A Drop in the Ocean? Is the Seaway reversal a non-event or contributor to $87.82 crude?

Yesterday (May 30, 2012) WTI Crude prices for July delivery dropped $2.94/Bbl – that’s nearly $3/Bbl to $87.82/Bbl. At the same time, ICE Brent dropped $3.45/Bbl to $103.23/Bbl. WTI crude prices have now declined 16 percent this month and seem firmly entrenched under $100/Bbl. What is causing this oil market free fall? Well it seems clear that the factors behind this decline are world economics not US fundamentals. The European banking crisis continues to drag on, to the detriment of recovery in those economies. A slowdown in China’s manufacturing sector and weak US jobs numbers are also contributing to a belief that energy demand is declining. Today’s blog “A Drop in the Ocean?” looks at the market impact of changing US crude flows from Cushing via the Seaway pipeline. Although much anticipated by the market, it looks as though the results of this reversal will initially have far less impact than previously predicted.

The Seaway pipeline runs from Cushing, Oklahoma to Freeport, Texas and originally moved crude from the Gulf Coast up to Cushing. The Seaway reversal is the first of several planned new pipelines to get additional Cushing barrels delivered to Gulf refining outlets. Reportedly, Seaway owners Enbridge and Enterprise are halfway through filling the 800-mile pipeline with 150 Mb/d of crude oil destined for US Gulf refineries. Widening differentials between falling Cushing prices  (represented by the West Texas Intermediate benchmark, WTI) and higher Gulf coast prices (sustained by the international market for Brent) have led many to hope that the Seaway reversal would cause WTI prices to rally against Brent. Now that the pipeline is filling and crude is on the way to the Gulf, we take a look at how the reversal is impacting crude markets.

No Use Banking on a Narrowing Spread

Let’s look first at the Brent/WTI price differential. Back in March we reported on Goldman Sachs’ advice to short the September Brent/WTI spread in anticipation that the Seaway reversal would cause the spread to narrow ( see You’ve Got to Know When to Hold ‘em Know when to Fold ‘em; Trading the Brent/WTI Spread). Back then (March 12, 2012) the September spread was $14.11 barrel (Brent minus WTI). Yesterday (May 30, 2012) the spread was $14.27. From the chart below you can see that near month Brent futures prices have maintained their healthy premium over WTI since the Seaway reversal was announced on November 16, 2011. The day the announcement was made, the prompt crude price spread shrunk to $9.21.  But that did not last long. Yesterday the prompt spread was $15.41. Looks like so far this bet is not one that traders can take to the bank.

Can 150 Mb/d Make a Difference to the Cushing or Gulf Supply Situation?

To find out if the incremental flow from Seaway to the Gulf makes a difference to the supply picture, we can look at the weekly petroleum inventory numbers, due out tomorrow (Thursday – a day late because of the Memorial Day holiday). The US Government Energy Information Administration (EIA) reports this data weekly. Two of the report statistics are of interest to us, because they tell us the crude oil inventory position at Cushing and the rate that refineries can consume that crude on the Gulf.

Crude stocks at Cushing have been running at historical highs lately (see Bad Moon Rising – Cushing Inventories). Last week (May 18, 2012) Cushing stocks were 46.8 MMb – a record high and the stocks are up 60 percent so far this year (see chart below). Rumor has it that the market expects to see a decline in Cushing stocks reported tomorrow after the Seaway partners began pumping 150 Mb/d out of Cushing on May 17, 2012. The EIA report is “as of” Friday May 24, 2012 so an incremental outflow from Cushing on the Seaway pipeline so far of 7 days at 150 Mb/d or a total of1.05 MMb would not be surprising.

So if Cushing stocks decline by a million barrels this week (i.e. they fall to 45.8 MMb) we can infer that Seaway is at least beginning to make a dent in the stockpile. Our friends at Genscape, who keep track of Cushing inventories from the air, are predicting today that Cushing stocks will be unchanged this week, showing no impact from the Seaway reversal.

Whatever is reported tomorrow, we can be sure of one thing: the flow of crude to the Gulf on Seaway is not going to be more than a trickle right now. At 150 Mb/d the current Cushing stockpile would take 312 days to clear – even assuming there was no new incoming crude. Future plans to expand Seaway to pump 800 Mb/d and to add 700 Mb/d of Cushing to Gulf capacity via the Keystone Gulf extension pipeline will increase Cushing outflows to 1.5 MMb/d but that won’t happen until at least 2014.

The weekly EIA report also tells us that the current refining capacity in the US Gulf (PADD III) is 8.725 MMb/d. That is the maximum operating capacity of Gulf refineries. The report indicates the current operating capacity of these refineries – how much crude is currently being processed. Last week, refining capacity in PADD III was about 90 percent meaning that at current flow rates of 150 Mb/d, the Seaway pipeline can supply about one fiftieth (1/50) of daily crude refinery requirements in the Gulf. This statistic confirms our belief that the Seaway pipeline will have minimum impact in the short term. It really is just a drop in the ocean.

So in the short term, despite the hoopla and trading strategies, the Seaway reversal is too small to make an impact. It certainly is dwarfed by the kind of macro-economic sentiments that moved crude prices yesterday.

Longer term however continued growth in US and Canadian crude production threatens to swamp Gulf refining capacity, replace US Gulf crude imports and potentially even disconnect the US market from international prices – but that’s a story for another blog.