Permian producers benefitting from tightening WTI-Midland spreads
Oil and gas producers in the Permian basin in West Texas suffer when the price of Midland crude decreases relative to the domestic benchmark crude of West Texas Intermediate (WTI). This is because the price producers in the Permian realize on their oil is generally closer to the Midland crude price and when Midland crude prices decrease, they receive less revenue from the oil they produce. Some companies which this affects include Range Resources (RRC), Laredo Petroleum (LPI), Concho Resources (CXO), and EOG Resources (EOG).
Since the beginning of February, the gap between Midland crude and WTI crude narrowed from $2.35/barrel to $0.55/barrel. The spread traded as wide as $14.00/barrel at the beginning of January. The current narrower spread is a positive indicator for producers in the Permian.
Midland crude has historically traded in line with WTI, as seen in the above graph. However, recently Permian production has ramped up significantly. Consequently, any disruption in takeaway capacity, which has been tight, has caused spreads to blow out. For instance, if a pipeline that normally takes crude out of the Permian goes down for some reason, the crude must be redirected to other pipelines or find other transport. If these other options are fully utilized, the disruption could cause a temporary glut of Permian crude, pushing prices downward. Additionally, takeaway capacity in the Permian had lagged the growth in production for some time, which had caused a price divergence between Midland crude (which is priced in West Texas) and WTI (which is priced at Cushing, Oklahoma). Companies in the Permian generally receive a price closer to Midland crude than WTI, so this price divergence had hit revenues of Permian producers.
From October through January, the spread widened significantly. The spread affected 4Q12 earnings and will likely affect 1Q13 earnings somewhat. Confirming this, Concho Resources COO Joe Wright noted on the company’s 3Q12 call, “One current situation we’re watching is the recent widening of the Midland-to-Cushing differential. I believe much of the current spread is a combination of scheduled refinery maintenance at the Phillips 66 Borger refinery and outages along the Northeast caused by Hurricane Sandy. Current shipments to the Northeast from regions like the Bakken are now heading to Cushing, so we’ll keep an eye on this situation and expect that there might be some impact to the fourth quarter realizations, but probably not enough to alter our 2012 annual guidance.” CXO recently reported that in 4Q12 it realized a price of $81.28/barrel for its crude, compared to the WTI price of $88.17/barrel.
Since the beginning of the year, the spread has steadily tightened with the exception of a minor short-term spike in late January. Currently, WTI and Midland crudes trade nearly at par, which may be a signal that sufficient infrastructure has been put in place to transport crude out of the West Texas region. However, disruptions like that CXO mentioned on its 3Q12 call can have the effect of causing the spread to widen significantly again. Investors holding names with Permian exposure such as CXO, LPI, RRC, and EOG may find it prudent to monitor the Midland-WTI spread. Additionally, several names with Permian exposure can be found in the Energy Select Sector SPDR Fund (XLE).
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