Locational WTI spreads are tightening across the US Gulf coast as new connectivity options boost total liquidity, ultimately paving the pathway for Argus AGS to succeed as a future benchmark for light sweet crude in global markets.
In this episode of The Crude Report, Alex Endress, Argus US Gulf coast physical crude markets reporter is joined by Amanda Hilow, associate editor, to discuss Argus AGS - the up-and-coming benchmark for Midland-quality WTI at the US Gulf coast - in more detail.
Alex Endress: Hello, and welcome to The Crude Report, a podcast series on global crude oil markets by Argus Media.
I'm Alex Endress, and I cover the US Gulf coast physical crude markets for Argus, but today, I'm here with associate editor, Amanda Hilow to discuss the up-and-coming benchmark for Midland-quality WTI at the Gulf coast, and that's called American Gulf Coast Select or AGS. Welcome, Amanda.
Amanda Hilow: Thanks, Alex.
Alex: Now, the AGS Marker is a relatively new benchmark, but it's already surpassed several other long-established benchmarks in terms of liquidity. Isn't that right?
Amanda: Yes, that's right. We just hit a record high trade month volume of more than 463,000 b/d during the January trade month, which closed on Christmas Eve. That makes AGS the third most liquid physical spot crude assessment in the Americas market, behind only WTI in Midland and the Argus Sour Crude Index or ASCI, which comprises three different grades.
Alex: So, can you tell us a little more about the assessment for those who are still unfamiliar with how it works? What's the story behind AGS and its origin at Argus?
Amanda: You read my mind. The AGS Marker was launched in late June in response to the oil market crash earlier in 2020 when the Nymex contract plummeted below $0/bl for the first time in history. Market participants had flocked to price supporting agencies like Argus for an alternative solution that could provide a more comprehensive view of the value of West Texas Intermediate outside of the landlocked storage hub in Cushing and with more direct connectivity to the export market. The transition from a Cushing benchmark to a more coastal price helps tie domestic US fundamentals with supply and demand dynamics from the international market, which helps position AGS for success as a potentially global benchmark in the future for US crude.
Alex: And different from our current US crude assessments that are published as a differential to Cushing WTI, AGS Marker is also assessed as an outright price. Could you explain the differences between AGS and the AGS Marker?
Amanda: Yes. As you said, AGS Marker is a daily volume-weighted average published as an outright price. It captures both pipeline and waterborne transactions of WTI across nine different locations at the gulf coast, including four pipeline and two waterborne terminals in Houston, as well as cargo deals out of Texas City, Beaumont, Nederland, and Corpus Christi. The AGS index is intended for those market participants wanting to use AGS but still wishing to hedge versus Nymex. We use the same methodology as the AGS Marker, but instead, we publish it as a differential versus Nymex WTI, alongside a synthetic outright price that applies the AGS index differential to the WTI formula basis.
The key difference between the two assessments is that the AGS Marker indexes each deal into the assessment by using the outright value of that crude at the exact time of the transaction rather than at the time of sale. This keeps the marker less exposed to extreme intraday volatility such as that which had led to the Nymex crash in April 2020, which happened roughly within the last 30 minutes of trade that day.
And the last point, so that way, the benchmarks reflect the same type of market each day regardless of where the majority of trade occurs, each deal in both the AGS Marker and the AGS index is always going to be normalized back to the Enterprise Products' ECHO terminal, which is positioned in the epicenter of Houston's vast connectivity matrix.
Alex: You mentioned the spread that exists between ECHO and other terminals. Could you just explain the quarterly process that Argus uses to account for this?
Amanda: Yes. Argus uses locational differentials to ECHO that are intended to adapt with shifting trade patterns. So, to that end, the adjustment factors that we use between the terminals are reviewed on a quarterly basis, as you said, and updated to reflect trade data and market feedback received over the prior three-month period.
Source: Argus Americas Crude
So, for example, WTI deals at the Magellan East Houston terminal or MEH were originally adjusted lower by 25¢/bl to reflect an ECHO value when we first launched the AGS marker. We've just completed our second scheduled update to the AGS locational differentials on the 28th of December, and that spread fell to just 2¢/bl based on the average MEH premium to WTI ECHO established over the October through December trade months.
Alex: Amanda, as you've covered AGS for the past few months, in your observation, what has prompted the spread to tighten?
Amanda: So, we were already seeing values and liquidity at MEH fall this year due to lower demand during the Covid-19 pandemic as well as a poor pipeline arbitrage from the Permian Basin, while values at ECHO have been drawing support from connectivity and storage projects. But what really helped close the gap between MEH and ECHO values is that Magellan decided it would allow third-party pipelines to deliver into its MEH WTI pool and into a Houston distribution system as of October. This pressured the MEH premium to other Houston area terminals lower amid reduced logistical constraints. Magellan also issued new quality parameters with its updated access rules, specifying that crude delivered into the MEH WTI pool would not only need to originate from the Permian Basin, but would need to maintain a gravity between 41 and 43.5 degrees API, with a sulfur content no more than 0.2% API. Those quality parameters match those that we see at the ECHO terminal, where WTI deliveries over the last year have averaged a 42.9-degree API and a sulfur content of around 0.15%.
Alex: Just to clarify, we know that Magellan East Houston is the location basis for our WTI Houston benchmark at Argus, but the Argus AGS adjustment process does not affect our WTI Houston methodology.
Amanda: Correct. And I'm really glad that you said that. It's important to know that WTI Houston, while it is indeed based at the Magellan East Houston terminal, it is entirely separate from our AGS assessment. WTI deals that we get reported at the Magellan East Houston terminal will both set the WTI Houston pipeline index and, in a separate process, be normalized to the ECHO terminal for inclusion in AGS and the AGS Marker.
Alex: So, what's on the horizon in terms of AGS methodology that could account for some new locational differentials?
Amanda: A consistent theme I've been seeing across the market is expectations that locational spreads are dissipating almost entirely compared to where they were in early and mid-2020. Tightening logistical spreads for WTI-quality crude has been seen across the market in terms of differentials versus both MEH and ECHO. For example, the AGS adjustment factors for Speed and Genoa Junctions are now both at 7¢/bl relative to ECHO. This reflects typical pump over fees in the market.
When we first launched AGS in June, the locational differentials to ECHO had been set at 10¢/bl for Genoa and 40¢/bl for Speed [Junction] to reflect the approximate logistical cost between the three locations. But now, with Magellan improving the accessibility to its Houston distribution system, the majority of market participants are calling Speed and Genoa, both of which are accessible via the distribution system, at parity to each other and just 0 to 8¢/bl higher than WTI values at the ECHO terminal.
Alex: And we know that waterborne cargoes are also included in AGS. What's the latest on that front?
Amanda: WTI cargoes loading out of Texas City in the Enterprise Hydrocarbon Terminal or EHT on the Houston Ship Channel will be adjusted 20¢/bl lower to reflect their equivalent values at the ECHO terminal, while cargoes loading at Magellan's Seabrook terminal will be adjusted lower by 15¢/bl to reflect market feedback and recent trends. We launched AGS with FOB Houston locations around 45¢/bl higher than ECHO initially to reflect logistical cost. But in reality, WTI FOB Houston had been falling relative to physical pipeline values as trade dried up and sellers were eating loading cost on their own during a low demand environment caused by Covid-19 in order to place cargoes in the international market. But as we see liquidity beginning to pick up again on an FOB basis, we've been able to re-establish a more reliable spread between cargoes and pipeline terminals, with WTI FOB Houston averaging about 15 cents per barrel over WTI at MEH and at ECHO.
Alex: That doesn't apply to all cargoes we include, right?
Amanda: Exactly. Since not all markets move at the same time, we consider the adjustment factors for AGS nine individual assessments. Cargoes loading out of Corpus Christi and out of the Beaumont, Nederland area will be adjusted down by 10 cents per barrel as of this trade month, compared to an initial 30¢/bl and 45¢/bl when we first expanded AGS in August to include the 2 new waterborne locations. Similar to our other AGS locations, the initial adjustment factors, relative to ECHO, were set to reflect logistical costs reported by market participants and have since been updated to reflect real trade data. WTI FOB Corpus has consistently maintained a 5 to 10¢ discount to cargoes loading out of Houston largely as a result of lower pipeline transportation costs from the Permian Basin. FOB Beaumont, Nederland, meanwhile, has fallen in value to reflect lower export demand from that port hub because of logistical constraints in fully loading Aframax volumes. Aframax tankers can usually load around 500,000 to 600,000 bls out of Beaumont, Nederland, for example, but can take 750,000 bls or more out of Houston and Corpus.
Alex: So I have one final question before we close, as I'm keenly interested to see whether these trends will continue. So, when are the AGS locational spreads up for review next?
Amanda: The next adjustment factors will be based on the first three trade months of 2021. So we'll be ready to give notice of what the spreads will likely be by the 26th of February, and then they'll take it back a month later on the 26th of March. As a reminder, the locational differentials are adjusted on a quarterly basis, so by the end of June, we will be already launching new adjustment factors based on the second-quarter trade patterns.
Alex: Well, thanks, Amanda. This has been an exciting period for Argus as we continue to build this new benchmark to capture the market for Midland-quality WTI at the Gulf Coast. We're looking forward to fresh updates on AGS and AGS Marker as we all settle into a fresh year in 2021.
Amanda: Thanks, Alex. I really enjoyed my time here. Thanks for having me.
Alex: Yeah. And, listeners, if you're in need of more in-depth daily coverage of US crude oil markets in 2021, consider subscribing to Argus Americas Crude. You can find more information on this service at www.argusmedia.com. Thanks for tuning in, and we look forward to you joining us on the next episode of The Crude Report.