Oil prices are falling, but American crude is suffering even worse than its international counterpart.
The price differential between WTI and Brent continues to widen, briefly hitting $9 per barrel on Monday, the largest discount in about three years.
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Discounts of this magnitude are pretty rare, particularly after the U.S. began exporting crude oil several years ago. There is a self-limiting aspect to these price differentials. If WTI falls significantly lower than Brent, then American crude oil becomes highly attractive to foreign buyers. Refiners around the world move to purchase as many cargoes as possible, removing the surplus from the U.S. while at the same time loosening demand on Brent cargoes. The result is that there is pressure on the two benchmarks to converge once again.
We saw this play out last year after the devastation from Hurricane Harvey, which decimated refining capacity in the U.S. and led to a buildup in crude oil supplies. The discount, which jumped from just a few dollars per barrel, widened to as high as $8 per barrel, although only briefly. U.S. exports surged because of the marked down price, and by early 2018, the discount narrowed.
However, the discount has spiked once again, although the situation could be a bit different than before. This time around, the discount isn’t merely a manifestation of surging shale production at a time when OPEC is keeping the rest of the market tight, although that is certainly a major factor. But adding to those forces is a pipeline bottleneck in the Permian, which is leading to a higher volume of supply trapped in West Texas.
The Permian Basin alone has already added about 300,000 bpd in fresh supply so far this year, but the drilling frenzy is running hard up against a midstream wall. Total production could hit as high as 3.277 million barrels per day (mb/d) in June, according to the EIA, adding 78,000 bpd month-on-month. However, the problem is that the region only has about 3.175 mb/d of pipeline, rail and local refining capacity combined, according to Genscape. Related: OPEC Has A Global Inflation Problem
That means that the Permian pipeline system is essentially maxed out. There is now a rush of demand for trucking oil from West Texas to the Gulf Coast, a bizarre side effect of the bottlenecks that have cropped up. Moving oil by truck is costly, so Permian drillers that have not already secured pipeline capacity are being forced to discount their product in order to secure sales.
It isn’t just Permian bottlenecks. Falling production in Venezuela and the prospect of outages in Iran have tightened the market elsewhere, keeping Brent higher than WTI. “It’s a function of U.S. oversupply and OPEC policy,” J. Alexander Blackman, an executive at Standard Delta, told the WSJ last week.
Of course, a $9-per-barrel discount relative to Brent suggests that everyone is going to want to buy U.S. crude oil on the cheap, which means that exports could spike in the coming weeks.
U.S. oil exports already hit a new record at 2.566 mb/d for the week ending on May 11, before dipping a bit in the most recent week. But, the trend is clearly up – last year, exports bounced around between 0.5 and 1.5 mb/d, hovering close to the upper end of that range in the second half of the year. For most of 2018, U.S. weekly oil exports have been hovering around the 2 mb/d range.
Exports could average around 2.3 mb/d in June, one prominent oil executive told Reuters. The wider the discount between WTI and Brent, the more U.S. oil will find its way to Asia, despite the long distances.
And at $9 per barrel – the largest in three years – there will be tremendous pressure working to push more barrels out from U.S. ports to buyers around the world. That is, as long as U.S. shale drillers are able to find a way to get their oil from West Texas to the coast.
By Nick Cunningham of Oilprice.com
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