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Mar 19, 2013 ||
Gary Morsches ||
With the reversal of the Seaway pipeline and expansion of rail moving crude oil to refineries on the U.S. East and Gulf Coasts, many expected a quick narrowing of the spread between the prices of NYMEX WTI and Brent.
However, for various reasons, that hasn’t happened. Some have attributed this to pipeline bottlenecks in Houston, and others have pointed to what’s being referred as the “Brent Syndrome,” or how declining North Sea production is causing that crude oil to remain artificially high even though world supplies are at adequate levels.
One interesting trend we’ve seen recently is a growing interest in the spread between Louisiana Light Sweet (LLS) crude oil, a waterborne grade on the Gulf Coast, and WTI. This spread is important because many believe it is the chief indicator that the substantial increases in onshore U.S. and Canadian production are pricing waterborne barrels in the U.S. Gulf Coast. This comes at a time when the EIA has reported that well over one million barrels per day of crude imports to the U.S. Gulf have been displaced over the past year.
As many are aware, the Seaway Pipeline, the southern leg of Keystone, other pipelines and railcars will bring an estimated 1.8-2.0 million barrels a day of crude oil – most of it light, sweet – to the Gulf Coast before the end of the year, with more to come early next year, creating a major shift in the way global crudes are priced.
In the past, LLS was highly correlated to WTI. That changed about two years ago when production started surging in North America and logistical constraints pushed the price of WTI down compared to waterborne crudes. However, with new pipeline capacity coming online this year, most believe LLS will break from Brent and correlate again with WTI. In fact, most believe it’s a question of when – not if – that will happen and how quickly it will take to move.
With that in mind, we’re beginning to see strong growth in trading volumes of LLS contracts (WJ, E5 and XA) on our exchange. Historically, these products have traded about 300-350 contracts a day. However, since the beginning of the year, we’ve seen that jump over 400 percent to over 2,000 contracts a day. Below is a chart that shows our volume and open interest in these products.
When looking at prices, we see how and when the market thinks this increase in supply will take place. While the front month for these contracts does not show much change, starting in April 2013, we begin to see the outright price of LLS break from Brent. By the end of the year, the difference between LLS and WTI approaches $10 per barrel, or what some estimate is the marginal cost of transportation from Cushing to the Gulf Coast.
Keep an eye on this spread as waterborne imports from West Africa and the North Sea continue to disappear from the North American market, and the huge build-out of infrastructure is completed, moving more than two million barrels a day to Eastern and Gulf Coast refineries. This cascading effect will tighten worldwide crude differentials and result in spreads more reflective of locational freight and relative crude quality.
Gary Morsches is managing director of energy products at CME Group.
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