ANALYSIS: US Gulf Coast adoption accelerates as deliveries outpace Cushing – research

Physical deliveries in ICE’s Midland West Texas Intermediate (WTI) futures, deliverable at Houston terminals (HOU), have outpaced the equivalent CME Group contract deliverable in Cushing (CL) this year, according to analysis of exchange disclosures (see graph 1). ICE last month saw a record of over 8.7 million barrels delivered against HOU futures for its November contract.

Open interest on October 31 was 137,000 contracts, 89% higher than this time last year while average daily volume this year has doubled to 21,500 lots, according to the exchange.

Graph 1

Source: Exchange physical delivery notices

While deliveries have gapped up, CME Group’s main Light Sweet Crude CL contract reported in September ADV up 6% on the same month last year to 986,317 contracts while open interest was flat on last year at 1.8 million lots, according to FOW Data.

Nevertheless, there has been a shift in factors feeding demand for WTI Midland in price discovery, according to the research.

One factor has been the rise in shale production, particularly in the Permian Basin in the US, increasing the grade and supply of US crude oil. The second is the inclusion of WTI crude oil in the basket that determines pricing for Brent oil from the North Sea in Europe.

“As Permian production continues to grow and outpace the overall US crude oil production growth rate, pricing WTI Midland at Houston will become increasingly more important,” said the report authored by Cory Stewart, pricing director at General Index, and Mike Wittner, global head of oil market research at ICE. “’Pure’ WTI (i.e, Midland-origin and Midland-quality crude) is demanded by refiners the world over and it meets the quality specifications for delivery in to the Brent complex.”

The report said WTI Cushing is typically a blended crude that results in lower quality grades than the Midland equivalent. Speaking as the firm presented results at the end of last month, ICE chief operating officer Stuart Williams pointed to the importance of WTI Midland for price discovery as the US group reported a significant increase in open interest across its oil complex.

“You'll recall that a few years ago, we set up a new market in the US Gulf Coast to better reflect the export price of Permian WTI coming out of the US Gulf Coast,” Williams said on a call with analysts. “As the US continues to export more and more Permian grade WTI, and as that grade is now linked into Brent, we're seeing a lot more physical participants in the US Permian producers using our numbers to price their exports out of the US Gulf Coast.

“You might have seen just this last week, the shale producer Continental Resources announced that it was switching its Permian pricing to ICE's HOU contract, which is replacing a differential to WTI Cushing. So that's all pointing in a good direction at the increased participation.”

CME pointed to the increased use of WTI weekly options as the US group reported its crude oil market growing by a fifth in the third quarter, according to CME results commentary.

Nevertheless, the research suggests, the Houston pricing complex has increased in importance by grasping some of the traditional issues such as the need for storing capacity in Cushing before transporting to the Gulf Coast, and three-day purely physical trading window during the month without derivatives expiries.

“Pricing US crude based on Cushing is antiquated, fraught with irregularities and creates confusion for buyers unfamiliar with the US market,” the whitepaper said. “Houston now stands as the true representative market for US crude, and pricing there completely avoids two of the most obscure issues – devoid of any clear rationale – that have bewildered newcomers and troubled seasoned market players alike.”

Commodity index firms Platts and Argus added WTI Midland to the basket of crude oils used to calculate Brent for deliveries in June last year, the first time a US barrel has contributed to the European benchmark.

ICE reported on October 14 an open interest record of 3.77 million lots across its Brent complex.