Unprecedented global market fundamentals have put intense stress on the oil industry in 2020 as companies respond to volatile arbitrage price signals and hedge the price risk associated with declining exports, rising inventories, and lower refinery utilization rates. The resulting price arbitrage has directed barrels into storage as the export economics became unfavorable. An early indication in the crude oil market of the oversupply and demand destruction from COVID-19 was reflected in the NYMEX WTI Houston Crude Oil futures contract (“WTI Houston futures”), which traded at a discount price to the WTI Cushing benchmark for the first time on March 13, 2020 after trading at an average premium of $2.65 in February 2020. The global oversupply of crude oil caused the export arbitrage window to close, and the price of WTI Houston fell sharply, and consequently Permian Basin crude oil production was directed into storage in Cushing and in the US Gulf Coast.
The physical-delivery requirement of WTI Houston futures is a direct link to the underlying cash market in the US Gulf Coast. As a result of the recent extreme market imbalances between demand (low refinery runs) and oversupply (rising stocks), the physical delivery volumes against the WTI Houston futures declined in April and May 2020, reflecting the unfavorable export dynamics.
Despite the extreme market conditionsthe physically-delivered WTI Houston futures provided important transparency and price discovery for the export arbitrage of waterborne loadings in the US Gulf Coast market. This paper provides a review of the WTI Houston futures contract as both a hedging and delivery mechanism, most notably its price discovery function.
In response to the volatile global market fundamentals, WTI Houston futures have seen sharp price swings in the first half of 2020. The expanded pipeline infrastructure in the US Gulf Coast and Permian Basin has provided strategic optionality to the marketplace, providing alternatives for barrels to flow into storage in the US Gulf Coast and in Cushing to benefit from the storage economics as export opportunities declined.
The first indicator in the crude oil market of the oversupply and demand destruction from COVID-19 was seen in the WTI Houston futures contract, which traded at a discount to the WTI Cushing benchmark price for the first time on March 13, 2020 and remained at a discount until April 17, 2020. This was a sharp price decline from the average price premium of $4.50 in 2019. The price premium for WTI Houston vs. WTI futures collapsed to a steep discount of $6.00 on March 30, 2020, reflecting the global supply overhang and the unfavorable export arbitrage. By late April, the deep discount shifted back to a price premium as shown in the chart below.
In May 2020, the WTI Houston price recovered to an average premium of $2.10 vs. WTI Cushing.
Further, the arbitrage spread between WTI Houston futures and Brent Crude Oil futures stabilized at $1.75 in May 2020, which does not cover the current freight cost for delivery to Europe.
Consequently, with the global oversupply and unfavorable export economics, crude oil stocks in the US Gulf Coast have risen to record-high levels.
Meanwhile, the growth in US exports has been transformative for the crude oil market, but the recent reduction in the export arbitrage has led to a decline in US crude oil exports in the second quarter of 2020 to 3.1 million barrels per day (b/d), down from the peak of 3.7 million b/d recorded in February 2020.
The WTI Houston futures contract features physical delivery free-on-board (FOB) at four Enterprise Products LP terminals with waterborne marine access geared for the export market: 1.) the Enterprise Echo terminal; 2.) Enterprise Houston Ship Channel terminal; 3.) Genoa Junction terminal; and 4.) Moore Road terminal in Houston, Texas. The FOB delivery mechanism allows importers and exporters to make and take delivery of export-grade WTI in Houston at a price that reflects the true value of waterborne ship loadings in the US Gulf Coast market. The Enterprise terminals are connected to all the major in-bound pipelines and refineries in the Houston area and provide out-bound access to the largest waterborne export terminal in the Houston market.
As a result of the recent extreme market imbalances between demand (low refinery runs) and global oversupply (rising stocks), the physical volumes delivered against the WTI Houston futures declined in April and May 2020, reflecting the unfavorable export dynamics.
The export grade of WTI in Houston is a fungible blend of domestic light sweet streams with quality parameters of 40 to 44 degrees API gravity maximum and 0.20% sulfur maximum, which are slightly lighter than the WTI specifications in Cushing. The contract specifications for WTI-type crude oil for delivery in Houston represent the export quality that is lighter than WTI at Cushing and mirrors the specifications for WTI-type crude oil at the export terminals in Houston.
Table 1 below outlines the in-bound pipeline capacity for crude oil flowing from West Texas and Cushing to Houston.
In-bound crude oil pipelines connected to Enterprise’s Houston terminals capacity expressed in barrels/day.
|BridgeTex PIPELINE (from Midland)||400,000||Magellan|
|Longhorn Pipeline (from Midland)||275,000||Magellan|
|Enterprise’s Sealy Pipeline (from Midland)||600,000||Enterprise Products LLC|
|Enterprise’s Sealy 2 Pipeline (from Midland)||400,000||Enterprise Products LLC|
|Enterprise Products Eagle Ford Pipeline||560,000||Enterprise Products LLC|
|Kinder Morgan Pipeline (from Eagle Ford)||350,000||Kinder Morgan|
|Seaway Pipeline (from Cushing)||850,000||Enterprise|
|Keystone MarketLink (from Cushing)||700,000||Transcanada|
|TOTAL In-bound capacity: approx. 4.1 million barrels/day|
Despite the volatile market conditions, the physically-delivered WTI Houston futures has performed a key function as a price discovery mechanism for the export arbitrage of waterborne loadings in the US Gulf Coast market. As a result of the recent market imbalances between demand (low refinery runs) and oversupply (rising stocks), the physical delivery volumes against the WTI Houston futures declined in April and May 2020, reflecting the unfavorable export dynamics. Going forward, the WTI Houston futures contract will be a useful hedging tool, as companies respond to volatile price signals and hedge the price risk associated with the export arbitrage and rising crude oil inventories.
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