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December 3, 2012 12:13 pm
Mark Merritt is selling some of the world’s cheapest crude oil.
His company, Fasken Oil & Ranch, is an independent producer in Midland, Texas, with about 1,000 wells around a patchwork of oilfields known collectively as the Permian basin. Using techniques pioneered in the shale revolution, the company has trebled Permian output in three years.
The production boost should be positive. But Mr Merritt is not alone: Texas oil output has surged to a 24-year high of 2m barrels a day, overwhelming pipeline infrastructure and creating a glut of West Texas Intermediate oil in the Midland producing hub. The surplus has driven the price of WTI there to a record discount to Cushing, the Oklahoma town that serves as the pricing point for the benchmark.
“Yesterday there was a $10 differential of Midland WTI to Cushing [WTI]. That puts us at about $75 a barrel, approximately,” Mr Merritt, director of oil and gas of Fasken, said last week.
The same day the cost of Brent crude, considered the global oil benchmark, was $110 a barrel, making Mr Merritt’s oil one of the global energy market’s best bargains.
The price differences between Midland and Cushing, from where WTI is shipped around the US, matter. First, they offer a huge arbitrage opportunity for physical traders and pipeline companies. And if the discount persists, it means less revenue for drillers, potentially reducing investment and, over time, slowing production growth. Fasken is joined in the Permian by listed companies such as Occidental Petroleum, Chevron and ExxonMobil.
The differential also affects the cost of WTI traded in the futures market of the New York Mercantile Exchange, which uses Cushing as its delivery point. Cushing has a glut of its own, depressing WTI relative to Brent in a problem traders call the “Cushing syndrome”. Now, they are starting to talk about a “Midland syndrome”. Through complicated supply contracts, the differential between Cushing and Midland even affects the price of Mexican and Venezuelan oil exports.
Since 1984 and until earlier this year, the price difference of WTI between Midland and Cushing rarely exceeded 50 cents a barrel – representing the fee traders paid to ship oil over roughly 500 miles of pipelines.
But as production has surged in Texas, the Midland discount to Cushing has widened, hitting a record $19 a barrel in November. At that level, it was economical to put the crude in trucks and drive it to market, traders say.
The hefty discount partly reflected lower demand for WTI due to the closure for maintenance of the 146,000 b/d Borger, Texas refinery operated by Phillips 66 and CVR Energy’s 70,000 b/d refinery in Wynnewood, Oklahoma. Andy Lipow, an oil consultant in Houston, says: “Takeaway capacity, being both pipelines and refineries, is quite tight. When either of those have a problem then crude oil backs up into the Permian basin and the price comes under pressure.”
As the discount has widened, price volatility has risen sharply, forcing executives and traders to pay attention to daily movements, instead of focusing on monthly or even quarterly averages as they used in the past. “In a market where you used to see 10-cent swings in a day, you are seeing an average of more than $5 swings per day, often much more,” says a senior Houston-based oil trader.
At the moment, few pipelines leave the desolate Permian basin for the Cushing hub. “Infrastructure is simply not there,” says Amrita Sen, oil analyst at Energy Aspect, a London-based consultancy.
The Basin pipeline, owned by Plains All American Pipeline, runs from the Permian to Cushing, with capacity of 450,000 b/d. Centurion Pipeline, a unit of Occidental, has 365,000 b/d capacity. Sunoco Logistics also has crude pipelines leading from west Texas. But production is now growing faster than pipeline capacity.
The situation should improve by the middle of next year with the opening of new pipelines linking the interior region with the refining hub on the US Gulf of Mexico coast. Magellan Midstream is reversing the 60-year old Longhorn pipeline to move crude from west Texas to near Houston. Sunoco Logistics is building the Permian Express pipeline, linking west Texas with Nederland, near Houston.
Mr Merritt is waiting eagerly for the new lines. “We hope to see some relief,” he says. “In the meantime, things may get worse before they get better”.
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