When industry observers frame comments about “living in a $50-plus world,” it reinforces just how much we have come to accept the fact of global commodity markets and, with it, the likelihood that they are heavily financially driven. This was clear in the November issue of Oil and Gas Investor, touching on the role of exports from the U.S. Gulf Coast and the opportunity for derivatives or hedging strategies.

These themes are also the focus of a report that examined global market balances, the shape of the forward oil commodity curve and the growing influence of the U.S. Gulf Coast as a key crude and product exporter. The RBC Capital Markets LLC report delves into how crude markets—or at least Brent—are in “backwardation.” (Don’t let your eyes glaze over.)

As industry players well know, West Texas Intermediate (WTI) has been trading at a steep discount to Brent—well over $6 per barrel at the end of October. The RBC report pointed to spare U.S. export capacity as “the global equalizer.” The WTI discount to Brent should narrow, said the report, as the call on U.S. exports helps to “even the playing field.”

U.S. exports of crude, much of it is destined for Asia, recently approached 2 million barrels per day (MMbbl/d). Previous consensus estimates were for exports to top out at 1.2 to 1.5 MMbbl/d, according to RBC, but now the forecasts suggest that “U.S. crude exports are unlikely to reach a physical level of capacity constraint until waterborne exports approach the 3.2-MM/d range.”

As for the $6/bbl discount of WTI to Brent, RBC set the stage by pointing out the differences between North American and international producers’ strategies for price realizations.

“The universe of active producer hedging programs is skewed to North American independent E&Ps. International majors are seldom hedgers, meaning that the Brent structure is not subject to as much undue pressure as the North American benchmark,” the report said. The Brent curve is “less prone to large swaths of lengthy financial pressure.”

To be clear, the idea here is that Brent—the benchmark for pricing about 60% of global crude—has a lesser degree of hedging pressure than WTI for E&Ps looking to lock in prices one to three years out.

Brent has for some time now been in backwardation, the term used to describe when near-dated contracts trade at a premium to longer-dated contracts, reflecting a tightening in near-term physical market conditions. For example, as of the end of October, the December 2017 Brent contract was at $61.37, above the June 2018 contract at $59.84, in turn higher than the December 2018 contract at $58.47, and so on.

The manner in which a market goes into backwardation is not always the same, observed RBC. The typical route to backwardation is due to a physical tightening of market conditions. Alternatively, the forward curve can be “financially pushed” into backwardation through hedging pressure on the longer-dated contracts.

The latter is what contributed to the recent unusual shape of the WTI commodity curve, which at the end of October loped upward over the first four WTI contracts (known as contango) and downward over subsequent contracts (backwardation). RBC said the WTI forward curve was unlikely to flip fully into backwardation until Cushing inventories draw down to near 55% capacity utilization vs. about 80% at the end of the third quarter.

Short term, how is the “financially pushed” portion of the curve likely to change?

Theoretically, U.S. producers could fully meet their hedging needs, allowing pressure to come off the longer-dated WTI contracts. But hedging levels are light going into 2018, and producers are expected to continue layering in hedge protection, especially with WTI being in a “critical pricing corridor where a $5/bbl move in either direction could be the difference between feast and famine,” said RBC.

Long term, fundamentals are likely to prevail, pushing WTI along the same path as Brent.

“WTI will play catch up as North American balances firm,” said RBC. “The view that the U.S. is the last place to rebalance means the market will reach a juncture in which the call on U.S. exports increases to plug supply gaps in other parts of the world. U.S. exports are the great global equalizer.”

Are there early signs?

Just months earlier, U.S. crude exports topping 1 MMbbl/d was noteworthy. For the week ending Oct. 27, 2017, U.S. crude exports exceeded 2.1 MMbbl/d!

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