Crude oil pipelines out of Cushing are filling up. With U.S. crude production approaching the 11 MMb/d mark, more and more production from the Rockies, Midcontinent and Permian is funneling into the Cushing, OK, trading hub. It’s getting increasingly difficult to get all of that volume to the major demand center at the Gulf Coast. The two major pipelines out of Cushing — Seaway and Marketlink — are near full capacity and differentials are responding as West Texas Intermediate (WTI) at Cushing is now trading at a $7.60/bbl discount to Magellan East Houston (MEH) at the Gulf. Today, we look at some of the major factors affecting the WTI-MEH spread, space on major pipelines between the two points, and potential implications going forward.
MEH has historically traded at just under a $2/bbl premium to WTI at Cushing (blue line in Figure 1). From January 1, 2017, through August 1, 2017, the spread was consistent, averaging about $1.65/bbl. In the fall of 2017, the MEH-WTI spread started to widen following refinery and export capacity outages due to Hurricane Harvey. The spread hovered above $4/bbl — and sometimes $5/bbl — until the end of 2017 as pipelines from Cushing to the Gulf were near capacity with increased domestic production trying to get to the Gulf. After settling back near $2/bbl earlier this year, the spread recently took off again, ratcheting higher and higher starting in April 2018 and averaging more than $8/bbl since the start of June. The pricing spread between WTI and MEH is now more than double the cost to transport crude from Cushing to the Gulf Coast, via “walk-up rates” or contractual rates. Walk-up rates, also known as uncommitted rates, are available to shippers that do not have a contractual commitment to move barrels on a pipeline and that don’t have firm pipeline space. Walk-up shippers choose to ship when they want to, but they can get shut out (usually through some kind of allocation or lottery process) when space is unavailable. Price differentials being larger than shipping rates is significant, as anytime the spread between two points is above the actual cost of transportation, it is typically a signal that pipeline space is full or close to it. This pricing/space situation is similar to what we’ve written about in regards to Permian pipelines and the blowout in the Midland-MEH differential. When takeaway capacity fills up, the pricing spread starts to widen. When takeaway capacity is maxed out with a glut of production rising behind it, price spreads blow out.