May 22, 2012

Unlocking the Crude Oil Bottleneck at Cushing


Matthew Philips 
Bloomberg Businessweek
May 16, 2012
The U.S. oil infrastructure is the product of four decades of rising imports and falling domestic supply. As those trends have reversed over the last few years, America’s network of pipelines has failed to keep pace. Designed in part to ferry oil and refined gasoline from the coasts to the interior, those pipelines are now ill-equipped to handle the enormous amount of crude gushing from shale reserves in North Dakota and Texas. Which is why so much of that oil ends up trapped in the central Oklahoma town of Cushing, the primary crude oil storage hub for the U.S.
Cushing developed as an oil trading center and then as the official price settlement point for West Texas Intermediate, the benchmark that most types of North American crude are priced against. Cushing is now best known as a bottleneck for the energy industry: Oil rushes in, but trickles out. There are now more than 44 million barrels of oil stuck in Cushing, a record, and 60 percent more than was stored there just five months ago. Overall U.S. crude inventories now sit at a 21-year high.
Pipeline companies are racing to build new projects aimed at pushing more oil through Cushing toward refineries as part of a larger effort to revamp America’s oil infrastructure. The first of those projects goes online this week when the flow of the 500-mile Seaway pipeline is reversed. Seaway, with a diameter of 30 inches, was built in 1976 to take crude south from the Texas Gulf Coast north into Cushing. On May 17, about 150,000 barrels of oil will be injected into Seaway at Cushing. Twelve days later, that oil will start arriving in Freeport, Tex., along the Gulf Coast, where refiners can access it. As the pump stations provide more horsepower and increase the pipe’s pressure later this year, the oil will travel faster, taking just five days to reach Freeport and increasing Seaway’s capacity to 400,000 barrels per day by early 2013. By mid-2014, that flow is expected to reach 850,000 barrels a day.
By the end of 2013, TransCanada (TRP) should be finished building the $2.3 billion southern leg of its Keystone pipeline, extending from Cushing to refiners on the Texas Gulf Coast. By 2014, Canadian pipeline company Enbridge (ENB), a part owner of Seaway, plans to connect Cushing to a system of pipes that converge around Flanagan, Ill., southwest of Chicago, with itsFlanagan South pipeline.
It’s difficult to predict what impact these pipeline projects will have on gasoline prices. The biggest effect will be to supply Gulf Coast refiners with more cheap domestic crude, which gets at the heart of what the Seaway reversal attempts to address. The glut at Cushing has created a large price spread between WTI and the international Brent benchmark, the world’s two most widely traded oil contracts. For years those contracts traded within $1-$2 of each other. Since 2011, though, WTI has traded well below Brent, by as much as $27. The spread is now just over $17.
This price differential has rippled through the domestic oil market, giving Midwestern refiners such asHollyFrontier (HFC) access to supercheap domestic crude, providing them some nice profits while their East Coast counterparts have been stuck taking delivery of more expensive Brent-priced oil from places such as Nigeria.
It’s also created a bizarre arbitrage opportunity that’s persisted far longer than most thought possible. Railroad traffic of crude oil has tripled over the last year. Midwestern trucking companies are in high demand as well. Yet when it comes to moving crude oil to refineries, pipelines are still by far the most efficient method.
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