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Trader's Corner

This week’s Trader’s Corner looks at the record high crude inventory in Cushing, Okla., and the move to take it south.

We are all reading the headlines about the growing crude production in the U.S. There are projections of the U.S. producing more crude than top producers Russia and Saudi Arabia in the not-too-distant future.

As the domestic production chart above shows, the current growth trend supports that possibility. Click to enlarge.

We see nothing but good from the U.S. producing more of its own energy needs. It is good economically and from a national security standpoint. The U.S. could nearly erase its trade deficit if it didn’t have to import energy sources.

But in the short term, all of the production has had a significant impact on crude pricing, which in turn affects propane’s value. Just like with natural gas and propane, the new crude production in the U.S. and Canada has overwhelmed the infrastructure for handling it.

The big difference between crude, natural gas and propane is that crude has enough domestic demand to handle all of the production from the U.S. and Canada. The pricing issues for crude have come from the inability to move crude to where it needs to be.

The new production is in the Midwest and West and in Canada. However, the bulk of the U.S. refining capacity is along the Gulf Coast. That was a natural occurrence – to be near the crude production areas and import terminals.

There doesn’t seem to be a lot of focus on building new refineries near the new production areas. Few companies are willing to tackle the new regulatory issues with building a refinery. The trend in the U.S. for a long time has been to expand existing refineries as opposed to building new ones.

That has put all of the focus on getting the crude to existing refinery facilities, which requires pipelines that are hundreds of miles long. While the industry waits on these connections, Midwest and Canadian crude producers are getting well below global prices for their production. Many have resorted to railing crude to the East Coast and Gulf Coast refiners.

The glut of oil in the north and the current bottlenecks in infrastructure for getting it out have caused the U.S. benchmark WTI crude to price well below Brent crude, which has become the global benchmark.

In October 2011, WTI was trading at a $27.88 discount to Brent. The discount has fallen recently with the opening of the Seaway pipeline to carry crude from Cushing, Okla., to the Gulf Coast. The chart below shows the price spread between WTI and Brent. Click to enlarge.

For WTI to close the gap with Brent, traders will have to see that the bottleneck (production coming to a point that doesn’t have enough outlets or demand to handle it all) in Cushing has been removed.

The spread started dropping in October 2011 on the announcement that Enterprise and Enbridge had bought the Seaway and would reverse it to take crude from Cushing to the Gulf Coast.

However, the initial capacity of the Seaway was only 150,000 bpd. It became apparent that it was not enough to offset all of the new production. As the chart shows, the spread between WTI and Brent began to expand again.

Then last December, the spread started closing again as the completion date for Seaway expansion neared. The question is if Seaway's new 400,000-bpd rate will be enough to pull Cushing crude inventory down.

The Seaway operated for about a week at its new rate and then ran into what is expected to be a short-term problem with outlets at the southern end of the line. The problem was not with the Seaway but with lines taking product away from the Seaway to end users.

The chart below shows Cushing, Okla., crude inventory. Click to enlarge.

Producers built inventory to record highs in anticipation of the new 400,000-bpd capacity of the Seaway being available to them. When the issues with the Seaway were announced last week, crude dropped sharply but then recovered on the assumption the issues would be short-lived.

Note that Cushing inventory dropped last week when the Seaway was operating at its full 400,000-bpd capacity. But also note from the top chart that U.S. production dipped a little last week, too. Was the dip in Cushing inventory due to the dip in production, the Seaway operating at full capacity or both?

Certainly one week is not enough to know for sure if the new capacity of the Seaway is going to be enough to draw down the excess inventory in Cushing. But if this one week is a harbinger for how inventory will trend once the Seaway is consistently operating at its new capacity, WTI crude will continue to face upward pressure.

Ultimately there will be plenty of pipelines from Cushing and Canada to get North American crude where it needs to be. That will back out offshore imports and cause WTI to once again price near the global price. We will simply have to wait a few more weeks to see if the new capacity of the Seaway alone is enough to start this transition.

As WTI crude prices rise, propane’s value will be affected. As we said last week, propane must still shed its excess to improve in value. A good environment for propane buyers exists right now due to the oversupply.

At some point, the oversupply will be addressed and propane will once again get its price lead from crude – WTI crude that is likely headed nearer the global price soon. Don’t expect the days of steeply discounted WTI to last much longer.

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The uptrend remained intact for crude despite the pullback on the announcement of the Seaway pipeline issues.

Propane is being driven by short-term demand caused by extremely cold weather that could hang around for at least another two or three weeks. That demand should limit the short-term downside for propane, but the longer term remains bearish.

We will remain bullish on our short-term outlook for propane prices because of the weather-related demand that is being generated.

Monday: Markets closed for Martin Luther King Jr. Day.

Tuesday: Brutal cold and associated demand sent propane prices up sharply. Word that Japan’s central bank would take measures to stimulate its economy helped crude keep the price uptrend that began on Dec. 11.

Wednesday: Reported issues with the Seaway crude pipeline that reduced its capacity from 400,000 bpd to 175,000 bpd sent WTI crude down. Otherwise, the passage of debt ceiling legislation by the U.S. House of Representatives was supportive.

Thursday: A 3-million-barrel draw on propane inventory was not enough to generate a lot of buying pressure for propane. Good data on global manufacturing and reports that the troubles with the Seaway pipeline would likely be short-lived helped crude erase about half of Wednesday’s drop.

Friday: It was a fairly uneventful day to close out the week. Both Belvieu and crude finished near its Thursday close. Conway gained on the cold weather and falling Midwest inventory. Data showing new home sales for December fell 7.3 percent limited the upside for crude.

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