Houston as a Global Crude Oil Benchmark: Two Futures Contracts Emerge to Foster WTI Price Discovery

Houston Port View
Blog November 15, 2018

The U.S. Gulf Coast emerged as a critical point of global price discovery for crude oil in recent years amid a confluence of domestic oil production in the Permian and Eagle Ford plays, reversals, conversions, and new construction of coastal-bound crude oil pipelines, and the advent of crude export movements. Houston, with a refining capacity of 2.2mn bpd, 93.6mn bbls of operational and maintenance crude storage capacity, and proximity to the prolific Permian Basin, now rivals traditional pricing locations like Cushing, OK, and St. James, LA, in terms of importance in the U.S. and global crude oil supply chain. The launch of CME’s West Texas Intermediate (WTI) Houston (HCL) crude oil futures contract on November 5 and ICE’s Permian WTI (HOU) Houston futures contract on October 22 reflects the changing U.S. crude landscape and highlights the continuing growing importance of coastal price discovery for crude oil. Genscape data provides a granular picture of the storage and pipeline fundamentals related to these new contracts – data that is not available anywhere else.

Contract Differences:

CME and ICE both launched flat-price futures contracts for Houston-based “WTI type” crude in the past few weeks to capture the market interest in U.S. Gulf Coast price discovery and to position Houston as a potential global benchmark location. While the launch of these two contracts is indicative of the importance of Houston as a trading hub for light sweet crude, they each represent separate crude streams.

The primary catalyst behind the development in a Houston-based market is the rampant growth of crude oil production in the Permian Basin (where WTI is produced) and the resulting changes in pipeline and terminal infrastructure needed to deliver supply to domestic and international consumers. As of October, Permian Basin crude oil production reached nearly 3.6mn bpd, up 32 percent from the previous October and 72 percent from two years ago, according to Genscape's oil forecast data. By the end of 2019, Genscape forecasts that Permian Basin crude oil production will top 4.7mn bpd.

Permian
Figure 1: Permian Basin Crude Oil Production Forecast. Click to enlarge

ICE launched its Permian WTI futures contract (HOU) on October 22. This contract represents the value of WTI physically delivered into the 8.4mn bbl Magellan East Houston terminal. Magellan East Houston has direct pipeline connectivity to Magellan’s 275,000 bpd Crane, TX-to-Houston Longhorn and 400,000 bpd Colorado City, TX, to Houston BridgeTex pipelines that deliver WTI crude produced in the Permian to the Houston market.

From Magellan East Houston, crude oil is accessible to other Houston area terminals and refinery locations via the Magellan Speed Junction terminal. The HOU contract quality specifications include gravity content of 36-44 API and sulfur up to 0.45 percent from the BridgeTex and Longhorn pipelines to Magellan’s East Houston terminal. These specifications reflect the pipeline specifications as defined by Magellan for its BridgeTex and Longhorn pipelines.

ICE’s HOU contract has seen interest grow since launching on October 22 with 347 lots of open interest after the first day of trading, rising to as high as 1,102 lots of open interest at the close on November 12.

On November 5, CME launched its Houston-based “WTI type” futures contract. CME’s WTI Houston Crude Oil Futures (HCL) reflects the value of free-on-board (FOB) barrels of “WTI type light sweet crude” from the Permian Basin and Eagle Ford to Enterprise terminals in Houston. The “WTI type” crude is defined by CME as a physically delivered barrel with gravity from 40-44 API, and a sulfur content less than 0.275 percent, a common stream of “WTI type” crude as defined by Enterprise Product Partners.

Deliverable on the contract is crude shipped on Magellan’s 400,000 bpd BridgeTex and 275,000 bpd Longhorn pipelines, Enterprise’s 575,000 bpd Midland-to-Sealy, and the 660,000 bpd Eagle Ford pipelines (all Enterprise lines listed above end in Sealy, TX, and feed into Enterprise’s 1 mn bpd Rancho II pipeline that terminates at ECHO). The CME as the contract also includes crude shipped on Kinder Morgan’s 300,000 Crude and Condensate (KMCC) Pipeline from the Eagle Ford and three pipelines from Cushing (Enterprise’s 850,000 bpd Seaway pipeline system and TransCanada’s 700,000 bpd Gulf Coast pipeline. These pipelines deliver to Enterprises’ 6.8mn bbl ECHO terminal, Enterprise’s Genoa Junction crude terminal (a pipeline junction point near Fairway’s 7.293 mn bbls of storage at the Houston Caverns) or Enterprise’s 8.35mn bbl Houston Terminal on the Houston Ship Channel.

Houston Crude Oil Supply Chain
Figure 2: Houston Crude Oil Supply Chain Logistics and Physical Delivery Locations for Future Contracts. Click to enlarge

 

Open interest in the CME HCL contract has grown since launch, but trails behind current ICE open interest levels. After starting out on November 5 at 21 lots, it stood at 84 lots of open interest by November 12, with volume of 466 lots transacted that same day.

While interest in both contracts has grown since their respective launches, the differences in quality specifications and the magnitude of the underlying supply source between the two contracts could ultimately determine which one becomes the pricing benchmark.

By defining the physical delivery location as Magellan East Houston, ICE’s Permian WTI futures contract is based on Permian-sourced barrels. Historically, U.S Gulf Coast and international refiners have preferred Permian-sourced WTI to “WTI type” blended barrels due to greater consistency in quality specifications and distillation curves.

In comparison, the CME WTI Houston Crude Oil futures contract casts a wider net of potential supply sources and delivery locations by design, with potential supply available for delivery into the contract sourced from Permian, Eagle Ford, and potentially “Domestic Sweet” Cushing blends via Enterprise’s 850,000 bpd Cushing-to-Houston Seaway pipeline system and TransCanada's 700,000 bpd Cushing-to-Houston Gulf Coast (Marketlink) pipeline. The sulfur and API specifications for the CME contract in Houston are tighter than the CME specifications for the Cushing, OK, light sweet futures contract, aligning with industry trends to bring consistency to “WTI type” blended common streams.

So far, ICE’s HOU contract seems to be the preferred of the two contracts for WTI delivered in to Houston. Traders speculated on the higher interest in ICE’s contract, saying that the market for WTI at MEH was already an established liquid market and that it benefited from being the first contract to launch.

“(The) Industry wasn’t ready, surprisingly,” one trader said. “Maybe the poor arb(itrage) prospects in November and now December is an issue, also. Some players want to look before leaping.”

Given the optionality available to traders deliverable on CME’s HCL contract – eight pipelines versus two on ICE, and three terminals compared to one – market sources expect it to gain traction eventually.

“I expected better from the new CME contract,” he said. “I still think it succeeds…The ECHO location is very useful to numerous players, and the physical delivery mechanism is useful for converting pipe batches to cargo stems.”

Recent Trends in Houston Storage and Pipeline Flows:

Through its proprietary monitoring network, Genscape covers 83.7mn bbls of operational storage in Houston on a weekly basis, including the terminals identified as physical delivery locations in the two recently launched futures contracts. In addition, Genscape monitors 3.5mn bpd of inbound crude oil pipeline capacity, including 100 percent of the pipelines that feed into the CME and ICE contracts’ physical delivery locations (Longhorn, BridgeTex, Rancho II (fed by Midland to Sealy and Enterprise Eagle Ford), Seaway, Seaway Twin, TransCanada Gulf Coast and KMCC to Houston). Genscape's Gulf Coast pipeline monitoring covers 84 percent of overall inbound capacity to Houston (onshore and offshore).

As of October, most inbound crude pipelines to Houston were running near capacity. Enterprise’s 850,000 bpd Seaway system averaged 90 percent utilization in October while TransCanada’s 700,000 bpd Gulf Coast pipeline averaged 93 percent utilization. Out of the Permian Basin, Magellan’s Longhorn and Bridgetex pipelines are virtually full, with both averaging above 90 percent utilization, as of October 2018. Enterprise’s Midland-to-Sealy pipeline, which connects to the 1mn bpd Rancho II pipeline at Sealy and can deliver into Enterprise’s ECHO terminal, is the only slacked line, having averaged 75 percent utilization in October, according to Genscape's Gulf Coast Pipeline data.

Houston
Figure 3: Houston Inbound Crude Oil Pipeline Flows. Click to enlarge

Crude storage volumes in the Houston area rose through the end of October, when the monthly average hit the highest point of the year of 37.7mn bbls. Combined storage levels at Magellan East Houston, and Enterprise’s ECHO and Houston terminals similarly grew from September to October, reaching 8.5mn bbls, on par with the year’s highest level reached in March. From January 2017 to October 2018, Enterprise constructed 5.4mn bbls of operational storage capacity across the three terminals, enhancing the attractiveness as crude delivery points, according to Genscape's Texas Gulf Coast Storage data.

Magellan East Houston developed the newest storage of the three terminals, bringing 2.3mn bbls online. The Enterprise Houston Terminal closely followed with 2.3mn new bbls and ECHO rounded out the total with 750,000 bbls, according to Genscape. Genscape's storage data delivers weekly insights on inventory changes at the Magellan East Houston, ECHO, and Enterprise Houston terminals, along with all other terminals across Houston, Beaumont-Nederland, and Corpus Christi, granting granular access down to the tank, facility, and operator levels, unlike PADD-aggregated governmental estimates.

Houston
Figure 4: Average Monthly Storage Levels for ECHO, Houston Terminal, and Magellan East Houston Facilities. Click to enlarge

Conclusion:

The introduction of the CME and ICE crude oil futures contracts cements Houston’s role at the forefront of the global crude supply chain and crude oil price discovery. The contracts establish a benchmark for WTI type crudes in one of the most important export and refining centers in the world, connecting the Americas to benchmarks in Europe and Asia. Understanding the value of and underlying fundamentals for crude oil delivered to Magellan East Houston, ECHO, and Enterprise Houston terminals necessitates the storage, pipeline, refinery, waterborne, and market information that Genscape reports deliver.

Genscape’s U.S. Gulf Coast Pipelines Report provides real-time crude oil pipeline data for 86% of pipeline capacity into Houston and Beaumont Nederland. Gain insight into critical pipelines that supply the U.S. Gulf Coast storage hubs and refineries by clicking here.

In addition, Genscape’s Texas Gulf Coast Crude Storage Report delivers weekly storage insights at key storage movements at the crossroads of the crude oil supply chain. To learn more, or to request a trial of Gensape's Texas Gulf Coast Crude Storage Report, please click here.