In the petroleum commodities businesses, constraints drive not only behavior but facilitate action. In response to such market conditions, midstream infrastructure solutions are often implemented—even though they may not always be as timely as desired.

At times, this infrastructure responds in phases, growing over time as business needs and the business environment changes. Some of these de-bottlenecking actions are short-term or immediate responses. Some are longer-term and may be transformative. In the crude oil midstream infrastructure sector, these responses and investments involve storage, pipelines, rail, trucking and often combinations of each.

Such is the current nature of crude oil transportation, storage and terminals in the U.S., as an increase in domestic crude production from a variety of unconventional resources and the potential for large volumes of additional Canadian crude drives a number of major midstream decisions and significant capital investment. Unique and complementary upstream, midstream and downstream infrastructure projects are being carefully pursued and have the ability to transform the U.S. crude oil transportation and storage network.

Excess storage capacity

Today, a crude oil transportation bottleneck exists at Cushing, Oklahoma, the largest oil storage and trading hub in the U.S., and the physical delivery point for the New York Mercantile Exchange oil futures contract. The Cushing Hub is in north-central Oklahoma at a nexus of crude oil pipelines, and receives crude oil from the Permian Basin area, the Rocky Mountain region and from local production in Oklahoma and Kansas. It also receives some Canadian crude routed from the Midwest and some crude from the Bakken region.

West Texas Intermediate (WTI) crude is a proxy for the many varieties of crude sourced into and out of Cushing—in general, exemplary of a light crude, which is also rated as a sweet crude with less than 0.5% sulfur. This crude is ultimately destined to be refined in the Midcontinent or Midwest regions or in refineries in the U.S. Gulf Coast market.

In the Cushing area, more than 300 steel storage tanks of various sizes and designs provided a maximum shell capacity of some 70 million barrels of crude oil at yearend 2011. The total capacity is not fully usable due to tank design and operational and safety issues. Therefore, Cushing's current working capacity (that which actually impacts the market) is about 80% to 83% of shell capacity, or currently about 58 million barrels. This tank capacity is continuing to grow beyond recent 2011 expansions, as forecasts show an additional 12 million barrels of capacity will be in place by 2014.

A recent snapshot of actual Cushing inventory, for November 18 through December 23, 2011, shows an average of 31 million barrels. Although storage peaked in late April 2011 at an all-time high of about 40.5 million barrels, it trended downward toward yearend. In general, Cushing storage has not been constrained, as only some 53% to 60% of working storage capacity is being utilized, not inclusive of continuing expansion capacity.

Having this excess available storage capacity supports a variety of commercial and operational functions, including receipts from incoming pipelines, support for transfers from incoming pipelines to outgoing pipelines, support for outgoing pipeline batch operations, customized blending services and quality analysis, and truck receipts of non-piped regional production. As evidenced by a review of the current storage developers and contract-capacity holders, the hub's storage is also essential as a tool for price arbitrage. For example, in a contango market, forward prices for crude oil can drive decisions to store the crude now and bring it out in future periods at higher prices. Table 1 is a list of the current crude oil storage operators at Cushing and their estimated shell tank capability.

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Cushing pipelines

A number of existing pipelines route only into the Cushing Hub. A few route through the hub with throughput transfers at Cushing from contracted capacity upstream to contracted capacity downstream. Several others gather local production from Oklahoma and Kansas to the hub, and a number are downstream and take-away pipelines from the hub directly to regional refinery markets. A list of the existing pipelines into (Table 2) or exiting from (Table 3) Cushing shows current capacities.

In 2011, companies working at Cushing Hub saw an upset from historical pricing norms. Early in the year, WTI crude began to trade at a discount relative to its historical relationship to similar quality crude such as Brent (UK, North Sea) crude oil. This WTI price discounting continued over the year and triggered an accelerated industry focus on overall crude oil transportation and storage infrastructure at Cushing. Not everyone saw the WTI price disparity as negative, because lower prices on the supply-side means that U.S. downstream crude markets had an opportunity to obtain their 2011 Cushing supplies at a lower than historical price, assuming they had pipeline access to actually obtain the cheaper supplies. This led quickly to revisions of short-term crude acquisition and refinery operating strategies to find a way to get more out of Cushing before that WTI price disparity disappeared.

As pipelines exiting Cushing in every direction were reaching maximum capacity, the level of WTI price discounting increased. This glimpse of a new, more-constrained and less-flexible Cushing Hub was not totally unexpected, but initial pipeline infrastructure solutions being offered to eliminate constraints and restore WTI price stability appeared to be several years away. Also, with TransCanada Corp.'s Keystone XL Pipeline's controversial environmental issues and recent oil spills by other operators into U.S. waterways, any newly constructed crude oil project's timeline would be at risk for potential delay.

With Cushing sellers and traders experiencing lower near-term sales margins in 2011, companies began to focus more on actions which might restore higher margins, including storing the crude with expectations to possibly tender to markets in subsequent periods at higher prices. Storage capacity positions at Cushing are advantageous to do such, but transportation capacity to withdraw from storage at that future date is also a critical path item. Thus, the market risk in storing the crude at Cushing is also very transportation-dependent.

A number of take-away pipeline proposals have been offered to ensure that increasingly available or stored inventory could leave the hub and access market demand, but, commercially, companies hadn't been quite ready to make those long-term commitments. A number of competing pipeline projects, the timing of those, and the delay or rejection of the Keystone XL project has complicated actual and potential infrastructure solutions and timing.

Seaway project

A number of proposed infrastructure solutions have been offered to resolve the Cushing pipeline bottleneck. It appears that a recent proposal—the conversion, reversal and expansion of the 500-mile Seaway Pipeline, now owned equally by Enbridge Energy Partners LP and Enterprise Products Partners LP—is the quickest solution with potential for 150,000 barrels (bbl.) per day of transportation capacity to the Gulf Coast by second-quarter 2012. As it involves reversal of an existing system, the expected impact to landowners and to the environment is minimal. Approval processes are expedited.

In fact, following the Seaway project announcement, its indicated timeline, and its near-term and potential long-term solutions, the WTI-to-Brent crude price discount reduced to $10 per bbl. from a previously recorded September 2011 peak of $29.70 per bbl.

Yet, complicated somewhat by the delayed permits for the competing Keystone XL pipeline, commitments are now being sought by Enbridge and Enterprise for several follow-on expansions of the Seaway Pipeline. If supported by shipper commitments at Cushing, or into Cushing from upstream pipelines, Seaway proposes to expand its mainline capacity from 150,000 bbl. to operate at a capacity of 275,000 bbl. per day in batch and mixed crude mode or up to 375,000 bbl. per day if transporting light crude only by early 2013.

In addition to this additional mainline capacity, companies are also requested to indicate their interest in participating in a new 85-mile pipeline to be built from Enterprise Products' Echo crude-oil terminal in southeast Houston to the Port Arthur and Beaumont, Texas, areas where refineries are designed to accommodate heavier imported crudes. This latter project (once again assuming shipper support) would be in service by early 2014. With the Seaway mainline and the possible Port Arthur delivery and connectivity, Seaway would be emulating much of the same capabilities proposed by the Keystone XL project, albeit in a smaller scale.

Separately, but in further support of Seaway's potential, Enbridge has indicated it will pursue construction of its Gulf Coast Access pipeline project, which will transport heavy Canadian crude oil from Flanagan, Illinois, south to the Cushing Hub and then, via the Seaway reversal, access U.S. Gulf Coast markets in the Houston area and possibly in the Port Arthur and Beaumont areas. This project would parallel Enbridge's Spearhead Pipeline, and completion is expected in mid-2014.

Downstream demand

While pipeline infrastructure solutions at Cushing are pursued, a bigger issue is developing downstream. Looking at the market side, the overall Gulf Coast area appears to be approaching an excess-supply situation.

From 2012 to 2014, domestic crude oil from the Eagle Ford shale, Permian Basin and Bakken—which are light crudes with some blended condensate—are expected to enter the U.S. Gulf Coast market in increasing volume. Meanwhile, Canadian heavy crude is aggressively seeking to increase its market share there, either via the various Seaway projects, via an approved Keystone XL project, or some combination of the two.

These four major sources of domestic light crude are on a collision course to compete for market share in a Gulf Coast market with minimal to modest demand growth, although imported crude oil volumes can be generally be backed out of the refinery-supply mix. Some refineries want the lighter crude; some might prefer the heavier crude; some may want combinations of each, depending upon their proposed product runs. All are hoping for reliable supply and predictable, competitive prices.

A de-bottlenecked Cushing Hub will continue to play a pivotal, if not key, role in future years. With large storage capacity for light and heavy crude, increasing support for batch pipeline operations, and the ability to blend crude, Cushing will become increasingly focused on providing valuable terminal services to the market.

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