[Editor's note: A version of this story appears in the January 2019 edition of Oil and Gas Investor. Subscribe to the magazine here.]

There are new financial tools at the disposal of U.S. light, sweet oil producers that are chasing the higher prices associated with export markets. CME Group has launched a WTI (West Texas Intermediate) Houston futures contract with delivery to Enterprise Products Partners LP’s (NYSE: EPD) Houston system. Intercontinental Exchange Inc. has launched WTI trading with delivery to Magellan Midstream Partners LP’s (NYSE: MMP) East Houston terminal.

Trading of CME’s January 2019 contract began Nov. 5 and, in a thinly traded market typical of a newly launched contract, was $63.57/bbl in mid-November. This compared with WTI delivered to Cushing at $57.35, while Brent was trading at $66.90.

The CME-contract delivery options are to Enterprise’s Crude Houston (ECHO) terminal, its Houston Ship Channel (EHSC) facility or to Genoa Junction. The contract offers “a new way to price and hedge WTI light sweet crude in Houston,” CME reported, and “will provide a superior hedging tool for the expanding U.S. export market.”

Since the U.S. lifted its decades-old oil-export ban in 2015, international markets have played a growing role for U.S. producers. Tim Dove, CEO of Pioneer Natural Resources Co. (NYSE: PXD), said in the operator’s third-quarter earnings call that, “with the Permian Basin growing as fast as it is … there really is no alternative for the entire industry other than to export.

“We’re going to satiate U.S. refining capacity … for this type of oil—even though there are a couple of expansions underway—within a relatively short period of time based on that growth rate.”

Pioneer ships some 200,000 bbl/d of oil to buyers in Europe and Asia. It’s met with “good demand in the world markets,” Dove said.

“In particular, this light, sweet [WTI] brand of crude oil works in a world where we’re trying to reduce sulfur content in motor fuels and in maritime-related fuels. So it’s right up the alley of some of the big refining centers.”

In the CME announcement in September of the contract’s upcoming launch, Peter Keavey, the exchange’s global head of energy, said, “We believe the [Houston] network of domestic users and [this] location close to export facilities will ensure this contract provides transparent price discovery and risk transfer in the growing Houston region.”

Price Transparency

The launch of the new Houston futures contract was partly inspired by interest from overseas buyers, Owain Johnson, CME’s London-based managing director of energy research and product development, told Oil and Gas Investor.

“The fastest-growing part of our energy business is on the international side, and we had been getting a lot of inquiries from customers around procurement and hedging of Houston barrels due to the growing U.S. export market,” he said.

“They wanted a little more price transparency in the Houston area for export volumes as well as greater ability to directly risk-manage some of those barrels. And the export community has been looking for a benchmark upon which to base their analytics as to where they should try to sell those barrels.

“Should you market those barrels into Europe or into Asia? And, then, you have to look at the various spreads—for example, the Houston-Brent spread or the Houston-Oman spread. There’s interest in locking in those spreads.”

U.S. producers want to move barrels to a coastal market to realize a price improvement over land-locked Cushing. Meanwhile, European and Asian buyers are looking for improved purchase-price realizations relative to Houston-Brent or Houston-Oman.

Houston To Oman

“Everyone is looking for those spreads,” he said. “And Houston is the missing leg of the spread trade.”

For example, Johnson said, consider an E&P that has taken firm transportation on pipe for its WTI from Midland, Texas, to Houston. For it to nail down the profits of transporting its barrels to the Gulf Coast, it needs to be able to lock in forward prices for, say, six or 12 months.

In terms of selling U.S. crude into international markets, he added, “it’s happened. The U.S. has gone global, and it is only going to get further widespread.

“The U.S. crudes are really getting popular, and it’s growing exponentially. People dip their toe in the water, then they take a test cargo, and, then, they take a slightly bigger cargo. And …, suddenly, it just becomes part of the standard diet for the Asian refiners.”

Export markets are mainly Asia, but also Europe. “You’re seeing Midland crude move to Northwest Europe. Midland is popular in Asia too. I think China’s back again. There was a little bit of a slowdown, but I’ve seen them coming back in.

“It was only last year that I saw the U.S. producers at the big Asian oil events; this year, there were scores of them.”

A direct link is being forged with Asia and sidestepping Brent, which is a big change, he added.

“The U.S.-to-Asia direct link is getting built, and it’s very positive for WTI and for Houston. In the past, people were looking at Asia via Brent, meaning they’d go from WTI-to-Brent spread and, then, Brent-to-Oman spread.

“Now they’re looking to go straight from WTI to Oman or Houston to Oman. That’s a real change—very positive for the U.S.”

Houston-Cushing Spread

Johnson sees recent infrastructure buildout as validating long-term prospects for the new futures contract.

“There’s an enormous amount of money going into improving logistics, expanding export capacity, building VLCC (very large crude carrier) ports,” he noted. “Everyone wants to get VLCCs loaded out of the U.S.

“The huge amount of investment that’s going into this tells us this is a long-term story. We wouldn’t be doing this if we didn’t think Houston has a really good long-term opportunity ahead.”

In its announcement, CME noted that Enterprise, the largest U.S. oil exporter, has 19 ship docks on the Gulf Coast. Its network of pipelines, storage facilities and marine terminals can handle more than 4 million bbl/d.

As for the risk of supplanting Cushing, Johnson said the two trading hubs are essentially complementary. “It’s so helpful to be able to build onto an existing pool of liquidity [at Cushing].

“We believe that the new Houston contract with physical delivery locations is just an add-on to what we have at WTI Cushing and cash settlement in Houston.”

Moreover, growth in Houston-contract trading will benefit from the complementary role it has to Cushing. The new physically delivered contract could also trade WTI Houston vs. WTI Cushing as a CME-listed spread.

Dan Brusstar, CME senior director, energy research, wrote in October in an overview of the new contract, “This mirrors how WTI Houston trades in the underlying cash market and will provide access to the deep liquidity of the WTI Cushing futures contract.”

ICE HOU
Trading began Oct. 22 of Permian WTI delivered to Houston as the HOU contract on Intercontinental Exchange Inc. (ICE) to Magellan Midstream Partners LP’s East Houston terminal via the Longhorn and BridgeTex pipeline systems.

“Houston has become the pricing center for U.S. crude oil production and exports, and the new Permian WTI futures contract is designed to serve hedging and trading opportunities in this growing market,” ICE reported upon the launch.

The exchange estimated Permian production had grown by this past fall to 3.5 million barrels per day.

“When we were designing the Permian WTI futures, customers consistently told us that it was critical to offer a high-quality, well-known, crude oil spec deliverable in Houston and available for the waterborne export market,” Jeff Barbuto, ICE vice president, oil markets, said in a company report.

Mark Roles, Magellan vice president, commercial crude oil, said, “The new ICE contract provides customers with extensive delivery options, pricing transparency and liquidity in the Houston Gulf Coast crude oil market, while increasing demand for Magellan’s pipeline and storage services.”

Laura Blewitt, energy fundamentals analyst for RBN Energy, wrote in mid-November that “the race is on” as “Houston crude oil futures contracts compete for market share.”

“Ever since crude flows to the Gulf Coast took off five years ago,” she wrote, “the crude market has been clamoring for a trading vehicle that would accurately reflect pricing in the region that dominates U.S. demand from refineries, imports and exports.

“Now, there are two.”

The ICE and CME contracts differ in delivery points, although all in Houston. “Will both survive? Probably not,” she wrote. “Futures markets tend to concentrate liquidity—trading activity—into a single vehicle that best meets the needs of the market.
“So which of these will come out on top? That’s what the crude oil market wants to know.”

She added that the specifications differ for each of contracts as to the quality of the crude. “That is not unusual for futures contracts with different delivery points. In fact, it is to be expected,” she wrote.

But, she added, “ it is important to note that crude oil quality is a particularly significant issue right now as the specs for crude oil delivered at Cushing … are about to undergo a significant change …. The change [became] effective with [this] delivery month.”

The net result of the technical specifications “will make it more difficult to ‘blend up’ low-quality crudes with very light crudes into blends that will meet CME WTI specs.”

Meanwhile, “lighter barrels can be delivered on both Houston contracts.”

Chris Sheehan can be reached at csheehan@hartenergy.com.

Comments