According to the US Energy Information Administration’s weekly data, crude inventories at Cushing, Okla., were 22.4 million bbl as of July 27. Cushing crude inventories have fallen continually since they peaked at 69 million bbl in April 2017.
“When Cushing inventory is falling, one or more of three fundamental factors are at work. The first, rather obviously, is that inbound flows into Cushing are lower than outbound flows, suggesting a regional supply imbalance. The second related fundamental is that refineries supplied by Cushing could be processing more crude than usual and drawing on inventory. The third is that Cushing crude is in demand at Gulf Coast refineries or the export market, pulling it out of storage to ship south,” said Sandy Fielden, director of Morningstar Commodities Research.
Importantly, the consistent decline in Cushing inventories over the past 16 months is consistent with a market structure known as backwardation, where forward delivery prices are lower than current ones. Under backwardation there is no price incentive to store crude.
To decipher what’s behind the Cushing draw, Morningstar looked first at EIA refinery input data in the PADD 2 Midwest region. PADD 2 crude inputs to refineries have increased steadily for years, up by an average 2%/year since 2010, according to EIA. Inputs ramped up this year after spring maintenance to reach a record 4.1 million b/d in June before falling back in recent weeks to 3.9 million b/d.
“These numbers are high, but not enough to explain the continued decline in Cushing stocks during the past 16 months, since crude inputs were growing just as fast in 2015 and 2016 when Cushing inventory was increasing,” Fielden said.
He then looked at inventory levels at the Gulf Coast (PADD 3), where inventories as of July 27 were 6.7% higher than the start of 2018. At the same time, relative crude inputs to Gulf Coast refineries have been just as high as the Midwest this year.
“A big differentiator between these two regions that helps explain why Cushing stocks are drawing while the Gulf Coast is building, is crude production. Although production has been growing in PADD 2 over the past 16 months, it hasn’t grown nearly as fast as PADD 3. Moreover, the fact that higher production is keeping PADD 3 inventories topped up even as Cushing stocks fall suggests that increasing US onshore production is flowing to the Gulf Coast rather than to Cushing or that it flows right through Cushing and continues to the Gulf Coast,” Fielden said.
Export drive
Exports have been the principal Gulf Coast crude-market driver since the start of 2017. Total US crude exports doubled in 2017 to 1.1 million b/d and have risen year-to-date in 2018 on a monthly average basis to 1.8 million b/d, according to the EIA.
“We believe this rising demand for exports, especially after Hurricane Harvey hit the Gulf Coast at the end of August 2017, is responsible for pulling crude south from Cushing to the Gulf Coast and nearly emptying tanks at the Midwest hub in the process.” Fielden said.
The growth in exports has been encouraged by a widening Brent price premium over West Texas Intermediate, making US shale crude competitive overseas. Meanwhile, higher WTI prices in Houston compared with Cushing have in turn encouraged increased flows from Cushing to the Gulf Coast.
However, since June, the Cushing crude storage drawdown has worsened to the point that refiners in the Midwest bid up Cushing prices relative to Houston, narrowing the spread between Cushing and WTI Houston from over $8/bbl at the end of May to less than $2/bbl on July 25, according to CME. This narrowing spread has removed the price incentive to ship crude south from Cushing to Houston for export.
“Cushing inventory draws may continue in the short term, with the recent Canadian Syncrude shortage being the most likely cause. But pricing signals now encourage Permian crude flowing between Midland and Cushing to stay in Cushing. Higher prices should also be bringing incremental barrels into Cushing from North Dakota and the Rockies. We expect the WTI Houston premium over Cushing to remain narrow until the Midwest supply equilibrium is restored and for Cushing demand to slow the pace of Gulf Coast exports in coming months,” Fielden said.
