News earlier this month that a change of ownership would soon lead to the reversal of the Seaway crude oil pipeline between Texas and the U.S. Midwest sent ripples through U.S. and international crude markets, as participants anticipated an opening of new coastal markets for rising North American crude production that had long seemed landlocked. On the surface, the impact was dramatic. The price discount of West Texas Intermediate (WTI) at Cushing, Oklahoma, relative to other grades, having dramatically widened for months, had already started to narrow before the news broke; word of the impending reversal added momentum to that trend. The narrowing of the WTI discount was particularly striking with respect to waterborne grades of similar quality, such as UK Brent or Louisiana Light Sweet (LLS). The Brent-WTI spread fell from a near-record average of $23 per barrel (/bbl) in October to about $10/bbl on November 21, according to U.S. Energy Information Administration (EIA) calculations from Bloomberg, L.P. data. Over the same period, the LLS-WTI spread shrank from $25/bbl to $11/bbl (Figure 1). But the WTI discount to heavier, sour grades such as Mexican Maya or Ecuadorian Oriente, which prior to the 2011 bottlenecks traded at a deep discount to WTI and other light, sweet crudes, proved more resilient. The Maya-WTI spread fell by only $6/bbl, from $13/bbl in October to $7/bbl on November 21; the Oriente-WTI spread narrowed by $11/bbl. Maya's own discount to LLS and Brent has become exceptionally small, reflecting strength across the heavy, sour crude market. Despite the quality gap between the two grades, the LLS premium to Maya has fallen to $4/bbl, from an average of $13/bbl over the last two years.
As hard as it may seem to overestimate the role of location in crude pricing, that is only part of the story. Unlike the real estate market, the oil market is not all about "location, location, location." Quality and timing also matter.
Recent commentary on the WTI discount has been rightfully focused on location and logistical issues, such as the challenge of bringing rising Canadian and North Dakotan production to market, the emergence of an oversupply of crude in the landlocked Midwestern market, and the lack of pipeline outlets to refining centers on the Gulf Coast. These supply challenges have been at the heart of the WTI "dislocation." The planned reversal of the Seaway pipeline, with initial capacity of up to 150,000 bbl/d in the second quarter of 2012 ramping up to as much as 400,000 bbl/d a year later, is designed to help address them.