John van Schaik
02 February 2013, New York – The US is poised to take another big step forward in its quest for crude oil self-sufficiency. Later this year, Gulf Coast refiners are expected to cease all imports of light, sweet crude, replacing them with fast-rising supplies of US domestically produced oil that is pushing its way south and east from shale oil fields in the continent’s deep interior. When this happens, the Gulf Coast will become the third US refining region to back out all sweet crude imports from countries other than Canada, following the Rockies and the Midwest.
With Gulf Coast marker Light Louisiana Sweet (LLS) losing its connection with international markets, it will start trading at a discount to Brent. LLS trading below Brent carries a large symbolic value, as it underscores the geographic widening of US self-sufficiency in oil supply. It also has some very real market consequences. These could potentially include both downward pressure on oil prices across the Atlantic Basin and, perhaps ironically, a narrowing in the discount for US inland benchmark West Texas Intermediate (WTI) to international benchmark Brent.
When the Rockies and Midwest refining regions no longer needed imports and became operationally disconnected from the international market, the abundance of sweet crude hammered the price of WTI and other domestic grades linked to it, as well as both sweet and sour output in Canada.). LLS has been spared a consistent discount so far because it still competes against foreign grades, so its price has tended to track Brent rather than WTI. But already, Nigeria is the only remaining supplier of meaningful volumes of light, sweet crude to the Gulf Coast, and its sales into the region have dropped from nearly 800,000 barrels per day in 2010 to less than 300,000 b/d in recent months. Such Nigerian sales may well dry up entirely in 2013.
Traders expect LLS to weaken soon in response, and to start trading at a few dollars — $3 is the discount most often mentioned in market chatter at the moment — below dated Brent. The next step will likely be for all crudes sold into the 8.5 million b/d Gulf Coast refining market and priced off LLS to fetch a few dollars less per barrel — or several dollars less if LLS trades at deeper discounts, as some suggest it may. This will lead to discounted crude prices in the US generally, for sweets and possible even medium sours, on the coasts as well as inland.
In corporate terms, the immediate impact of the disappearance of Gulf Coast sweet crude imports will be that LLS producers in the shallow waters off Louisiana — Chevron, Royal Dutch Shell and Apache are notable examples — will earn less for their output. Salivating refiners, in contrast, stand to earn the same kind of eye-popping margins that have so far been limited to inland refiners, as feedstock prices plummet but prices for the gasoline and gas oil they turn out remain at high international levels due to the continued two-way US trade in refined products. US refiners also benefit from low natural gas prices.
Independent refiner Valero says it can already buy domestic crude at a 50¢ discount to LLS, whereas imported grades would cost 50¢ over LLS. With oil over $100/bbl, $1/bbl might not sound like much, but Valero has backed out more than 500,000 b/d in imports, for an earnings boost of $500,000 per day. With LLS dropping, the benefits will grow. Valero sees enough incentive to invest much of its $2.5 billion capital-spending budget this year on railcars, pipelines, storage tanks and terminals to bring stranded domestic and Canadian crude to its all its plants, from the Gulf and West Coast to Canada. Logistics have always been crucial in oil economics, and the US light oil revolution is demonstrating yet again the huge profits available to those who understand how to benefit from stranded supplies. Like many US refiners, Valero plans to run as much discounted crude as possible. Since it will produce more products than it can sell at home, it is also investing in larger dock facilities so it can export more of those products.
Roughly 1 million b/d of additional US output is expected in 2012, followed by a similar increment in 2013. In this environment, the light oil glut has even started backing out some medium-sour imports, including Mideast grades. The medium-sour slide could get precipitous around 2015, when the deepwater US Gulf of Mexico is slated to add output of this type in large volumes.
Go West — or East — Just Go
With US crude producers still banned from exporting crude oil, LLS might soon start making the short trek to the US East Coast, despite the historically prohibitive $4.50/bbl cost for shipping oil on this route, resulting from the so-called Jones Act requirement that all oil moving between US ports travel on US-built, flagged and crewed vessels. With the Gulf Coast increasingly awash in feedstock supply, Canadian and US Midwest crude producers are already shifting their attention to pushing their crude to the US East and West coasts, where they plan to replicate their southern strategy, this time primarily with rail transportation. They are also targeting the Canadian East Coast through pipeline reversals.
The need for alternatives is clear: Sour West Canadian Select (WCS) is trading at $50 below Brent and North Dakota’s Bakken at $20/bbl below Brent. These two grades make a nice blend that looks like US Alaska North Slope and would, even if rail charges hit $15/bbl, be beneficial for both producers and refiners. The East Coast, where refiner PBF started railing in crude last quarter and will start up a new 70,000 b/d rail facility for Bakken and WCS this week, has already backed out medium-sour imports from Iraq.
But how does this get us to a lower WTI discount? With more pipeline capacity installed between the Cushing, Oklahoma, pricing point for WTI and the Gulf Coast, the WTI discount to Gulf Coast-delivered LLS should shrink, traders say, to pipeline costs of at most $6/bbl. If LLS does trade at a $3 discount to Brent, the WTI-Brent discount would be less than $10. In recent weeks, speculators have been loading up on the WTI contract, perhaps more with a WTI-Brent play in mind than the outlook for the US economy: The current WTI discount to Brent is around $17.