Narrow arb blocks Canadian crude from USGC

Author Argus

Production cuts have supported Canadian crude prices at Edmonton and Hardisty, with the consequence of closing the arbitrage to the US Gulf coast.

Meanwhile, the trade of Canadian crude at Houston has proved a much better reflection of the daily heavy crude value at the US Gulf coast than the Maya formula, which is set monthly on the basis of light crude prices. Brett Holmes, market reporter, and Alex Endress, crude reporter, talk with Jeff Kralowetz, VP crude and NGLs, about the market shifts.

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Jeff: Hello, everyone, and welcome to our podcast. There are so many changing market relationships in U.S. crude these days that we're planning to look at the biggest changes as they arise in a series of podcasts that we're calling just "The Crude Report." So today we'd like to start with a look at what trade data and recent company quarterly earnings are telling us about the high sulfur crude market in the Gulf coast and specifically, we want to talk about the role of Canadian crude.

So with me today are two Argus reporters, Alex Endress based in Houston and Brett Holmes based in our office in Calgary. So, Brett, maybe we could start with you. You've written a lot in the last several days about the big changes in trade volumes for Canadian crude at the Gulf coast, can you tell us what you're seeing and what it tells us about the role of Canadian crude at the Gulf coast?

Brett: Sure. Thanks, Jeff. So over the last couple of years, Canadian crude has become more and more important as Latin American crudes have sort of waned in production or had their own struggles that we all see in the news. But what we saw just recently was a trade volume on our WCS Houston assessment way down, it's become quite a robust assessment. But we noticed it went way down in the month of May, it went to about 40,000 b/d traded in that assessment from a record 260,000 b/d in the April trade cycle. So we want to dig a little deeper in that.

So it's important to note that the WCS Houston index is based on WCS, of course, and Cold Lake. So the big downturn of trade volume is on Cold Lake which tends to be sold more on a spot basis while WCS is more termed. So we're also seeing that the number of participants active on the WCS and Cold Lake spot trade market in Houston are down. Number of buyers are down more dramatically than a number of sellers, indicating that indeed demand was decimated by the Covid fallout and falling refinery utilization. So this data tends to confirm what we're seeing, less WCS and Cold Lake crude getting to the US Gulf coast.

Jeff: Okay. So one indication that less is coming is just that we're seeing less trade. So, Alex, let me switch this to you. I think you've noticed some interesting fluctuations in the price of WCS at Houston versus the price of Maya, which is a very similar quality of crude. What are we learning from this change in the relationship?

Alex: Right. So WCS Houston averages roughly $1.55 premium to Maya during the March calendar month and the spread actually widened as WCS Houston averaged about $5.25 over Maya during the April calendar month. And part of the reason seems to be that the Maya formula is based on sweet grades like WTI Houston and Brent. So we know the Mexican government adds K factor but only changes the K factor once a month. So WCS Houston, the daily price actually reacts more quickly to market fundamentals. And in this case, refinery demand in the Gulf coast was more for heavy sour than for light sweets. So the sweet prices that made up the Maya formula got weaker relative to the actual trades for WCS Houston. So WCS Houston moved to a stronger premium over Maya.

Another factor that tended to support WCS Houston has been the closed arbitrage between Hardesty and Houston. That closed arb is discouraging Canadian barrels from coming to the coast. You know, there were days in recent weeks when the price of WCS at Hardesty was actually within $3 of the price at Houston. So since it costs about $8 a barrel to move WCS or Cold Lake from Western Canada to the Gulf Coast, there was really no incentive for Canadians to send the crude to the Gulf Coast. And so once that closed arb came into the market, buyers and sellers in Houston realized there would be less Cold Lake and WCS available and so this propped up the price of what little spot barrels of Cold Lake and WCS were available to deliver in the Houston area in May.

Jeff: Okay. Very good. Thanks, Alex. And that's a great lead-in. Brett, to come back to you, Alex mentioned that the arb is very tight between Hardesty and the Gulf coast and that's in part because of cuts in Canadian crude production. Can you give us some detail and maybe some color about what's happening in terms of production cuts in Western Canada?

Hardisty discount to Houston must exceed rail or pipeline costs to open the arbitrage to Gulf coast

Source: Argus Crude

Brett: Sure, no problem, Jeff. So we're seeing about 800,000 barrels of production cuts that have been announced by companies from a base of almost 4mn b/d of total production in Alberta. So of that total production, less than 2 million is of the heavy variety. So if you're taking mostly 800,000 b/d and mostly heavy of 2 million off, that's quite a hit to the heavy sour complex. So naturally, the prices have increased quite a bit here in here in Alberta, in Hardesty they hit a record high just a week or two ago of minus 370 underneath the basis for June delivery.

But most cuts have come from the thermal production where you inject steam into wells, it's kind of complicated. A lot of oil since production is complicated in general and then you extract the bitumen after you steam it and blend it with diluent to form dilbit or WCS or Cold Lake, what have you. And this contrasts to the mined oil sands which is what exactly what the word says. Mined, it's closer to the surface and you can take big trucks and you can literally mine it from just a little bit underneath the surface and then you upgrade it often at site or you can ship it down say in CNRL’s case or at the Athabasca oil sands projects case to the Scotford Upgrader and then it's upgraded and becomes light, sweet synthetic crude. Because it's upgraded, it's taken some impurities out, it has a higher distillate yield and therefore can command a higher margin. One good instance of this contrast is CNRL who posted their results just this last week and they showed positive margins of about $20/bl in their light synthetic crude. Meanwhile, they barely broke even, or in fact, were negative on some of their heavy crude production.

Jeff: So that actually connects a lot of dots if the cutbacks are largely in thermal that create the dilbits like Cold Lake, that's one reason why we would expect less Cold Lake and WCS to be getting down to the Gulf coast. I'll tell you what, let me follow-up with one thing with you, Brett, and that is that in the United States, producers have been cutting back largely because they don't have access to storage. What are the storage issues in Canada?

Brett: Absolutely, it's a perpetual problem in Canada and it goes back to this lack of demand in the Gulf coast and it's backing up. And if there's not enough storage, there's some storage Cushing obviously for Canadian producers, but if it backs up even further and there's not enough storage in Hardesty or Edmonton, it'll back up into the wellhead. So people are looking...their preference would be to not to shut-in. So they're looking for other options for storage. So there has been limited options of course. And one interesting development on storage is that Enbridge just in the last couple weeks, this is the largest pipeline company in Canada, they own the mainline system which is about 3 million barrels per day of export capacity out of Canada. They said they're going to store about 900,000 barrels of crude in an old unused Canadian section of their Line 3 system. This system had carried light crude from Western Canada to Superior, Wisconsin, but it's kind of been a shut-in as they try to expand the system or replace the system rather, so this was kind of idled. So it's kind of an interesting thing, people are looking at different options almost anywhere to put their crude these days where storage is tight and they prefer not to shut in if they don't have to.

Jeff: Well, thank you very much. And, Alex, we're going to give you one more shot at the conversation here before we have to wrap up. An interesting thing about the Canadian crude is that it never went negative on April 20th when the Nymex futures for May went negative. Can you explain why that happened and, you know, how Canadian crude is priced on the market?

Alex: Absolutely. So WCS is traded at a differential to the calendar month average Nymex futures price at Cushing. So without getting into too much detail, the price of Canadian crude for May delivery was priced at a differential to a combination of June and July Nymex futures contract prices. Since the market has been in a steep contango when May Nymex futures went negative on April 20th, Nymex in June, July, contract prices were still positive. And since the Canadian barrels for May delivery were pricing on a calendar month average of June and July Nymex futures prices, the outright price for the Canadian grades never went negative.

Jeff: Okay. Very good. And I will follow-up with one last point with you Alex, and that is that even though we've seen the volume of trade of WCS and Cold Lake at Houston fall off, we've actually seen pretty steady volumes of trade, very strong volumes of trade for WCS and Cold Lake at Cushing, why do you think that's happening?

Alex: Well, first it tells us that there is actually greater optionality for delivery out of Cushing. So you can move a Canadian barrel from there into Ohio or Kentucky or Kansas, Missouri, or a few other states. You can also move that barrel from Cushing to the coast if the spread widens, or several Canadian companies have leased storage at Cushing also. So there are more options there than at the Gulf coast. And second, even though the volume of trade for WCS and Cold Lake at Houston is down from its very strong levels just a month or two ago, the price of the Canadian grades at Houston is still holding firm. So as we mentioned, WCS Houston averaged a $5.25 premium to Maya and briefly moved to a premium to a much lighter Mars. And so U.S. Gulf Coast refiners still want the Canadian barrels and there is every reason to believe that as U.S. Gulf coast refinery utilization recovers so will the flow of Canadian barrels to the Gulf Coast which is the natural clearing market for Canadian heavy crude.

Jeff: Okay. Well, we are out of time. Thank you guys both for giving us this background on Canadian crude at Cushing and at the Gulf coast. We'll wrap it up here. Thanks to everybody for listening. And we hope to be back to you soon with another podcast highlighting a trend that's shaping US Gulf coast crude markets. Thanks a lot.

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