The oil market is getting a stimulating start as oil traders look to the ECB to give the trade a boost. Italian bond yields fell hard. It appears their election standoff has ended with the Prime Minister Enrico Letta put in power. Weak data in Europe and weak inflation leaves Mario Draghi little choice but to cut rates. If not, then oil will focus on a very bearish demand outlook and rising supply. But add a dash of stimulus and we see oil near a two week high.
Friday we saw a sharp drop in oil and other markets as it appears someone had a margin call that had to be met. The market is rebounding and is glowing in the anticipation of a world where money is cheap and easy.
Natural gas is bouncing back! Once again natural gas seemed to reverse direction when oil took a sudden drop. Nat gas was lower and came back late in the session. Perhaps it was just expiration movement or perhaps more evidence of natural gas as a safe haven commodity.
I still believe that natural gas is one of the best plays in the commodity markets today. By using a combination of futures and options we feel that we can build a nice long term position preparing for perhaps a doubling of the current price in a couple of years.
All of the talk about the Whiting, Indiana BP refinery and whether or not they are close to ramping up after the replacement of a crude unit may have a significant impact on the global oil market in ways that might be a bit of a surprise. It may have a big impact on the Brent/WTI spread. Robert Campbell of Reuters writes, "West Texas Intermediate crude oil futures have climbed sharply against Brent this week, but there is good reason to believe it is the beginning, not the end, of the rally. Since the start of April, WTI has raised nearly $4 a barrel against Brent, spurred by traders betting that the glut at Cushing, Oklahoma, the delivery point for WTI futures, is poised to clear.”
This week there are signs that oil major BP is stepping up the amount of crude it was withdrawing from Cushing on its pipeline between the hub and its refinery in Whiting, Indiana, gave WTI bulls the final push. So now the question is, could the rally reverse as WTI nears its 100-day moving average? Will traders reassess the risks to WTI after a big move up?
WTI has been held back for the last two years by a glut of crude at Cushing caused by a shortage of pipeline capacity that would take oil to more profitable markets. But with the anticipated restart of BP's 405,000 barrels per day Whiting, Indiana refinery, traders are betting Cushing is no longer short takeaway capacity. WTI doubters worry that as the contract gains in strength, oil producers will send their crude to Cushing, Oklahoma, the delivery point for WTI futures, rather than rely on costly rail shipments to coastal markets.
This is a legitimate argument and one that has to be looked at carefully. Effectively the producers worried about can be divided into two categories: those from the North (Canada and North Dakota) and those from the West (the Permian Basin in West Texas and New Mexico). Look at both cases more closely. Worries about northern producers flooding Cushing ignore the current capacity limitations on pipelines to Cushing from northern markets. Even if Canadian or North Dakotan oil producers wanted to send oil to Cushing, there simply is not the southbound pipeline capacity available to do so. But even setting aside the availability of capacity on pipeline routes, it is far from clear the producers are poised to pump their crude to Cushing in place of other markets. While Canadian producers may be locked into their current markets by limited transportation infrastructure, the situation is different for Bakken producers in North Dakota. More oil is going to coastal markets via trains than on pipelines.
So the risk, in the north, is that producers currently shipping by rail opt instead to go to Cushing. This is the true effect of all the new crude by rail infrastructure in the United States. By giving Bakken producers access to Gulf Coast prices, they are effectively removed from the Cushing equation.
Using the Enbridge pipeline system would cost a North Dakota producer with access to the cheapest tariffs nearly $8 a barrel to move crude oil from the Bakken field to Cushing. In other words, the producer would receive a netback, the oil industry term for the value of oil after transport costs are deducted, of approximately $86 a barrel based on Thursday's settlement price for WTI. But even if rail costs to the Gulf Coast are double, what the pipeline costs to move oil to Cushing, a Bakken producer will still opt to move crude to the Gulf Coast.
Bakken crude at St James, Louisiana fetches prices similar to Light Louisiana Sweet LLS, which on Thursday closed near $105 a barrel, meaning a Bakken producer would get a netback of $89 a barrel, or $3 a barrel more than by shipping by pipeline at the best rates possible. Or put differently, it would not make sense for our hypothetical Bakken producer to ship oil to Cushing until WTI strengthened by at least $3 a barrel against world prices. And considering the fact that few producers or traders have confirmed capacity on the Enbridge system at the lowest tariffs all the way from North Dakota to Cushing, it is highly unlikely that a flood of Bakken barrels into Cushing will happen even if WTI does gain more than $3 a barrel against world prices.
Gulf Coast prices are the key. ”The foregoing analysis assumes a great deal. It assumes an inflexible (and probably too high) marginal cost for rail shipments. It assumes that all crudes are equal, which they are not. Even those that are roughly similar have different yields in different refineries. It also assumes that the market-clearing barrel is able to move on the pipeline at the cheapest possible rates, which is unlikely. Tariffs for uncommitted shippers on some systems are considerably higher than for committed shippers, so pipeline economics are likely less attractive than the example above. If so, the example understates the netback when shipping to the Gulf Coast and overstates it when selling on the inland market. And since the pipeline space into Cushing from the North is already full, the brunt of the impact from a stronger WTI price may fall on North Dakota oil producers who will have to accept lower wellhead values to keep rail economics working. But the critical assumption has been the resilience of Gulf Coast crude oil prices which have defied expectations of decoupling from the world market. A combination of infrastructure bottlenecks and much greater refinery flexibility than anticipated has helped keep Light Louisiana Sweet at a premium to Brent crude. With rail delivery terminals proliferating on both the East and West coasts this year, the pressure on the Gulf Coast from rail deliveries may abate, not increase.
However, the coming weeks will test this resilience as new pipelines directly linking the Permian basin to coastal markets start up. But critically these pipelines are also taking oil to the Gulf Coast that would otherwise go to Cushing. Here we come back to the second group of producers, the Permian Basin firms, that will influence events at Cushing this summer. Again the netback logic must apply. Although it is cheaper by $2 to $4 to move oil to Cushing by pipeline than to the Gulf Coast, so long as Gulf Coast prices hold up it would be illogical to ship oil to Cushing when the Gulf Coast option is available.
With sufficient pipeline capacity on hand, the price of oil at the Gulf Coast will determine the limit for WTI. A trader holding crude at Cushing will always opt to move the oil to the Gulf Coast if the price at the delivery point less the cost of shipping exceeds the value of WTI at Cushing. The upshot is that so long as Gulf Coast pricing does not disconnect from the rest of the world, WTI can probably rise by more than $4 against Brent before inland prices get too high and choke off movements to the Coast. That's the bottom line to this equation. The arbitrage trade is not Brent-WTI, it is WTI-Gulf Coast. So while the marginal cost of moving oil between Cushing and the Gulf Coast may be $5 a barrel, that does not mean Brent has to be $5 above WTI. If the Gulf Coast is Brent +$2 then ultimately WTI could be Brent -$3. This spring has shown so far that delivered prices for light sweet crude on the Gulf Coast have remained remarkably resilient in the face of growing domestic supplies of crude. If that situation holds into the summer, traders who failed to buy WTI at today's discounts will not be happy. But by the same token buyers must beware. A new glut on the Gulf Coast would have devastating consequences for WTI and the emergence of a glut in Houston or St. James cannot yet be ruled out. The last two years have been full of false dawns dashed by the market's sudden reaction to oversupply.