The difference between WTI and Brent narrowed significantly over the past few days, as the forces driving the two benchmarks apart seemed to have reversed course.
For the past few weeks and months, WTI suffered a steep discount relative to Brent, a reflection of a series of factors that made North America well supplied with oil, while the rest of the world saw supplies tighten significantly. U.S. shale production has soared over the past few years, but really accelerated at a blistering pace in 2018. North America has been overflowing with oil, and much of the additional supply has been routed through Gulf Coast export terminals, if producers can get their oil out of West Texas.
Meanwhile, the OPEC cuts began to bite harder in the second half of 2017 and in the first six months of this year. The result was a sort of two-speed oil market – ample supplies in the U.S., and an increasingly tight market everywhere else.
The discount widened to nearly $10 per barrel in June, a staggering differential.
But in a surprising turn of events, the two benchmarks converged significantly in the past few days. A week ago, the price differential topped $9 per barrel, but the gap narrowed to $6 per barrel as of Monday.
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The reasons for this are multiple, but they largely come down to the fact that the fortunes of both benchmarks suddenly flipped. OPEC+ decided to add more oil onto the market last week – nominally 1 million barrels per day, but in reality something more akin to 600,000 bpd. That has eased fears about a supply crunch. Related: The New OPEC Deal: Paper Barrels Won’t Materialize
Meanwhile, the supply/demand balance in North America suddenly looks a bit tighter than it did earlier this month. The pipeline constraints in the Permian are starting to bite, and there are growing expectations that shale drillers will have to curb output growth because available takeaway capacity has all but vanished. The long list of aggressive forecasts regarding shale growth might have to be revised down.
Also, inventories continue to decline. Last week saw a rather significant decline of 5.9 million barrels. Stocks in Cushing are already at their lowest level in years. “The spread between WTI and Brent is shrinking as OPEC’s output increase is having a bigger impact on Brent than WTI,” Hong Sungki, a commodities trader at NH Investment & Securities Co., told Bloomberg. “Cushing stockpiles are quickly withdrawing as the U.S. summer driving season boosts refiners’ demand for crude, supporting WTI prices.”
More importantly, at least in the near run, was the unexpected outage from an oil sands project in Canada. Syncrude Canada saw an equipment malfunction that could reduce flows from Canada by 360,000 bpd for the month of July, “putting Cushing potentially on a path to an inventory stockout,” according to a note from Goldman Sachs. “With the global market pricing to pull crude out of the U.S., this loss of U.S. supplies will exacerbate the current global de?cit, making the increase in OPEC production all the more required.” The expected loss could translate into a reduction in inventories by around 14 million barrels.
The outage in Canada led to a “sharp repricing of North American crudes with sharply stronger WTI timespreads and tighter differentials,” Goldman wrote. The cash vs. front-month WTI differential went from essentially nothing to nearly $3 per barrel immediately after Syncrude Canada’s announcement. In other words, investors became worried about the immediate availability of supply. Related: Norway’s Oil Discoveries On Track For Best Year Since 2010
The narrowing of WTI to Brent could eliminate the incentive to ship oil by rail from the Midwest to the Gulf Coast, as the arbitrage opportunity gets zeroed out. “Such differentials, if sustained, would help limit the magnitude of steeper draws in Cushing, albeit by reducing supply to the USGC and global market,” Goldman concluded. In essence, the shrinking price differential between WTI and Brent could lead to more oil staying within the U.S., offsetting the interruptions from Canada to the U.S. Midwest.
That means a potential slowdown in the growth of U.S. crude oil exports. U.S. oil exports surged this year, particularly to Asia, because Asian refiners could save a bundle by opting for crude oil from the U.S. Gulf Coast instead of oil from the Middle East, for instance, even after factoring in higher transportation costs. There is still plenty of room for U.S. exports at a $6-per-barrel WTI discount, but if it narrows further, the business case starts to get trickier.
The pressure on WTI could ease if the outage in Canada is not as bad as feared, or if U.S. shale continues to grow at a quick pace. But, for the first time in months, WTI and Brent have narrowed the gap.
By Nick Cunningham of Oilprice.com
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