Oil prices surged on Wednesday on news that the Keystone pipeline might not restart for several weeks. The outage at the damaged pipeline ended several years of contango for WTI, pushing the benchmark into a state of backwardation for the first time since 2014.
TransCanada made a lot of headlines in the past week. The Keystone pipeline ruptured and spilled more than 200,000 gallons of crude oil in South Dakota last week, just days before TransCanada was given a greenlight for the Keystone XL in the state of Nebraska. South Dakota regulators now say that they could revoke the permit for the Keystone pipeline if it is found that the company violated the terms of its license. The spill was the third for the Keystone pipeline in less than 10 years.
“If it was knowingly operating in a fashion not allowed under the permit or if construction was done in a fashion that was not acceptable, that should cause the closure of the pipe for at least a period of time until those challenges are rectified,” said Gary Hanson, a member of the South Dakota Public Utilities Commission, told Reuters.
TransCanada said on Wednesday that it could take weeks to clean up the spill and bring the pipeline back online – news that sent shockwaves through the oil market. WTI spot prices surged on the news, pushing the benchmark back up above $58 per barrel.
TransCanada said that November deliveries through the pipeline would be cut by about 85 percent, a major outage for the nearly 600,000-bpd pipeline. Phillips 66, a major refiner that purchases crude from the pipeline, said that it is expecting an outage of about four weeks.
This will accelerate the inventory drawdowns in the U.S. as refiners lean more on storage. According to Reuters, the outage could cut shipments to the U.S. by about 7 million barrels through November, a figure that would obviously grow if the outage lasts longer than expected.
The news not only sent spot prices up, but it also pushed WTI futures into a state of backwardation, a situation in which near-term oil futures trade at a premium to longer-dated contracts. Backwardation tends to be a sign of a tighter oil market, which is why supply for immediate delivery trades at higher prices. WTI has not been in backwardation since 2014. A few months ago, Brent flipped into backwardation, helping to incite some bullishness in the oil market, but WTI remained in a narrow contango.
The opening up of backwardation could induce steeper drawdowns on inventories as it becomes costlier to store oil because the cargo will only fetch lower prices when sold off at a later date. As companies unload inventories, the drawdowns could provide a further boost to WTI. At the same time, WTI is still trading at a discount to Brent, which means that U.S. crude exports will continue at elevated levels, another reason why inventories could continue to post strong weekly declines.
Of course, what happens next largely depends on the outcome of the OPEC meeting next week. There is a danger of a sharp selloff in crude prices if OPEC fails to extend its production limits for 9 months through the end of 2018, a proposal that has been heavily hyped by OPEC officials for weeks. The large buildup in bullish bets by hedge funds and other money managers adds another element of danger, making the downside risk much greater than the upside.
But should inventory data from the U.S. demonstrate much larger-than-expected declines – owing in part to the Keystone outage – that would go a long way to putting a floor beneath WTI. “We’re going to need to see this kind of [reduced inventories] data every week to start another leg on this rally,” Gene McGillian, research manager at Tradition Energy, told the Wall Street Journal.
By Nick Cunningham of Oilprice.com
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