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Pipelines could mean more money for Kansas producers

  • The Wichita Eagle
  • Published Wednesday, Feb. 27, 2013, at 11:01 p.m.

Cushing may be just another modest-sized town in central Oklahoma, but below ground, it’s immense.

The town, halfway between Oklahoma City and Tulsa, serves as the connection point for oil and gas pipelines from the Gulf Coast, west Texas and the Midwest.

And now, with the North American oil industry in the midst of a dramatic surge in production, Cushing has become a bottleneck.

Pipeline developers are rushing to eliminate that bottleneck within the next two years, which promises more money in the pockets of Kansas oil producers and less for Kansas oil refiners.

According to the U.S. Energy Information Administration, during the next two years:

• An additional 1.2 million barrels a day of pipeline capacity will be added for delivering crude oil from Canada and the Midwest to Cushing.

• It will be balanced by 1.2 million barrels a day of capacity from Cushing to the Gulf Coast, plus 830,000 barrels a day of new pipeline capacity to move crude oil directly from the Permian Basin in Texas to the Gulf Coast, opening up capacity at Cushing.

The result, according to the EIA: no more bottleneck at Cushing.

Midwestern refiners have enjoyed a bonanza for a few years by being able to buy the surging ocean of oil at a discount.

HollyFrontier, which has five refineries in the Midwest and Rocky Mountains, including the El Dorado refinery, saw its profits rise 69 percent in 2012, CEO Mike Jennings said during a conference call with analysts this week. He cited the differential between buying oil from inland sources, processing it into gasoline and other products and selling it at national prices.

The differential between crude prices in the Midwest and prices on the coasts has grown larger in two years. The gross margins for the company were $24 per produced barrel in the fourth quarter, 57 percent higher than the same quarter of 2011 and almost three times as high as the same quarter of 2010, he said.

So while producers in the midcontinent region and Canada have seen enormous growth and success, they haven’t enjoyed all of the fruits of their success.

There is a roughly $20 difference between Brent crude, the world benchmark for oil, and the U.S. benchmark, West Texas intermediate, which is set at Cushing. Kansas oil is priced about $10 below similar grades at Cushing.

Kansas oil producer Mark Shreve, president of Mull Drilling, said that 60 percent of his production, from western Kansas, is carried by truck to a storage and pipeline hub. From there it goes to Cushing.

With more capacity at Cushing, he might get better bids for his oil from buyers.

“We are optimistic that it will turn into better prices for Kansas producers,” Shreve said.

Higher prices

David Loger, executive vice president of Lario Oil in Wichita, said he feels the Cushing discount acutely. The company’s oil from North Dakota’s Bakken fields commands a higher price than similar Kansas oil because the North Dakota oil moves by tank car directly to the Gulf Coast, bypassing Cushing.

Loger said he sees the new pipelines mainly cutting into the $10-per-barrel discount Kansas oil receives compared to West Texas intermediate. He predicts it will shrink, putting an extra $5 to $8 per barrel in the pocket of the producer.

But Jim Williams, an energy analyst with WTRG, said that doesn’t capture the full impact of eliminating the Cushing bottleneck.

As all that Canadian and Midwestern oil flows freely to the Gulf Coast, not only will Kansas producers erase the $10 discount to West Texas intermediate, but they also will eliminate the further $20 discount to Brent crude. The only difference in price will be for grade and transportation costs. That means, Williams said, that Kansas prices could rise to within a few dollars of the Brent crude price, currently nearly $118 per barrel – without any impact on the end consumer, who already pays the world price for gasoline and diesel. In other words, with no additional work, Kansas producers could get $20 to $30 more per barrel for their product.

Right now, much of that differential is going to refiners and shippers.

“It’s what happens when there is too much stuff in town and no more customers – you drop the price,” Williams said. “An oversupply gives refiners leverage.”

But Jennings, in the conference call, didn’t sound anxious about the future.

He said he expects the company’s strong margins to continue in part because it looks as if the amount of exploration and production will continue to grow.

What’s being built

The current pipeline system was set up at time when oil was mainly produced in Texas and the Gulf, refined there or carried to refineries in the Midwest. Oil and gasoline largely flowed north.

But the boom in exploration, mainly in the Bakken Shale in North Dakota and the oil sands of Alberta, Canada, means more oil is now being produced in the center of North America than can be consumed. And the prospects are that production will increase in the years to come.

Until the middle of last year, only one pipeline delivered crude oil from the Midwest to the Gulf Coast. The 96,000-barrels-per-day ExxonMobil Pegasus pipeline between Patoka, Ill., and Nederland, Texas, which originally shipped crude oil north, was reversed in 2006 to ship Canadian heavy oil to the Gulf Coast. In May, the 150,000-barrels-per-day Seaway pipeline, which shipped from the Gulf to Cushing, was reversed to ship crude south; it was set to be expanded this year by an additional 250,000 barrels per day.

According to the Energy Information Administration, other expansions also are planned this year. Expected to become operational in the fourth quarter is TransCanada’s 700,000-barrels-per-day Gulf Coast Express, the southern piece of the controversial Keystone XL pipeline. In early 2014, Seaway will open a second pipeline alongside its current one, increasing the combined capacity to 850,000 barrels per day.

A number of other pipelines are expected to join the network in 2014.

Reach Dan Voorhis at 316-268-6577 or dvoorhis@wichitaeagle.com.

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