Volatile US crude markets turn to secondary benchmarks

Author Jeff Kralowetz, Vice-President and Bruce Fulin, Vice-President

Amid the current volatility in crude markets, secondary benchmarks such as WTI Houston are becoming an increasingly valuable tool for market participants to manage their price exposure.

One of the early lessons from US crude trading in the days after the collapse of the Opec+ production agreement has been the value the market puts on secondary benchmarks, particularly WTI Houston.

Open interest soared to more than 187,565 contracts — more than 187mn bl of crude — on 17 March on CME Group’s HTT contract, which settles on the trade month average differential price of Argus WTI Houston. Last week and into this week, the market was putting positions on HTT for months in 2021, while decreasing those for most months in 2020.

Daily volume on the HTT contract hit its high point on 12 March, exceeding 20,000 contracts traded, representing 20mn bl of crude.

Daily exchange volume chart

Source: www.cmegroup.com

The WTI Houston physical price index on which HTT settles has maintained a much steadier relationship to Ice Brent than has the CME Nymex Cushing contract (see graph below). The moves emphasized that it is WTI Houston that global markets look to for signals of the Atlantic basin export price for US light sweet crude.

Nymex Cushing Futures and Argus WTI Houston vs. Ice Brent

Nymex Cushing Futures and Argus WTI Houston vs Ice Brent

Source: Argus Americas Crude

The Nymex Cushing contract has gathered strength relative to Brent in part because Cushing offers less expensive options for storage in the current contango market than does the Brent market in the North Sea. Storage in the North Sea is likely to involve relatively expensive floating options, whereas US EIA data indicate that Cushing has more than 30mn bl of available storage in less expensive tanks.

This relative abundance of storage at Cushing has made it a more desirable destination for crude than either Midland, near the Permian production wells, or Houston. In the past two weeks, the market has seen the price of WTI at Midland fall from a $1/bl premium to Cushing to more than a $2/bl discount, while WTI at Houston has fallen from a premium of $3/bl to Cushing to now trading at about parity to Cushing.

WTI: Midland and Houston Weakens vs. Cushing

WTI Midland/Cushing crude differentials

Source: Argus Americas Crude

These relationships, and their volatility, have increased the desire of the market to manage its exposure to the price of WTI at Houston. Many companies learned the value of hedging the WTI Midland to WTI Houston spread in early 2019, when the lack of pipeline capacity between the Permian basin and the Gulf coast caused the spread between Midland and Houston to balloon to more than $20/bl. 

The WTI Houston price has taken on an added importance to heavy crude markets because Mexico’s Maya price formula for the US Gulf coast is now based on 65pc Argus WTI Houston and 35pc Ice Brent, plus a K Factor. Both of the price elements in the formula are hedgeable, with HTT being the most active swap on the Argus WTI Houston element. It is also possible to hedge the Argus WTI Houston physical index using the ACM contract on Ice.

Mexico has put in place a $1.67bn hedging program for its crude sales, using a series of “put” options, which Mexico’s finance minister, Arturo Herrera, says lock in a price of $49/bl.  

Alongside the WTI Houston market development, an actively traded and fully hedgeable market for Canadian heavy crude at the Gulf coast has emerged. The Argus WCS Houston price index reflects the pooled trade of similar-quality Canadian Cold Lake and WCS at three locations in the Houston area — Enterprise’s ECHO terminal, Energy Transfer’s Nederland terminal, and the nearby P66 Beaumont terminal. The industry has embraced this pooled price index for Canadian crude at the Gulf coast, and Argus now has about 60 trades reported into this index each month (see graph).

WCS/Cold Lake number of trades reported

Both CME Group and ICE offer financial swaps contracts that settle on the Argus WCS Houston price index. 

Volatile markets lead many market participants to seek additional pricing tools to protect their positions. With the VIX volatility index closing on March 16 at 82.69, the market is experiencing exceptional volatility. The Houston area has two relatively new pricing tools – WTI Houston and WCS Houston – that markets are using to address this uncertain price scenario.

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