This is Part 1 of a two-part review of Gulf Coast crude price differentials that extends a series on the topic that we started back in November (2013). The first episode in the series described 4 MMb/d of current and planned expansions to crude transportation capacity into the Texas Gulf Coast region (see Handling The Texas Gulf Coast Crude Flood). Our analysis showed that the new incoming light crude capacity will exceed Texas Gulf Coast demand by somewhere north of 0.5 MMb/d by the end of 2015. In episode two we described how some of these excess crude supplies would move east on the reversed Ho-Ho pipeline (see Gulf Coast Crude West to East Flows). In episode three we looked at how shippers could divert supplies away from Texas Gulf Coast congestion (see Texas Gulf Coast Bypass Options). Episode four looked at progress bringing TransCanada’s Keystone XL Gulf Coast extension (a.k.a, Cushing Marketlink Pipeline (CMP)) online (see Keystone Marketlink Comes to Texas). Episode five looked at the impact of the twin Seaway Pipeline from Cushing to Freeport expected online during the second quarter of 2014 (see Impact of the Seaway Expansion). Now we’ll get into what happens to price differentials as new crude supplies come flooding into Texas in the next six months.
Forecasting prices for tomorrow is like gambling – only fun if you don’t mind losing money. And the odds of being right get worse the further out the predictions go. So our intent here is to concentrate on price differentials – the spread between key crude benchmarks rather than getting into absolute price levels. We start with a review of what has happened since 2012 and then offer some scenarios for how things might turn out next year (2014). Buckle up.
Recap 2012
Figure 1 below shows average differentials for key benchmark light sweet crude grades at the Gulf Coast during 2012. The prices are averages for the year versus the West Texas Intermediate (WTI) NYMEX benchmark price at Cushing - set to $0/Bbl. Recall that during 2012 surging crude production in North Dakota and Canada exceeded demand in the Midwest and supplies started backing up at Cushing, OK because there was very little pipeline capacity from the Midwest to the Gulf Coast (where 50 percent of US refining capacity resides). Because of this logjam a stockpile of crude built up at Cushing and inland domestic prices based on WTI were discounted heavily versus Gulf Coast supplies priced against the international benchmark Brent crude (see The Seven Gates of Hell for WTI Traders). Domestic light sweet crude grades sold at the Gulf Coast – represented by Light Louisiana Sweet (LLS) in our diagram - traded at the higher international levels. In 2012 both Brent and LLS averaged $18/Bbl above the discounted WTI “stranded” at Cushing. The dotted yellow line on the chart indicates the pipeline ‘capacity constraint’ boundary that split Cushing and Gulf Coast pricing markets at that time. You can think of that yellow line as separating zones of domestic and international pricing along the Gulf Coast region.
Figure 1 - Source: RBN Energy
Prices for WTI are set both at Cushing, OK – the gateway to Midwest refineries – as well as at Midland, TX, closer to the Permian Basin production region. During 2012, Midland prices for WTI were discounted by an average of $4/Bbl to WTI at Cushing because of capacity constraints on the pipelines between Midland and Cushing (caused by surging crude production in the Permian Basin). Until new pipelines opened up from the Permian direct to Houston in 2013, WTI had to travel to market from Midland to Cushing - into an already oversupplied Midwest market (see New Adventures of Good Ole Boy Permian).
But before we get to those numbers we need to fill in the gap in our analysis covering the first 9 months of 2013 – since Figure 1 only covered 2012. That nine-months was a transition period during which new pipeline capacity opened up between Cushing and Houston (Seaway Phase 2 expansion) and between the Permian Basin in West Texas and Houston (Longhorn Reversal). Crude-by-rail shipments also increased the flow of light sweet Bakken crude from North Dakota to the Gulf Coast during this period (hence the rail track shown on Figure 2). As a result more light sweet crude by-passed the Cushing logjam and reached Gulf Coast refineries - reducing the need for waterborne imports. The crude stockpile in Cushing declined from its record high levels and Gulf Coast crude stocks began to increase. The net effect was that the Brent premium to WTI, which reached $23/Bbl in February 2013 evaporated to less than $1/Bbl by July (see Strangers in the Night). Between July and September 2013, Brent, WTI and LLS traded in a narrow range of about $5/Bbl with Brent “in the middle” at a discount to LLS and a $3/Bbl premium to WTI.
Since the middle of September, however, Brent prices have taken off on their own track, leaving LLS trading at a narrow $3/Bbl premium over WTI that is roughly equivalent to the pipeline tariff between Cushing and the Gulf Coast (see Goodbye Stranger). And that situation has prevailed ever since – as depicted in Figure 2 below. Over this period the Gulf Coast has been oversupplied with light sweet crude, leaving no need for imports – allowing Brent prices to effectively disconnect from LLS and take their own path – reaching as high as a $17/Bbl premium over WTI but averaging $10/Bbl over the period. The yellow dotted capacity constraint line separating international and domestic markets at the Gulf Coast moved offshore. Behind that imaginary yellow line, LLS prices tracked more closely with WTI and traded at a discount to Brent that averaged $7/Bbl. Prices for WTI in Houston and LLS in Louisiana tracked closely together – indicating that both markets were equally well supplied. The WTI prices at Midland continued to trade at a discount to Cushing over this past three month period because although new capacity opened up from the Permian to Houston, surging production in West Texas continues to overwhelm pipeline capacity.
Figure 2 - Source: RBN Energy
And one argument for next year is that price differential relationships at the Gulf Coast will stay basically the same as they have been for the past three months. A December 11 “This Week in Petroleum” report from the Energy Information Administration (EIA) notes that its short term forecast for US domestic crude production - 7.5 MMb/d in 2013 rising to 8.5 MMb/d in 2014 will place continued downward pressure on crude oil prices such as WTI and LLS. EIA expects the WTI discount to Brent to average $12/Bbl during the fourth quarter of 2013 and $9/Bbl during 2014. EIA also expect the price for LLS to continue to move in step with the WTI price plus the pipeline tariff.
So we will use that scenario as our base case – holding steady. In the next episode in this series we will revisit the pipeline events that will impact the differentials in 2014 and examine alternatives to our base case price scenario for 2014.------------
| Sandy Fielden |  | Energy market pricing and fundamental data, Data Integration with ETRM, writer on Energy Markets, Consultant, Conference Speaker |
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