Christmas Comes Early for Permian Refiners

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(Bloomberg Gadfly) -- A good definition of Christmas for a commodities trader goes something like “this thing that costs X over here costs X+Y over there.”

Christmas has come way early in Texas. As I wrote here, the spread between crude oil priced in Midland, Texas – the heart of the Permian shale basin – and the international Brent crude benchmark has blown out from about $3.50 a barrel two months ago to almost $14 a barrel, the widest in about three years. The shale boom has run into logistical constraints, forcing an increasing amount of barrels in West Texas to be priced at a discount as they seek alternative (and more expensive) routes to market, such as rail-cars or trucks.

The cure for spreads is infrastructure. New pipelines aren’t due to show up until the second half of next year. So that means anyone owning existing infrastructure has a rare opportunity here.

Refiners have a ton of infrastructure. You may recall they did very well in the few years leading up to the lifting of U.S. crude-oil export restrictions. In effect, they bought discounted crude barrels bottled up inside the U.S. and then processed them into exportable products such as gasoline that could be sold at world prices, thereby pocketing a fat margin. What’s happening right now in the Permian basin is like a localized version of that.

In a report Wednesday morning by Tudor, Pickering, Holt & Co., analysts noted the widening spread between West Texas Sour crude oil priced at Midland and West Texas Intermediate priced at Cushing, Oklahoma (the physical hub for settling Nymex futures contracts). This has blown out to about $8.50 a barrel.

More importantly, futures have widened even more, with the spread on December prices now almost $10. That means refiners on the ground such as Delek US Holdings Inc. and HollyFrontier Corp. have an extended period in which to take advantage of this Texan disconnect.

Things are less fun on the exploration and production side, where discounts mean less cash flow even as international prices are higher than $70 a barrel.

Some are better protected than others, though. Pioneer Natural Resources Co., for example, transports about 80 percent of its Permian oil to the Gulf Coast under firm pipeline contracts – something it made a point of mentioning on its earnings call in February. It is also building new export capacity in Houston, due for completion this summer. Other E&P firms in the area with access to significant pipeline exit capacity to defray their local pricing exposure include Occidental Petroleum Corp. and Parsley Energy Inc.

E&P firms that aren’t tied completely to the Permian basin should also benefit while the window is open. The Permian has tended to suck all the oxygen out of the room vis-a-vis the Bakken and Eagle Ford basins. The latter, especially, may benefit from renewed interest while its prolific cousin to the north sorts out its bottlenecks. One company that springs to mind is Carrizo Oil & Gas Inc., where an activist is pushing for the company to sell its Eagle Ford position.

Eventually, these spreads will attract enough dollars to close them back up again. In the meantime, those that can celebrate will.

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

©2018 Bloomberg L.P.

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