JP Morgan Hikes 2012 Crude Price Target To $110 On Seaway Reversal
JPM, which has been stuck holding on to reflationary assets for months and months expecting a QE3 announcement which keeps on not coming as the market always frontruns it and makes any actual reflationary progress by the Fed impossible, couldn't wait to release today's crude price update following the reversal of the Seaway pipeline. The bottom line: JPM is lifting its WTI forecast to $110/bbl in 2012 and $118/bbl in 2013, and see the Brent-WTI spread narrowing to $5 and $3/bbl in those years, respectively. Previously WTI was seen as hitting $97.4 in 2011 and $114.25 in 2013. Consumers everywhere rejoice as they will have to take even more debt on (never to be repaid of course) in addition to never paying their mortgage payments. As noted earlier, now that WTI is well north of $102, kiss any deflation risks goodbye and with that the announcement of MBS LSAPs. At least until tomorrow's post 3 am European gap down, which will be fully filled and then some in the period between noon and 4pm.
Oil Markets Weekly: Seaway Reversal Lifts WTI Price Forecasts
The announced reversal of the Seaway pipeline by the second quarter of 2012 will help to further debottleneck the US Midwest, lowering the cost of moving Canadian sour crude and Bakken light sweet crude to US Gulf Coast refineries. As a result we are lifting our WTI forecast to $110/bbl in 2012 and $118/bbl in 2013, and see the Brent-WTI spread narrowing to $5 and $3/bbl in those years, respectively.
Assuming the deal is completed in December and gains regulatory approval, joint owners Enbridge and Enterprise have indicated that they will be able to reverse by the second quarter of 2012 at an initial flow rate of 150 kbd and, subject to shipper interest and reconfiguration, will be able to raise its capacity to around 400 kbd early in 2013. This is a material addition to takeaway volume for the region and should allow Canadian and Bakken crude oil production expansions to increase and should also lower the marginal cost of shipping oil from the WTI pricing point of Cushing, Oklahoma to the US Gulf Coast.
Pricing and allocation guidelines for the reversed pipeline have not yet been announced, and could take many forms. Pricing can vary from fixed cost, with some volume flexibility, to take or pay, or even some form of auctionbased pricing system for marginal barrels. A mixture of systems is not uncommon, but at the end of the day, pipelines serve a utility function and it is important for them to be competitive, run at a high utilization rate and to have a steady revenue stream. As such, pipelines are nearly always the low cost option for moving crude. As long as this is the case, it means that the Seaway pipeline will not (certainly at the outset) set the marginal cost of moving oil from Cushing to the Gulf Coast.
What it does is add to capacity and to displace the high cost option—trucking—from the route. The analysis in our August 25 Oil Market Weekly: Brent and WTI Forecasts and Risks suggested that up to 700 kbd of additional takeaway capacity, mostly rail, could be added by the end of 2012. We projected at the time that increase in capacity would narrow the Brent-WTI spread to around $10/bbl by the end of 2012, and to $7/bbl in 2013. That projection, which was seen as widely optimistic at the time, has not only been proved correct, but we now believe that the reversal of the Seaway pipeline will lower this spread more aggressively over the next two years.
In the summer, the wide Brent-WTI spread of roughly $25/bbl reflected the marginal cost of trucking crude from Cushing to the Gulf Coast. Although most of the movement away from the hub came from areas such as Eagle Ford, where the cost of transport was much lower, the economic price for the spread should always represent the marginal cost to move oil from the pricing point. The recent aggressive easing of the spread represents the partial transition of the marginal barrel from truck to rail. That shift does not happen overnight, but the potential for arbitraging the flows by putting oil into storage, means that the spread can lie between the two cost levels for a period of time. In 2012, while trucking will still be used to move oil from nonconnected fields to hubs, and even from fields close to the Gulf Coast, we see rail as setting the marginal price.
The cost of rail from Cushing to the Gulf Coast is broadly between $5 and $8/bbl depending on whether it is a unit train or manifest system. Pipelines could price competitively against these costs in an auction system next year, and would likely put downward pressure on rail and truck costs in 2013. If the market is anticipating that these costs will trend lower, WTI differentials to Gulf Coast crudes are likely to trade somewhere between cost options. Further, when considering the price relationship between Brent and WTI, we have to subtract a further $1.50 for the transportation (theoretically at least) for Brent from the North Sea to the Gulf Coast. As such we think that next year we could see Brent-WTI trading around $3.50 to $6.50/bbl by the second quarter, and on the assumption that costs are driven downwards as Seaway expands and that more rail and possibly pipeline competition is available, those costs could fall to between $2 and $4/bbl. Ultimately, we see Brent- WTI trending towards a more stable relationship between $1 and $2/bbl in 2014.
This pricing shift does not change the global supply outlook, and therefore we have not adjusted our Dated Brent forecast for 2012 and 2013. However, by virtue of a projected Brent-WTI spread in 2012 of $5/bbl and $3/bbl in 2013, we lift our WTI projections from a prior forecast of $97.50/bbl in 2012 and $114.50/bbl in 2013 to $110/bbl and $118/bbl respectively. We have marked to market our 4Q2011 Brent forecast, but leave the forecast balance of the year unchanged at $115/bbl.
Phew: all that in 3 hours? Great job Larry Eagles!
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