FocusUS refiners lose advantage of large Brent, WTI spread

24 July 2013 20:43  [Source: ICIS news]

US refiners lose big crude spread, get steady oil suppliesBy Al Greenwood

HOUSTON (ICIS)--US refiners, mainly in the Midwest, have lost the advantage of the wide double-digit spread between Brent and West Texas Intermediate (WTI), which allowed them to benefit from large profit margins.

WTI prices were depressed because much of the oil was stranded in the interior of the US, away from refineries along the nation's coasts, said Phil Flynn, senior market analyst for the Price Futures Group.

That created a glut of oil supplies in the interior of the country, putting downward pressure on WTI prices. The lower prices benefitted Midwest refineries that could obtain the crude. But coastal refineries had limited access to the lower cost crude, limiting its benefits.

"What good did it do to the economy that you had cheap oil that you couldn't use?" Flynn asked.

New pipeline capacity is bringing that oil to refiners, giving them access to reliable and growing supplies of crude, made possible by the advent of shale oil and increased production from Canada.

Once oil from the interior reached the US coast, it started to re-align with global prices. Hence the decline in the spread, also known as the negative trans-Atlantic Brent/WTI arbitrage.

That arbitrage represented the price that coastal refiners have been paying for foreign crude.

As North American crude becomes more available, refiners should benefit from a more stable and reliable source of oil, Flynn said. "The risk premium of producing oil from the US on land will be dramatically less."

For example, US refiners are less exposed to buying oil from volatile parts of the world. In addition, their supply lines have shortened significantly, lessening the need to keep large inventories on hand.

Short-term, however, the narrow gap between Brent and WTI should squeeze refiners' margins, said Sandy Fielden, director of energy analytics at RBN Energy.

"Obviously, if refiners are paying higher prices for crude, unless products go up by a similar amount, their margins will be reduced," Fielden said. "In the short term, it is not good for refiners."

Brent and WTI had traded near parity until August 2010, according to RBN Energy. By November 2011, Brent was trading at a $28/bbl premium over WTI.

The price gap began expanding because of growing crude production in North Dakota, west Texas and western Canada, which overwhelmed refineries in the Midwest, RBN said. Crude inventories in the interior of the country consequently increased faster than the nation's infrastructure could ship it to coastal refineries.

Thus, the oil became stranded at supply hubs in the interior of the US, causing prices to drop.

The industry gradually began removing those bottlenecks.

Earlier in April, Magellan Midstream Partners began shipping oil from west Texas to the Gulf coast through its reversed pipeline.

Last year, Enbridge and Enterprise Products reversed the flow of their Seaway Pipeline, bringing oil from the oversupplied Cushing hub in Oklahoma to the Gulf coast.

In addition, the energy industry has relied increasingly on railcars to move oil from new production centres such as the Bakken and the Eagle Ford to refineries along the east, west and Gulf coasts of the US.

From 1 January through 13 July, the number of railcars shipping petroleum and refined products reached 382,190, up 46.2% year on year, according to the Association of American Railroads (AAR).

While interior crude supplies dwindled, demand rose as US refiners began processing increasing amounts of crude and exporting growing amounts of products.

Refinery utilisation rates for the week ending 12 July reached 92.8%, the highest level since reaching 92.9% in 2006, according to the Energy Information Administration (EIA).

During that week, US crude stocks fell by nearly 7m bbl, the EIA said.

With higher demand and lower inventories, the gap between Brent and WTI shrank to 2 cents on Friday.

Since then, the gap has widened, although it is still below $2/bbl.

RBN, though, expects the gap to widen further.

One-time events caused the spread to narrow in the first place – such as a synthetic-crude upgrader in Canada undergoing maintenance and BP temporarily increasing crude distillation at its Whiting refinery in Indiana, Fielden said.

Once those one-time events resolve themselves, supplies should increase, pressuring prices lower.

Plus, US crude production should continue increasing, according to the EIA. For 2014, US crude production should reach an average of 8.1m bbl/day, up 11% from a forecasted 7.3m bbl/day for 2013.

That increased capacity should reach coastal refineries because pipeline companies continue to add capacity.

Consequently, the Brent/WTI spread should widen, but not to the double-digit levels that refiners enjoyed during the first half of the year, RBN said. Right now, the forward curve indicates that the spread should stay above $6/bbl.

According to the EIA, Brent should reach a premium of $8/bbl by the end of this year.

Additional reporting by Anna Matherne and Ignacio Sotolongo

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By: Al Greenwood
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