Monday, May 24, 2010

JPMorgan sees U.S. crude at discount for "years"

(Reuters) - The U.S. oil benchmark price will on average be lower than its European counterpart for "the next few years," undermining West Texas Intermediate's (WTI) status as a yardstick for global crude markets, JPMorgan said.

Front-month futures of WTI crude, priced at the U.S. mid-continent hub of Cushing, Oklahoma, where growing imports of Canadian crude are stored, settled almost $6 a barrel below North Sea Brent on May 14, the biggest discount in 15 months. The discount was at about $1.20 on Monday.

"It's not going to be a static relationship between international crudes and mid-continent crudes, but on average, over the next few years you are going to have to see WTI priced at a discount," Lawrence Eagles, JPMorgan's managing director and global head of commodities research said at the Reuters Global Energy Summit.

"You've got to see Canadian crude in particular trading at a significant discount to Gulf Coast crudes. That means WTI de facto is going to trade cheap relative to its historic norms."

U.S. crude had for decades commanded a premium to European and Middle Eastern supplies to attract transatlantic arbitrage cargoes and plug a deficit in the North American market.

Brent is the benchmark for about two-thirds of the world's oil, including the eastern Atlantic basin comprising Europe and Africa. Exports of most Middle Eastern grades to the Mediterranean and trade of selected Asia-Pacific crudes are also referenced to the European marker.

WTI reflects the specific balance between supply and demand at Cushing, detached from U.S. crudes produced along the Gulf of Mexico coast, which maintain a steadier relation to Brent.

Inventories at Cushing soared to 37.9 million barrels the week to May 14, government statistics from the Energy Information Administration show. Refineries in the U.S. Midwest have reduced crude intake over the past two months as they carried out spring maintenance.

Genscape, which uses visible and infra-red spectrum monitoring techniques to estimate storage levels at crude tanks in Cushing, said supplies rose even further to 39.46 million barrels in the week to May 18, or 77 percent of shell capacity, which cannot be exhausted because of operational requirements.


As U.S. oil demand slumped over the past year and a half, U.S. imports of Canadian crude originating mainly from Alberta's oil sands jumped to about 2.5 million barrels per day (bpd) from 1.5 million bpd a decade earlier, EIA data shows.

"Canadian crudes have to price themselves at a level which will encourage pipeline capacity to move crude out of the region," Eagles said.

"By virtue of storage economics, that means that if there is surplus of Canadian heavy sours, it translates into a discount for WTI."

The glut has also depressed the value of prompt WTI contracts relative to later-delivery contracts, a market structure called contango. The opposite structure is known as backwardation because of progressively lower prices for contracts further out.

An extended refinery maintenance season in Asia and the overhang at Cushing will delay an expected flip in the market structure from contango to backwardation until July or August, JPMorgan (JPM.N) said in a report dated May 21.


Eagles says the volatility in front-month WTI does not prevent it from remaining as a marker for crude produced in the U.S. and the rest of the Americas.

"Benchmarks are difficult to create. They tend to be chosen by the market, and as such, WTI still has a significant number of crudes which are priced off it," Eagles said.

But the emphasis may gradually switch to Brent as a headline figure, he said, because news organizations tend to quote the highest price, especially at times of rising oil costs.

"Brent has always been the more significant physical benchmark. Previously, when the price of crude was high, people always wanted to quote the highest crude benchmark and that was WTI. But if it is no longer the highest, then people will talk about Brent more."

The most liquid market for Brent crude futures is the ICE exchange, which centers trading of the contract in London, while for WTI it is the New York Mercantile Exchange.

"As always within all these markets, volume attracts more volume, liquidity attracts more liquidity. At the moment, you wouldn't say there is any sign that WTI liquidity is shifting significantly," Eagles said.

(Editing by Ramthan Hussain)

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