WTI-Brent, Midland-WTI both near multi-year highs

Oil markets are beginning to separate, as several trends drive rising differentials in local and national pricing.

The WTI-Brent spread rose to over $11/bbl in intraday trading on both Thursday and Friday, the highest level in over three years.

Even after the recent drop in oil prices on speculation that OPEC may increase output, producers outside the U.S. are enjoying oil prices above $75/bbl (Brent). E&P companies in the U.S., by contrast, are receiving less than $65/bbl. The spread has been driven by several factors, but is primarily the result of the rapid growth in U.S. production.

American Oil Producers Face Pain from Rising Differentials

Source: EnerCom Analytics

Since bottoming in September 2016, the strengthening of crude prices has allowed American oil output to rise rapidly.

In the 18 months after reaching a low, U.S. oil production has skyrocketed, breaking all-time records. The U.S. produced 10.47 MMBOPD in March, representing 1.92 MMBOPD of growth in the past 18 months. Preliminary data suggests that growth has, if anything, accelerated in recent months. While this data is often revised, the EIA estimates that last week the U.S. produced 10.77 MMBOPD.

American Oil Producers Face Pain from Rising Differentials

Source: EnerCom Analytics

This rapid growth has helped separate domestic and international pricing, driving a widening wedge between WTI and Brent. Current forecasts predict this growth will continue through the year, with the EIA estimating total U.S. crude production will expand 14.6% in 2018 and 10.6% in 2019.

This means that while the spread may temporarily close when immediate transportation problems are resolved, the underlying cause is here to stay.

American Oil Producers Face Pain from Rising Differentials

Source: EnerCom Analytics

Permian producers suffer twice – from double differentials

If the U.S. is rapidly growing its production, this is doubly true for the Permian. Unfortunately for producers in the basin, this growth also brings widening local differentials.

The large current Midland-WTI differential has been a key concern of Permian companies in recent months, as pipelines out of the basin fill to capacity. The recent expansion of the WTI-Brent differential has done little to close the gap between Permian and national pricing, meaning oil in the basin has sold for very low prices.

The Midland-WTI differential reached $12.25/bbl last week, on top of an already large WTI-Brent spread. This means oil in the basin was sold for only $55.23/bbl, the lowest level in six months, and more than $20 below the international benchmark. The spread between Midland oil and WTI or Brent has reached its highest levels since 2014.

American Oil Producers Face Pain from Rising Differentials

Source: EnerCom Analytics

Pipelines are a year out

Like the WTI-Brent spread, the Midland-WTI differential is unlikely to close any time soon, based on companies’ spending plans in the basin.

While new pipeline capacity is in the works, the first pipelines will only come online in Q2 2019, with significant volumes becoming available at the end of the year. Until that point, producers will have to turn to less economic means to move oil out of the basin, ensuring the differential remains in place.

American Oil Producers Face Pain from Rising Differentials

Export capacity limited, cannot send enough oil to close the spread

This situation does benefit exporters, of course, as the spread between Brent and WTI directly drives the profitability of sending oil overseas. However, the U.S.’s export capacity is limited, and beyond 2 MMBOPD, a widening spread will not produce an increase in exports. This limit has essentially already been reached, as the U.S. exported 2.1 MMBOPD in the past four weeks.

This limited export capacity means closing the spread will be difficult, especially given current growth projections. However, eventually export capacity is expected to expand. The largest project to accomplish this is in Corpus Christi, where planners hope to dredge the ship channel to allow larger tankers to dock. If federal funding can be secured, the project should be complete by 2021.

Further projects will also expand exporting capacity. The IEA estimates that the U.S. will be able to export nearly 4.9 MMBOPD in 2023, more than double the current capacity. This is a good long-term sign for U.S. oil producers, as America’s northern neighbor provides an example of what can happen if exporting facilities are neglected.

The Canadian WCS-WTI differential is consistently above $10/bbl, and often rises significantly beyond this level. The differential reached over $30/bbl in January, and briefly dropped to $26/bbl last week. While several pipeline projects are in the works, getting lines approved and completed is very difficult. Most recently, the federal government of Canada was forced to purchase Kinder Morgan’s Trans Mountain project outright, as British Columbia was blocking any development.

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