US oil glut shifts to Gulf of Mexico

Brent-WTI dislocation to hit Light Louisiana Sweet crude

Once upon a time, the world of oil price differentials was stable. Then the US shale revolution occurred. Production surged, pipelines clogged. And chaos followed.

The new era is nowhere more visible than in the price differential between Brent and WTI. For 20 years WTI traded at a small premium to Brent, over the past four years WTI has plunged relative to Brent – this week it was trading at a $21-a-barrel discount.

The reason? Lack of pipeline capacity in the US Midwest to move the surge in US and Canadian oil production, which has created a glut of WTI-like crude in Cushing, the Oklahoma town that serves as the benchmark price point.

Now the Brent-WTI dislocation is about to move from the US Midwest towards the US Gulf of Mexico with the construction of new pipelines, including the reversal of Seaway, that would move thousands of barrels from Cushing to the Gulf. Other pipelines, including Permian Express and Longhorn, will also transport crude to the Gulf. Companies also plan to move extra oil via rail and barges.

This is all set to hit Light Louisiana Sweet crude – an important benchmark for the US Gulf of Mexico refining industry which until now has been unaffected by the problems hitting WTI.

Analysts and traders believe LLS, as the crude is known, is about to suffer the same fate as WTI as the glut moves towards the US Gulf of Mexico. “Light sweet grades such as LLS will probably start to decouple from Brent through 2013,” says Francisco Blanch, commodity strategist at Bank of America Merrill Lynch.

Over the last 10 years, LLS has traded at an average discount to Brent of roughly 55 cents per barrel. But the Brent-LLS forward curve has begun to change to reflect the potential of higher volumes of light, sweet crude arriving to the Gulf. Oil brokers quote the Brent-LLS price spread at around $2 a barrel for the second quarter of this year, rising to $2.5 in the third and more than $3 for the fourth quarter. The calendar 2014 Brent-LLS price spread is quoted at around $4.

Stefan Wieler, energy analyst at Goldman Sachs, warned clients recently that the Gulf of Mexico region will “become saturated with light sweet crude”.

But he noted that the whole Gulf area will not receive the flood of high quality crude oil at the same time. Texas, rather than Louisiana, is going to be particularly affected, opening the door to a big price spread between local crude oil streams. “We expect the region to become a fragmented crude oil market,” he said.