six months, we think that conservatively we see this WTI/Brent spread pull back into $3 Brent over WTI but if the EU continues to see weakness, we have WTI flip back over by the end of the year," Larry said.
Another trader said he expected the spread to widen back out for a short period of time, to perhaps $10 to $12/b. "But I look for it narrowing later in the year," he added.
"Factors include additional expanded pipeline and BP's massive Whiting, Indiana" refinery that will come back online and pull more barrels out of Cushing, the trader added. The upgraded Whiting plant will be able to process up to 85% heavy crude compared to about 20% before.
