A veritable flood of more than 3 MMb/d of new crude production from the US and Canada will come into the Houston region by 2015 via long awaited new pipeline infrastructure. The most immediate impact will be to back out light sweet crudes from the Gulf Coast region – as early as 2013. Today we assess how the changes will affect light sweet crude pricing.
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In the last part of our recent blog series on the Ho-Ho pipeline reversal we looked at the entire PADD 3 Gulf Coast region supply/demand picture out to 2015 and projected that imports of light sweet crude would be backed out during 2013 by the flood of new crude arriving by pipeline (see The Bigger Gulf Coast Supply Demand Picture). Light sweet crude imports will no longer be required because increased flows of domestically produced light sweet crude will reach the Gulf Coast by 2013 to take their place. These light sweet crudes are predominantly from tight oil shale in North Dakota and South Texas but also from the older conventional West Texas Permian Basin. This time we are going to look at the pricing of light sweet crudes both before the flood of new crude (today) and after light sweet crudes are backed out in 2013.
Before the Flood
A backup of crude supplies in the Midwest is still dominating US crude oil pricing today. That has caused a stockpile at Cushing, OK and a $20/Bbl or higher discount for the US domestic light sweet benchmark West Texas Intermediate (WTI) crude against the Gulf Coast light sweet benchmark Light Louisiana Sweet (LLS) and the international light sweet benchmark Brent. The latest data from the Energy Information Administration (EIA) shows Cushing crude stocks for the week of November 30 2012 are still only 4 percent below their all time high (47.75 MMBbl back in June of this year).
The chart below shows the current price situation for the key benchmark light sweet crudes in the Gulf Coast region. The prices are averages for the month of November versus the WTI benchmark price at Cushing set to $0/Bbl. The WTI price at Cushing is the benchmark for US crude pricing because it is the delivery point for the NYMEX futures contract. Prices for WTI at Midland, TX are for delivery closer to the Permian Basin in West Texas where WTI is produced. During November 2012, Midland prices for WTI were discounted by an average of $8/Bbl to WTI at Cushing because of capacity constraints on the pipeline between Midland and Cushing (caused by surging crude production in the Permian Basin and refinery outages). Until new pipelines are opened up from the Permian direct to Houston in 2013, WTI has to travel to market from Midland to Cushing or further east into the already oversupplied Midwest (see New Adventures of Good Ole Boy Permian).
Source: RBN Energy
The price for LLS at the Gulf Coast (St. James LA) averaged $22/Bbl above WTI at Cushing this November. LLS is still linked to light sweet crudes imported to the Gulf Coast that are priced against the international benchmark Brent. The Brent price averaged $21.50/Bbl above WTI at Cushing during November and $0.50 below LLS at St James. The LLS and Brent prices are dislocated from the WTI Midwest price because of the crude logjam at Cushing. Until next year when the Seaway pipeline expands and the Keystone Gulf Extension pipeline comes online, only a trickle of crude from the Midwest can reach the Gulf Coast refining market by pipeline. The dotted yellow line on the chart indicates the dividing line between the pricing markets. Although there are crude movements directly from light sweet crude producing areas in North Dakota by rail and by barge into St James, LA and South Texas Eagle Ford crude is being shipped from Corpus Christi to Houston and St James, the stockpile in Cushing persists and keeps the lid on WTI prices.
After The Flood
Now lets turn to what happens to light sweet crude prices after the flood. WTI will no longer be stranded in the Permian Basin and reliant on passage through Cushing to get to market. New capacity on the reversed Longhorn Pipeline among others (see New Adventures of Good Ole Boy Permian for the full list of additions and dates) will open up routes to Houston and further along the Gulf Coast to St James LA. To assess the impact we looked first at tariff rates on the new pipelines in place after the flood (see map below). For our analysis we assume that producers can find capacity on the new pipelines at the tariff levels publicized in their open season documents. The cost to ship WTI crude from Crane (close to Midland) to Houston on the Longhorn pipeline was $2.30/Bbl in the open season – we rounded it up to $2.50/Bbl. The tariff to ship crude from Cushing to Houston on the Seaway pipeline is currently $3.82/Bbl – we rounded that down to $3.75/Bbl since the $3.82 is a “walk-up” rate that a committed shipper would be able to improve on. The Cushing to Houston rate will likely get more competitive once the glut of Cushing stocks is run down after the Keystone Gulf Extension adds another 700 Mb/d of capacity on the route at the end of 2013. The important point to recognize here is that it will be at least $1/Bbl cheaper to send WTI direct to Houston on the Longhorn (or West Texas Gulf or Permian Express) pipeline than to send it to Houston via Cushing. The preferred route to market for WTI will therefore be from the Permian basin – direct to Houston.
Source: RBN Energy (Pipeline Tariffs from Company Websites)
After the Flood, around 200 Mb/d of crude WTI will be able to move from Houston to St James, LA by pipeline via the Shell Ho-Ho Reversal and can therefore compete directly with LLS (see Oh-Ho-Ho It’s Magic The Missing Link for Gulf Coast Crude for the project details). The anticipated tariff for that journey is $2.50/Bbl. As we pointed out in the Ho-Ho series, with all the new crude flooding into Houston, the Ho-Ho pipeline is going to be constrained but there will be alternate routes from Houston to St James by rail and barge at prices that compete with Ho-Ho.
The chart below shows our projection of crude price relationships “after the flood”. WTI remains the benchmark for US domestic light crude at Cushing because of its link to the NYMEX crude oil contract and because it will still set the price for light sweet crude in the Midwest. The price of WTI at Midland will be at a premium to WTI Cushing of $1.00/Bbl. That is because the preferred route to market for WTI will be direct to Houston via Midland meaning that WTI crude in Cushing will be worth less than WTI in Midland. WTI in Houston will be priced around $5.00/Bbl higher than Cushing with the premium representing transport costs from the Permian Basin to Houston.
Source: RBN Energy
The LLS price at St James, LA will no longer be linked to Brent but will be priced at a $6.50/Bbl premium to WTI Cushing based on the transport differential. That differential is the cost of moving WTI from Midland to St James, LA. Brent prices will “detach” from LLS and trade at a premium to WTI that should be higher than the LLS premium to WTI – we have used $10.00/Bbl. In our chart the yellow dotted line has moved offshore meaning that Brent prices will be set by international crude supply/demand fundamentals outside the US. However, Brent or Brent priced light sweet crudes will continue to compete for US East and West Coast refiner’s business until domestic light sweet crude delivered by rail from the Bakken (or from the Permian basin to the West Coast) pushes out imported light sweet crude from these markets.
All of the above is predicated on the US not changing the Bureau of Commerce rules that prohibit crude oil exports without a license. If crude exports are allowed, then US prices will again be linked more closely to international markets. In the absence of exports, Gulf Coast crude prices will dance to the domestic tune.
So to sum up - we have shown that light sweet crudes currently caught up in the Midwest logjam are being discounted unless they can reach the Gulf Coast by rail or barge. LLS crude produced at the Gulf Coast is priced higher against the Brent international benchmark. Crude flowing on the new pipeline infrastructure coming online in the next two years will push out imports of light sweet crude – as early as next year. The result will be a changing price environment for the benchmark light sweet WTI and LLS crudes. WTI prices in Houston will become more important than they are today and Midland WTI prices will be higher than Cushing. On the Gulf Coast LLS prices will be linked to WTI and Brent prices will disconnect from the US domestic market.
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