WTI-Brent differential to close as USGC refineries come back online after Harvey and Chinese stock building slows

November 2017 | Jingrui Fang and Anders Norlen


The price spread between US inland benchmark WTI and seaborne Brent has widened by ~ USD 5.6/bbl from late August, when Hurricane Harvey hit Houston and effectively disrupting 3.5 mmbd of refining capacity. This in turn led to an oversupplied situation in Cushing, OK that put downward pressure on the WTI contract. In addition, the seaborne Brent market has remained strong as Chinese inventory build has continued at levels of 30-40 million barrels per month. With refineries returning online over the next months and Chinese imports reaching the time of year when they normally slow down, it’s likely that the WTI-Brent spread will normalize to USD 1.5-2/bbl over the next weeks or months.

WTI-Brent spread

With crude flows running from north to south, the theoretical differential between the price in Cushing and Houston should be reflective of the pipeline transportation cost of USD 1.62/bbl.

Now, the spread has become narrow since December 2015, when Congress lifted a 40 year ban on crude exports, effectively normalizing prices on the USGC. Since then, the spread between the Cushing, OK traded WTI-contract and the international Brent-benchmark has averaged USD 0.95/bbl, effectively lower than the transportation cost on the Seaway pipeline system from Cushing to the Houston refinery hub.

Refinery outages and crude exports

When Hurricane Harvey hit Houston in late August 2017, the impact was mainly on the demand side of the crude balance as flooding reduced throughput in the PADD 3 refinery system by about 3.3 million barrels per day in the week following the event. With refineries offline, incentives for sellers to move crude through the Seaway system and into refineries was strongly reduced. This in turn led to growing inventories in Cushing building almost 7 million barrels from end Aug to late October, at a time of year when inventories normally are being run down.

The excess crude not processed in refineries has triggered an export boom, with crude exports from the USGC hitting 1.9 million barrels per day in late October. Due to the limit of exporting infrastructure, not all excess crude will be timely exported. That leads to a temporary stock pile-up in PADD 3 in the first half of September.

This situation is not likely to last for much longer as refineries are gradually coming back online and throughput already being back at normal levels for the season. With full utilization of refining assets, exports are also likely to see levels normalized to the 500-700 kbd range.

Chinese stock building

China has been ramping up its Strategic Petroleum Reserve (“SPR”) building from 2014 through 2017, having amassed a gross volume of over 900 million barrels of crude by October 2017. On a monthly basis, the buying has hovered between 10 and 50 million barrels of crude per month, with a significant increase over the last few months.

The Chinese SPR building is a part of a wider Chinese energy strategic move that is set to enhance resilience to supply shocks, with officials previously announcing a target of having strategic storage covering 90 days of imports (similar to previous US target).

This buying has given support to the Brent prices over the last few years, but it has a clear seasonal component to it, typically peaking in the third quarter each year before slowing down in the fourth. Should this pattern repeat itself as it has in the last couple of years, Chinese stock building is set to slow down over the next months – all else equal weakening Brent prices vis-à-vis WTI.

Conclusion

The recent widening of the WTI-Brent spread following Hurricane Harvey is set to weaken over the next weeks or months as US crude flows and refinery runs will normalize, exports will weaken. Additionally, Chinese stock building could see a slowdown if it follows normal seasonal patterns.

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About the authors

Jingrui Fang is an Analyst and Anders Norlen is a Specialist, both in McKinsey Energy Insights' London office.