Several major oil pipelines connecting West Texas to the Gulf Coast are set to come online in the next few weeks and months, allowing more Permian oil to hit the global market.
One result of the onset of new midstream capacity is to erase part of the price difference between Brent and West Texas Intermediate (WTI). The discount that WTI trades at relative to the more internationally-focused Brent benchmark has widened and narrowed depending on a variety of factors over the years, but the two markers are now converging.
The perennial problem of U.S. shale production in the Permian outpacing the ability of the midstream sector to move oil has been the main driver of the WTI discount in recent years. Oil trapped in West Texas led to painful discounts for oil producers, who at times had to sell their oil $10-$20 per barrel below what oil fetched at the Gulf Coast.
But those large discounts could be a thing of the past. On Monday, Brent was trading only about $4 per barrel more than WTI, the smallest difference in nearly a year.
Why the sudden change? Part of the reason is that more Permian crude will reach the global market, smoothing out the differences between WTI conditions and those for Brent. U.S. exports have steadily ratcheted higher, and more midstream connections will allow for another step up in exports.
In total, three pipelines are set to come online by the end of the year, leading to a massive 2.5-mb/d jump in midstream capacity. While that will help WTI, more pipelines create a new set of challenges. The Permian is about to go from a multi-year midstream bottleneck, to one of surplus pipeline space. “There’s no way another 2.5 million bpd are waiting to get sent to Corpus Christi (Texas),” Sandy Fielden, an analyst at Morningstar, told Reuters. “Clearly, there’s going to be too much capacity … There will be buying up of barrels in Midland like it’s going out of style.” According to Reuters and data from Tudor, Pickering, Holt & Co., the Permian already has about 3.9 mb/d of pipeline capacity, but the region is set to see an additional 2.5 mb/d of more space. As pipelines battle it out to attract customers (oil producers), they are set to slash the rates they charge for using the pipeline. “We see the Permian as over-piped,” Matthew Blair, an analyst at Tudor Pickering, told Reuters. “Spot rates are going to be pretty cutthroat, with really low tariffs, given all this extra capacity.” The burden on oil producers will suddenly shift to pipeline companies.
New pipelines have essentially erased the discount that WTI in Midland traded at relative to Houston. In turn, the more widely traded WTI Cushing benchmark is narrowing its discount to Brent.
In addition to new pipelines, another reason that WTI and Brent are converging is that the pace of growth in the shale patch is slowing. More oil might now be able to reach the Gulf Coast, but the shale industry more broadly is slowing down because of low prices and financial stress. “Drilling activity there has declined to its lowest level in 1½ years, which points to lower production growth,” Commerzbank said in a note. Easing production growth – and expectations of slower growth – has helped push up WTI.
Meanwhile, the main narrative characterizing market sentiment is one of weakening demand and fears of an economic recession. China, in particular, is showing signs of an economic slowdown. That tends to put downward pressure on Brent a bit more than WTI, which, again, helps to push WTI and Brent together.
Finally, one other bullish factor relating to Brent has dissipated somewhat. In recent months, the threat to oil shipments through the Strait of Hormuz added a risk premium to the price of oil, but the effect was stronger on Brent than it was for WTI. With the market seemingly no longer concerned about risk in the Persian Gulf, that has helped push Brent back towards WTI.