U.S. Domestic Crude Oil Grade Market

  • 18 Aug 2017
  • By Dan Brusstar, Ricky Li and Kevin Grady
  • Topics: Energy

Executive Summary:

The U.S. domestic crude oil grade market has experienced both substantial growth in liquidity and an increase in the number of market participants. Rising domestic production, higher volumes of crude exports, and extensive pipeline infrastructure together drive the thriving U.S. grade market. CME Group recently launched a slate of Average Price Options on major domestic crude grades to provide more risk management tools and enhanced liquidity for this expanding market.

Table 1: New CME NYMEX Crude Grade Average Price Option Products

 

Option Contract Title

Commodity Code

 

Underlying Futures Contract Title

Underlying Futures Commodity Code

LLS (Argus) vs. WTI Trade Month Average Price Option

E5O

Argus LLS vs. WTI (Argus) Trade Month Futures

E5

LLS (Argus) vs. WTI Average Price Option

WJO*

Argus LLS vs. WTI (Argus) Financial Futures

WJ

WTI Houston (Argus) vs. WTI Trade Month Average Price Option

HTO

WTI Houston (Argus) vs. WTI Trade Month Futures

HTT

WTI Houston (Argus) vs. WTI Calendar Month Average Price Option

HIO

WTI Houston (Argus) vs. WTI Financial Futures

HIL

WTI Midland (Argus) vs. WTI Trade Month Average Price Option

WTO

WTI Midland (Argus) vs. WTI Trade Month Futures

WTT

WTI Midland (Argus) vs. WTI Calendar Month Average Price Option

FFO

WTI Midland (Argus) vs. WTI Financial Futures

FF

Mars (Argus) vs. WTI Trade Month Average Price Option

YVO

Mars (Argus) vs. WTI Trade Month Futures

YV

Mars (Argus) vs. WTI Calendar Month Average Price Option

YXO

Mars (Argus) vs. WTI Financial Futures

YX

WTS (Argus) vs. WTI Trade Month Average Price Option

FHO

WTS (Argus) vs. WTI Trade Month Futures

FH

WTS (Argus) vs. WTI Calendar Month Average Price Option

WSO

WTS (Argus) vs. WTI Financial Futures

WTA

Western Canadian Select Oil (Net Energy) Monthly Index Average Price Option

WCI*

Western Canadian Select Oil (Net Energy) Monthly Index Futures

WCW*

*Existing products

This slate of options and their underlying futures contracts are financially settled based on crude oil price assessments published by Argus Media. These cleared derivative contracts provide hedging tools for managing arbitrage risk in the growing U.S. domestic market and in the surging export marketplace. Rising liquidity in these products provides for better price discovery in the U.S. domestic grades market and in the international market. Table 2 shows the current liquidity information for the grade spread futures contracts trading at CME Group.

Table 2: CME NYMEX Listed Gulf Coast Crude Grade Futures Products*

 

Product Name

Commodity Code

 

Type

Average Daily Volume YTD (in barrels)

Open Interest (in barrels)

Argus LLS vs. WTI (Argus) Trade Month Futures

E5

Spread Futures

292,840

9,354,000

Mars (Argus) vs. WTI Trade Month Futures

YV

Spread Futures

972,672

18,660,000

WTI Houston (Argus) vs. WTI Trade Month Futures

HTT

Spread Futures

459,480

31,310,000

WTI Midland (Argus) vs. WTI Trade Month Futures

WTT

Spread Futures

262,712

29,183,000

LOOP Crude Oil Storage Futures LPS Futures 172,248 17,100,000
LOOP Gulf Coast Sour Crude Oil Futures MB Futures 89,824 1,700,000

Source: CME Group as of clearing date 06/30/2017

* Calendar month version of the spread futures products are available on CME Group

To help better understand the growing significance of the U.S. domestic grades market and its impact on the international market, an overview of the key U.S. domestic crude grade benchmarks is provided below.

Figure 1: U.S. Domestic Crude Oil Grade Benchmarks

Table 3: Quality Specifications for the Key U.S. Crude Grade Benchmarks

Product Name

API Gravity

Sulfur Content (%)

Category

Light Louisiana Sweet (LLS)

38.5

0.39

Light Sweet

WTI Houston

44.0

0.45

Light Sweet

WTI Midland

40.0

0.37

Light Sweet

Mars

28.0

1.93

Medium Sour

West Texas Sour (WTS)

38.0

0.50

Light Sour

Overview of the LLS Market

Louisiana Light Sweet (LLS) oil has a 38.5 API and 0.39% sulfur1 content and is considered a light sweet crude oil. LLS is a blended grade of domestic crude oil streams from the Gulf Coast (Texas  and Louisiana) region.

Light sweet crude oil production from Louisiana and Texas accounts for a significant portion of the LLS-quality crude that is blended and traded in St James, LA. Light sweet crude produced in the Eagle Ford and Permian regions in Texas is frequently shipped via pipeline and barge to the hub in St. James, and blended into the LLS stream. There is direct pipeline connectivity from Houston to St. James via the Shell Zydeco Pipeline (also called the Ho-Ho Pipeline) with capacity of 375,000 barrels per day, as shown in Figure 2. In addition, light sweet crude oil is delivered by barge from Houston and Corpus Christi, TX ports to terminals in St. James for blending into the LLS stream.

Figure 2: Shell Zydeco (Ho-Ho) pipeline

Source:  http://www.shellmidstreampartners.com/fsZydeco.cfm

The LLS grade is traded at the hub in St. James, Louisiana, which consists of storage facilities and major pipelines for distribution of crude oil from the Gulf of Mexico to refineries in Louisiana and in the Midcontinent. The Capline pipeline system is a strategic high-volume transportation resource that links the Gulf of Mexico and foreign crude supplies to key refineries

throughout the Midcontinent area of the United States. It carries 1.1 million barrels of crude oil per day from St. James to Patoka, Illinois, as shown in Figure 3. There is active trading in forward cash deals on the  Capline.

Figure 3: Capline Pipeline System

Source:  Capline Pipeline

The typical transaction size in the LLS market is 30,000 barrels, with hundreds of separate transactions occurring daily. The volume of spot transactions is more than half of all cash transactions, and the balance of trades are longer-term contracts. The bid/ask spreads are typically in increments of 10 cents per barrel, which reflects robust liquidity in the LLS crude oil OTC market, and diverse market participation.

Overview of the WTI Houston Market

There is an active physical crude oil trading center based in Houston, Texas, which is a major hub for storage and pipelines with direct connectivity to the Cushing, Midland, and U.S. Gulf Coast markets. There is active trading in light sweet WTI type crude  oil (also referred to as domestic sweet). The WTI crude oil stream in Houston is a fungible blend of domestic light sweet, streams with quality parameters of 44 degrees API gravity maximum and 0.45% sulfur maximum, which are slightly lighter than the WTI specifications in Cushing. The Houston physical delivery mechanism is comprised of a network of nearly a dozen pipelines and 10 storage terminals. There are substantial pipeline inflows of WTI-type crude oil to Houston from three major hubs: 1) from Cushing via the Seaway and the Transcanada MarketLink Pipeline; 2) from Midland, Texas via the BridgeTex Pipeline and the Longhorn Pipeline; and 3) from the Eagle Ford production area in South Texas via the Enterprise Pipeline and the Kinder Morgan Pipeline.

The Argus assessment for WTI Houston crude oil is based on delivery at the Magellan terminal in East Houston, which is a    key hub for delivery of WTI-type crude oil. The cash market liquidity is vibrant, and market participation is deep, with 20 to 30 market participants.

Based on feedback from industry sources, the recent pipeline flows of WTI-type crude oil inbound to Houston is in the range of

1.0 to 1.5 million barrels per day. The capacity of each pipeline is presented in Table  4 below.

Table 4: Crude Oil Pipelines to Houston (Barrels/Day)

Incoming Pipelines

Capacity

Owner

Seaway Pipeline (from Cushing)

850,000

Enterprise/Enbridge

MarketLink Pipeline (from Cushing)

700,000

TransCanada

BridgeTex  Pipeline (from Midland, TX)

350,000

Magellan

Longhorn Pipeline (from Midland, TX)

250,000

Magellan

Enterprise Eagle Ford Pipeline

350,000

Enterprise

Kinder Morgan Pipeline (from Eagle Ford)

250,000

Kinder Morgan

TOTAL In-Bound Pipeline Capacity: 2.75 Million Barrels/Day

Overview of the WTI Midland and West Texas Sour (WTS) Market

There is an active physical crude oil trading center based in Midland, Texas, which is a major hub for storage and pipelines  with direct connectivity to the Cushing and U.S. Gulf Coast markets. There is active trading in light sweet WTI- and West   Texas Sour (WTS)-type crude oil at Midland. Further, there are substantial pipeline flows of WTI- and WTS-type crude oil from Midland, Texas to Cushing and Houston. Two major pipelines carry crude oil from Midland to Cushing: the Basin Pipeline and the Centurion Pipeline. In addition, the Magellan Pipeline was completed in early 2014 and connects Midland directly to the Gulf Coast market in Houston. Figure 4 shows the pipeline systems between Midland, Cushing, and Houston.

Figure 4: Crude Oil Pipelines in Midland

WTS is a light sour crude oil stream with average API gravity of 38 degrees and sulfur of 0.50%, by weight. WTS is a blended crude oil stream that is produced in the Permian Basin area in the vicinity of Midland, Texas, which includes districts 7C, 8,  8A, 9, and 10 as defined by Texas Railroad Commission (TRC), which are shown in Figure 5. The WTS crude oil cash market is moderately active, with diverse market participation from 15 to 20 commercial  companies.

Figure 5: Texas Oil/Gas Districts

Source: Texas Railroad Commission (TRC)

Furthermore, in recent years, there has been a sharp increase in production of light sweet WTI-type crude oil in the Permian Basin of West Texas in the region of Midland, Texas. The WTI cash market at Midland is robust, and market participation is diverse, with 30 to 40 participants in the marketplace.

Overview of the Mars Market

The Mars market represents spot trade of Mars blend crude oil which is deliverable at the Louisiana Offshore Oil Port (LOOP) LLC facilities in Clovelly, Louisiana. According to Argus, the Mars oil stream has quality parameters of 28 degrees API gravity maximum and 1.93% sulfur maximum. Market participants in the U.S. Gulf Coast sour crude oil cash market include 40 to 50 companies.

The Mars Pipeline System2,3 originates approximately 130 miles offshore in the Deepwater Mississippi Canyon and terminates   in salt dome caverns in Clovelly, Louisiana as shown in Figure 6. The System transports offshore crude oil from the Mississippi Canyon area, including the Olympus platform as well as the Medusa and Ursa pipelines, and from the Green Canyon and Walker Ridge areas via the Amberjack pipeline connection4. It has a capacity of up to 600,000 barrels per day.

Figure 6: Mars Pipeline System

The Mars Pipeline System:

  • Gathers from producers in: Mississippi Canyon
  • Gathers from pipelines: Ursa, Medusa, and  Amberjack
  • Delivers to terminals: Chevron’s Fourchon Terminal and LOOP Clovelly Terminal
  • Delivers to pipelines: Clovelly to Houma, Clovelly to Norco, LOCAP, and Chevron’s Fourchon to Empire pipeline

In conjunction with the Mars Pipeline System, the Mars infrastructure network consists of an 8 million barrel dedicated storage cavern constructed at the LOOP Clovelly Terminal. This cavern and its interconnection to other LOOP facilities provide the most flexible market link in the overall Gulf network. Virtually any significant Louisiana or Midwest crude market can be accessed from the Clovelly hub.

Gulf Coast Production Growth

The U.S. Gulf Coast (PADD 3) region is the major tight/shale oil production area, accounting for 37% of overall U.S. production   in 2016. Driven by reduced drilling costs and higher efficiency, shale plays have increased production significantly since 2010.  The Eagle Ford shale formation is located in South Texas from the US-Mexico border, north of Laredo in a narrow band extending northeast for several hundred miles to north of Houston. Permian Basin shale spans West Texas and in Southwest part of New Mexico. Both shale plays are among the most prolific oil production areas. Figure 7 shows the two shale regions in PADD  3.

Figure 8 shows the trend of their production for the past three years together with overall U.S. production. Crude oil produced from these regions is largely light sweet crude.

Figure 7: U.S. Shale Regions

Source: EIA Drilling Productivity  Report

Figure 8: Crude Oil Production in Gulf Coast and U.S. Total

Increasing Crude Oil Exports

U.S. crude oil exports from this region have increased significantly following the lifting of the domestic oil export ban in December 2015. In PADD 3, crude oil exports averaged 775,000 barrels per day in April 2017, 2.6 times the average of 2015, which was 291,000 barrels per day, as shown in Figure 9.

Figure 9: Gulf Coast (PADD 3) Exports of Crude Oil

It is more noteworthy that total U.S. exports now extend a long way beyond Canada. Canada accounted for 94% of total U.S. exports in 2014, but declined to 30% in June 2017 after the removal of export restrictions. Figure 10 below shows the distribution of exports by destination in 2017.

Figure 10: U.S. Export by Destination in 2017

Light sweet crude oil in the Gulf Coast region has traditionally competed with imported crude oil from the North Sea and West Africa. Domestic crude grades are priced to the refineries in competition with similar-quality imported grades. The price is usually in line with the Free On Board (FOB) quotes for these grades, plus the cost of transportation to the U.S. With rising exports, Gulf Coast grades are accessing the international market, rivaling other Atlantic Basin crude grades to serve Canada, Europe, South America and Asia. With OPEC keeping its production ceiling in place, the Dubai benchmark price has been at a premium over WTI, which gave WTI-benchmarked grades a competitive edge in the Asian market, as of mid-2017. As shown in Figure 11, Brent’s premium over WTI has widened to over $2 per barrel and remained at this level during the first half of 2017. This wider spread has contributed to the rise in exports from the Gulf Coast  region.

Figure 11: NYMEX WTI-ICE Brent Spread

Summary

The rise in U.S. domestic production, OPEC’s plan to control production, and increases in U.S. exports are all contributing to the strong growth of the U.S. domestic crude grade market. An understanding of this market and the pricing dynamics of each crude grade is essential to managing crude oil price risk in both the domestic and international energy markets.



 

All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author(s) and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.

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