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Strong Gulf Contago Benefits Refiners

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The backwardation that has perpetuated in WTI crude oil is a function of the large draws seen in Cushing Oklahoma over the past 3-months. The draws in Cushing have created a large backwardation in the term structure of WTI crude oil which is not reflected in Gulf crudes. Currently, the December 2014 futures contracts minus the December 2015 futures contracts (December versus Red December) is trading at 6.85, nearly the highest backwardation seen in the past 2-years with the exception of the levels seen earlier in March.

The recent drawdown of stocks at Cushing resulted from the startup of TransCanada’s Cushing Marketlink pipeline, which is now moving crude from Cushing to the U.S. Gulf Coast. Additionally, expanded pipeline infrastructure and railroad shipments have made it possible for crude oil to bypass Cushing storage and move directly to refining centers other regions of the United States.

Marketlink is the most recent in a series of infrastructure developments that have either increased Cushing crude takeaway capacity or made it possible to bypass Cushing and move crude directly to refining centers. In January 2013, significant new capacity was added with the completion of Enbridge/Enterprise Seaway’s 250,000-barrel per day pipeline expansion. With new infrastructure online, average crude movements from the mid-continent to the gulf coast rose to 470,000 barrels a day in 2013, 68% higher compared with 2012.

The backwardation in WTI is normally viewed as bullish as spot prices are in high demand and that is why they are higher than deferred prices. In this situation the backwardation comes as prices are declining because the backwardation is only a function of crude moving out of storage in Cushing and into storage facilities in the gulf. Since WTI is priced in Cushing and not in the gulf the backwardation is a facade. Crude production remains strong which has spilled over into robust distillate production. With enough crude oil at refinery locations, refiners should be able to meet summer gasoline demand which should keep prices subdued.

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