Tank House Blues – Brent, WTI and LLS Learning to Live With A Crude Oil Glut

In spite of a brief respite provided last week by increased geopolitical risk in Saudi Arabia, crude oil prices are still in the $50/Bbl range – down more than 50% since last Summer - and inventories at Cushing and on the Gulf Coast continue at record levels. The fall in crude prices was initially consistent across markets with international benchmark Brent trading within $1/Bbl of U.S. benchmark West Texas Intermediate (WTI) and Gulf Coast marker Light Louisiana Sweet (LLS) in January 2015. But since February the relationship between Brent, WTI and LLS has changed as the build up of Cushing inventories weighs on prices in the Midwest. Today we provide an update on crude price differentials at The Gulf Coast.

Previously on Brent/WTI

This is the latest in a long running occasional series covering the ongoing relationship between U.S. domestic benchmark crude WTI and its international counterpart Brent. Historically (prior to 2010) these two crudes of similar (light sweet) quality enjoyed a close pricing relationship governed by the U.S. need to import light sweet crude to meet domestic demand – with Brent trading at a slight discount to WTI mostly reflecting freight costs. Huge increases in domestic light crude production from shale have changed the relationship over the past four years – including a WTI discount to Brent averaging $18/Bbl during 2012 as new production was stranded at Cushing. That prompted construction of a lot of new pipeline capacity from Cushing to the Gulf.

As new domestic supplies reached the Gulf Coast market – home to 50% of refining capacity and a traditional center of light crude imports - the U.S. reduced its dependence on crude priced against Brent in the international market. The result (as we described in “The Year of Daft Punk”) was that Brent prices disconnected from WTI at the Gulf Coast during 2013. This new situation was confirmed by the behavior of a third crude, LLS – the Gulf Coast light sweet crude benchmark. Instead of tracking Brent – as they had previously, LLS prices began to track WTI (see Goodbye Stranger) meaning that the Gulf Coast market for light crude had become domestic instead of international. We last posted a blog specifically about the WTI/Brent spread back in June 2014 (see You Can Call Me Queen Brent). At that time Brent prices were disconnected from the Gulf Coast market and a glut of domestic supplies kept LLS trading close to WTI. At that time of course, (early June 2014) crude prices were over $100/Bbl and the market was in backwardation – meaning futures market prices were lower than prompt month cash on expectations that excess supplies would exceed demand.

 

And that’s precisely what happened in the second half of 2014 as both Brent and WTI prices crashed by more than 50% from the $100/Bbl range to $50/Bbl or less in response to growing concerns that the market was oversupplied (see Crude Falls To Pieces and Crying Time At OPEC). The root cause for the price crash was a worldwide increase in crude supplies coupled with a downturn in demand. Supply of crude from U.S. shale based production has been increasing at the rate of 1 MMb/d a year for the past three years - pushing out imports into the world market and creating increased competition among producers to retain their market share.  On the demand side, economic recovery continues to splutter in most of the world and demand for oil is down or the same as it was a year ago. When supplies exceed demand like this a market condition known as “contango” often develops where future prices are expected to be higher than spot prices today – encouraging the use of storage to “save” cheap crude today for use when prices recover (see Skipping The Crude Contango). Without new sources of demand or supply interruptions, a contango market keeps downward pressure on today’s market prices as storage fills up and becomes more difficult and expensive to find – increasing the contango spread required to cover storage costs (see Fly Me To The Moon).