Seaway pipeline creates contango with oil glut

Enbridge Inc. and Enterprise Products Partners LP haven’t just reversed the way benchmark oil flows in the U.S. They also changed the price relationship in the futures market by creating a temporary glut in the main delivery point for crude contracts.

The reversal of the 500-mile (805-kilometer) Seaway pipeline from the trading hub at Cushing, Oklahoma, to refineries on the Gulf Coast is intended to clear a supply build-up that depressed prices of West Texas Intermediate oil traded on the New York Mercantile Exchange. The shift is attracting more oil to Cushing to meet demand once crude flows change direction. Inventories grew 6.4 percent to 32 million barrels in the past seven weeks, according to U.S. Energy Department data.

Increased stockpiles depressed crude for next-month delivery, making it less expensive than later futures so that investors have to pay more for each successive contract. January oil traded in contango, or at a discount to August crude, on Nov. 22 for the first time in a month, following the action by Enbridge and Enterprise six days earlier.

“We expect the WTI contango to increase in coming months as Cushing inventories rise in anticipation of the reversal,” David Greely, head of energy research at Goldman Sachs Group Inc. in New York, said Nov. 23 in a phone interview. “After the reversal of the Seaway, these barrels would move down to the U.S. Gulf Coast, drawing Cushing inventories back down and reducing the contango.”

Oil for January delivery gained 0.8 percent to $97.53 at 12:46 p.m. on the Nymex. That compares with $97.68 for the February contract, a premium of 15 cents, down from 20 cents on Nov. 23.

Backwardation, Contango

Over the past five years, oil for front-month delivery was in contango versus the contract for the next month 82 percent of the time. The front month was in backwardation, or more expensive than the next month, on 18 percent of trading days.

U.S. crude rose relative to Brent for January settlement last week on the London-based ICE Futures Europe exchange as Brent prices dropped $1.38, or 1.3 percent, to $106.40 a barrel on Nov 25. Between 2001 and 2010, WTI traded at a premium of 87 cents a barrel to Brent, according to data compiled by Bloomberg. With an influx of oil at Cushing, that flipped to a record discount of $27.88 on Oct. 14. The gap has since narrowed 63 percent to $10.38 today.

Refiners on the Gulf Coast have been forced to pay higher prices for imported oil because of a lack of transport from Cushing. Oil used on the Gulf has been linked to Brent, which is the benchmark for more than half of the world’s oil.

The Seaway line will operate with a capacity of 150,000 barrels a day by the second quarter of 2012, according to Enterprise and Enbridge. Pump modifications expected by early 2013 will boost that to 400,000 barrels.

Pipeline Capacity

Currently, there is 1.64 million barrels a day of pipeline capacity into Cushing and only 995,000 out, according to Martin Tallett, founder of EnSys Energy & Systems Inc., a Lexington, Massachusetts, consulting company.

Additional lines may be needed to handle increased production. Canadian output will jump 37 percent to 2.16 million barrels a day in 2015 from 1.58 million this year, the Canadian Association of Petroleum Producers said in June.

North Dakota, which produces oil from the Bakken field, almost doubled output in the past two years and pumped a record 464,129 barrels a day in September, according to the state government. Production may grow to between 1.5 million and 2 million barrels a day within five years, Katherine Spector, a New York-based analyst with CIBC World Markets Corp., said Nov. 22 at The Energy Forum in New York.

Canceled Projects

The Seaway reversal is replacing Enbridge and Enterprise’s Wrangler pipeline proposal, which would have carried as much as 800,000 barrels a day from Cushing to the coast by mid-2013, Rick Rainey, a company spokesman, said Nov. 16.

Enterprise and Energy Transfer Partners LP said Aug. 19 they wouldn’t move forward with plans to construct a separate 584-mile line from Cushing to Houston.

The State Department announced Nov. 10 it was delaying a decision on TransCanada Corp.’s proposed Keystone XL oil pipeline to study an alternative route for the $7 billion project that avoids environmentally sensitive areas in Nebraska.

Further study “could be completed as early as the first quarter of 2013,” said the department, which has jurisdiction over the line because it crosses an international border.

“Because of all the euphoria around Seaway, we’ve lost a lot of other news in the background,” said Amrita Sen, a London-based analyst with Barclays Plc. “A lot of key pipelines have actually been canceled.”

Lower Prices

For now, January futures on the Nymex are cheaper than every contract through June, when prices turn lower than previous months. Oil for delivery in December 2012 trades at $97.58 a barrel, falling to $93.50 the following December and $91.08 in the same month of 2014.

The months closest to delivery will remain in contango until next year because of ample stockpiles at Cushing and a slowing economy, Harry Tchilinguirian, the London-based, head of commodity markets strategy at BNP Paribas SA, said Nov. 25 in a phone interview.

Oil for sale at a later date is lower, reflecting the concern of hedge funds about bullish bets when there is “uncertainty in the global economic outlook,” he said.

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