Editorial: Risky business

Taking positions on the Brent-WTI crude price spread has become an even riskier exercise than usual

US crude market dynamics are playing havoc with the largest traded oil spread in the world, the Brent-WTI differential. The discount of WTI to Brent moved to its widest in three years at close to $11.50/bl in early June, as infrastructure and pipeline bottlenecks weighed on prices and trading companies rushed to export crude to markets across the Atlantic. The discount had been about $5/bl just a month before the surge and since early July has been trading at a much narrower $3/bl (see graph).

Production in the Permian basin is rising at over 70,000 b/d every month. Most pipelines from the basin to the Nymex futures delivery point at Cushing in Oklahoma or to the Houston export market are operating at or close to capacity, as are local refineries. Alternative shipping options, such as transporting crude by rail or truck, are limited and expensive. US midstream firm Plains All American puts rail capacity from the Permian at 125,000 b/d and road tanker capacity at 25,000-50,000 b/d. That additional capacity represents little more than two months of growth at current rates. Another 300,000 b/d of pipeline capacity from the Permian is meant to start up in late 2018, with the next project not on line until the end of 2019.

The strain is already showing up in wild swings in location and time spreads. The WTI market at Midland in the heart of the Permian is trading $15/bl below the coastal price at Houston, compared with $2-4/bl at the start of the year. More importantly for Brent-WTI spread trading, Cushing spreads are ballooning.

The trigger was the unexpected shutdown of a 350,000 b/d oil sands upgrader in Alberta on 20 June. It reduced the amount of light sweet crude coming into the midcontinent at a time when there is little capacity to divert more Permian crude to Cushing. Crude stocks at Cushing have fallen below 30pc of tank capacity for the first time in four years. The Canadian oil sands upgrader is expected to be fully operational again in September.

The Brent-WTI price spread was most recently trading at close to $3/bl, with the outlook for the differential held hostage by a myriad of opposing market forces. WTI has recorded occasional spells of steep discounts to the seaborne markets for nearly a decade, when supply bumps up against pipeline and other infrastructure limits.

Going forward, supply dislocations in inland US crude markets are expected to ebb and flow as rising Permian production meets capacity constraints. The EIA has forecast that crude production in the Permian will rise to 3.41mn b/d in August, 940,000 b/d higher on a year earlier. Permian production is expected to average 3.4mn b/d this year and 3.9mn b/d in 2019.

The shifting supply dynamics in the US are occurring at a particularly choppy time in the global oil markets. Short-term volatility measures on North Sea crude are the highest in over a year and a half, reflecting uncertainty over the supply outlook for the remainder of the year, and especially the extent to which the US will enforce its Iran sanctions. The shifting fortunes of production in Libya, Venezuela and Nigeria will also make for volatile trading in Europe in the coming months. It makes taking positions on the Brent-WTI spread a more risky exercise than usual.

WTI discount to Brent