This week on Monday WTI prices crossed the $100/Bbl mark for the first time since the end of December (they closed at $100.37/Bbl yesterday February 12, 2014). Brent crude traded at a $19/Bbl premium to WTI at the end of November but the spread has fallen to less than $10/Bbl in recent weeks ($8.42/Bbl yesterday). One of the biggest concerns hanging over the crude market is the fear of oversupply – both inside and outside the US – with the forward curves pointing towards WTI at $78/Bbl and Brent at $90/Bbl by 2020. Today we provide an update on the crude market.
In our last blog on the Brent/WTI spread at the end of last year we looked back at 2013 (see Why 2013 Was The Year of Daft Punk for the Brent/WTI Spread). This time we look at how the spread is panning out so far in 2014 and the implications of the forward curve for the future direction of prices. The next two paragraphs provide a catch up on the storied relationship between these two critical crudes for those new to the saga.
WTI, the US domestic benchmark and Brent, the benchmark for crude sold in Europe and many other parts of the world are both light sweet crudes with similar refining qualities that should be priced about the same if they are trading in the same market. Historically that was the case, and WTI and Brent prices tracked closely - with WTI generally having a slight premium over its international rival – reflecting the freight cost to ship Brent to the US. A little over three years ago in August 2010, WTI began to trade at a discount to Brent because of a build up of crude inventory at the Midwest Cushing, OK trading hub. Growing crude production in North Dakota and Western Canada overwhelmed Midwest refinery needs and got caught in a Cushing glut because of inadequate pipeline transport capacity to Gulf Coast refineries. The WTI discount to Brent widened out as far as $28/Bbl in November 2011 and averaged $18/Bbl in 2012.
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During 2013 the Brent/WTI spread traded in three distinct ranges. For the first 6 months of the year until the end of June the Brent premium to WTI collapsed to less than $1/Bbl as surging Midwest and Texas crude production began to bypass Cushing and reach Gulf Coast refineries. Between July and September underlying Brent and WTI prices both rallied. Tensions in the Middle East and Brent production shortfalls due to maintenance kept international prices high while increased demand for WTI in the Midwest and falling stocks at Cushing underpinned WTI (see The Cushing Floodgates Open). The Brent premium to WTI widened out again during this period to $5/Bbl but remained in a relatively narrow range with the two crudes tracking roughly the same path. Then from mid-September to the end of the year Brent prices took off on their own track, leaving WTI behind as the Spread surged back to $19/Bbl at the end of November. But this time when the Spread widened, the behavior of a third crude, Light Louisiana Sweet (LLS) – the Gulf Coast light sweet crude benchmark – became very significant. That was because instead of tracking Brent – as they had during the past three years, LLS prices began to track WTI (see Goodbye Stranger).
The reason for this change in LLS behavior relative to Brent was that the Gulf Coast had become oversupplied with light sweet crude, leaving no need for imports to meet refinery demand. This oversupply was caused by the cumulative impact of new pipeline and rail routes into the region as well as crude supplies arriving in Louisiana from the South Texas Eagle Ford basin (see Float, Float On). The implications of this oversupply are magnified by the Federal ban on crude exports that dates back to the 1970’s - restricting the export of US crude to anywhere except Canada. That ban means producers cannot simply export excess light-sweet crude supplies to overseas markets – increasing downward pressure on domestic prices.
The chart below shows Brent (red line) and LLS (blue line) premiums to WTI (black line) since September 2013. Over this period Brent premiums to WTI averaged $10.55/Bbl with a high of $19/Bbl at the end of November narrowing back to less than $10/Bbl in early February. LLS premiums to WTI averaged $4/Bbl over the same period. From September to the end of November LLS tracked WTI rather than Brent. In December LLS prices pushed higher to an $8.39/Bbl premium over WTI as US Gulf Coast refiners increased their throughput to 96 percent utilization and Gulf Coast crude inventory fell 18 percent (source EIA). Since the start of January Gulf Coast refinery utilization has fallen back as refineries reduced their throughput for maintenance (utilization was 88 percent as of February 7, 2014). In the last month crude oil inventory in the region has recovered by 12.6 MMBbl pushing LLS prices back to a $5/Bbl premium over WTI (green circle on the chart). Refiners have recently paid a premium for LLS over WTI at the Gulf Coast that is higher than the transport cost between the WTI Cushing, OK hub and the LLS St James, LA hub (about $4/Bbl). That is because LLS produces slightly higher yields of the more valuable diesel product that Gulf Coast refiners can export profitably than competing light shale crudes such as Eagle Ford (see Gulf Coast Diesel Crack Habit), which are sold at a discount to LLS.