Reverse Strategies

Due to the changing gas flows from the increasing production from unconventional plays, many pipeline operators are re-thinking previous strategies. For example, the Seaway pipeline that currently transports crude oil from Texas to Oklahoma will soon reverse its flow.

Beginning in mid-2012, the Seaway system, owned by Enbridge Inc and Enterprise Products Partners, will reverse direction and begin moving oil southward from storage at Cushing, Oklahoma, to refineries in Freeport, Texas. The capital markets’ reaction to this November 16h announcement was dramatic, belying the significance of the event.

WTI rally

Front-month West Texas Intermediate (WTI) oil prices rallied 3.24% and backwardation in the futures curve steepened as deferred months lagged near-term months in price performance. With oil able to move out of storage and into a vast refinery complex, crude supply will fall, which should boost prices over the long-term.

However, the market gave Seaway more immediate credit for its potential impact in reducing Cushing supply than warranted. Seaway will not be operational for at least another seven months. At that time it will be able to move a modest 150,000 barrels per day out of storage. With new pump stations, Seaway’s takeaway capacity could be expanded to 400,000 barrels per day, but that will not happen until 2013.

International effect

Before the Seaway reversal agreement, WTI had been in a long period of contango—the further into the future, the higher the price—and at a discount to Brent. Near-term WTI contracts were depressed due to the supply glut at Cushing, while a host of global supply disruptions in Libya, North Sea and West Africa kept the more global Brent benchmark in steep backwardation with higher prices at the front-end of the curve.

One of the most widespread commodity trades was to short prompt-WTI contracts and to long deferred-Brent contracts. Commodity futures investing entails monthly buying and selling of the prompt month and the second futures contract, respectively. By being long deferred Brent, investors profited from positive roll yields from the sale of higher-priced prompt month contracts and the purchase of a cheaper forward month contracts.

Repositioning effect

However, WTI’s appreciation relative to Brent actually began in late October, two weeks prior to the announcement of the Seaway reversal. But Cushing inventories have been declining steadily since the springtime due to growing rail capacity to evacuate landlocked crude and higher midcontinent refinery utilization.

It is therefore unclear what would have triggered a sudden unwinding of one of the most popular commodity trades. Some analysts speculated that a large-scale OPEC producer initiated a hedge for 2012-2013, which caused vast repositioning by money managers.

With minimal fundamental support for recent movement in WTI time spreads and WTI-Brent differentials, these spreads could easily revert back to where they were this past summer.

At the least, time spreads and oil-grade differentials are likely to be more volatile going forward, pending greater clarity on the takeaway capacity of Seaway (whether it is expanded), the pipeline’s long-term shipper contracts (U.S. land producers or Canadian producers) and the ultimate verdict on Keystone XL.

No pump-price relief

On the Brent side of the equation, North Sea production has recovered from a heavy period of summer maintenance and Libyan output is coming back faster than originally anticipated, all of which could pressure Brent prices relative to WTI.

Unfortunately, U.S. drivers have not seen much benefit at the pump from inland crude oversupply because refiners on the Gulf Coast ship much of their output to emerging economies in South America, where demand is stronger and access is easier.

Net exporter

According to data released by the U.S. Energy Information Administration in the last week of November, 2011 marks the first year that the U.S. is a net exporter of petroleum products since 1949. This raises larger questions about the domestic energy infrastructure system, not only for crude oil, but for transporting refined products within the continental U.S. as well.

However, as the U.S. remains the world’s biggest net importer of crude oil, it is still a long way from energy independence.

Tamar Essner is associate director of energy advisory services for Thomson Reuters Advisory Services and can be reached at tamar.essner@thomsonreuters.com, 646-822-3646.