Brent/WTI on the Road to Normalcy

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The most significant event in the oil complex over the last twenty four hours has been the further deterioration in the Brent/WTI spread. Over the last twenty four hours the spread narrowed by another 22 percent or over $1/bbl. In spite of the first weekly build in Cushing crude oil stocks in months the spread still narrowed on the potential of the return of Libyan crude oil, a slight calming in the Ukraine and disappointing export and crude oil import data out of China.

As I have been forecasting for months the spread is on the road toward normalcy or to the trading level that was in play prior to the Cushing surplus build-up. The following two charts continue to highlight what has been happening. The first chart shows current Cushing crude oil inventory data compared to its five year average as well as the highest and lowest levels hit during the last five years for each individual week  In addition I have included what I call the pre-surplus five year average for the period 2004 through 2009. This average inventory level was approximately 21.7 million barrels over the aforementioned period.

As shown on the chart crude oil stocks in Cushing have been declining (except for this week) at an accelerated rate for the vast majority of this year with the level still well below the current five year average as well as the minimum level over the last five years for the same week. Inventories are heading toward the so called normal pre-surplus level as the industry moves stocks to normal operating levels required by the refining and logistics sectors. 

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Crude oil stocks are now only about 5.9 million barrels above the pre-surplus inventory average. With the WTI forward curve still in a relatively steep backwardation the rate of destocking in Cushing is likely to continue at the rate of decline it has been running at over the last few months. If so current inventory levels should hit the pre-surplus level within the next several months.

As the Cushing overhang continues to recede it has a direct impact on the pricing relationship between Brent and WTI. The following chart shows the current path of the spot Brent/WTI spread compared to its current five year average as well as the average trading level during the pre-surplus five year average for the period 2004 through 2009. Over the 2004 through 2009 period the Brent/WTI spread averaged a $0.79/bbl discount of Brent below WTI. As of this writing the spot spread is trading around a $4/bbl premium of Brent over WTI and has been in narrowing trend for most of the year as it works its way back toward the pre-surplus trading level.

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Several factors continue to support my view of the spread returning to a more normal historical trading relationship (what I refer to as the 2004-2009 average). The main drivers keeping the spread in a narrowing pattern are:

  • The WTI forward curve still in a relatively steep backwardation while Brent is starting to move into a slight contango in the front end of the curve.
  • The outflow capacity out of Cushing is continuing to increase as the Keystone Gulf Coast pipeline works its way to its design capacity while the Seaway Twin pipeline readies for start-up toward the second half of May or early June.
  • Global oil demand seems to be easing especially in China and Europe which will impact the Brent side of the spread.
  • The potential return of Libyan oil production in the short term as discussed above will also have a more direct impact on the Brent side of the spread.

This week’s EIA oil fundamental snapshot was biased to the bearish side with total crude oil and refined products inventories increasing as crude oil stocks increased in the US and in PADD 3 due to the re-opening of the Houston Ship Channel. With another above normal build in crude oil stocks in this week’s report the main focus continues to be the big shift that is well underway in crude oil supply between PADD 2/Cushing and PADD 3 (Gulf Region).

The shift of crude oil from PADD 2 and Cushing showing up in the Gulf region will result in inventories continuing to build further as the refining sector progresses into the maintenance season. The maintenance season has not impacted the Gulf yet as refinery run rates in PADD 3 are once again above the 90 percent utilization level. The movement of crude oil to the Gulf is certainly beginning to impact all of the pricing interrelationships for both US and international crude oil grades as well as refined product markets. For example the LLS/WTI spread is now trading below the $3/bbl level making spot movement of light Bakken crude oil by rail uneconomical.

PADD 3 crude oil stocks surged by 3 million barrels (or almost three times as much as the decline from the HSC closure during the previous week) as crude oil imports into PADD 3 increased strongly.  PADD 3 crude oil stocks are now showing a surplus of 15.2 million barrels versus last year with an 18.7 million barrel surplus versus the five year average. PADD 3 crude oil stocks set yet another new record high as shown in the following chart. The big shift continues.

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