Commodities 2021: WTI MEH/Midland spread set to remain narrow into 2021

Houston — Lowered production and flagging demand due to the coronavirus pandemic, coupled with an expansion of Permian pipeline takeaway capacity, has led to a drastic narrowing of the spread between West Texas Intermediate crude in Midland, Texas and at the Magellan East Houston terminal on the US Gulf Coast, with little signs of abatement heading into 2021.

Through the fourth quarter of 2020, the WTI MEH/Midland spread averaged 55 cents/b, down from an average of 72 cents/b in Q3 2020, and sharply lower than the average of $2.31/b in Q1 2020.

Driving this narrowing spread has been a sharp fall in Permian output as a response to the cratering of global oil demand observed following the start of the coronavirus pandemic. Indeed, in February, prior to the sweeping lockdowns in many Western countries, Permian basin oil production was estimated at over 4.8 million b/d by the US Energy Information Administration.

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Fast forward to December 2020 and Permian production is estimated at 4.24 million b/d, according to the US EIA, and is slated to sink further in January 2021 to just under 4.2 million b/d. This sharp drop in production was in response to falling global oil demand. International Energy Agency forecast in their December Oil Market Report that demand will drop 8.8 million b/d year on year in 2020.

Furthermore, refinery runs in the US Gulf Coast have also fallen precipitously amid weak demand and poor margins, with the four-week-moving average for USGC refinery runs over the period ended on Dec. 25 at 7.88 million b/d, over 1 million b/d lower than the 9.04 million b/d of USGC refinery runs averaged during the same period last year.

LOWER PIPELINE UTILIZATION

Reduced demand and the corresponding decline in production has caused pipeline utilization out the Permian basin, a region where takeaway capacity has been significantly increased in recent years - well past the level of production, to fall. Indeed, pipeline utilization out of the Permian fell below 60% in May when production troughed, but has recovered slightly, according to S&P Global Platts Analytics.

Lowered production, combined with the completion of Enterprise's Midland-to-ECHO-III pipeline is expected to cause pipeline utilization out of the Permian to fall back below 60% in late 2020, according to Platts Analytics. Even with production expected to rebound in mid-2021, pipeline utilization is expected to remain low for several years as the over 1 million b/d ExxonMobil/Lotus Midstream-led Wink-to-Webster pipeline is due to come fully online in the second half of 2021.

"Spreads should be tight for some time unless we see production go up," one trader said about the MEH/Midland spread, "but I don't see a lot of production coming on very soon."

Indeed, Permian production levels could take years to recover to pre-pandemic levels, particularly as many producers have looked to cut costs during the pandemic.

"Permian is currently down 600,000 b/d from [the pre-pandemic] level, so it might take 3 years," another trader said. "The days of over producing is over. Everybody wants to be run with smaller growth plans."

Platts Analytics expects that Permian production will continue to fall into Q2 2021 as natural declines outpace new wells, however, production is expected to climb in the second half of the year, causing Permian production to end 2021 slightly higher than the end of 2020. Annual average production in 2021, however, is expected to be 460,000 b/d lower year-on-year, according to Platts Analytics.

While the MEH/Midland spread is expected to remain narrow going into the New Year, there could be some widening in the spread should trading activity pick up. "[The spread will be tight] probably for the first [half] of the month, but as we get into back half of trade cycle, USGC may pick up more," one trader said.

Another market source noted that "shippers [are] losing a lot of money" with the narrow spread not covering the costs of transporting the crude to the demand centers on the USGC. "At least if you're a producer, you don't mind unless you don't have enough production," the source added.

Even with the IEA expecting a 5.7 million b/d growth in global oil demand in 2021, led by growth in demand for gasoline and diesel, challenges remain for both the US oil market, and the global market more broadly after the coronavirus pandemic drastically changed the landscape of markets, politics and way-of-life.