The unprecedented market fundamentals that have played out due to the global COVID-19 lockdowns have resulted in lower oil demand and lower refinery utilization rates. In the second quarter of 2020, the global oversupply of crude oil caused the export arbitrage window to close, and consequently, the price of WTI Houston crude oil fell relative to the WTI Cushing benchmark price. Permian Basin oil production was re-directed into storage in Cushing and in the US Gulf Coast. After a sharp decline in oil production and exports, and a sharp rise in inventories, the oil market began to move back into balance in the third quarter of 2020. US Crude oil inventories peaked in June 2020 and dropped sharply, while US crude oil exports recovered in the third quarter to a level exceeding three million barrels per day (b/d).
Despite the extreme market conditions, the physically delivered NYMEX WTI Houston Crude Oil futures contract (“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 price discovery mechanism. Further, the Exchange is introducing a new cargo loading feature as a re-delivery option for the WTI Houston futures contract.
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, offering 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. For the period of June through September 2020, the WTI Houston price has been stable at an average premium of $0.80 per barrel vs. WTI Cushing.
In the second quarter of 2020, the global pandemic led to oversupply and unfavorable export economics, and crude oil stocks in the US Gulf Coast rose to record-high levels. In the third quarter of 2020, the oil market began to move back into balance, as reflected in the sharp decline in crude oil inventories.
Meanwhile, with the global contraction in demand, US crude oil exports fell below 3.0 million b/d in the second quarter of 2020, down from the peak of 3.7 million b/d recorded in February 2020. In the third quarter, US exports showed an uptick to 3.2 million b/d.
Further, the arbitrage spread between WTI Houston futures and Brent crude oil futures stabilized at $1.75 in the third quarter of 2020, which allows exporters to cover their freight costs for delivery to Europe in the fourth quarter of 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 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.
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.
|BridgeTex Pipeline (from Midland)||400,000||Magellan|
|Longhorn Pipeline (from Midland)||275,000||Magellan|
|Enterprise Midland to Echo 1 Pipeline||600,000||Enterprise Products LLC|
|Enterprise Midland to Echo 2 Pipeline||400,000||Enterprise Products LLC|
|Enterprise Midland to Echo 3 Pipeline||350,000||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|
|Wink to Webster (early 2021)||1,500,000||ExxonMobil/Plains|
CME Group will introduce a new delivery feature for buyers that will allow firms to re-deliver light sweet crude oil onto a cargo ship at the Enterprise LP Houston Ship Channel (“EHSCLP”) terminal after taking delivery via the WTI Houston futures contract. The EHSCLP marine terminal is one of the largest export facilities on the US Gulf Coast, with more than 30 million barrels of storage capacity.
This redelivery feature is a supplementary and optional service that can be utilized at a buyer’s discretion. This mechanism provides a direct link to the loading dock for futures contract delivery participants and will simplify the hedging of US crude oil exports.
Redelivery of crude oil would occur at dock space loading windows offered by EHSCLP at a fixed per barrel fee and allocated to buyers through dock space allocation sessions administered by CME Clearing. EHSCLP at its discretion will offer various two-day delivery windows within a 10-day duration (referred to as a “decade”) on a monthly basis, which the Exchange will randomly allocate to participants who must take delivery of a sufficient number of futures positions to comprise a full cargo loading of 650,000 to 850,000 barrels. The purchase price of dock space would also include EHSCLP’s provision of redelivery terminal services.
Despite the volatile market conditions, the physically delivered WTI Houston futures have performed a key function as a price discovery mechanism for the export arbitrage of waterborne loadings in the US Gulf Coast market. As US export volumes recover after the global pandemic, 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 export arbitrage. Further, the new cargo redelivery mechanism provides a direct link to the loading dock for WTI Houston futures contract delivery participants and will simplify the hedging of US crude oil exports.
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