By Robert Campbell
NEW YORK, July 18 Stubbornly high inventories at the Cushing, Oklahoma, delivery point for West Texas Intermediate crude oil contract, are a ticking time bomb that could blow out the spread between WTI and Brent futures.
Take the spread between the October WTI and Brent contracts. Although it has jumped more than $3 a barrel since early July to hit $14 a barrel, it is still below the $15.71 per barrel level hit in April.
Similarly the gap between the January 2013 contracts is only $12 a barrel, well below the nearly $19 a barrel level hit in September 2011.
With only seven weeks remaining in the summer peak refinery operations season, there is precious little time for the industry to pare back the overhang at Cushing before refinery turnaround season is upon the market.
Indeed, the dismal showing this summer at Cushing, where stocks have built since the start of May, portends a surge in inventories to a fresh record in the fall.
Since the beginning of May, crude oil stocks at Cushing have risen more than 3.3 million barrels to 46.3 million barrels and stand only 1.4 million barrels below the record high hit in June.
Over the same period last year, Cushing stocks fell 3.8 million barrels and they would continue declining over the rest of the peak refining season.
The build in Cushing stocks over the first part of the summer is critical. Even if substantial declines are posted in the seven weeks to the end of August, the peak refining season may end with Cushing stocks only flat.
Last year, stocks at Cushing declined more than 7 million barrels over the peak refining season. This gave the industry breathing room to get through the period between September and November when refinery utilization rates decline due to seasonal overhauls.
Among the plants that are expected to undergo maintenance after the summer are Holly Frontier's Tulsa refinery and CVR Energy's Wynnewood plant. The two Oklahoma refineries are direct consumers of crude oil at Cushing.
Expansion projects at BP's Whiting, Indiana, plant, and Marathon Petroleum's Detroit refinery will only further exacerbate the situation.
Whether a blowout in the spread occurs is another question. With almost nothing in the way of a physical arbitrage route between Cushing and the Gulf Coast, the upper and lower bounds to the Brent-WTI spread are at best conjectural.
The spread tends to move more in line with market sentiment and investor flows. But that said, once traders get the spread in their sights, moves can come quickly.
Moreover physical traders with infrastructure at Cushing have a leg up on financial players in this market. They simply know a lot further ahead of time what the supply situation at the hub is likely to be. Chances are they are already taking their positions.
Thus far, the broader market has been relatively sanguine about prospects for WTI. At the front month, the Brent-WTI spread has largely held at -$15 a barrel or less, and further along the forward curve, the gap is even narrower.
Although the reversal of the 150,000 barrels per day Seaway pipeline between Cushing and the Gulf Coast has proven too little to trigger a meaningful drawdown in stocks, the planned expansion of the line in early 2013 is giving traders hope.
Once operational, the 250,000 bpd expansion should eventually help the situation at Cushing. But before it starts up Cushing stocks will have several months after the summer refining season to build up.
And refinery work in the winter and spring of 2013 could easily blunt the immediate impact of the Seaway expansion on stock levels.
Factor in anticipated increases in Canadian and U.S. oil output in 2013, plus new pipelines connecting to Cushing and the balance at the hub could easily be in surplus into at least the third quarter of 2013, the earliest possible start of TransCanada's Cushing pipeline to the Gulf Coast.