Explaining The Double-Digit WTI Discount

Authored by Nick Cunningham via OilPrice.com,

Global oil benchmarks are suddenly heading in different directions, upending what have consistently been close linkages between prices in various parts of the world.

To be sure, oil prices have declined everywhere over the past week on news that OPEC and Russia might agree to lift production levels. But regional differences are wreaking havoc on the oil market, dragging down some benchmark contracts more than others.

Western Canada Select (WCS), for instance, consistently trades at a discount to WTI, but the spread has widened recently. On May 23, WCS traded $17 per barrel lower than WTI, which is, to be sure, a very large discount. However, WCS has plunged this week, and by May 31 the Canadian heavy oil benchmark was trading at $41 per barrel, or $25 below WTI.

Pipelines are full and the bottleneck in Alberta is weighing on the Canadian benchmark. This has pushed Prime Minister Justin Trudeau to extreme lengths to get the Trans Mountain pipeline expansion built. But, the ceiling on midstream capacity is expected to persist, perhaps for several more years.

Pipeline problems are not unique to Canada. The Permian basin has continued to grow oil production, but the region’s pipeline network is not adding capacity fast enough. The most recent data suggests that the pipelines from West Texas to the Gulf Coast are full and Permian producers are scrambling to find takeaway capacity by rail or even by truck, which, needless to say, is expensive and inefficient, forcing producers to accept steep discounts for their oil.

For the last few weeks, Midland WTI has traded at a double-digit discount relative to WTI in Houston or Cushing. No new pipeline capacity is imminent, and in fact, the shortfall could grow over the next year. While the Midland discount is around $10 per barrel now, futuresfor November 2018 has Midland trading at a $17-per-barrel discount, a reflection of the fact that the pipeline bottleneck will only grow worse over the course of this year.

WTI, for its part, is trading at a multi-year low relative to Brent. As of May 31, WTI was down below $67 per barrel during midday trading, dropping to an $11-per-barrel discount relative to Brent.

Again the blowout in the spread is the result of surging shale production at a time when supply is restricted elsewhere in the world.

Brent, meanwhile, has lost ground relative to the Dubai benchmark. This is the result of tighter supplies in the Middle East, which has pushed up prices. Not only is OPEC keeping supply off of the market, reducing flows, but the scrapping of the Iran nuclear deal has also raised fears of supply outages from the Middle East. The discount for Dubai relative to Brent has shrunk to less than $3 per barrel, the lowest spread in months.

“The three benchmarks -- Brent, WTI and Dubai -- have been fluctuating based on a combination of domestic factors, as well as wider geopolitical risks,” Den Syahril, an analyst at industry consultant FGE, told Bloomberg.

“WTI is currently reflecting inland economics, as the U.S. struggles to bring oil to its coast. Brent and Dubai, on the other hand, are pricing in geopolitical tensions around U.S.-Iran sanctions, as well as uncertainties around the upcoming decision between OPEC and its allies.”

Obviously, American crude priced at more than $10 per barrel below oil found elsewhere in the world makes it highly attractive to buyers. That should result in an explosion in U.S. crude oil exports in the coming weeks. Export levels have already been trending up for the past year, but the price differential is now at its highest level in more than three years, likely sparking a stampede of purchases from Asian buyers, for example.

Bloomberg reports that refiners in South Korea, India, Thailand, China and Japan are scrambling to buy up as much U.S. shale oil as possible from where they can get it, including from the Eagle Ford, the Bakken and the Permian. Interestingly, Chinese buyers are cut purchases from Saudi Arabia for the second consecutive month, swapping them out with more American cargoes. Why buy oil from the Middle East for $10-per-barrel more than from the U.S.?

It is often said that the oil market is global, that oil is a “fungible” commodity, meaning that prices are largely the same everywhere. There are always regional discrepancies, but as a general rule, oil is globally priced. However, infrastructure bottlenecks, geopolitical fears, supply increases and outages are cropping up in various parts of the world, leading to an unusual divergence in the top benchmarks. With many of those factors not set to immediately go away, the price differentials may not dissipate anytime soon.