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This key factor could impact Permian names like Pioneer and Concho

Ingrid Pan, CFA

Permian producers realize prices closer to WTI Midland than WTI Cushing

Oil and gas producers in the Permian Basin in West Texas suffer when the price of WTI (West Texas Intermediate) crude priced in Midland, Texas (WTI Midland) decreases relative to the domestic benchmark crude of WTI priced at Cushing, Oklahoma (WTI Cushing). Note that WTI Cushing is generally accepted as the U.S. benchmark for crude prices, as it’s a major storage and transportation hub for oil.

Permian producers suffer when WTI Midland crude decreases relative to WTI Cushing crude, as the price they realize on their oil is generally closer to the Midland crude price and when Midland crude prices decrease, they receive less revenue from the oil they produce. Some companies that this affects include Pioneer Natural Resources (PXD), Laredo Petroleum (LPI), Concho Resources (CXO), and EOG Resources (EOG).

Background: Why Midland and Cushing crudes have traded out of line

Midland crude had historically traded in line with WTI, as the above graph shows. However, over the past few years Permian production has ramped up significantly. Consequently, any disruption in takeaway capacity, which had been tight, caused spreads to blow out. For instance, if a pipeline that normally takes crude out of the Permian goes down for some reason, the crude must be redirected to other pipelines or find other transport. If these other options are fully used, it could cause a temporary glut of Permian crude, pushing prices downward. Plus, takeaway capacity in the Permian had lagged growth in production for some time, which had caused a price divergence between WTI Midland and WTI Cushing. Companies in the Permian generally receive a price closer to WTI Midland crude than WTI Cushing, so this price divergence had hit the revenues of Permian producers.

Midland has traded at points at a slight premium to Cushing, as infrastructure such as Magellan Midstream Partners’ (MMP) Longhorn pipeline have started service and helped to alleviate bottlenecks in the area. Also, Sunoco’s Permian Express Pipeline and the reversal of Magellan Midstream Partners’ Longhorn Pipeline are allowing more crude from the Permian Basin in West Texas to flow directly to the Gulf Coast, where much refining capacity sits, and bypassing the glut of crude that has accumulated at the Cushing storage hub.

The spread has recently widened again

Since early October, the spread between WTI Midland and WTI Cushing widened from near par to as wide as $7 per barrel. Currently, Midland trades around $4 per barrel below Cushing.

Pioneer Natural Resources (PXD) commented that this may have been a result of some disruptions on the Longhorn Pipeline, which is operated by Magellan Midstream Partners (MMP). The Longhorn Pipeline carries crude oil from West Texas (the Permian Basin region) to the Gulf Coast, where much refining capacity is. PXD noted that the Longhorn Pipeline was set to ramp up to 225,000 barrels per day, but “had some hiccups getting up to their full 225.” Also, an outage at a refinery in the Texas Panhandle affected demand for some Permian Basin crude, causing the spread to widen. PXD also commented that the takeaway capacity for Permian crude is still “very, very tight and will be tight until the next pipeline comes on mid 2014 and then two more in the first half of 2015, and so every time there’s a hiccup… it blows out.”

Though the spread between Midland and Cushing crude closed in earlier this year, in recent weeks, it has widened again. Further disruptions to Permian takeaway capacity could impact revenues of companies with production there. More capacity coming online, such as the reversal of the Longhorn Pipeline, can mitigate these risks. Investors holding names with Permian exposure such as CXO, LPI, PXD, and EOG may find it prudent to monitor the Midland-WTI spread. Also, several names with Permian exposure can be found in the Vanguard Energy ETF (VDE) and SPDR Oil & Gas Exploration & Production ETF (XOP).

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