On January 11, Enbridge (NYSE:ENB) and Enterprise Products Partners (NYSE:EPD) announced that they had completed the upgrade of their Seaway Pipeline joint venture. The pipeline, which connects the U.S. inland oil hub in Cushing to the Gulf Coast, began shipping crude south from Cushing last May at a rate of 150,000 bpd (barrels per day). Meanwhile, the owners have been working on upgrades to the pumping stations. After being closed for about a week at the beginning of this month, the Seaway pipeline reopened, with its capacity nearly tripled to 400,000 bpd.
The Cushing Oil Glut
This expansion will finally begin to relieve the glut of oil at Cushing, which has depressed WTI prices relative to Brent for more than a year. Moreover, as I have written elsewhere, it is likely to bring Brent prices (which heavily influence oil product prices in the coastal U.S.) below $100 by year-end. The WTI-Brent differential has already begun to close. In December, the WTI spot price was nearly $22 below the Brent spot price, on average. This differential had shrunk to $18.46 by January 15, and the gap for futures this spring is around $16.
It will be very interesting to see how this situation plays out over the next few weeks and months. A recent article published at ValueWalk (and elsewhere) claims, prematurely in my opinion, that the increase in flow rate will not "solve the Cushing oil glut". For the week ending on Jan. 11, Cushing oil inventories increased by 1.8 million barrels to 51.9 million barrels, a new record. This is nearly double the 28.3 million barrels of inventory at Cushing at this time last year. However, the Seaway pipeline was closed entirely for that week. With the line now taking 400,000 bpd (2.8 million barrels per week) out of Cushing, there should be enough capacity to negate the 1.8 million barrel weekly inventory increase and then draw down inventories by 1 million barrels per week. At that rate, Cushing inventories would return to "normal" levels by the middle of 2013.
However, that is not the end of the story. Oil flow rates vary on a weekly basis, and U.S. production has been rising rapidly over the past few years. Bakken oil production may increase by approximately 250,000 bpd over the course of 2013, to 1 million bpd, according to bullish forecasts. (That said, bears believe that production may already be near a peak.) If the expected Bakken production increases occur, they will account for much of the Seaway pipeline's excess capacity.
Additionally, since WTI has been trading at a severe discount to Brent, many Bakken oil producers have been sending crude by rail to the coasts recently. Oneok Partners (NYSE:OKS) recently canceled the Bakken Crude Express pipeline project, which would have brought 200,000 bpd from the Bakken to Cushing by 2015. I believe that the main reason why the company had trouble securing commitments from producers is that the cost savings of transporting by pipeline rather than rail (likely $8-$12/barrel) is outweighed by the higher prices for oil on the coasts.
As the WTI price approaches the Brent price, more producers will opt to send oil by pipeline to Cushing, necessitating additional takeaway capacity. This need will be met in late 2013 and 2014 with the opening of TransCanada's (NYSE:TRP) Keystone Gulf Coast Project (700,000 bpd) and the "twinning" of the Seaway line (450,000 bpd). TransCanada's Keystone project is primarily being built to serve Canadian oil production; after all, it is part of the larger transborder Keystone XL project. However, Enterprise and Enbridge are only going ahead with the "twinning" of the Seaway line because of strong demand from oil producers. Oil producers clearly believe that rapid production growth will continue for at least the next year or two.
Production increases, primarily in the Bakken area, will clearly account for much of the recent increase in capacity on the Seaway pipeline. However, the additional 250,000 bpd should be sufficient to halt the buildup of crude inventories at Cushing, which is significant in and of itself. As a result, I expect the WTI-Brent spot price spread to narrow to around $15 for the spring and summer. The opening of the Keystone Gulf project (expected later this year) should create some breathing room, causing the WTI-Brent spread to close to approximately the cost of shipping: $5-$10. This does not mean the ultimate end of shipping constraints. If and when the Keystone XL pipeline opens, the addition of large quantities of Canadian oil flowing to Cushing could reopen the spread. However, this is unlikely to occur until 2015 or later.
I continue to see opportunity in logistics companies like Enterprise, Enbridge, and TransCanada, as well as Sunoco Logistics Partners (NYSE:SXL). These companies will all benefit from the reshaping of the U.S. oil transport infrastructure over the next several years. Another way to play this opportunity is to buy oil producers heavily invested in the Bakken region, such as Continental Resources (NYSE:CLR). As infrastructure continues to catch up to growing Bakken production, these producers will receive better prices (closer to Brent), which could significantly improve margins.