LONDON (Commodity Online): Risk aversion, profit taking and another bout of scepticism regarding Europe’s sovereign debt crisis were the key drivers of prices on Thursday, with December WTI settling $3.77 lower at $98.82/bbl and January Brent shedding $3.66 to $108.22/bbl, said Barclays Capital in a Research note.
Essentially, the highly unstable equilibrium that oil prices have been in continues, with heightened fundamental and geopolitical risks fighting for influence against the escalation of sovereign debt concerns. However, the past week in oil markets has been dominated by the three p’s: pipelines; politics; and psychology.
Indeed, some of the key events have been combinations of these three, but within them, the reversal of the Seaway pipeline has been of huge significance in narrowing the differential between WTI and Brent. Seaway has a huge totemic significance – in its ability to debottleneck Cushing. Suddenly, all the fundamental data (low pipeline flows from PADD 3 to PADD 2, high movement of crude by rail, etc., all leading to low Cushing stocks) that Bank has been highlighting for some time now get noticed and the reason for WTI to massively dislocate against other benchmarks disappears. Bank would thus expects WTI to continue rising relative to other benchmarks, narrowing the gap towards parity further.
Should a situation arise where, due to large refinery maintenance schedules and higher Gulf Coast to Midwest flows (now that WTI is attractive again), Cushing fills to the brim, then WTI would start to dislocate to the point where rail transportation becomes economical once again (around $10-14 per barrel).
In general, the spread, while remaining volatile through next year due to the variations in pipeline and rail flows, should then be constrained within the $0-15 range (Barclays expects a $5 spread on average between Brent and WTI in 2012), and should not (under circumstances dictated by fundamentals) widen to a stubborn average of $20-25 that Barclays has seen for many months this year.
For the slightly longer term though, the cancellation of major pipelines like the 0.8 mb/d Wrangler and the postponement of 0.6 mb/d Keystone XL will have a larger impact on Cushing balances than the reversal of Seaway. Moreover, the movement of crude from Cushing by rail is highly price sensitive. While the large sunk costs associated with the establishment of rail could imply that even if the spreads do narrow, crude by rail movements continue at a loss for the operators, this is likely to be the largest marginal factor in determining the scale of the spread.
With WTI closing in, producers would be incentivised to push further volumes down to Cushing, although the rapidly growing North Dakotan production may still find it hard to reach Cushing due to the lack of rail capacity connecting the two hubs. Nonetheless, with Canadian sour crudes yielding the best margins currently, the incentive to process light, sweet is limited and thus could be a bearish factor for Cushing.
