Over the past few weeks, the price differential between two of the world’s most prominent oil benchmarks has contracted significantly. Brent crude oil traded at a premium of $4.50 per barrel relative to West Texas Intermediate (WTI) crude oil at the close of trading on July 5–a significant retrenchment from the October 2011 peak of more than $28.00 per barrel.
This spread initially blew out because rising oil production from unconventional plays such as the Bakken Shale, coupled with an influx of Canadian supply, overwhelmed local takeaway capacity in Cushing, Okla., the delivery point for the WTI that trades on the New York Mercantile Exchange. The resulting supply overhang depressed WTI prices relative to Brent crude oil, an international benchmark that better reflects supply-demand conditions in the global marketplace.
The reversal of Enbridge (TSX: ENB, NYSE: ENB) and Enterprise Products Partners LP’s (NYSE: EPD) Seaway pipeline added 400,000 barrels per day of southbound takeaway capacity and provided a welcome boost WTI prices. Further relief will come when the Gulf Coast leg of TransCanada Corp’s (TSX: TRP, NYSE: TRP) Keystone XL project comes onstream and the Seaway pipeline expands by another 450,000 barrels per day.
What prompted the recent contraction in the WTI-Brent differential? For one, Canada Syncrude in June moved up turnaround of a bitumen upgrader capable of producing 350,000 barrels per day of synthetic light crude oil. Enbridge compounded these problems with the shutdown of its Athabasca and Waupisoo pipeline systems in Alberta after discovering a leak toward the end of June. To offset these supply disruption, refiners are turning to replacement volumes from the Bakken Shale, Permian Basin and other US oil plays
The narrowing WTI-Brent spread has weighed on stock prices in the refinery industry, where profitability hinges on the difference between feedstock costs (crude oil) and refined products (gasoline, diesel and jet fuel). Over the past few years, refineries in the Midcontinent region benefited from the widening price spread between inland crude oils such as WTI and refined products that reflect global supply-demand balances. With this differential coming in, investors are concerned that refiners’ profit margins will shrink accordingly. The onset of a seasonally weak period for refiners has also spurred profit-taking in shares of US independent refiners.
Source: Bloomberg, Energy & Income Advisor
Energy & Income Advisor’s proprietary index of US independent refiners, which excludes the handful of master limited partnerships that operate in the space, has gained only 2.7 percent since the start of the year after a selloff that began in early June. In comparison, the S&P 500 Energy Index has appreciated by 10.6 percent and the Philadelphia Oil Service Sector Index is up 18.5 percent over the same period.
Despite these headwinds, we expect the best-positioned independent refiners to benefit in the intermediate term from improving feedstock costs in California and potential weakness in the price of Louisiana light sweet crude oil as more and more volumes make their way to the Gulf coast.
Elliott and Roger on Dec. 21, 2017
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