Sumit Roy: Cushing inventories have been declining, but the WTI-Brent spread keeps getting bigger. Weak U.S. fundamentals are to blame.
The Department of Energy reported this morning that in the week ending June 10, 2011, U.S. crude oil inventories decreased by 3.4 million barrels, gasoline inventories increased by 0.6 million barrels, distillate inventories decreased by 0.1 million barrels and total petroleum inventories decreased by 0.6 million barrels.
Crude oil prices rallied a bit after the report, but then proceeded to sell off notably as U.S. equity markets hit fresh three-month lows on continued concerns about the economy and as the euro plunged on sovereign debt concerns related to Greece. The S&P 500 is now down almost 8 percent from its multiyear peak set last month.
Earlier, Brent hit another one-month high just below $122, while WTI remained locked in its range of a few dollars above and below $100. The spread between the two benchmarks widened to a record of almost $22/barrel yesterday, but as we see in this week’s inventory data, the culprit for the latest increase in the spread is not the pipeline and inventory situation at the NYMEX delivery point, Cushing, Okla. Indeed, as discussed below, inventories in Cushing and the broader Midwest region have been declining rapidly.
Rather, U.S. crude prices nationwide have weakened significantly. Louisiana Light Sweet Crude—a Gulf Coast crude—is now trading more than $4 below Brent prices. Because LLS is a waterborne crude, large spreads between it and other global crudes of similar quality can be easily arbitraged in contrast to landlocked West Texas Intermediate. Thus, don’t expect this large spread to last, but it illustrates the stark divergence in oil fundamentals across different geographies.
On the one hand, you have the U.S., where demand is down significantly year-over-year and unlikely to rebound vigorously anytime soon given the current state of the economy. On the other hand is the rest of the world. Emerging market demand continues to grow briskly, and while European demand is weak, the region must make up for 1.3 mmbbl/d of lost Libyan production—output that it typically relies on.
All things considered, these large spreads in the oil market that we currently see are the market’s way of incentivizing oil to travel to destinations other than the United States.
Turning back to the latest inventory data, we see that total petroleum inventories in the U.S. fell counter-seasonally, which sent the surplus over the five-year average to 17.2 million barrels, or 1.6 percent.
Gasoline inventories rose slightly last week, in line with what we would expect seasonally. The surplus over the five-year average was steady at 5.2 million barrels, or 2.5 percent. Distillate inventories fell counter-seasonally for the ninth time in 10 weeks; the surplus over the five-year average now stands at 6.7 million barrels, or 5 percent.
U.S. crude oil production hit a new seven-year high near 5.65 mmbbl/d, thanks to surging output in unconventional oil plays.
Inventories at the NYMEX delivery point in Cushing, Okla. fell by 1.1 million barrels to 37.8 million barrels, or 65 percent of the EIA’s estimate of capacity. Overall Midwest inventories plunged almost 3 million barrels to 97.9 million barrels, or 78 percent of estimated storage capacity. Cushing inventories have fallen nearly 4 million barrels from recent peaks, while total Midwest inventories have fallen almost 10 million barrels in that same period. Both are just slightly above year-ago levels.
Front-month WTI calendar spreads narrowed week-over-week to -0.47 from -0.59.
Meanwhile, West Texas Intermediate’s discount to Brent expanded to a record $21.28 from $17.11 last week. The WTI discount to Louisiana Light Sweet was better-behaved at $16.60, near last week’s $16.80.
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