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Nick Cunningham

Nick Cunningham

Nick Cunningham is an independent journalist, covering oil and gas, energy and environmental policy, and international politics. He is based in Portland, Oregon. 

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Permian Oil Now Selling At A Discount

Gulf Coast refiners are having trouble swallowing up all of the ultralight oil coming out of the Permian.

The Permian continues to add production, even as drilling activity slows down in Texas and elsewhere. According to the EIA, the Permian could add another 42,000 barrels per day in May, with output now well above 4 million barrels per day (mb/d). That comes even as the rig count has declined sharply from fourth quarter highs last year.

The record levels of production present new challenges. The pipeline bottleneck that really became an acute problem a year ago has eased somewhat. New capacity came online in recent months, while larger pipeline projects are expected to reach completion later in 2019.

That will allow more oil to reach the Gulf Coast. But from there, the flow of oil runs into other bottlenecks. U.S. oil exports continue to break new records. Although the numbers bounce around from week to week, U.S. crude exports now routinely top 2 mb/d, and even exceeded 3 mb/d at times this year. A year ago, exports above 2 mb/d would have been considered exceptionally high, and only occurred on rare occasions. As recently as 2017, exports tended to hover below 1 mb/d.

Still, Gulf Coast ports are bumping up against their limits, unable to export every last barrel. That leads to another bottleneck: Gulf Coast refiners are not equipped to handle huge volumes of ultralight oil. Refineries built years ago were done so with the intention that they would import medium and heavy barrels from abroad. They can’t simply switch over to light and ultralight oil without problems.

Growing supplies of light and ultralight oil come at a time when medium and heavy blends around the world are in shorter supply. Iran sanctions, Venezuela sanctions, Canadian pipeline woes, declines in Mexican heavy oil, and the OPEC+ cuts have all cut into the supply of medium and heavy oil.

Light oil was already coming under pressure from soaring production at a time when medium and heavy blends were tight, but now the increasing volumes of ultralight oil have made it difficult to even put together the right specs for what is commonly known as WTI.

Related: The Giant Floating LNG Project You’ve Never Heard Of

As such, the surplus of ultralight oil has led to discounts of a few dollars per barrel below WTI, according to Reuters. “For the past 10 years, US traders have been able to manage the wide range of crude oils coming from the various shale basins to create marketable, WTI quality barrels,” Bank of America Merrill Lynch wrote in a report on April 18. “Recently though, this task has become more difficult due to surging output of superlight crude in the Permian.”

The discounted oil comes in the form of a new blend, West Texas Light (WTL). WTL trades at a $1-$2-per-barrel discount to WTI in Midland and Houston.

Barrels marketed under the WTL benchmark will continue to grow as Permian drillers steadily add new production capacity. “As a result WTL's discount to WTI could deteriorate as supplies of super light oil rise in a market that is short medium and heavy crudes,” Bank of America Merrill Lynch warned.

Behind this trend is increasing output from the Delaware basin as opposed to the Midland basin. While much of the Permian produces light oil, the Delaware is particularly light. “According to Enterprise Products Partners estimates, crude oil produced in the Delaware averaged 45° API in 2018, while crude from the Midland basin has averaged closer to 40°,” Bank of America wrote. “Rising Delaware output has led to blending constraints. Rapid growth of superlight crudes is making it difficult to create crude blends that meet WTI quality specifications (37-42° API).” The new WTL benchmark has an average API between 44-50°.

Of course, to have segmented blends means that they need to move by pipeline separately. But moving WTL by itself means shipping different oil blends in batches. That puts even more pressure on pipelines.

The discounts for ultralight oil also come at a time when the discount for Midland oil has reemerged. Last year, pipeline constraints led to discounts in excess of $20 per barrel below WTI. In the last few weeks and months, that disparity zeroed out as new capacity came online. However, oil in Midland saw a discount widen to as much as $7.50 per barrel below WTI, according to Bank of America Merrill Lynch. Production gains have once again led to midstream bottlenecks.

If this problem continues to grow worse, it could eventually impact oil producers in the Permian. “Weaker WTL pricing could eventually weigh on US upstream development activity,” the investment bank said.

By Nick Cunningham of Oilprice.com

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