Shale boom cuts Gulf oil premium to 24-year low

Oil workers work on a rig over the Eagle Ford shale formation near Tilden, Texas in mid march of 2011. Wells in area are extracting oil and gas using a technique called hydraulic fracturing. JOHN DAVENPORT/jdavenport@express-news.net Photo: JOHN DAVENPORT, San Antonio Express-News / jdavenport@express-news.net

The U.S. shale boom has driven the cost of Gulf Coast light, sweet oil to its lowest level versus Brent crude in almost a quarter century as the nation?s dependence on foreign supplies wanes.

Light Louisiana Sweet, the benchmark grade for the Gulf Coast known as LLS, has traded on the spot market at an average of 15 cents a barrel more than Brent this year, the smallest premium since at least 1988, data compiled by Bloomberg show. The spread?s highest annual average was $4.02 in 2008.

The drop has cut costs for refiners in Texas and Louisiana accounting for 45 percent of U.S. capacity and replaced competing shipments from Africa. Gulf imports of light, sweet crude have fallen 56 percent since 2010, according to U.S. Energy Department data. A shale-oil influx from the Eagle Ford formation in Texas and Bakken in North Dakota and new ways to bring crude to the Gulf, such as this year?s reversal of the Seaway pipeline, may accelerate the shift.

?The market dynamics are changing,? Edward L. Morse, head of commodities research at Citigroup Global Markets in New York, said in a telephone interview. ?When the Gulf Coast was a crude importer, they had to attract crude from elsewhere in the world, which meant LLS had to be at a premium to Brent. But now we?re moving into a totally different situation.?

Light Louisiana Sweet, a grade prized because its low- sulfur content and density make it easier to process into fuels such as gasoline, was 92 cents cheaper than Brent yesterday. It averaged 20 cents less than the benchmark in the third quarter.

Brent oil for October settlement rose 40 cents, or 0.4 percent, to $113.49 a barrel yesterday on the London-based ICE Futures Europe exchange. The contract advanced 89 cents, or 0.8 percent, to $114.38 a barrel at 8:42 a.m. in New York.

Energy Independence

U.S. oil output surged to the highest level in 13 years in July, according to weekly Energy Department data. The U.S. met 83 percent of its energy demand from domestic sources in the first five months of this year and is heading for the highest annual level since 1991, department figures compiled by Bloomberg show.

?Unconventional oils and gas are changing everything about our competitiveness in the United States,? Bill Klesse, Valero Energy Corp.?s chief executive officer, said yesterday at the Barclays CEO Energy/Power Conference in New York. ?Before you know it, we?re going to have so much light, sweet crude that in the U.S. Gulf Coast we?re not going to be importing light, sweet crude, and we think that happens next year.?

Houston, New Orleans and other ports along the Gulf Coast accepted about 554,000 barrels a day of light, sweet oil from outside the U.S. in June, down from 964,000 barrels a day in June 2011 and about 1.25 million in June 2010, according to the Energy Department?s Energy Information Administration.

African Imports

The West African nations of Nigeria, Angola, Gabon and Equatorial Guinea accounted for 58 percent of the light, sweet crude imported into Gulf Coast ports in June 2012. North African nations accounted for a further 30 percent.

LLS will become about $5 a barrel cheaper than Brent during the next 12 months, David Pursell, a Houston-based managing director for Tudor, Pickering, Holt & Co., said in a telephone interview. The discount would take into account the extra cost of getting LLS to other customers, such as refiners on the East Coast, Pursell said.

Like oil in the Midcontinent, the relationship between LLS and Brent has been upended by surging shale production. West Texas Intermediate oil at Cushing, Oklahoma, the U.S. benchmark grade traded on the New York Mercantile Exchange, shifted to a discount to Brent almost two years ago after trading at a premium for decades.

Midcontinent Glut

Cushing inventories surged to 47.8 million barrels in June, the highest level since Energy Department records for the hub began in 2004. The WTI-Brent spread reached a record $27.88 in October. It was at $18.03 a barrel today.

?Over the last year and a half, with the WTI-Brent spread blowing out, the primary beneficiaries have been the Midcontinent players,? Cory Garcia, a Houston-based oil analyst for Raymond James & Associates, an arm of the financial-services company with almost $40 billion under management, said in a phone interview. ?As LLS disconnects next year, the benefits to Gulf Coast refiners will be brought to the forefront.?

Enbridge Inc. (ENB) and Enterprise Products Partners LP (EPD) reversed the flow of crude on the Seaway pipeline on May 19. The link, carrying as much as 150,000 barrels a day from Cushing to Gulf Coast refineries, is scheduled to pump as much as 400,000 barrels a day early next year.

Shale Production

About 300,000 barrels a day of Bakken oil is being shipped from North Dakota by rail, Al Monaco, Enbridge Inc.?s president, said in a July 11 presentation in Calgary. Some rail deliveries of Bakken are reaching Texas and Louisiana, Lee Klaskow, a Skillman, New Jersey-based analyst for Bloomberg Industries Research, said.

The Bakken formation, which stretches across parts of North Dakota, Montana and Saskatchewan, and the Eagle Ford formation in south Texas produce the majority of shale oil in the U.S., ahead of formations such as Niobrara in Wyoming and Colorado, Bone Spring in Texas and New Mexico and Monterey in California.

Eagle Ford produced about 283,000 barrels a day this June, up from about 98,000 barrels a day in June 2011 and no barrels in April 2008, according to the Railroad Commission of Texas, the state?s oil and gas regulator.

Getting to Market

?We have all these sweet barrels in the Midwest that need to find a home, and they?re getting to the market by planes, trains and automobiles, you name it,? said Stephen Schork, president of the Schork Group Inc. in Villanova, Pennsylvania. ?You compound that with increased production in west Texas and the Eagle Ford, and you have a template for LLS to move to a discount.?

The capacity to transport light, sweet oil to the Gulf Coast from Cushing and inland shale formations will expand to more than 2 million barrels a day by the end of this year and 4.5 million by the end of 2014 from less than 500,000 barrels a day at the end of 2011, Klesse said yesterday.

Valero currently buys about 140,000 barrels of oil a day from Eagle Ford, said Bill Day, a San Antonio-based spokesman for the company. The crude is transported by truck to an unloading dock next to Valero (VLO)?s Three Rivers, Texas, refinery. About 70,000 barrels a day is fed to that refinery, and the remainder via recently reversed pipelines to plants in Corpus Christi and Houston.

The company brought two foreign oil shipments totaling 547,000 barrels of light, sweet crude to Gulf Coast ports in June, down from 4.88 million barrels in June 2010, data from the Energy Department showed.

Inflection Point

Companies such as Phillips 66 (PSX) are also rethinking long-term business plans because of cheaper domestic supply.

Phillips 66 Chief Executive Officer Greg Garland said Aug. 1 that the refiner had changed its mind about selling its Alliance plant in Louisiana in part because of forecasts that LLS will shift to a $2- or $3-a-barrel discount to Brent.

?In the interim year that passed since we first made that decision, our view has changed in terms of Gulf Coast crudes, particularly LLS, becoming an advantage,? Garland said on a conference call with analysts and investors.

The shift in the U.S. market could have lasting repercussions on global markets as well.

Weaker Brent

A drop in U.S. imports of light, sweet oil could weaken Brent, Garcia said. Raymond James is forecasting $80 Brent next year, based predominantly on production growth in non-OPEC countries like the U.S., he said.

?People think that U.S. supply growth is sort of disconnected or irrelevant because it can?t export, but it can back out imports and we believe that will have a significant impact on the global oil markets,? Garcia said.

Federal law restricts exports of crude oil without permission from the president. The U.S. exported just 0.7 percent of domestic oil production in June, with none of it leaving from the Gulf Coast, Energy Department data show.

Source: http://fuelfix.com/blog/2012/09/07/shale-boom-cuts-gulf-oil-premium-to-24-year-low/

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