With the amount of crude oil being shipped to the Texas Gulf Coast increasing, some producers are calling for a new pricing hub in Houston to reflect overseas demand for U.S. crude and rival the Cushing, Okla., hub, where prices are driven by domestic factors.
Crude oil exports increased by more than 80% from the first half of 2017 to the first half of 2018, reaching a record of 2.2 million barrels per day in June, according to an Oct. 3 report by the U.S. Energy Information Administration.
Much of that oil is West Texas Intermediate crude that is priced based on the hub in Cushing. Part of the appeal of U.S. oil to importing countries is that it tends be cheaper than that of other nations, but producers believe they are being shortchanged by the use of Cushing prices. In what may be an indication that sellers are looking to avoid Cushing, the EIA said, oil inventories at the hub as of Sept. 28 were 24.5 million barrels, or 22.1 MMbbl lower than the start of the year and 21.8 MMbbl lower than the hub's five-year average for the time of year. Capacity on pipelines to the Gulf Coast, on the other hand, was at or near capacity.
"Traders would prefer to price these transactions based on crude delivered free on board, or FOB, onto tankers provided by the buyer at a given location. That's how most major equity producers and national oil companies transact their international sales," Morningstar Inc. analyst Sandy Fielden said in a commentary. "Until recently, there was no liquid waterborne Gulf Coast FOB crude price, and traders had to use U.S. domestic crude pipeline prices instead."
Creation of a Houston price hub for crude oil could have mixed results for the massive hub in Cushing, Okla.
Fielden noted that U.S. prices have largely been dictated by pipeline pricing, which is "dominated by domestic market considerations." Prices at the waterline, on the other hand, can be more heavily swayed by international fundamentals.
Since much of the oil is being exported through the Houston Ship Channel, the argument for a price hub in that city is finding a receptive audience. With the lack of a solid pricing mechanism, sellers are using a variety of different methods, including FOB price quotes by S&P Global Platts.
Fielden argued that the creation of a Houston hub would benefit exporters but could mean trouble for Cushing's status as the supreme price hub in the U.S.
"Within the past three months, and with an eye on the pendulum of crude trade moving from Cushing to Houston, the world's largest commodity futures exchanges have joined the competition for Gulf Coast export trade," he said.
Other analysts believe a Houston hub would not necessarily damage Cushing.
"It doesn't need to compete; it just adds another point of liquidity to the market. It allows traders to arbitrage between markets," said Kenneth Medlock, a professor of energy studies at Houston's Rice University. "If prices got out of whack in one place, then it would encourage flows to go to the other."
Cushing has one of the world's largest oil storage facilities, something Houston is nowhere near matching. Even though the creation of a Houston pricing hub would mean the development of related infrastructure, the chances of it matching Cushing are hard to fathom, Medlock said.
"Cushing offers a storage service that Houston won't. Houston offers a point of liquidity because it's close to the water that Cushing can't," he said. "Houston could actually help alleviate some of the infrastructure constraints at Cushing. It's a win-win from a market perspective."
If a Houston price hub is created and a solid pricing regime comes with it, then the demand to ship crude to the coast is likely to increase even more. The desire to ship crude to the Gulf has already helped create a pipeline shortfall in the Permian Basin but has done little to reduce interest.
"If you're a producer and can get to the Gulf Coast instead of Cushing, you're going to do it," Medlock said. "But Cushing isn't going away. That's not going to happen."
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