US Shale Cash Markets Offer Hope amid Gloom
In shale strongholds of North Dakota and Texas, physical crude grades are trading at the highest premiums to futures prices in years, offering a glimmer of hope that a pickup in global oil markets might follow.
While crude futures hover around 6-1/2-year lows, the cash markets, where producers and refiners buy and sell physical barrels of oil, are sending a more optimistic, if short-term, signal.
West Texas Intermediate crude delivered to Midland, Texas <WTC-WTM>, at the heart of the Permian Basin, is trading at a record $2.75 premium to benchmark U.S. futures. North Dakota's Bakken crude fetches more than 50 cents more, the highest in two years. The two areas produce more than 60 percent of U.S. shale oil.
Many cash crude traders say the relative strength of these markets most likely reflects local, short-term factors: newly built pipelines in Texas are increasing demand for local crude, while Midwest refiners are snapping up Bakken supplies following unexpected month-long outage in Canada.
But as the gains persist, some are wondering if that could also be a sign that a year-long supply glut is beginning to ease, helping put a floor under world prices that have tumbled to their lowest since 2009.
They point out that supply at Cushing, Oklahoma - the delivery point of the U.S. futures contract - continues to fall, defying expectations it would keep rising because of weak demand, refinery closures and maintenance season shut-downs.
Instead, stocks at Cushing have fallen in five of the past seven weeks as operating refiners bid aggressively for dwindling supply of crude.
"Supply for light (crude) in Cushing is tight," said one trader.
For months, the U.S. market has been gripped by fears that Cushing may run out of space as traders were choosing to store they supplies rather than sell on holding out for prices to rebound. That has prompted traders to roll over futures contracts to later deliveries making those more expensive.
Now that negative spread between front and second month U.S. oil crude contracts has narrowed to about 50 cents <CLc1-Clc2>, instead of blowing out to more than $1 as earlier expected.
"There's something odd about the spreads," said Michael Cohen, head of energy commodities research at Barclays (BCS) in New York. Cohen reasons that spreads should widen - not narrow - because of softer demand after summer driving season and the start of refinery maintenance work.
One possible explanation: oil production may be slowing even more quickly than many expect. With official output data released with a lag, cash prices may be the best real-time indicator of tightening conditions.
Cohen warns though that a rebound in prices could prove short-lived because it could spur producers to pump more oil again.
WHAT CONTANGO?
Cash markets where producers sell physical commodities directly to consumers, without the influence of financial investors, are often regarded as a leading indicator for more speculative futures markets.
Traders and oil executives are saying that U.S. cash markets could be sending now such a signal to the futures markets, where the fundamentals of U.S. shale oil supply and demand have become a central factor.
"We think the market is rebalancing as we speak," EOG Resources Inc Chief Executive Bill Thomas said at the Barclay's Energy-Power Conference this week. "We think prices could be a little better next year than they are now."
Cash prices also point to strengthened demand. On Thursday, traders paid 10 cents more to receive October delivery in Cushing instead in September, the smallest charge since the market moved into a contango, where later deliveries are more expensive than those in the immediate future, last year. Three weeks ago, traders paid up to 25 cents more for the October crude.
To be sure, inventories, down from a record high of 62.2 million barrels in April are still relatively high at 56 million barrels compared with just over 30 million at the end of last year.
Dominic Haywood at Energy Aspects in London, expects they will begin rising again as more refiners shut for work, especially in October. That would cause spreads to widen again.
The strength in physical markets coincides with new data, though, showing that booming U.S. oil production has moved into reverse. Last week, the Energy Information Administration released survey-based figures showing that U.S. output in June had fallen to 9.3 million barrels per day from a 9.6-million bpd peak in April.
Next year's output could fall further by as much as 400,000 bpd, according to an International Energy Agency report on Friday. In addition, shale oil drillers cut back on their rigs for the second week running, reversing a brief two-month rise.
Even so, some traders advise caution. They note that Gulf of Mexico grades such as Light Louisiana Sweet <WTC-LLS> and Mars Sour <WTC-MRS> are still relatively weak, and that markets in Europe remain glum.
"Globally, we're still over supplied," said one crude trader. "(But) there will be whiplash at some point when production really falls off."
Reporting By Catherine Ngai