Why Cushing Matters: A Look at the WTI Benchmark

At the heart of the global pricing network, the Cushing hub provides the physical delivery mechanism for the CME Group’s NYMEX WTI futures contract.  When the WTI futures contract was first listed in 1983, Cushing was a vibrant hub for cash market trading of crude oil with a network of pipelines, refineries, and storage terminals.  Today, Cushing is the key nexus of market fundamentals for the global crude oil market, with nearly two dozen pipelines and 20 storage terminals.

According to the U.S. Energy Information Administration (“EIA”), the working storage capacity in Cushing is 76 million barrels and 91 million barrels of total shell capacity as of September 2019.  Currently, the shell capacity in Cushing is approaching 100 million barrels in the second quarter of 2020.  The EIA defines the “working storage capacity” and “net available shell capacity” for Cushing and by PADD district.^[1]  Generally, the working storage capacity accounts for around 85% of the nameplate shell capacity of a tank, given that each storage tank has a roof and a heel, and they typically are not able to use the full 100% shell capacity.   

The pipeline infrastructure in the Cushing market is expansive, with approximately 3.7 million b/d of inflow pipeline capacity to Cushing and 3.0 million barrels per day of outflow capacity.  The in-bound pipelines deliver crude oil streams produced in Canada and the US shale oil areas, including the Bakken, Niobrara, and Permian producing areas.  The out-bound pipelines supply crude oil to the main refining centers in PADDs 2 and 3. 

It is not just the storage or pipeline capacity that make Cushing the critical hub as the delivery point for the global oil benchmark, but also the interconnectivity between a diverse mix of operators at Cushing.  The WTI futures contract allows for delivery through Enterprise or Enbridge facilities in Cushing or at a facility that is connected to either.  The Enterprise terminal provides a key junction point in Cushing, capable of facilitating the transfer of tens of millions of barrels of crude oil every month.  A commercial company that elects to take delivery after the termination of the WTI futures contract must have storage and/or pipeline capacity connected to one of the NYMEX delivery locations in Cushing.  From there, the firm can elect to take the oil into storage or into a pipeline with connectivity to PADD 2 refineries and to the Gulf Coast market.

The physical-delivery requirement of WTI futures provides a direct link to the underlying physical market, and futures also provide the security of a financially-guaranteed clearinghouse for buyers and sellers.  Further, Cushing terminal operators require firms to submit nominations for crude oil flows ahead of the delivery cycle in order to ensure the deliveries scheduled on and off exchange flow unencumbered.  

The unprecedented global market fundamentals have put intense stress on the oil industry in the first half of 2020, as companies responded to the volatile arbitrage price signals and hedged the price risk associated with demand destruction, declining US exports, and rising stocks of crude oil. 

The first indicator of the energy demand destruction from COVID-19 was seen in the New York Harbor RBOB gasoline futures contract (“RBOB futures”).  The futures market for RBOB gasoline forecasted demand concerns early when prices traded at a 20-year low of $0.376 on March 23, 2020.  RBOB futures is an important indicator for global gasoline as it is the only gasoline futures contract to trade electronically around the clock.  Historically, gasoline stocks build in the winter in anticipation of the peak summer driving demand.  As it became apparent that the summer driving season would be significantly curtailed, flat price RBOB futures prices started to decline at a faster pace than crude oil prices.  Meanwhile, the price of New York Harbor ULSD futures held up relative to RBOB futures in March and April 2020 due to stronger demand from the transportation sector for delivery of essential goods during the pandemic, as reflected in the crack spread chart below.

In response to the sharp drop in gasoline and ULSD prices, the oil refining companies were quick to respond to the price signals, as is evident in the decline in the US refinery utilization rate, which has been stuck below 75% utilization during the peak summer demand period when refinery utilization typically rises over 90%.  As the refining sector ramped up production with the re-opening of global economies, the stocks in Cushing have been drawn down significantly since the peak level of 65.4 million barrels in storage on May 1, 2020. 

As a result of the surging global over-supply, US crude oil production dropped sharply to 10.5 million barrels per day (b/d) in June 2020, down from a peak of 13.0 million b/d in December 2019.  With the over-supply coupled with demand collapse on a global scale, the price arbitrage was not favorable for US crude oil exports, which also declined in the first half of 2020 to 2.5 million barrels per day (b/d) in June, down from the peak of 3.7 million b/d recorded in December 2019.  The growth in exports has been transformative for the US crude oil market and has enabled US crude to become the marginal barrel of supply in the global energy market.

Another early signal of oversupply of crude oil was the rapid price decline in the US domestic crude oil cash markets.  By late March 2020, WTI Midland and WTI Houston were trading at widening discounts to the WTI futures benchmark, providing an early indicator that there were supply and demand imbalances in the US crude oil market.  This price arbitrage led market participants to direct barrels to flow into storage at Cushing.  The chart below shows the general price volatility of the US domestic crude oil grades   during the March and April 2020 timeframe.   Ultimately, WTI futures provided for convergence between the futures and cash markets at expiry on April 21, 2020.  

At futures expiration, CME Group matches the buyers and sellers who elect to make or take delivery of physical oil.  As a result of the recent extreme market imbalances between demand (low refinery runs) and supply (rising stocks), the day prior to the expiration of the May 2020 WTI futures contract led to negative oil prices as buyers and sellers had to settle their futures positions.  It is also important to note that after trading negative on both the afternoon of April 20 and the morning of April 21, the May WTI futures contract ended up with a final settlement price of $10.01, reflecting the successful convergence of futures and cash prices at final settlement.  As the global economic recovery has unfolded, the volatility in WTI futures has stabilized, and the July 2020 contract expired at a price of $40.46 per barrel.

It is important to note that CME Group futures markets worked as designed.  Our futures prices continue to reflect the fundamentals in the physical crude oil market driven by the unprecedented global impacts of the COVID-19 pandemic, including decreased demand for crude, global oversupply, and high levels of US storage utilization.  In the end, WTI futures performed its critical function as the central clearing mechanism for buyers and sellers in the crude oil market, and provided a transparent, fair, and robust benchmark price.

Going forward, the market fundamentals characterized by significantly lower fuel demand and decreased global oil production will continue to put intense stress on the oil industry in 2020, as companies respond to the volatile arbitrage price signals and hedge the price risk associated with “new normal” in the global economy. 

1. For reference, the United States is divided into five PADD (Petroleum Administration for Defense Districts) regions to enable detailed analysis of petroleum product supply and movements.