Today’s posting continues yesterday’s review of the Brent – WTI spread. In Part I we focused on the history of that differential, advice from Goldman Sachs to short the Brent-WTI spread, and what has happened to the crude market over the past few weeks. If you did not see that one, please go to Part I. Otherwise the paragraphs below won’t make much sense. Part II looks at the risks inherent in this trade. There are two big ones – (1) the difficulty of predicting the market impact of the event, and (2) the uncertainty about the timing of the event. To frame these risks, let’s consider a few questions:
Question #1: Will the crudes being diverted and replaced have the market impact anticipated? Initially the reversal backs out 90 Mb/d that has been flowing from the Gulf to ConocoPhillips (CP), and turns that around to pump 150 Mb/d from Cushing to the Gulf. That’s a 240 Mb/d net change. Is that enough to make a difference? Some prognosticators seem to think that volume is on the ragged edge of a level necessary to correct the imbalance at Cushing. As always with crude oil, quality matters. It was light crude that historically has moved north to CP. Who knows what will move south. Will it be light Bakken that has low yields of diesel and will compete with light-sweet imports? Or Canadian Heavy that will compete with heavy-sour imports from Mexico and Venezuela? Depending on the qualities shipped, the market impact can swing dollars one way or the other. Furthermore, whatever happens on day one will probably change over time. For both quantity and quality reasons, the impact of the reversal on the WTI – Brent price differential is a moving target.
Question #2: What happens to Midwest refinery supply when 240 Mb/d is diverted south? Will tightening of supply drive up the price of Cushing WTI? The existing stockpile at Cushing will be able to “fill the gap” for a few months. As of March 2, 2012 EIA reported a 36.1 million bbl stockpile at Cushing. That would take 150 days to reduce if no new crude is added. So it would seem that there will be no major supply shortfall anytime soon. In the longer term, again it depends on which crudes are shipped south. For example, if the crude shipped south to the Gulf is Canadian Heavy, the new heavy crude refinery processing expansions in the Midwest (BP Whiting, IN 2013, Marathon Detroit 2013, BP-Husky Toledo 2015) will be starved of supply as they come on line. This would bid up heavy crude prices in the Midwest and thus Cushing.
Question #3: In the mid-term, Seaway is set to be expanded to 400 Mb/d starting in the first quarter of 2013. That should certainly tighten that differential, right? Yes, unless the combination of increasing Bakken + Permian + Niobrara + Canadian imports have increased so much that 400 Mb/d is no longer enough to balance the market. In the past 15 months since 1/1/2011, the Bakken is up about +230 Mb/d Permian +130 Mb/d, Niobrara +50 Mb/d. Canadian imports +120 Mb/d. Uh oh. That’s up 530 Mb/d in 15 months. Given this rate of growth, 400 Mb/d will not be enough capacity to balance things out by Q1 2013. It could get worse. The rate of crude oil production growth is not slowing down.
Question#4: How do you time this thing? Reportedly, purging of the line is happening right now. Will it take between March and June to get the work done? Or might it be late? Clearly this is difficult for the outsider to know. And heaven help us if things were to get delayed enough to clash with BPs Whiting turnaround, scheduled for Fall 2012. When it happens it will take 500 Mb/d of demand out of the Midwest market.
Then there are the wild cards. War in the Middle East? Or probably more significantly – lack of war in the Middle East. That could blow the differential out to astronomical levels. Or not. Or economic meltdown in Portugal? Same story in reverse. The world of oil prices makes for a volatile gambling joint and … every hand's a winner and every hand's a loser. Sometimes the best that you can hope for is to die in your sleep.
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Note: This story is deeply intertwined with recent RBN posts about storage at Cushing (You’re Doin’ Fine Oklahoma!), the rising production of light crude from the Bakken (It Ain’t Heavy, It’s the Bakken) and the influx of Canadian Heavy crude south of the border (It’s a Bitumen ,Oil). |
"The Gambler" was written by Don Schlitz and recorded by Kenny Rogers in November 1978. It was one of five consecutive songs by Rogers to hit #1 on the Billboard country music charts, and won the Grammy award for best male country vocal performance in 1980. It’s famous refrain - You got to know when to hold 'em, know when to fold 'em.
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