When the market closed yesterday, the spread once again approached 20% of the WTI price (This is more accurate way to measure the spread).
Brent is fast approaching $122/barrel (bbl); WTI stands north of $102.
Both benchmarks have accelerated; and both are now up 2.5% for the week.
Brent is also up 10.2% for the month, while WTI started its climb just recently. All of its monthly gains (at 2.4%) occurred in the past week.
But it's not just the rising price tag that has us concerned.
We are fast approaching that time of year when gasoline and diesel demand are at their peak.
In the U.S., more than 20 municipalities will introduce new summer gasoline mixtures by May 1.
Now, you might never have heard of this. But there are two types of seasonal gasoline.
There is a winter-blend and a summer-blend fuel.
The summer blend is mixed to cause less smog from its emissions. It is also designed to reduce pressure in your gas tank when summer weather reaches scorching temperatures.
Those additives traditionally add about 15% to the cost of a gallon of gas. And, the transition requires that U.S. refineries temporarily retool their production capabilities, which can lead to a short-term supply dip.
We will certainly see the highest gasoline costs on average in the U.S. market this summer.
Just how high?
We will be pushing $5 a gallon, even if the Iranian drama mellows, and no one closes the Strait of Hormuz.
Kent, You Mentioned a Positive Side to This?
In the Midwest, refinery capacity has been strained; however, there is a glut of crude coming from Canada, which is creating a discount for these companies.
By the beginning of this week, discounts to refiners were resulting in a barrel of Canadian synthetic crude from the oil sands going for as much as $40 below the price it could command on the world market.
This results from three things:
- Rising Canadian production in Alberta's oil sands
- Rising production in the Bakken tight oil field in North Dakota; and
- Diminishing pipeline capacity moving crude to the 10 largest refineries in places like Illinois, Ohio, Indiana and Minnesota.
Simply put, oil is "backing up" in the Midwest, and crude contract prices are restrained as a result.
But what I find so surprising about this situation is the timeframe.
The Keystone Quandary Will Be Solved
Like everyone else analyzing the markets, I agreed that the pipelines in the Midwest would reach their capacity in 2016—about the same time the Keystone XL (the next stage in the massive pipeline system down from Canada) would be ready.
Yes, we know that Keystone is having its political problems right now.
But it will be approved.
Engineers will alter the pipeline route, and construction will begin.
However, it now looks like maximum capacity in the Midwest will occur in 2013, three years earlier than expected.
Canadian producers would like their oil to reach the most desired U.S. refinery market—the Gulf Coast.
But since the bottleneck is forming well north of Cushing, Oklahoma (where the Nymex daily rate is determined, and the greatest concentration of pipeline interchanges is located) that is not going to happen until more pipeline capacity is added further up in the Midwest.
This brings us back to why Keystone XL is necessary.
As I said, there is this glut. But why is that positive?
It's because Midwestern refineries are able to use the WTI–Brent spread to their advantage.
Despite resulting price increases from that spread, the processing costs are actually declining in the Midwest.
That means refinery margins—the difference between what it costs to produce products from crude oil and the price those products can command on the wholesale market—are improving.
This means refinery profits are ready to pop.
But there are other important reasons this is true.
First. the growing supply of Canadian and Dakotan crudes has largely shielded Midwest refiners from the price impacts of dwindling North Sea output, and various other supply concerns going to a rising Brent price.
By playing the WTI–Brent spread, therefore, refiners in this part of the country are actually making money.
That is unlikely to stop until the supply glut is reduced.
It's having an upward effect on refining profits as a whole. This has been shown in the improvement of refinery stocks recently.
There is certainly still volatility in the refining market segment (as in the oil sector as a whole).
Yet refiners can play another kind of spread to offset it—so long as the prices of the crude oil flow upon which they depend remain subdued and demand continues to increase.
In the Midwest, the first of these two considerations will remain until additional capacity is added to the pipeline network.
A second is that unlike other parts of the world, demand in the American market has been slow to return.
Yet we are poised to see that change as we get closer to Memorial Day.
The precursors are already taking shape.
Here, that "other" spread refiners can use to offset pricing volatility kicks in. This is the "crack spread," which relates available crude to the amount of products like gasoline and heating oil produced from it.
You can even trade crack spreads in the futures markets.
But for the refiner, this is like dealing poker and being able to see the hand everybody else is holding.
By using what is called a "crack ratio," the producer can actually balance the available oil flow with the various products realized from processing it to end up with heightened profit levels.
Now this does not work all the time.
But as we move into the summer driving season, it is likely to prove successful for Midwestern refiners.
As the price of crude continues to increase, as the WTI–Brent spread continues to widen, and as the discount remains in place for Canadian oil, the crack ratio will work more often than not.
That means greater profits for the companies running those region-specific refineries and the investors holding stock in them.
However, I still need to put this in perspective.
Gasoline prices for everybody will be rising an average of 3.6 cents per gallon at the pump for each $1 price in a barrel of oil. Oil from Canada and North Dakota will still be discounted, yet its price will still be going up.
Just not as high as elsewhere.
For followers of U.S. reality TV, it seems there was another reason for Kim Kardashian to consider moving to Minnesota.
Kent Moors, Money Morning