WTI Oil Poised for Benchmark Comeback as Glut Diminishes: Energy

Apr 09, 2014 9:03 pm ET

(Energy column news alert: SALT NRGI <GO>)

April 9 (Bloomberg) -- West Texas Intermediate crude is poised to be a worldwide benchmark once more as an easing supply glut narrows the grade’s discount to global oil markets.

Inventories at Cushing, Oklahoma, the delivery point for WTI futures, tumbled to a four-year low in March. The discount to Brent, used to price more than half the world’s oil, is now about $5 a barrel, from as much as $23 in February 2013. Futures and options outstanding, a measure of investor interest, rose 3.2 percent this year, after slumping 14 percent in the past three years.

The changes underscore how WTI is reconnecting to global trading as improved pipeline networks boost the flow of WTI to refineries on the Gulf Coast where the oil can be processed. Its status as a benchmark underpins everything from what airlines pay for fuel, to the cost of a tank of gasoline, to how much Mexico makes selling a barrel of crude to the U.S.

“You really don’t have that glut potential anymore,” said Stephen Schork, the president of the Schork Group Inc. in Villanova, Pennsylvania. “We are seeing the normalization of WTI prices back to parity with Brent and that is repositioning WTI to become the benchmark again.”

WTI for May delivery climbed $2.12 to $102.56 a barrel on the New York Mercantile Exchange yesterday. Brent rose $1.85 to $107.67 on the London-based ICE Futures Europe, for a premium of $5.11, the narrowest since October on a settlement basis. Aggregate open interest for WTI futures and options combined stands at 2.19 million contracts on April 1, up from 2.09 million on Dec. 24.

Southern Link

Supplies at Cushing dropped to 27.3 million barrels in the week ended March 28, the least since November 2009, according to the Energy Information Administration. Inventories fell from a record 51.9 million barrels in January 2013 after the southern link of TransCanada Corp.’s Keystone XL pipeline started shipping Cushing crude to the Gulf Coast in January this year.

Inventories may keep contracting because Enterprise Products Partners LP is more than doubling the capacity of the Seaway pipeline linking Cushing to Houston by as early as May.

“More Gulf refineries will have access to Cushing oil and it can compete with seaborne imports now,” said Michael Lynch, the president of Strategic Energy & Economic Research in Winchester, Massachusetts.

The EIA abandoned WTI in price forecasts for its Annual Energy Outlook 2013, adopting Brent for the first time. The Energy Department’s statistical arm said the price of WTI “has diverged from Brent and other benchmark prices.” Open interest in Brent futures doubled in the past three years on ICE.

Better Benchmark

The U.S. ban on most oil exports and limited capacity to ship crude around the country will continue to make Brent a better global benchmark, said Julius Walker, a global energy markets strategist at UBS Securities LLC in New York.

A 1975 law, adopted after the Arab oil embargo, prohibits almost all U.S. crude from being shipped abroad, though exports of refined goods such as gasoline and diesel fuel are allowed. Easing the ban would strengthen the link between the U.S. and global trading and allow WTI to play a bigger role in the world market, Lynch said.

WTI traded at close to parity with Brent until 2011, when Cushing inventories exceeded 40 million barrels for the first time. The grade’s discount to Brent reached almost $28 by October 2011. Stockpiles grew as a combination of horizontal drilling and hydraulic fracturing, or fracking, unlocked supplies in shale formations.

Airline Hedging

Delta Air Lines Inc. switched the majority of its WTI positions to Brent crude or heating oil in the first quarter of 2011 in response to the dislocation of the price of WTI to jet fuel, the company said in a statement at the time.

American Airlines Group Inc. primarily uses jet fuel, heating oil, Brent and WTI crude option and collar contracts as cash flow hedges to mitigate price risk, Casey Norton, a spokesman, said last week.

Marathon Oil Corp. benefited from “having exposure” to WTI, Brent and Light Louisiana Sweet, a low-density, low-sulfur oil with similar quality to WTI, Chief Executive Officer Lee Tillman said in a December conference call with analysts.

Brent’s open interest reached almost 1.73 million contracts on ICE at the end of 2013, from 878,891 at the beginning of 2011, according to exchange data.

Pricing Reference

Producers in Europe and Africa use Brent as a reference in pricing their output and Middle East exporters use the Dubai oil price, which moves with Brent, according to Walker of UBS Securities. Mexico pegs its U.S. exports to both WTI and Brent, according to company documents.

The shrinking Cushing supply has already moved WTI prices closer to what refineries on the Gulf Coast, where 51 percent of U.S. refining capacity is located, pay for crude. WTI’s discount to LLS narrowed to as little as $2.25 on March 24, the least since November, according to data compiled by Bloomberg. The gap was above $10 in January.

“The days of significant glut at Cushing have passed,” Schork said. “With greater access to global waterborne trade, WTI can again be a global benchmark.”

--With assistance from Carlos Manuel Rodriguez in Mexico City.