While most corners of the energy market have been experiencing record volatility, U.S. light sweet crude spreads have been a calm in the storm – but this may be changing.

Light sweet crude oil in the United States is benchmarked by the NYMEX WTI futures contract deliverable at Cushing, Oklahoma, and has an active market in West Texas at Midland and on the Gulf Coast at Houston. WTI Houston and WTI Midland trade as spreads to the NYMEX WTI. The differences between prices at these three locations collapsed in late 2019 when new pipelines alleviated transportation constraints. Then in 2020 oil production plummeted, bringing pipeline utilization to unforeseen lows. The price spread between WTI Houston and WTI Midland has been limited to a narrow  40-cent range since then, offering little volatility for traders.

Spreads between light sweet crude oil primarily reflect the incremental transportation cost between regions. When there is significant excess pipeline space between locations, these spreads, sometimes called basis differentials, trade at “variable cost” – typically 25 to 50 cents per barrel depending on the pipe and the period in history. Temporary disruptions in regional balances, such as refinery outages or pipeline issues, are typically easily absorbed without the need for a large move in spreads. 

The narrow and rangebound WTI Houston and WTI Midland spreads of the last few years are in sharp contrast to those in 2018 and 2019 when midstream projects lagged the surge in production in several U.S basins. By late 2018, the spread between WTI Houston and WTI Midland – representing the arb to deliver Midland barrels to the U.S. Gulf Coast – widened to over 20 dollars per barrel. “Kinks” of several dollars per barrel in the forward curves for these products implied traders’ point of view on the race between new pipeline projects and growing production.

In late May 2022, Permian production forecasts showed volumes setting new highs in 2022 and driving significantly greater utilization of space on Permian-to-Gulf Coast pipelines over the next five years. 

While a shortage of pipelines like that seen in 2018 is not expected, higher utilization means more competition among pipeline operators and more costly tiers of transportation for shippers. As spreads between regions are influenced by transportation costs, this means wider price spreads. 

Higher pipeline utilization also means the potential for more volatility in location spreads like WTI Houston and WTI Midland. As periodic disruptions in regional supply and demand occur, larger moves in the prices between regions may be required to incentivize the necessary changes in pipeline flows. Decisions to convert crude oil pipelines to other higher value purposes in the near term may drive further volatility. 

While nearby spreads remain narrow today, the expected growth in production and pipeline utilization may be starting to surface in the forward curves for WTI Houston versus WTI Midland. In Q1, the Cal 2024 spread between the regions held steady at 70 cents per barrel; throughout Q2, this spread has drifted upward, hovering at $1.25 in June 2022 – a level not seen since early 2020.

This move coincided with large increases in Cal 2023 and 2024 open interest in WTI Houston and WTI Midland – a sign participants are starting to take notice.

The evolution of market expectations for oil production and capital projects is likely to continue to drive shifts in the forward curves for WTI Houston and WTI Midland – offering opportunity for traders to express points of view from their own forecasts.

WTI Houston (Argus) vs. WTI and WTI Midland (Argus) vs. WTI are liquid futures products, with combined open interest of nearly 300,000 contracts, and tradable via the broker market. You can find more information about U.S. crude oil products here or contact energy@cmegroup.com.

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.

CME Group is the world’s leading derivatives marketplace. The company is comprised of four Designated Contract Markets (DCMs). 
Further information on each exchange's rules and product listings can be found by clicking on the links to CME, CBOT, NYMEX and COMEX.

© 2022 CME Group Inc. All rights reserved.