Podcast – Upside down: New price relationships in the US Gulf coast crude markets

Author Argus

Podcast: Long-stable crude oil price relationships at the US Gulf coast have been upended by the global crude supply/demand imbalance.

What is likely to happen next? How much crude can Cushing store? And what does this mean for US exports? Argus VPs for Crude Business Development, Jeff Kralowetz and Bruce Fulin, and Argus Americas Crude Editor Gus Vasquez discuss this and more.

The Effects of the Coronavirus on Markets

Transcript

Jeff: Hello, everybody and welcome to our podcast. Today we want to give a brief overview of the historic and volatile new price relationships for crude at the Gulf coast. I'm Jeff Kralowetz and with me today are Americas crude editor Gus Vasquez, and crude business development vice president Bruce Fulin. So, Gus, let's start with you. You and your team have seen some dramatic shifts in the price relationships in the Gulf region in just the last several days. Maybe the most important or noteworthy of these is that our index for WTI Houston at the MEH terminal is now the discount to WTI Cushing. Can you explain why this really unusual relationship has developed and then maybe tell us a little bit about Midland and Corpus prices too?

Gus: The first thing that we have to realize here is that there is demand destruction and that is not only a global issue but it's also a U.S. issue now. So, what we are seeing is that the inability to export crude out of the U.S. Gulf coast has started to back up barrels into places like Houston and Midland, and that's pressuring the prices there. Now, for a place like Houston, traditionally, what you would do is if the export market is not really moving, if you can't get barrels out, you would then supply the local refiners. But we have been in refinery maintenance and now there's talk of refinery cuts in the U.S. as demand for jet and gasoline, etc. keeps dropping. So, what we have is essentially an oversupply of crude that's starting to build up in storage in places like Houston and Midland and we're starting to see that also at Cushing now, and all of that crude is gonna weigh on the prices. So, we saw WTI at the Magellan Houston terminal actually hit a record low in terms of value. It got to about $1.30 under Cushing a couple of days ago. We've seen Midland also under pressure and it's down to around $2.50, $3 under Cushing as well. And all of this is back to that, it's just barrels being backed up, and the inability to export, which is usually kind of the release valve here in the U.S. for those barrels.

Jeff: Okay, well, thanks a lot. Those are a lot of moving parts. But there's one other really unusual price relationship I wanted to ask you about, Gus. And that is that WTI on the water in the Houston area, WTI FOB, is actually trading at a discount to WTI Houston barrels at the MEH terminal. It's very unusual because usually you have to pay money to get from MEH out to the water. Why is this happening?

Gus: Right. So, what you're describing there is basically an arbitrage, so that is currently not open. So, you can't even cover the cost of transportation from the terminal to the water to get crude exported. And the reason for that, and we've talked about this before in the past, is that the pipeline market in the U.S. and the FOB market in the U.S. really are two different markets. And as much as people think, oh, you know, it's just pipeline plus transportation, that's not really the case because we do have different fundamentals that are at play here. And so, while the pipeline market has the domestic refinery system that they can feed into, the export market doesn't really have that kind of safety net. Once you have bad economics globally and you can't export, those differentials on the water are gonna be punished a lot more than some of those pipeline prices that we see. So, that's kind of where we are right now, in terms of global demand for U.S. crude at this minute, there really isn't much at all. The sellers are really struggling to find buyers. This is really weighing on those FOB prices separate from whatever's happening in the pipeline market. One of the things that we have seen as a result of this is that we have a spread between cargoes trying to leave Houston and cargoes trying to leave Corpus where Corpus cargoes are about $1 or so per barrel weaker than barrels being offered out of Houston. The reason for that, and we kind of mentioned this earlier, is that in Houston, you do have that refining system that you can sell into if you can't export. In Corpus, you don't really have that. So, once volumes get to Corpus, you really have to export. And so, there's a lot of pressure to sell and that means, you know, if you have to discount more in order to move volume, then as a seller, you're going to do that because you're really out of options at that point.

Jeff: So, Bruce, let's get you involved in the conversation now. The middle of last week, I remember, you were flagging to all of us the fact that we were seeing record volumes on CME's HTT contract, which is the financial swap that settles on the Argus WTI Houston physical price index at Magellan East Houston. Since then we've seen the open interest on that contract is also kind of hitting new highs. What's happening there?

Bruce: Hey, Jeff, actually, it's been very exciting in the trading world of what's been going on and the activity. I've seen daily amount of trade activity going over 21,000 contracts in this swap. This is actually quite exciting because as the volatility has accelerated in the market, we're seeing the HTT contract from CME absolutely perform beautifully. Right now, the open interest is over 200,000 contracts in this market, and it's just continuing to explode.

Jeff: Okay, Bruce, another question, I guess, is about Gus was talking about Cushing being at an unusual premium to HTT or to the WTI at the coast. And a lot of that's because Cushing has the ability to store crude where Houston doesn't have so much ability. I know you've been talking to people about how much crude Cushing can store. What are you hearing?

Bruce: Well, this is also a very fascinating area right now, as global inventories are gonna have to build as the crude surplus is gonna dominate across the world, all eyes right now are on Cushing. EIA says Cushing can hold 76 million, another 10pc, or another 7 million barrels a day can quickly be added on liner tanks that are either maintenance or out of service.

Jeff: Great. Thanks a lot. And finally, Gus, can you tell us what this availability of storage at Cushing means for the WTI/Brent spread and for the ability of the U.S. to export crude economically to the rest of the world?

Gus: Okay, yeah, so there's a couple of angles there. So, the first thing to consider is that there is cheap storage at Cushing and that helps to drive the spot price at Cushing higher because people can, you know, put that volume away and then sell it later. And we are in a contango structure right now in the market. In the meantime, though, the spot price at the North Sea is getting pushed down because they don't have the same storage options that we have here in the U.S. So, you know, Northwest European traders are generally having to use the more expensive floating storage. So, the incentive to store maybe is not quite there as much as it is here in the U.S. And also, the logistics get trickier too. And then secondly, that stronger Cushing price and a weaker North Sea price is going to compress that WTI/Brent spread that many people tend to use as an indicator of how competitive U.S. crude can be in the export market. Now, the twist here is though that WTI Houston really has become kind of the barometer for how competitive U.S. crude is on the export market and WTI Houston specifically has dropped to a discount to Cushing to stay essentially at a steady spread to ICE Brent in the last several days. So, while we do see that difference between Cushing and ICE Brent changing, you know, that relationship is changing, WTI Houston is actually staying pretty steady. So, this is going to be a tough environment for the U.S. crude exporters.

Jeff: Well, thanks, guys, for these really timely observations. And thanks to all of you for listening. We hope to be back with you again soon with another update on physical crude markets at the Gulf Coast.

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