The new Permian West Texas Intermediate (WTI) oil contract just launched in Houston, the latest sign that the shifting nature of U.S. shale production is changing the way that oil is bought and sold. The new contract not only underscores the growing importance of the Permian basin as a source of production, it illustrates how the coast of Texas has become a core hub for the international oil trade.
The new contract
The Intercontinental Exchange (ICE) launched the Permian WTI contract on October 22, a contract based on the physical delivery of crude oil at Magellan Midstream Partners’ terminal in East Houston. “With the growth in shale oil production in the Permian basin in West Texas, which is now estimated at 3.5 million barrels a day, and increased U.S. exports alongside growing international demand for light sweet crude oil, Houston has become the central delivery point for U.S. crude,” ICE said in a press release.
At 3.5 million barrels per day (Mbd), Permian output has doubled over the last four years.
There are several factors that gave momentum to the decision to launch a Permian contract in Houston. First, U.S. shale production in the Permian has skyrocketed in recent years. At 3.5 million barrels per day (Mbd), Permian output has doubled over the last four years. Second, the U.S. is emerging as a major supplier of crude to countries around the world. Exports are up from virtually nothing prior to the lifting of the crude oil export ban in 2015, to over 2 Mbd today (although precise export levels fluctuate from week to week).
Third, the flow of oil from West Texas to the Gulf Coast bypassed the pipeline network and storage facilities in Cushing, Oklahoma, which is often been called the “pipeline crossroads of the world.” Cushing has the capacity to hold around 90 million barrels of oil, and movements in inventories have historically offered clues as to the health of the oil market. Inventories in Cushing are now near multi-year lows, but unlike in the past, oil traders are less concerned about dwindling stocks precisely because Cushing has seen its importance decline with the rise of Permian-to-Gulf-Coast oil flows.
Cushing has the capacity to hold around 90 million barrels of oil, and movements in inventories have historically offered clues as to the health of the oil market.
The diminished role that Cushing plays has meant that the Cushing-based WTI futures contract has also seen its star fade. Moreover, the price of WTI did not accurately reflect the price of oil in Midland, Texas, close to where booming shale production is located. The lack of takeaway capacity from the Permian has led to steep discounts for oil trapped in West Texas, with prices surpassing an $18-per-barrel discount to WTI in August. More recently, that discount has narrowed sharply, dipping to just $2.50 per barrel in mid-October, before rising again to about $6.25 per barrel as of October 24. Nevertheless, the differential between prices in West Texas and the price that crude could fetch along the Gulf Coast has been volatile, putting urgency on price clarity for oil on the Gulf Coast.
The differential between prices in West Texas and the price that crude could fetch along the Gulf Coast has been volatile, putting urgency on price clarity for oil on the Gulf Coast.
The new Permian WTI contract in Houston addresses many of these issues at once. The new contract will help provide price discovery, settlement and delivery of Permian crude at the Gulf Coast. It will capture the importance of rising light sweet oil from West Texas, but it will also offer a benchmark price for oil exported from the U.S., a trend that is growing in significance. “When we were designing the Permian WTI Futures, customers consistently told us that it was critical to offer a high-quality, well known crude oil spec deliverable in Houston, and available for the waterborne export market,” said Jeff Barbuto, Vice President of Oil Markets at ICE.
The new benchmark also bolsters Houston as a global energy hub. “Houston has become the pricing center for U.S. crude oil production and exports, and the new Permian WTI futures contract is designed to serve hedging and trading opportunities in this growing market,” ICE said in a statement.
With more buyers from around the world requesting U.S. crude, a Houston-based price point has become necessary. “A coastal pricing point for U.S. light sweet crude will be much more relevant in coming years as the U.S. crude export story continues to unfold with export markets and coastal pricing becoming more of a focus for U.S. crude producers,” John Coleman, Wood Mackenzie’s senior analyst North American crude oil markets, said in July after ICE revealed plans to initiate the contract.
The U.S. is expected to see crude exports surge over the coming years, more than doubling to 4.5 Mbd by the 2030s, according to WoodMac. S&P Global Platts believes the U.S. will hit the 4-Mbd mark within the next two years.
If the U.S. is to live up to export forecasts, it will require an expansion of export facilities.
If the U.S. is to live up to that forecast, it will require an expansion of export facilities. The only port that can handle fully laden very large crude carriers (VLCCs), which can hold 2 million barrels of oil, is the Louisiana Offshore Oil Port (LOOP). Others, such as in Houston and Corpus Christi, have water depths that are too shallow. For now, shippers are loading oil onto smaller vessels, which then transfer the crude to VLCCs off the coast in deeper waters. This “reverse lightering” process is costly and time consuming, and can run as high as $700,000 to $1 million per loading, according to the Wall Street Journal.
There is a race underway to expand export terminals. Several companies are competing to build or expand terminals, with about four projects under consideration. As the WSJ notes, there may not be a large enough market for that many facilities, so the early projects are more likely to be successful.
The new Permian WTI contract will be a central feature of this export boom.