Executive summary

The U.S. domestic crude oil grades market has seen a tectonic shift in response to the global demand and supply shocks that flowed from the COVID-19 pandemic, recent OPEC+ meetings, and the conflict in Ukraine. Traded volume in the U.S. grade markets is seeing an increase amid volatility in the markets that have sent levels of open interest climbing.

Following the announcement by S&P Global Platts, WTI Midland, which is produced in the Permian basin, has been proposed to reflect cargo deliveries in the Dated Brent assessment. Due to declining crude oil output in the North Sea, the assessment has seen an inclusion of various grades throughout the years. WTI Midland will be the first non-North Sea grade to be added to the mechanism which currently comprises of Brent, Forties, Oseberg, Ekofisk, and Troll. This further solidifies CME Group’s WTI Light Sweet Crude Oil Futures presence as a global benchmark.

U.S. exports saw an increase in the fourth quarter of 2021, and arbitrage price signals have responded consistent with volatile global market fundamentals. The major challenge for the Midland trading hub was building additional takeaway pipeline capacity to the U.S. Gulf Coast to access the export markets and to keep pace with the rapid rise in crude oil production in the Permian Basin. Today, the expanded pipeline infrastructure in the U.S. Gulf Coast and Permian Basin has provided critical optionality to the marketplace, providing an outlet for barrels to flow to the Cushing hub to benefit from storage economics in lieu of export arbitrage in the U.S. Gulf Coast market.

With the expanded pipeline connectivity and export arbitrage, the CME Group’s WTI Houston (Argus) vs. WTI trade month futures contract continues to exhibit gains in volume and open interest. Further, the WTI Midland (Argus) vs. WTI trade month and calendar month futures contracts have shown solid growth in volume and open interest, as the Midland barrels have been pulled to the Cushing market due to the storage incentives via the contango price structure in the NYMEX Light Sweet Crude Oil Futures Contract.

The Mars market has continued to sustain its liquidity as a sour crude oil benchmark in the U.S. Gulf Coast. However, the major infrastructure changes in the U.S. Gulf Coast market have led to a sharp drop in activity in the LLS market. 

Market overview

The U.S. domestic crude oil grades market has seen a tectonic shift in response to the global demand and supply shocks that flowed from the COVID-19 pandemic, recent OPEC+ meetings, and the conflict in Ukraine. Table 1 below shows the recent liquidity trends for the key domestic crude oil futures contracts trading at CME Group. CME Group’s slate of futures contracts for the U.S. domestic crude oil grades are financially settled based on crude oil price assessments published by Argus Media. These cleared futures contracts provide the hedging tools for managing arbitrage risk between the U.S. and global markets.  

Table 1: Key CME Group Domestic Crude Oil Grade futures contracts (spread vs. WTI)

Product Name Commodity Codes Average Daily Volume in July – December 2021 (in lots per day) Change vs. Full Year 2021 Average Daily Volume Open Interest as of February 28, 2022
WTI Houston (Argus) vs. WTI Trade Month and Calendar Month Futures HTT HIL 3,021 -17% 141,316
WTI Midland (Argus) vs. WTI Trade Month and Calendar Month Futures WTT FF 1,300 +15% 142,646
Mars (Argus) vs. WTI Trade Month Futures YV 732 +14% 24,792
LLS vs. WTI (Argus) Trade Month and Calendar Month Futures E5 WJ 313 +21% 12,319

Note: One contract is equal to 1,000 barrels

In response to the volatile global demand and supply fundamentals, the U.S. domestic grades market has exhibited dramatic price swings in the first quarter of 2020.

The expanded pipeline infrastructure in the U.S. Gulf Coast and Permian Basin has provided strategic optionality to the marketplace, providing alternatives for barrels to flow to the Cushing hub to benefit from the storage economics as the export opportunities decline in the U.S. Gulf Coast market.  To visualize the tectonic shift in the U.S. domestic grades market, the price chart below shows the sharp move in the price spreads in March 2020 for WTI Houston and WTI Midland (versus WTI Cushing) which dropped into deep discounts as exports dropped and as storage economics attracted barrels from Midland to Cushing.

The price premium for WTI Midland vs. WTI collapsed from $1.50 per barrel on March 1, 2020 to a steep discount of $9.00 on March 30, 2020. In a similar pattern, WTI Houston vs. WTI made a volatile move from a premium of $3.00 per barrel on March 1, 2020 to a discount of $6.00 at the end of March. The deep discounts have since reverted back to price premiums for the WTI Houston and WTI Midland (versus WTI Cushing) spreads. The arbitrage price signals in the U.S. domestic grades market have shifted dramatically in response to global demand and supply fundamentals, and consequently, the market will seek out the most economic destination for barrels in the global marketplace.

Figure 1

To help understand the tectonic shift in the U.S. domestic grades market and its impact on the international market, an overview of each of the four major crude oil grade benchmarks is provided below.

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 Houston physical delivery mechanism is comprised of a network of nearly a dozen pipelines and 10 major storage terminals.

There are substantial pipeline inflows of WTI-type crude oil to Houston from four major hubs: 1) from Cushing via the Seaway and the TransCanada Marketlink Pipelines; 2) from Midland, Texas via Enterprise’s Sealy Pipelines, the BridgeTex Pipeline and the Longhorn Pipeline; 3) from the Eagle Ford area in Texas via the Enterprise Pipeline and the Kinder Morgan Pipeline; and 4) from the Bakken production region in North Dakota via the Dakota Access Pipeline (DAPL).

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 diverse.

Figure 2

Table 2: Crude oil pipelines in-bound to Houston (barrels/day)

Incoming Pipelines Capacity Owner
Seaway Pipeline (from Cushing) 850,000 Enterprise/Enbridge
MarketLink Pipeline (from Cushing) 700,000 TransCanada
Rancho II Pipeline (from Midland) 1,000,000 Enterprise
BridgeTex Pipeline (from Midland, TX) 350,000 Magellan
Longhorn Pipeline (from Midland, TX) 275,000 Magellan
Enterprise Eagle Ford Pipeline 560,000 Enterprise
Kinder Morgan Pipeline (from Eagle Ford) 300,000 Kinder Morgan
Dakota Access Pipeline (DAPL) 520,000 Energy Transfer Partners

TOTAL In-Bound Pipeline Capacity: 4.5 Million Barrels/Day

Overview of the WTI Midland market

There is an active physical crude oil trading center based in Midland, Texas, which is a major hub for barrels produced in the Permian Basin area with direct connectivity to the Cushing and U.S. Gulf Coast markets. Two major pipelines carry crude oil from Midland to Cushing: Basin Pipeline and Centurion Pipeline, with total capacity of 750,00 b/d. In addition, there are multiple pipelines that provide access to the Gulf Coast market in Houston with takeaway capacity of nearly two million b/d.  

The major challenge for the Midland trading hub was building additional takeaway pipeline capacity to the U.S. Gulf Coast to access the export markets and to keep pace with the rapid rise in crude oil production in the Permian Basin. In March 2020, with the dramatic change in global demand and supply fundamentals, the price arbitrage has shifted and has led to a reduced flow of crude oil from Midland to the U.S. Gulf Coast. In fact, the volatile price arbitrage has re-directed barrels to flow from Midland to Cushing to take advantage of the storage economics. In response to the volatile global market fundamentals in March 2020, the price of WTI Midland (versus WTI Cushing) has dropped into deep discount as U.S. exports have dropped, and as storage economics have attracted barrels from Midland to Cushing. The expanded pipeline infrastructure in the Permian Basin area has provided critical optionality to the marketplace, providing an outlet for barrels to flow into storage at the Cushing hub in lieu of declining export arbitrage in the U.S. Gulf Coast market.

Figure 3

Overview of the Mars market

The Mars market represents spot trade of Mars Blend crude oil which is deliverable at the LOOP facilities in Clovelly, Louisiana. There are significant developments in Louisiana that will impact the Mars market. First, the LOOP facility has begun loading export vessels from its deep-water port that allows for loading of Mars onto VLCC vessels with capacity of 2 to 4 million barrels. This provides direct access for Mars to be exported to the global marketplace, with better arbitrage opportunities for the Mars benchmark.

Figure 4

In addition, Marathon Pipe Line LLC recently completed the reversal of the Capline system, which became fully operational in January 2022. The pipeline commenced service with an initial capacity of 200,000 barrels per day and excess capacity available for contracted and spot shipments. Previously, Mars flowed northbound to Midwest refineries via the Capline, but these pipeline flows have been terminated. The Capline can now provide southbound access for Bakken and heavy Canadian crude oil to flow to the Gulf Coast in direct competition with Mars. This pipeline reversal has significantly altered the logistics in the Mars market, and as a result Mars has become a key export grade from the LOOP terminal.

Figure 5: Capline Pipeline System

The Mars Pipeline System1,2 is 163 miles and 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 connection.3 It has a capacity of up to 600,000 barrels per day.

In conjunction with the Mars Pipeline System, the Mars infrastructure network consists of a storage cavern with capacity of 8 million barrels at the LOOP Clovelly Terminal. This cavern and its interconnection to other LOOP facilities provide a flexible market link to the Gulf Coast pipeline network.

Figure 6: Mars Pipeline System

Overview of the LLS market

The LLS grade is traded at its hub in St. James, Louisiana, which consists of storage facilities and major pipelines for distribution from the Gulf Coast to refineries in Louisiana. There are significant new developments in Louisiana that will impact the logistics around the LLS market. First, Marathon Pipe Line LLC completed the reversal of the Capline system, which terminated northbound shipments from St. James. As a result, the Capline is no longer available as an outlet for LLS crude oil to flow to refineries in the Midwest market.    

With the completion of the Capline reversal, the line can now provide access to Bakken and Canadian crude oil to flow southbound from Patoka to the Gulf Coast in direct competition with LLS. The temporary shutdown of Capline has significantly altered the logistics in the LLS market, as market participants sought out additional outlets for LLS in Louisiana and in the export market.

Second, the LOOP facility has completed work to load export vessels from its deep-water port that will allow for loading of LLS onto VLCC vessels with capacity of 2 to 4 million barrels. This will provide access for LLS to be exported to the global marketplace and could provide new arbitrage opportunities for the LLS benchmark.

Light sweet crude produced in the Permian regions in Texas can flow via the Shell Zydeco Pipeline to the hub in St. James and is blended into the LLS stream. The Shell Zydeco Pipeline (also called the Ho-Ho Pipeline) has capacity of 375,000 barrels per day.

Figure 7

Crude oil exports increased in Q4 2021

U.S. crude oil exports increased in the fourth quarter of 2021 to 3.4 million b/d, down from the peak of 3.6 million b/d recorded in December 2019. The growth in exports has been transformative for the U.S. crude oil market. Houston has become a major export hub, and new infrastructure has been constructed to process the growing export volumes. These infrastructure changes have transformed the U.S. into the marginal supplier of oil to the world.

Figure 8: U.S. Crude Oil Exports Increase in Q4 2021

U.S. oil production peaked in Q1 2020

U.S. crude oil production peaked in March 2020 at 13.0 million barrels per day (b/d) which is more than double the low of 5.1 million b/d in January 2009. In its report for the week ending March 4, 2022, the U.S. Energy Information Administration (EIA) reported that crude oil production was at 11.6 million b/d. Concurrently, in the short-term energy outlook dated March 8, 2022, the EIA forecasts U.S. crude oil production will rise to 12.0 million b/d in 2022, down 0.3 million b/d from the previous average record that was set in 2019. In 2023, the EIA forecasts U.S. crude production to increase further 13.0 million b/d which translates to record- high production on an annual average basis. According to the EIA, most of the U.S. crude oil production is WTI type crude oil with API gravity between 40 and 45 degrees. This is significant for the WTI benchmark, as it underscores the similarity in quality between the new oil production and the WTI pricing reference.

Looking ahead

The U.S. domestic crude oil grades market has been transformed in response to the demand and supply shocks from the global Covid-19 pandemic, OPEC+ meetings and the conflict in Ukraine. Consequently, the arbitrage price signals have responded to the global fundamentals, and the U.S. domestic crude oil grades market has provided needed liquidity and greater transparency.

The new pipeline infrastructure in the U.S. Gulf Coast and Permian Basin has provided critical optionality to the marketplace, providing an outlet for barrels to flow to the Cushing hub to benefit from the storage economics in lieu of declining export arbitrage in the U.S. Gulf Coast market.

With the expanded pipeline connectivity and higher price volatility, the Exchange’s WTI Houston (Argus) and WTI Midland (Argus) futures contracts have exhibited gains in volume and open interest. In addition, the ability to export from the LOOP facility is a game-changer that will provide direct access to the global marketplace and will provide new arbitrage opportunities for the Mars and LLS benchmarks. In addition, the completion of the reversal of the Capline system will significantly alter the logistics in the Gulf Coast market and will impact the pricing of these benchmarks.

In summary, the U.S. domestic crude oil grades are competing in the global marketplace and have become important price references in the international market. The inclusion of WTI midland in the Dated Brent assessment will further solidify CME Group’s Light Sweet Crude Oil Futures presence as a global benchmark. At a time of increased risk and expanded volatility, the ability to hedge price risk has never been so important.

References

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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 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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