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WTI Sinking Ahead of Expiration
Brent crude futures for June expired at the close today and there was very little movement in the price because there are no delivery problems associated with the Brent contract. Brent closed at $112.73 with a loss of -$1.10.

The WTI contract expires on Friday and it does have some serious delivery issues. The WTI contract lost -$2.65 in regular trading and it down another 50-cents overnight. The last EIA report showed that storage levels at Cushing Oklahoma, the delivery point for the WTI contract, had soared to a record high of 41.6 million barrels leaving only a fraction of its assumed working capacity of 42.0 million available.

Cushing has a nameplate capacity of 48.0 million barrels. However, tanks are seldom filled to 100% capacity in order to leave a margin for error and not stress the tanks. Operationally Cushing storage is assumed to be 80%-90% of the nameplate capacity or roughly 42 million barrels. As recently as a year ago that working capacity limit was thought to be in the 38-40 million range. Current oversupply conditions have evidently pushed operators to utilize every space available.

Another reason for the less than 100% utilization is the different type of oil that arrives daily. Some of it can be mixed but some of it cannot be mixed and has to have its own storage tank. Also, the oil coming in by pipeline has to have a certain amount of reserves cushion in the available tanks space to avoid locking up the pipeline for lack of storage. Cushing always has to allow extra space for new oil coming down the pipeline.

Several companies have announced plans to build new storage at Cushing totaling about 14 million barrels by the end of 2011 to an estimated 52 million operating capacity. Plains All American Pipeline LP is planning to build 5.4 million barrels of storage. The Gavilon Group LLC is building storage for 4.0 million barrels. Magellan Midstream Partners LP is building 4.25 million barrels of storage.

Cushing is located 54 miles northeast from Oklahoma City. The pipeline hub receives oil from West Texas, Oklahoma and several states north of Oklahoma. It also receives oil from the Gulf Coast and oil sands from Canada. Cushing was established in 1983 and designated the delivery point for the WTI contract because of its central location and pipeline connections. It primarily delivers oil to refiners in the Midwest.

When the new capacity is completed it will reduce the volatility associated with contract expirations. If there is room to store excess oil and the ability to quickly distribute that oil then the game playing around expiration will ease.

One problem with Cushing today is the lack of demand. There is more oil flowing into Cushing than there is demand for oil from Cushing. The oil from Canada is flowing constantly and with every upgrade to the Canadian facilities the volume of oil grows. The oil from the Bakken has increased from 75,000 bpd less than ten years ago to 325,000 bpd today. That is a 33% jump in just the last year. Cushing does not currently have the ability to deliver oil to the Gulf Coast. It can receive oil from the coast but there is no pipeline going in the other direction.

Because Cushing has more oil coming in than going out some Midwest refiners are able to buy oil at a discount to the WTI price and that WTI price is already $10 under the Brent price because of oversupply.

The pipeline problem is expected to be corrected by the end of 2013 with the completion of the Keystone pipeline from Cushing to the coast. This pipeline extension will connect from Alberta Canada through Illinois to Cushing and on to the coast. This will allow Cushing to offload some of its capacity to the bigger refiners along the coast. By 2015 the oil imports from Canada are expected to jump from 2.72 mbpd to 3.29 mbpd and that pipeline to the coastal refineries will be crucial in distributing the new oil.

In the short term Cushing is full. They may be able to squeeze a few thousand more barrels but anyone thinking of buying cheap June oil, taking delivery and storing it until the prices move higher is out of luck.

This week is especially bad since nobody really knows how the flood will impact future demand. As of Monday evening there are no refineries offline although several pipeline in the area have been shutdown. The 5,500 mile Colonial pipeline system goes right through the flooded areas below the Morganza spillway. If that pipeline was damaged by flood waters it could cause some serious distribution problems and cause Cushing to be backed up even more than it is today.

This uncertainty and the lack of Cushing storage is likely to cause some additional volatility in WTI prices ahead of expiration on Friday.

Jim Brown

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