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Reversing flow: How the shale revolution redefined where oil trades, how it moves and how it is priced USAEE Washington, DC Jeff Kralowetz 19 June 2015

• How spot markets work ◦ Benchmarks ◦ Local physical markets

• How the rise of light tight oil (shale) production has changed physical market pricing relationships and logistics

• Where new price discovery hubs are emerging

Topics covered

Copyright © 2015 Argus Media Ltd. All rights reserved.

The Argus perspective

• World’s largest independently held energy markets PRA ◦ 700 staff in 23 countries ◦ Produce > 8,000 daily price

assessments

• Pricing reference for US crude ◦ ASCI prices >1.5mn b/d ◦ LLS is key benchmark price ◦ Swaps/futures settle on Argus

pricing

• Consulting • Conferences • Training

Market Reporting

Consulting Events

Crude market 101: Benchmark pricing in North America

• The benchmark/differential system aims to maximize liquidity and accuracy

• Hundreds of grades of crude exist, but nearly all are priced at a differential to 3 liquid benchmarks: ◦ Brent ◦ WTI ◦ Oman-Dubai

• System allows basis price to be set by very liquid and transparent markets – lay off most risk

• The differentials allow accurate value adjustments to reflect regional fundamentals – address basis risk

• Argus assesses differentials

Benchmark-based global oil price system


How it works – valuing Permian shale crude at Houston

• Main North American benchmark is WTI Cushing = 60.14 • WTI at Houston is Permian crude trading at Magellan’s East Houston

terminal. It trades at a diff to WTI Cushing = WTI +2.60 = 62.74 • Match highly liquid WTI Cushing base price with the fundamentals of

Houston market for Permian light tight oil.


Source: Argus Americas Crude, 9 June 2015, p1

Global benchmarks – big liquidity, broad valuation


Brent has surpassed WTI in use as primary benchmark


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Physical oversupply in US midcon Bottlenecks and US crude export ban WTI is a less relevant benchmark, less used

Brent rising relevance

Market Reporting

Consulting Events

Effect of shale fields on pricing: A push to the coast

Cowboyistan: US output affects global pricing despite export ban


Source: Harold Hamm, CEO Continental Resources, 28 Jan 2015 at Argus Americas Crude Oil Summit, Houston, TX

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crude output (b/d) C3 output (b/d)

US Crude output doubled – need for new infrastructure

• Crude output has climbed from about 5.4mn b/d in 2010 to about 9.2mn b/d now

• Most new liquids production is from inland fields – North Dakota, Texas, Rockies


Source: US EIA

Production is inland; Most refining is at coasts


Source: EIA Drilling Productivity Report, June 2015

Logistics shift to accommodate rising flows to the coasts


Crude flow changes: 2012 to 2013 Crude flow changes: 2013 to 2014

Total change 2012 to 2014: • US Gulf crude imports – Down 1.084mn b/d • West Texas to Texas coast – Up by 1.58mn b/d • Bakken to East Coast – Up by 235,000 b/d • Bakken to West Coast – Up by 181,000 b/d

• Texas: ◦ Longhorn ◦ BridgeTex ◦ Permian Express I & II

• Eagle Ford: ◦ KMCC-Double Eagle ◦ Enterprise/Plains ◦ Cactus

• Cushing to coast ◦ TC Marketlink ◦ Seaway/Flanagan

South • Reversed

HoHo/Zydeco • Further north: White

Cliffs, Pony Express, Enbridge expansions

New or reversed pipelines move crude to the coast


Source: Argus Petroleum Transport, Jan 23, 2015

illuminating the markets

US crude export ban effect: US Gulf merchant refiners convert non-exportable crude to exportable products


165,000 b/d distillates 40,000 b/d gasoline

150,000 b/d distillates

570,000 b/d gasoline

1,150,000 b/d distillates 350,000 b/d gasoline

Shale boosts use of exceptions to US crude export restrictions; pricing at the coastal export points


US crude exports (‘000 b/d)

Source: EIA

• World’s largest heavy crude refining center is US Gulf

• Increased access by Canadian heavies

• Also accessible by other global heavy producers – Saudi Arabia, Iraq, Mexico, Colombia

• Unlike light crude market, export ban less of a factor – Canadian is exportable

US Gulf: Potential global price point for heavy crude


Multiple heavy grades converge at US Gulf

• Canada making slow progress on export lines to its coasts – export via US ports is an alternative, though expensive

• Canadian crude may be re-exported from US ports if: ◦ It remains segregated throughout its movement across the US

- Must be batched if travelling in pipeline - Must be kept in segregated storage

• Canadian access to US by pipe is growing despite Keystone XL ◦ Enbridge Line 67 (Alberta Clipper) expanding from 570kbbd to 800kbd,

expected in 3Q15 if US State Department approves

Re-exports of Canadian crude from US Gulf likely


Market Reporting

Consulting Events

How price discovery has gone coastal – the rise of secondary price benchmarks

Pricing adapts to shale with secondary benchmarks


ASCI

Brent

WTI

LLS, Mars

----LLS has the fastest growing open interest – used as bridge to WTI ----ASCI and Mars are sour coastal benchmarks

LLS: the bridge connecting WTI to global market


Open interest on LLS on CME & ICE Soaring LLS open interest from mid 2013

• LLS is the defacto light tight (shale) oil benchmark at the coast

• Used by large refiners in 10Ks to value crude • Financial positions on LLS have risen since

OPEC strategy to challenge shale

WTI Midland used as marker for Texas LTO


• Until February 2015, there was not a transparent spot price assessment at Houston

• WTI Midland quality is better than WTI Cushing – not a blended barrel

• Quality and location differences from Cushing prompt Texas shale market to look to secondary benchmark

• Argus Sour Crude Index is composite of three offshore high-sulphur (sour) grades: Southern Green Canyon, Mars, Poseidon

• ASCI remains the benchmark for every barrel of Saudi, Kuwaiti and Iraqi imports

• Ecuador announced adoption of ASCI based pricing in 2014

• Argus VWA and ASCI methodology was overhauled 2014 to include even more transactions ◦ Increased benchmark volume an average 7%

• ASCI grade production is up 100,000 b/d to near 700,000 b/d

ASCI: A sour crude reference for >1.5mn b/d


Other sour price signals: Mars, Castilla and Maya


Open interest on Mars on CME & ICE

• Mars is medium sour; not a perfect match for heavy Canadian at the coast

• Maya is very similar in quality to Canadian WCS, but a government formula price

• Castilla is heavy sour and freely traded, but liquidity is variable

• Blended by 4 Canadian producers to consistent fungible specification at Hardisty

• Production of about 350,000 b/d

• Widely resold on spot markets

• 2 WCS prices exist: Hardisty and Cushing ◦ Act independently

(see graph) ◦ WCS at Texas

coast beginning to trade spot

WCS – Created to be a North American sour benchmark


WCS Cushing moves independent of Hardisty

Market Reporting

Consulting Events

Characteristics of an emerging price discovery hub

• WTI at Houston – convergence of 500kbd supply from Longhorn and BridgeTex lines; assessment launched Feb 2015

• WCS at Nederland (Houston) – Flanagan South will support • Patoka sees convergence, but a long way from liquid spot

market

New markets can emerge with new infrastructure


• Surplus crude, widely accessible/easily transferable

• Industry consensus on: ◦ Location ◦ Quality and means for measurement ◦ Timing ◦ Basis of trade – eg diff to WTI ◦ Modality – pipe, rail, barge, ship

• Information availability – Argus assessments and indices

are based on trades done and actual market conditions; not modeled ◦ Reported trade ◦ Bids/offers/information on related markets

Checklist for new price index


• Location - Magellan East Houston terminal • Quality - Permian WTI spec as defined Longhorn and BridgeTex pipelines

◦ Segregated from other “domestic sweet” ◦ In-tank trade facilitated by terminal operator

• Timing – monthly US pipeline schedule • Basis – priced at a differential to WTI Cushing • Modality – pipeline • Spot trade is reported to Argus

Where it has worked: WTI at Houston


• Fungible WTI storage – receives only Longhorn and BridgeTex WTI • In-tank transfer system (Product Transfer Orders) • Connections to Houston Ship Channel refineries and to Speed, Genoa

(and Texas City refineries), Webster, Ho-Ho, Oiltanking and ECHO

Easily accessible across Houston…


Source: Magellan Midstream Partners

…and to Texas City, Louisiana and water


Source: BridgeTex tariff documents

• WTI at Houston does not track LLS exactly

• Reflects local fundamentals

• LLS is increasingly disconnected from Texas coast

• Committed shipper effect: WTI Houston does not always = WTI Midland + pipeline tariff

Reflecting local fundamentals: WTI Houston vs LLS


Market Reporting

Consulting Events

Where will new price discovery hubs emerge?

Attributes • Convergence of

pipelines, rail off-loading capacity

• Large amounts of storage

• Waterborne exit and access

• Local refinery demand

• Brings Latin, Mid East, Canadian face to face – useful signal of value

Liabilities • Connectivity still

immature • Terminal operators

not setting aside tanks for fungible grade trade as at Cushing

Nederland: The world’s new global heavy price signal?


• Blocked and delayed pipeline projects have led to more crude-by-rail movements from Canada

• Build-out of receiving terminals for heavy crude/bitumen in US

• Also may be buying for re-export at Nederland ◦ Has waterborne access

at Sun Nederland and other terminals

Rail off-load capacity adds to convergence at Nederland


• Enbridge comingled grades at Superior from mid 2014 to conserve storage and pipeline capacity

• AWB and WCS remain segregated streams

• SYN is now either from Syncrude Canada or Suncor

• LLS, WH, LLK and SC are all comingled under label of CHV (conventional heavy)

WCS survives Enbridge co-mingling as distinct grade


• Wide swings vs Mars reflects difference in quality from medium sour Mars

• Recent strength of WCS at Nederland as supply from Canada tighter, competition from Padd II refiners, increased demand for heavy crude to offset abundant lights in feed slates

• Basis: Trades vs calendar month average rather than prompt WTI

Trends we’ve seen in Nederland WCS “ghost quote”


• Diffs to Mexican Maya formula reflect the fact that Maya is a government-set formula, not a traded spot price

• Recent price has been very close to Maya – qualities are similar

WCS Nederland’s recent relationship to Maya


• Already a swaps contract on ICE based on Argus WCS Cushing • Cushing has more optionality and liquidity • But Nederland reflects more exactly the higher coastal value of heavy

Canadian crude • WCS Nederland could come to reflect the influence of re-export

potential given its dock access

Is WCS at Texas coast needed?


illuminating the markets

• Location(s): Corpus, Gardendale, Three Rivers, ECHO, other – no agreed place to trade or value it; often valued at refinery gate

• Quality: ◦ API gravity varies from high 30s to 70s ◦ Assays from fields continue to change ◦ New routes being opened for Permian crude to get into

Eagle Ford pipelines (Plains Cactus) • Timing: US Gulf pipeline nomination schedule • Basis: Trades vs WTI, LLS, posted price, Brent • Modality: Pipe, rail, barge, ship

Eagle Ford’s hurdles on path to spot price index


Corpus Christi

• Developing waterborne infrastructure • Quality has not been uniform • Pipelines largely batched • Multiple destinations value EF differently – petchems,

splitters, refiners, Canadian diluent market


Bakken: Clearbrook doesn’t tell the whole story


• Bakken is only major producing basin where rail spot price is widely watched

• Argus provides commentary without a daily published price

• Volumes of Bakken crude moving by rail have declined

• Pipelines have taken more share as play matures

• But movement to east and west coasts is likely to remain on rail

Bakken fob rail price relevance in question


Current liabilities • Limited commercial

storage • Limited connections to

Canada and Bakken

Future potential • Potential blending

center for lights from Capline, Canada and Bakken with Canadian heavies ◦ Enbridge ◦ Express/Platte

• Growing storage • New/expanded

pipelines in-bound

Patoka – lots of connections, but limited trade


East coast unlikely home for price discovery


• Increased flows of Bakken and Canadian heavy • Insufficient storage, market participants for

robust spot market • US crude arriving at east coast is constrained by

US export ban

• West coast is isolated, has no pipeline connections to US Gulf/midcon

• ANS (Alaska North Slope crude) prices off Brent ◦ No other dominant baseload

grade • Latin American grades compete

in USWC ◦ About half of all Escalante

produced goes to USWC (1mn bl/month)

- Prices at 30-cent discount to ANS

◦ Colombian South Blend, loading at Tumaco, competes in USWC

◦ Colombian Vasconia occasionally goes to California

US West Coast also hard to price


Market Reporting

Consulting Events

Conclusions

• Rising light tight oil (shale) output has rerouted US logistics toward the coasts

• US crude export ban means crude demand is at US Gulf coast merchant refining center

• With pricing at coast, secondary benchmarks have arisen ◦ Secondary coastal benchmarks pair the financial

transparency of WTI with the accuracy of coastal market fundamentals

• Nederland/Port Arthur could be the key global pricing center for heavy crude ◦ Canadian, Mideast Gulf and Latin heavies converge there

Rising US crude output changes how crude prices


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[email protected] 832-492-6082 Houston www.argusmedia.com

Documents

Reversing flow: How the shale revolution redefined where ... · Nov-10. Apr-11. Sep-11. Feb-12. Jul-12. Dec-12. May-13. Oct-13. Mar-14. Aug-14. Jan-15. crude output (b/d) ... EIA