With this week’s launch of a long-awaited new oil pipeline from the US Midwest to the Gulf Coast, traders are on high alert for a flood of crude they expect to drown local prices. Yet, instead of heralding a new era of relatively stable prices, TransCanada Corp’s new 700,000 barrels-per-day line may be paving the way for a period of greater volatility as traders attempt to work out exactly when, and how, the long-awaited coastal glut will finally arrive.
Since late last year, analysts and traders have warned that the Gulf Coast will choke with so much oil that it may become the next Cushing – a storage and pricing hub so bloated that it depresses US oil prices. Their logic is straightforward. The country is producing more oil than it has in 25 years and new pipelines are eliminating supply bottlenecks in the Midwest. With US oil exports effectively banned, the glut will shift to the coast. But prices are in for more of a bumpy ride than a downward spiral as the physical market adjusts to abrupt shifts in supply and seasonal changes in demand, roiling prices. “It is a fluid situation. Pinning the exact timing is tough, but the bigger picture is that there will be oversupply in the Gulf Coast,” said Vikas Dwivedi, a global oil and gas strategist with Macquarie Capital in Houston.
Dwivedi expects supplies to overtake demand late in the third or fourth quarter of this year following a few false starts. “It’s going to happen, but how do you know if it’s real or if it’s here to stay? That’s the difficult question,” he said.
The immediate outlook is already muddled by two factors. Strong refinery demand, steadily decreasing imports, and year-end tax issues have whittled the Gulf Coast’s oil stocks so much that it will take the new infrastructure and the fast output growth some time to replenish inventories, analysts say. Making matters murkier, oil demand will take a hit when refiners take an estimated 1.6 million bpd of their capacity offline for a bi-annual maintenance season. Imports, notoriously hard to forecast, may also pick up, given the recent strength in Gulf Coast cash oil prices.
On Wednesday, TransCanada started commercial services on its pipeline from Cushing, Oklahoma, to Port Arthur, Texas, which was originally-conceived as the southern leg of the controversial Keystone XL. While the line has a nominal capacity of 700,000 bpd, the company says it will transport an average 520,000 bpd of oil this year, after starting operations at 300,000 bpd.
Other pipelines, such as the 450,000-bpd Seaway Twin, slated to begin service in the second quarter, should further narrow price differences between Cushing and the Gulf Coast crudes. The expansions of Magellan’s 225,000-bpd Longhorn line will bring an additional 50,000 bpd from West Texas to Houston later this year, easing another price gap.
Initially, those barrels will likely be needed to help top up regional inventories that have dwindled. In mid-January, Gulf Coast refiners were so pinched for oil that they only had enough in stock to last 19 days, the tightest supplies since September 2004, according to the US Energy Information Administration data. The deficit was initially pegged on what is known as last-in-first-out accounting, in which Gulf refiners can avoid paying higher taxes on recently purchased, pricier goods by using them up first, ultimately lowering inventories.
Production cuts in the Texas Permian basin and Eagle Ford shale, which were hit by a deep freeze in December, may have aggravated the stocks draw. It is not clear how much the weather affected output, although the US Energy Information Administration estimates the two fields will produce more than 2.5 million bpd this month, a 34 percent jump from last year.
Meanwhile, Gulf Coast imports were in the doldrums, at a 10-month low on a four-week average basis, due to local crude oil pricing. Gulf Coast crude benchmark Light Louisiana Sweet, which had traded at an average $1-a-barrel premium to international Brent in the first three quarters of last year, fell abruptly to a steep discount in the fourth, discouraging imports. In November, in the midst of autumn refinery maintenance, it traded at a record $16 below Brent.
“In late summer, the market was priced to incentivize large imports whereas since November, pricing for local crudes has been consistently below Brent in order to reject crudes,” said Jan Stuart, head of global energy research at Credit Suisse. “Imports are difficult to predict (but) I suspect they are going to continue to be weak,” he said.
Many traders had expected a repeat of that early winter price decline this month, as they eyed the new pipelines delivering more oil just as refiners shut down to retool. Instead, LLS has swung back to a premium against Brent as of last Friday for the first time since August, once again confounding the market. The strength in the Gulf Coast crude market is at least partly explained by unprecedented demand from refiners, who continue to make healthy profits turning discounted US crude into diesel and gasoline for sale in Latin America.
After a brief dip in the fourth quarter due to unplanned outages and planned maintenance, Gulf Coast refiners that account for nearly half of the nation’s capacity are once again running faster than ever. In the first two weeks of this year they processed more crude, on average, than they have ever done in January, according to government records going back to 1992. Those record rates will not continue with plants, such as Marathon Petroleum Corp’s Garyville, already shutting down key units for overhaul.
Some refiners could ultimately opt to forego routine work in order to capture robust margins, as US plants did in the spring of 2011, when the shale glut brought margin windfalls. “The big question on how things shake out over the next couple of months primarily rests with the Gulf Coast refiners and their ability to curtail imports,” said Adam Longson who heads Morgan Stanley’s commodities research. “There will clearly be some pricing pressure in the Gulf, but we see a few data points that give us some hope that the disaster scenario may not play out.”
Selam Gebrekidan, "For US Gulf Coast crude oil market, choppy waters before the flood," Business recorder. 2014-01-24.
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