Houston, We Have A Solution

At a Glance

  • As the U.S. exports record levels of crude oil, global hedgers look to connect pricing to major U.S. hubs. A new futures contract offers a solution.

The global markets want U.S. oil badly at present.

Venezuelan production is in freefall, Libyan production remains low and U.S. sanctions will dramatically reduce Iranian crude exports. Meanwhile, demand from key oil users like the United States, China and India remains strong.

Luckily, the shale revolution means that U.S. production is soaring.  U.S. crude oil output will average around 10.7 million barrels per day (b/d) in 2018, up from 9.4 million b/d in 2017, and will average 11.5 million b/d in 2019, according to the Energy Information Administration

No other country can begin to match that level of expansion.  Saudi Arabia, Kuwait, Russia and the U.A.E. have all stepped up production recently.  But none of these oil giants is looking at a growth trajectory like the U.S.

U.S. producers and exporters are benefiting from higher price levels that are making more and more shale projects viable.  The U.S. oil industry is also able to lock in these higher levels using the liquidity on WTI crude oil futures forward curve, where the number of open positions – or open interest — continues to grow.

The challenge for American producers is not price or demand or even opportunity.  All of these are favorable at present.  The challenge is instead to bring shale oil to the export market at a reasonable cost.

Cushing to Houston

Cushing, Oklahoma is the heart of the U.S. oil market and the delivery point for CME Group’s benchmark WTI crude oil futures. Cushing is known as the crossroads for U.S. oil because so many pipeline systems meet there.  Oil flows in and out of Cushing according to changing supply and demand in the domestic and international markets.

Since the shale revolution and the lifting of the U.S. export ban in December 2015, one of the most important routes has been the link between Cushing and the export infrastructure located around Houston, Texas.  As U.S. exports surge, particularly to Asia, the ability to move oil to Houston has become highly significant. Crude exports from the U.S. hit a record 3 million b/d at the end of June.

Huge investments are being made in U.S. oil export infrastructure and in expanding the pipeline capacity between the Gulf Coast and the wider U.S. market, which is centered on Cushing.

But until this infrastructure is fully developed and utilized, there will continue to be significant price differences between oil in Cushing and in Houston.  This price difference (‘the spread’) can also be relatively volatile, making it difficult for U.S. producers and exporters to properly manage their economics.

A New Benchmark

The need for price transparency and risk management in the Houston area has encouraged CME Group to launch a new physical crude oil futures contract based on three terminals operated by Enterprise – the largest U.S. exporter.

The new contract includes delivery at the Enterprise Crude Houston (ECHO) terminal, Enterprise Houston Ship Channel (EHSC) or Genoa Junction.  This will allow producers and exporters to lock in the value of U.S. export volumes.  Price signals from the Houston contract will also help lenders evaluate the value of Gulf Coast infrastructure investments.

The world markets are thirsty for U.S. oil.  With the launch of CME Group’s new contract, both exporters and importers will have the ability to value oil in Houston and to hedge their risks.  This step forward for Houston could become a major leap forward for global oil.

is Managing Director of Energy Research and Product Development at CME Group. He is based in London.

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