Midland light-sweet oil prices have recently traded near parity with those at Cushing. This follows the peak pandemic-induced demand crash back in April that turned many price spreads on their head. Unless supply-demand fundamentals in the Cushing-Midland-Houston triangle change, the Midland-to-Cushing (Mid-Cush) differential swap curve is likely to remain near a $0-$1.00/Bbl premium..
Mid-Cush has recently weakened. The differential has fallen about $0.40 since its mid-July high of +$0.48/Bbl. Higher supply has likely played a part. Voluntary production shut-ins have nearly all returned as oil prices have rallied from their April lows. There is good evidence: several AEGIS clients have revised near-term production (consistent with public comments), much of the gas flows in the region have returned, and there has been little observable D&C activity to offset natural PDP declines..
An uptick in Permian production, from the shut-in lows, and the present bid Nymex WTI has had over the past few weeks, could be responsible for why Mid-Cush has traded closer to parity than in the recent past.
Midland to Houston and Cushing to Houston
In addition to Mid-Cush, price spreads between both Midland and Cushing to Houston have narrowed. These two corridors have compressed quite a bit since the beginning of the year. The Midland to Houston leg has tightened to below (what we estimate is) transportation cost at around $0.75/Bbl. Similarly, the market rate to ship crude from Cushing, Oklahoma, to the Houston area has collapsed to about $0.96/Bbl for the October swap. Spread compression has likely been caused by more competition among marketers for scarce barrels. Re-sellers of pipeline capacity are apparently reducing their rates to outbid each other for supply.
The large pipeline buildout in the Permian basin in the second half of 2019 provided excess takeaway capacity in the region. Recently lower production has given the region even more of a buffer for transporting crude out of the basin. Permian-basin oil production has fallen to just above 4 MMBbl/d, down from 5 MMBbl/d early this year, according to the EIA. And except for the brief period in April when storage capacity at Cushing was in danger, the Mid-Cush spread has stayed between $0.00 and +$1.00/Bbl due to excess pipeline capacity.
The Permian basin should have ample takeaway capacity for years to come even if oil prices rise moderately.
Excess pipeline capacity is likely to support the Mid-Cush spread for a few years. However, there are ways Mid-Cush could lose value. If Cushing’s price is especially strong, or if the Texas Gulf Coast’s exports or storage system is disrupted, Midland’s relative value to these other markets would diminish. The upside is more limited. We generally recommend hedging the Mid-Cush spread whenever it is positive. The potential for a large downward movement is greater than one to the upside.