There’s been some interesting commentary on Friday regarding the ongoing problem of the widening WTI- Brent spread, which struck a record wide in like-for-like basis terms on Thursday.
First this from John Kemp at Reuters, on the mechanics of arbitrage and the substantial physical hurdles to closing out the current window.
As he points out, until now, the arbitrage has only really had to work one way:
Historically, Brent has traded at a discount to higher-quality WTI. Arbitrage has kept the differential within fairly tight limits, since (cheaper) Brent can be delivered against (more expensive) WTI if the gap widens too much.
But the arbitrage does not work so easily the other way around. WTI is not deliverable against the Brent contract. Pipelines are currently configured to handle imports and run crude oil inland from PADD III to PADD II but not in the other direction to handle exports from the midcontinent to the coast. In any event, current export regulations prohibit the export of domestically produced crude oil under the terms of the Energy Policy and Conservation Act (42 USC 6212) and other federal laws.
Since midcontinent and Canadian syncrude cannot be exported, the only way for the market to rebalance is to halt the flow of imported crude up the lines from the Gulf Coast, raise Midwest refinery output, and export refined products from PADD II to other parts of the country or abroad.
Consequently, until all that excess crude can break out of PADD II — the Mid-West region in which Cushing is based — the price of WTI will likely remain detached from prices elsewhere.
But this presents a potentially unfair advantage to any refinery based in PADD II.
JBC Energy takes note of the dynamic on Friday:
The implications are that US PADD 2 refiners are enjoying a de facto subsidy that has boosted their profitability far above competitors elsewhere. It is therefore hardly surprising that crude runs in PADD 2 are above 90% compared to a national figure of just 81.8% (EIA). The juxtaposition with Northwest Europe is particularly striking as European refiners have had to make do with strong Brent prices, leaving cracking margins far below those in Asia, the Med and the US. Brent has benefited from a healthy physical market, improving demand from European refiners and tighter loading programmes.
It might therefore be easier to arbitrage the WTI-Brent distortion by turning cheap WTI crude into product and then selling that at a profit elsewhere. But only a few refineries are in a privileged enough position to take advantage of that.
But it does seem they are doing so.
Kemp, for example, notes that PADD II operating rates are almost nine percentage points higher than the national average of 81.6 per cent and much higher than the neighbouring regions of PADD I East Coast (73.7 per cent) and PADD III US Gulf Coast (84.5 per cent).
As he puts it:
…Midwest refiners have been ramping up their output in response to massively profitable spreads between the price at which they can buy cheap crude locally and selling prices for refined products.
So, quids in for the likes of BP’s Whiting and other Mid-West refiners (see here, for instance.)
Those seeking arbitrage opportunities but without access to a PADD II refinery, might be inclined to look to the product markets too though — especially since the physical result of WTI-Brent distortion gate will be more product supply and less crude imports.
As for PADD politics and Cushing gate — perhaps a sensible interim solution could be a non-deliverable contract based around a virtual delivery point.
They could call it the iPadd.
(NB – last point is a joke. The proposal’s not actually viable…)
WTI’s upcoming ‘Keystone’ problem – FT Alphaville
Correlation trading and the WTI-Brent spread – FT Alphaville
US mulls ’supplemental’ draft EIS for TransCanada’s Keystone XL: Clinton – Platts
Brent’s got its problems too – FT Alphaville
‘WTI about as useful as a chocolate oven-glove’ – FT Alphaville