Publications: Notes at the Margin

A Tightening US Crude Market (July 5, 2021)

 

The US crude market is tightening. Some writers now warn that crude oil inventory declines could push US prices up sharply. The stock decrease is reflected in the increased backwardation in the WTI market.

 

The tightening is probably not accidental. Indeed, the upswing in backwardation can be attributed to US producers exporting increased WTI or WTI-type crude oil volumes. By diverting WTI to Houston for export rather than shipping it to Cushing, producers have caused inventories held at the latter to decline. Cushing stocks are down by thirty percent since January 1, while inventories in PADD III, which includes Houston, have decreased just four percent. The stock reduction increases backwardation and, in turn, producer revenue. In some cases, producers may fare better by accepting less for the oil they export because this boosts the benchmark WTI price and thus their income on crude sent to Cushing. This tactic works because most oil sold in the United States is priced off WTI.

 

The economic practice of diverting crude to the Gulf Coast to raise overall earnings is not new. Nor is it illegal if producers do not collaborate in doing it. Indeed, it represents smart trading.

 

BP, for instance, used the approach to increase the price of Alaskan crude sold on the West Coast before it acquired Arco.[1] Unfortunately for the firm, the Federal Trade Commission discovered what it was doing and forced BP to sell its Alaskan assets as a condition for approving the merger. The FTC took this action because it determined that, after the merger, BP would have increased market power to raise oil prices to West Coast buyers.

 

Bulow and Shapiro described the strategy that appears to be in use today in the US crude market in a 2004 paper. As mentioned above and explained below, diverting WTI or other crude streams from Cushing to Houston reduces stocks in the critical Oklahoma oil storage location. The lower stocks raise backwardation in the market; that is, the spot crude price rises if forward prices remain unchanged. The higher WTI cash price then lifts the cash prices of most other crudes.

 

More diversions will likely occur in the coming months as this effect becomes better understood. Oil producers have every incentive to drive Cushing stocks down and raise backwardation even more.

 

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