The current volatility of crude oil spreads like Brent/WTI and Brent/LLS are a sign that, when it comes to light, sweet crude in the US, refining capacity limits are being reached, Ed Morse, head of commodities research at Citigroup, said Friday.
At a press event for the release of Citi's annual market review, Morse was asked whether the US will soon run out of refining capacity as US production of crude oil continues at a high pace.
"Broadly, we think there is growing investment in capacity to move beyond what we currently identify," he said.
Morse said his research group had identified 700,000 b/d of clear capacity to refine more light crude than is currently being done.
"The 700,000 b/d is less than the 1.1 million b/d of growth in the system as a whole," he said. "But there is about 300,000 b/d of new investment to increase capacity to run light crude."
Morse noted that Citi does not have a full view of the 8 million b/d US Gulf Coast refining system "because we don't know about two very large refiners [there] and their capacity. We assumed it's about the same as comparable facilities."
By 2015, Morse said, the volatility in crude spreads currently seen as refiners go in and come out of maintenance periods will reach a limit.
"Clearly the limit has a number of variants to ease the problem, including the alleviation of the Jones Act, to make it easier to move crude by ship, rather than rail, to refiners on both coasts," Morse said.
Also, he said, a further extension of what is embodied in the free trade agreement with Canada and other countries, could work to move expanding US crude production elsewhere.
"We have free trade agreements with more than 20 other countries, some of whom are potential importers of light crude, ranging from Mexico to Korea and Chile," Morse said. "It's something that would probably push those governments to move to add those arrangements that are embodied in the arrangements of the free trade agreement with Canada." The agreement includes a provision that US crude exported to Canada must be refined there, he said.
Eventually, Morse said, the debate on US exports will be raised, although it has already been heading in that direction. BRENT/WTI SPREAD TO REMAIN VOLATILE
In its annual market outlooks, Citi analysts said that crude exporters may be willing to supply crude to the US at a discount to global prices, if it supports the rest of their portfolio, which could keep a larger wedge between the price of Brent and WTI.
"Every time each exporter diverts a chunk of their supplies elsewhere, Brent/WTI could narrow. But it could be more of a case of Brent coming down to WTI, than WTI rising," the report noted.
Since reaching parity in late July, the front-month Brent/WTI spread has been volatile, widening to around $8/b in early September, then narrowing back near $2/b about two weeks later.
By mid-November, however, the spread widened to more than $15/b, and has since continued to trade within a tight, sideways range.
Brent's premium to LLS also recently blew out, moving to more than $12.60/b this week. LLS had been at a premium to Brent for most of the year before flipping to a discount on August 19.
"The blowout in the Brent/LLS spread should remind us that while there remains ways to absorb the crude glut that don't require larger Gulf Coast discounted in theory, frictions and time lags can mean growth absorption can fall behind growth in crude availability," the analysts said.
But when each chunk of the glut is cleared, this can cause pops in Brent/WTI, "especially if combined with times of high refinery runs and say, Syncrude outages."
Citi analysts have forecast a base Brent/WTI spread of $2-$3/b in the first quarter of 2014, then moving closer to $7/b by the fourth quarter of 2014.
Out to the fourth quarter of 2015, the base spread is forecast around $8-$9/b, with bearish outlook nearly $10/b and the bullish outlook around $1/b.