Fluctuations in production growth expectations echo in forward price volatility
In addition to the benchmark NYMEX WTI futures contract deliverable at Cushing, Oklahoma, there is an active futures market for WTI-quality crude oil in West Texas at Midland and on the Gulf Coast at Houston. The WTI Houston and WTI Midland markers trade as spreads to NYMEX WTI, and their futures contracts are setting records in volume and open interest.
Since the boom in pipeline capacity from the Permian Basin to the Gulf Coast in 2019, the prompt price spread between WTI Houston and WTI Midland has been limited to a narrow 40 cent range. But the forward prices have been much more volatile. Why?
Spreads between light sweet crude oil prices at different locations primarily reflect the incremental transportation cost between regions. When there is significant excess pipeline space between locations, these spreads trade at “variable cost” – typically 25 to 50 cents per barrel depending on the pipe and the period in history. Temporary disruptions in regional balances such as refinery outages or pipeline operations are typically easily absorbed without the need for a large move in spreads: volatility is low.
Even as production climbs, crude oil pipeline capacity out of the Permian Basin is expected to be ample. More production means higher pipeline utilization and more costly tiers of transportation for shippers. This means wider price spreads between WTI Houston and WTI Midland – but how wide and when?
In their February 2023 Short Term Oil Market Outlook, the EIA forecast domestic oil production in 2023 to average 12.5 million barrels, up from 11.9 in 2022, and climbing to 12.65 in 2024. Their 2024 outlook marked a decline of 160 thousand barrels per day from their January forecast, continuing for 2024 the trend that marked their 2023 views. In their June 2022 forecast, 2023 supply was seen at 13.0 million barrels per day, an impressive increase of one million barrels per day, mostly from the Permian Basin – now a level not expected to be seen until the end of 2024. This is not meant to call out the EIA as most other forecast providers have experienced similar forecast slippage. As costs escalated, and investor preferences and natural gas takeaway constraints weighed, production estimates have been scaled back.
EIA Short Term Energy Outlook for Domestic Production by Forecast Date
Expectations for crude oil production growth have been evolving lower
Along with growing production, the WTI Houston vs. WTI Midland curves have been in consistent contango, but the shape and level has been anything but consistent. In spring 2022, values for the second half of 2022 were trading over $1 per barrel and the Calendar 24 strip was $1.30, while prompt differentials were below $.50 cents. At the same time as production expectations for the balance of the year and 2023 crept lower, so did these spreads. From May to November, the Calendar 2023 Houston vs. Midland values fell from 90 cents to 35 cents; over a similar period, Cal ‘24 fell from $1.25 to 65 cents. While the evolution has been generally lower, there has been volatility along the way.
CME Group WTI Houston vs. WTI Midland Forward Curves
The forward curve for WTI Houston and WTI Midland is shifting along with production expectations
In addition to wider spreads, higher pipeline utilization brings the potential for more volatility in prompt location spreads. As periodic disruptions in regional supply and demand occur, larger moves in the prices between regions may be required to incentivize the necessary changes in pipeline flows.
An extreme example of spread volatility was in 2018 and 2019 when midstream projects lagged the surge in production in several U.S. basins. By late 2018, the spread between WTI Houston and WTI Midland – representing the arb to deliver Midland barrels to the U.S. Gulf Coast – widened to over $20 per barrel. “Kinks” of several dollars per barrel in the forward curves for these products implied traders’ point-of-view on the race between new pipeline projects and growing production.
2018: Argus WTI Houston vs WTI Midland
Production growth outpaced infrastructure in 2018, creating significant volatility in the forward curves for HTT vs WTT
The evolution of market expectations for oil production and capital projects is likely to continue to drive shifts in the forward curves for WTI Houston and WTI Midland. These moves highlight the need for traders to manage regional price exposure and create opportunity for those with advantaged positions and points-of-view.
WTI Houston (Argus) vs. WTI and WTI Midland (Argus) vs. WTI are liquid futures products, with combined open interest of over 395,000 contracts as of March 2023. They are tradable both on- screen and via the broker market. CME Direct users can track spot values via the Argus Crude Market Ticker. Find more information about U.S. crude oil products here or contact energy@cmegroup.com.
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
