Refiners adapt to Midland crude premiums

OREANDA-NEWS. August 10, 2015. Refiners will tap stranded crude production and turn to old familiar blends as a nearly decade-long run of West Texas-to-Cushing discounts is reversed.

Refinery executives this week called Midland-priced crude's longest sustained premium to the US domestic benchmark since 2008 an anomaly, but one that could persist for up to two years. Midland barrels have fetched a premium to Cushing since 18 June.

Southwestern refinery outages could cause large swings in the differential between crude at Midland, Texas, and the US storage hub at Cushing, Oklahoma, until production restores a narrower spread, companies said during calls discussing second quarter earnings.

"It is obviously a changing landscape," HollyFrontier chief executive Mike Jennings said.

Prices for field-quality Midland barrels have held their longest premium to Cushing blends in roughly eight years, according to Argus assessments. And Midland-priced crude has not held a sustained premium of this size — peaking at a record \\$1.65/bl in mid-July — in at least 20 years. The differential averaged above \\$1/bl this week.

West Texas producers had for decades sent production up to the crude storage hub in Cushing, Oklahoma, to be blended into the benchmark West Texas Intermediate. But as shale drilling and completion techniques kindled a resurgence of light, sweet production from the Permian basin of Texas and New Mexico, refiners looked to cut out the middleman and retrieve neat barrels from closer to the source.

Production that outstripped the region's takeaway capacity led to a discount as low as \\$14.75/bl below Cushing in the past three years.

But completion of new pipelines over the past two years, including Magellan Midstream Partner's 275,000 b/d Longhorn pipeline and its 300,000 b/d BridgeTex joint venture with Plains All American, has increased Permian producer access to the Texas coast. The April startup of Plains' Cactus pipeline, which will grow to 330,000 b/d, added access to Permian crudes for Corpus Christi-area refiners. Take-or-pay agreements on those lines have spurred competition for barrels and helped to drive up the premium.

Supply of Midland barrels has meanwhile grown tight. Though production in the region remains lower cost than other shale projects, refiners and pipeline operators expect a 46pc drop in prices over the last year will lead producers to cut back.

"The short answer is, production needs to increase, and production is going to increase when the price recovers," Magellan chief executive Mike Mears said.

Until then, the conditions will create more local differentials and volatility in the Permian and Delaware basins of West Texas.

Midland prices will become susceptible to the status of the southwestern refiners closest too them, said Jennings. The company operates a 100,000 b/d refinery in Artesia, southeastern New Mexico.

"The likelihood of large blowouts in Midland, I think, is now really limited to significant refiner downtime in the Panhandle or Southwest, or dramatic increases in production, which, with the current rig count, are going to be hard to achieve," Jennings said.

Western Refining, which has developed pipeline infrastructure to retrieve local production for its 125,000 b/d refinery in El Paso, Texas, and to move Delaware basin production east to larger markets, expects geographic and quality differentials to persist.

Producers on the western edges of current production still lack the cheapest pipeline access, and may negotiate for local takeaway capacity, said Western Refining chief executive Jeff Stevens. Crudes with 43°API to 44°API will fetch stronger prices than 47°API and 48°API production, he said.

Western had turned to light, sweet barrels from the San Juan basin of northwest New Mexico. The company began flowing that production to El Paso in June, and takes those barrels at a \\$3/bl to \\$4/bl discount.

But production would continue in the Delaware, he said.

"Everything we see from those producers is that they are not swayed by where current oil prices are," Stevens said. "They are looking at long-term plays here, and I think we're going to continue to see growth, particularly in the stronger areas of the Permian basin."

Some companies will turn their attention elsewhere. Delek US, which has moved Midland barrels across the state to its refineries in Tyler, Texas, and El Dorado, Arkansas, will turn to blended barrels at Cushing, chief executive Uzi Yemin said.

Delek in the second quarter had used excess naphtha from the light West Texas production as a gasoline blendstock. Shifting to Cushing would fill up octane-producing reformer units and underline the company's strategy of having many sources of crude, he said.

"Cushing will allow us to bring different types of crude we like and to fill up other units," Yemin said.

But Delek joined other west Texas players expecting a return. Growing pains in the Delaware would pass, Sunoco Partners chief executive Mike Hennigan said.

"Long term, we're still pretty bullish that Permian production is still a great place to be," Hennigan said.