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Midland-WTI spread remains tight, positive for Permian producers

2013.04.08 - Midland SpreadEnlarge Graph

  • Producers in the Permian region in West Texas generally receive prices on oil closer to the Midland crude price rather than the domestic benchmark of WTI.
  • Midland and WTI usually trade close to par, however, several times over the past two years the spread has blown out, sometimes to up to $20/barrel.
  • Spreads have tightened since the beginning of the year and in mid-March Midland actually traded to a slight premium and the two crudes now generally trade at par. The gradual closing of the Midland-WTI spread over the past several months has been a positive medium-term catalyst for Permian-based producers.
  • As of April 5, Midland crude traded just $0.05/barrel below WTI crude, unchanged from the week prior.

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).

Midland crude traded as much as $14/barrel under WTI crude at the beginning of this year, but narrowed throughout 1Q13. The spread as of last Friday, April 5 was $0.05/barrel, unchanged from a week prior. The narrower spread is a positive indicator for producers in the Permian as it means they are not getting as large of a haircut off of WTI.

Note that 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, it 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 of certain Permian producers such as Concho Resources (CXO). 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. The spread also remained wide into the beginning of 1Q13 and will likely affect earnings for the quarter somewhat. Confirming this, Concho Resources COO Joe Wright noted on the company’s 4Q12 call, “While pricing for the first quarter is not quite complete, it appears the average Mid-Cush differential will be in the range of $7.50 to $8 per barrel. As a result, our expected unhedged realization in the first quarter as a percentage of NYMEX crude is likely to be in the low 80s.”

Additionally, CXO had commented as to potential drivers behind the wider on its 3Q12 call in November 2012, “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.”

Note that in mid-March, Midland crude even traded to a slight premium above WTI as Magellan Midstream Partners stated that it expected to begin filling its reversed Longhorn pipeline system, which will carry crude from Crane, TX (in West Texas, the Permian region) to the Houston area. The pipeline will carry about 75,000 barrels a day of crude in mid-April, expanding to 225,000 barrels per day in the third quarter. The increased takeaway capacity from the Permian to end markets is a catalyst for bringing Midland crude pricing in line with other crudes such as WTI.

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, and spreads remained tight last week and Midland crude trades nearly at par with WTI in a positive medium-term catalyst for Permian names. However, as long as takeaway capacity is tight, disruptions like that CXO mentioned on its 3Q12 call can have the effect of causing the spread to widen significantly again. More capacity coming online, such as the reversal of the Longhorn Pipeline, can mitigate these risks. 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 Vanguard Energy ETF (VDE).