West Texas Sour (WTS) in the Permian has been trading at a premium of $0.16/bbl YTD 2019 to its lighter counterpart, WTI Midland. This is a reversal of standard relationships between light sweet crude and intermediate sour crude which requires more complex refining and therefore often trades at a discount to less complex light sweet crudes. In a region where the average Delaware horizontal well is 46° API gravity and an average Midland horizontal well is 39.8° API gravity, could producing a lower gravity crude serve as an advantage? How long can the WTS to WTI Midland premium last and what are the key drivers?
Historically, the heavier crude grades have been used in not only local Permian refineries, but also for blending to help meet crude oil pipeline specifications. The value of the heavier Permian crude grades to be used in refining or blending can be seen in the West Texas Sour (WTS) compared to WTI Midland. WTS crude specifications are for a 38° API gravity crude with up to 0.5% sulfur compared to WTI Midland crude which is for a 44° API gravity crude with up to 0.45% sulfur. As light production has grown in the Permian, the relative value of West Texas Sour has increased due to a greater need for blending for both refiners and pipelines. In 2010, WTS averaged a $1.87/bbl discount to WTI Midland compared to a 2018 discount of $0.50/bbl and a 2019 YTD average premium of $0.16/bbl.
The light blue line on the chart above is the spread between WTI Midland and WTI Cushing and is an indicator of overall pipeline utilization and Permian infrastructure constraints. Conversely, the dark blue line is the differential between WTS and WTI Midland and captures crude quality dynamics. One of the drivers of WTS pricing is blending crude to meet pipeline specifications. The table below shows that almost 60% of existing Permian pipeline capacity has a max API gravity specification of 44° or 45°.
Therefore, taken in context with the fact that ultralight (45°-55° API) and condensate (>55° API) production has been surging, especially out of the Delaware Basin, creates a need for heavier barrels for blending. The intermediate and heavier crude produced in areas like the Central Basin Platform is a prime candidate. Most recently in 2014 and 2018/2019, this need to blend has strengthened WTS and even led to WTS trading at a premium to WTI Midland for brief periods. These periods closely tie to times when pipeline capacity out of the basin has been highly utilized, indicating that in periods of high utilization, meeting pipeline specifications is difficult and drives value in WTS.
While in-basin blending dynamics impact the WTS/WTI Midland spread, overall global supply dynamics likely play a role as well. As highlighted in our previous Energy Market Commentary “Lack of Heavy Crude Weighing on US Refiners”, there is a general shortage in the global market of heavier crudes and an oversupply of light crude due to OPEC cuts and sanctions on Venezuela and Iran. As the Permian brings on as much as 1 MMb/d of new pipeline capacity later this year, the demand for WTS to blend to meet pipeline specifications may erode. However, globally, heavier crude grades are likely to remain in short supply and could continue to bolster West Texas Sour. For more on BTU Analytics’ oil market outlook and price forecasts, request a sample of the Oil Market Outlook.