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Brent-WTI: Waiting for Keystone XL

New York, 30 August 2011: Reuters

Oil analysts are in increasing agreement that the current spread between Brent and West Texas Intermediate crude oil futures is in some way fundamentally wrong but few are willing to state when it might collapse. Recent price action underscores why they might be reluctant: the flop of the proposed Double E pipeline and a slowdown in the decline in crude oil stocks at the WTI delivery point in Cushing, Oklahoma combined to keep the spread under pressure and at more than $25 a barrel.

 

 

Last week the U.S. government reported crude stocks at Cushing were essentially flat at 33.7 million barrels as refinery utilization in the Midwest struggled due to operational problems. This brought back into focus the fear of a big rebound in Cushing stocks this autumn when refineries shut for planned maintenance.

Following soon after the announcement that the proposed 450,000 bpd Double E line would not go ahead due to a lack of committed shippers, the inventory data took the wind out of the sails of those willing to bet on a narrowing spread.

But lost in much of this noise was a significant development: the Keystone XL pipeline edged closer to winning approval from the U.S. government on Friday. Keystone XL has been the solution to, and, it would seem, the cause of, much of the uncertainty surrounding the Brent-WTI spread. That uncertainty may be easing as the line moves forward in the regulatory process. That in turn should provide a window for a narrowing of the Brent-WTI spread.

BALL IN EPA'S COURT

When built, the 591,000 barrels per day line will move mostly Canadian crude through the Midwest to the Gulf Coast. Although the line is largely intended to be a direct method of shipping Canadian oil to the Gulf Coast, some shippers have contracted space on it to move oil out of Cushing.

Nevertheless, it will permit a significant amount of oil to bypass the Midwest market. With much of the space under long-term contract, Keystone XL shippers are likely to move as much oil as possible out of the Midwest when it begins operations in 2013.

Therein lies many of the recent problems for potential shippers on proposed Cushing-to-Houston pipelines. Plenty of refiners would like to buy cheap Midcontinent crude oil but do not want to sign up for more pipeline space than they need. With many signed up for space on Keystone XL, competing proposals have a smaller pool of potential customers. Indeed, it has been rumored that some Keystone XL shippers were looking at ways to extricate themselves from their shipping commitments with operator TransCanada although nothing has come of this talk.

The big worry for the oil market has been that Keystone XL will fail to win U.S. government approval due to environmental objections. These fears were reinforced when the Environmental Protection Agency pointedly criticized the preliminary environmental assessments conducted by the government.

The final environmental assessment published last Friday by the State Department, the agency leading the review of the project, addresses the EPA's concerns, officials claimed. A final round of public hearings is slated for September and October while the EPA has until November to formally challenge the environmental review before an anticipated decision to award the necessary permits to TransCanada in December.

ELECTION YEAR POLITICS

While environmental objections to the line remain strenuous the logic of the project remains compelling, especially to politicians in an election year. Keystone XL will enhance U.S. energy security and create thousands of construction jobs. Rejecting the pipeline would expose President Barack Obama to the charge, no matter how spurious, that he was prepared to hold cash-strapped U.S. consumers hostage to environmentalists' demands. In any case, pipelines, despite recent spills, remain by far the safest way to transport crude oil.

The recent boom in shipping crude by rail should serve as notice that rejection of the pipeline will not halt the import of Canadian crude but could mean a higher risk of spills. So the logical bet would be that Keystone XL does finally get approved at the end of this year, which TransCanada has maintained leaves it able to start operations in 2013 as originally planned.

That ought to put an end to the worry that the Brent-WTI spread will be a long-term problem that lasts beyond 2013. The focus will then turn to how crude oil stocks in the Midwest behave during maintenance season. This summer has shown that regional stocks can be cut substantially when refineries operate near capacity and regardless of how heavy the maintenance season is the incentive to run hard remains.

On this logic it is hard to see how the spread can be at $25 a barrel this time next year. The bet that the spread will widen further may be successful in the short term but faces significant downside risk. The opposite position, a bet on a narrowing spread, particularly in 2013, looks far safer.

Ends --

 


 

By Robert Campbell, Reuters market analyst – for Commodities Now.

The views expressed here are his own.