August 4, 2013

Kansas segment of oil pipeline to begin

The vast stack of oil pipe lying in a field north of El Dorado is part of a great race between rising oil production in the middle of North America and the ability to move that oil to market.

The vast stack of oil pipe lying in a field north of El Dorado is part of a great race between rising oil production in the middle of North America and the ability to move that oil to market.

Construction will start this month on the 260-mile-long Tallgrass Pony Express pipeline connecting an existing pipeline in Lincoln County to the pipeline/storage hub at Cushing, Okla.

When completed next year, the pipeline will carry up to 320,000 barrels a day of crude oil from the burgeoning production in North Dakota to refineries further south.

Pipeline companies are building capacity to carry the dramatic increase in oil production in the center of the North American continent. In the last two years, the surge in production has caused an oil oversupply at Cushing, allowing savvy traders there to buy oil at a discount. That has cost Kansas oil producers and helped Kansas oil refiners. But, in the last month, as more pipelines and other transport have come on line, the bottleneck at Cushing – and the price discount – has eased.

Starting in early July, the price for Kansas Common jumped to more than $90 per barrel, according to price postings by McPherson refinery NCRA. The average price of $94.60 per barrel for July is $9 to $13 per barrel higher than monthly averages over the first six months of 2013.

“There is some fairly clear evidence we are draining the swamp,” said analyst James Williams of WTRG. “And that’s having a direct impact on Kansas producers, everybody north of Cushing, really.”

WTI-Brent spread

The Kansas Common price is tied directly to the price of West Texas Intermediate crude, for long the benchmark for American oil prices. For decades, the price of WTI, which is set at Cushing, traded within a few dollars up or down from Brent Crude, the benchmark for international oil. Starting in January 2011, oil from the Canadian tar sands, the Bakken field of North Dakota and Montana, as well as other fields invigorated by stepped up drilling, really started to flow south. But the pipeline network wasn’t configured for this new supply. Instead, most of the pipelines in the region were built to carry Texas and Gulf oil north into the Midwest, not the other way around. So, much of the new oil is carried via more expensive barges, rail and trucks.

As oil flowed south, and the amount stored and traded at Cushing grew, the price for WTI traded at a discount to the Brent price – a discount as high as $24 per barrel. One of the main beneficiaries has been Midwestern refineries, such as HollyFrontier, which has a refinery in El Dorado; CVR Energy, which owns the refinery in Coffeyville; and NCRA. They have been buying at a discount and selling gasoline and diesel at national prices, fattening up their margins.

But pipeline owners have been busy. The owners of the 150,000-barrel-per-day Seaway Pipeline between Cushing and Houston reversed the flow to take oil south, opening it in June of 2012. They raised capacity to 400,000 barrels in January. Another pipeline was converted to carry crude produced in west Texas directly to the Gulf, bypassing Cushing. As a result, the amount of oil sitting in storage at Cushing is down about 10 percent from where it was a month ago, said Williams.

And the carrying capacity will continue to rise. One piece of the Keystone XL pipeline that has been approved, from Cushing to Port Arthur, Texas, is under construction and will start carrying 400,000 barrels per day in December. And the owners of the Seaway want to expand pipeline capacity to 850,000 barrels per day by the first quarter of 2014.

Longer term

But the bottleneck isn’t completely gone. Oil production in the Midwest and Canada continues to rise and put pressure on the transport infrastructure.

Jack Lipinski, CEO of CVR Refining, told analysts in a conference call on Thursday that its margins have been hurt by the narrowing of the WTI-Brent spread, but that won’t last.

“Our view is the Brent-WTI spread will once again widen as additional shale-based crude is produced,” he said.

The price of CVR Energy stock is down about 6 percent since Thursday.

The rise in prices is nice for Kansas’ producers, said David Loger, executive vice president of Lario Oil & Gas Co. in Wichita, but not really that meaningful.

The oil wells here are already profitable, with costs relatively low – about $500,000 to complete a vertical well – and production relatively low, say several dozen barrels a day. He said he doesn’t see any more drilling for his company in Kansas as a result of the price increase.

But Lario also has wells in North Dakota, where the wells are $8million to $10million, but have the potential to produce several hundred barrels a day. That, he said, is where people will push to drill more because the payoff is potentially so high.

Regardless of whether the production system favors producers or refiners, the end sum, Loger said, is good news for the country as a whole.

“It’s good for America because we’re not importing that oil,” he said, “so we’re not paying through the nose for it, and it’s creating good jobs here.”

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