Narrowing Cdn Heavy Oil Differentials, Even Before OPEC Cuts Reduce Deliveries To US

Jan 16, 2017


Cdn heavy oil prices are off to a strong start in Jan with differentials narrowing by ~US$2.50/b so far in Jan, and this is before the OPEC cuts lower medium/heavy deliveries to the US.  This strong start to Cdn heavy oil prices in Jan has been overshadowed by last week’s announcement of BC’s conditional approval of the Trans Mountain expansion (see our Jan 12 blog [LINK]) that should provide support to Cdn heavy oil prices post 2019.

As expected, Cdn heavy oil is benefiting in 2017 with a better (lower) differential for WCS less WTI.  The below Bloomberg graph shows that , since Jan 1, the WTI discount to WTI has narrowed by ~US$2.50/b.   WCS is Western Canada Select, the marker price for heavy sour Cdn blended oil with a nominal API gravity of 20.5 and sulfur content of 3.4%.

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Source: Bloomberg

We say as expected because the thesis, post the OPEC Nov 30 cuts, was that OPEC producers would first cut medium/heavy oil instead of light oil ie. so they can maximize production of higher revenue light oil barrels.  And that that cutting medium/heavy exports would primarily impact US deliveries and therefore help narrow WCS less WTI differentials.  But the narrowing differential wasn’t expected to really kick in until the actual OPEC production cuts flowed thru to lower deliveries to the US.

The expectation of reducing deliveries to the US was supported by consistent reporting in Dec that OPEC producers like Saudi Arabia were going to try to maximize deliveries to Asian markets and cut back on deliveries to the US and Europe.  There were others that reported similarly to the Dec 9, Reuters story “Saudis order oil cuts to U.S., Europe before non-OPEC talks[LINK] that highlighted the priority to Asia.  Asian markets have rightly been the primary fighting grounds for OPEC producers (and Russia) as these are the key growth oil demand markets going forward.

But the reason for our blog today is that it is important to note that this narrowing of the WCS less WTI differential is happening now, before the OPEC cuts have had a chance to lower deliveries to the US.  Recall that the OPEC Nov 30 cut agreement is “production” effective Jan 1.  The OPEC Nov 30 announcement said “countries participating in today’s meeting agree to commit themselves to the following actions: 1. In the fulfilment of the implementation of the Algiers Accord, 171st Ministerial Conference has decided to reduce its production by around 1.2 mb/d to bring its ceiling to 32.5 mb/d, effective 1st of January 2017;”

This is the key, deliveries to the US aren’t being cut yet, and it is being supported by the EIA’s US oil import data.   The US hasn’t seen any reduction in oil imports from key OPEC countries yet and won’t until Feb.  There were no significant production cuts in Dec by key OPEC producers who export to the US.  Bloomberg reported that OPEC Dec production was down 310,000 b/d vs Nov, but primarily due to Nigeria being down 200,000 b/d.  Bloomberg estimated that Saudi Arabia was down 50,000 b/d and Venezuela was down 40,000 b/d.   Whereas the agreed OPEC cuts were Saudi Arabia down 486,000 b/d, Iraq down 210,000 b/d and Venezuela down 95,000 b/d.

OPEC members were producing at high levels in Dec prior to the Jan 1 start date for production cuts.  And if we assume that a typical oil tanker travel time is ~5 days from Venezuela to the Gulf of Mexico, and 30 to 40 days from the Persian Gulf to the Gulf of Mexico, then the EIA’s most recent weekly preliminary crude oil imports by country will not reflect the Jan 1 start of OPEC cuts.  In fact, it likely won’t reflect the cuts from Saudi Arabia and Iraq until Feb.  The EIA’s current data is for the week ended Jan 6, 2017, and it shows how imports from Saudi Arabia, Iraq and Venezuela were at or near the highest levels over the past six weeks.

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Its been a good Jan for Cdn heavy oil producers with the WCS less WTI differential narrowing by ~US$2.50/b already in Jan.  This is positive as the US has not yet seen the impact of the OPEC production cuts starting Jan 1.  It has been consistently reported that OPEC producers like Saudi Arabia and Iraq will be cutting medium/heavy exports and that they are favoring deliveries to Asia at the cost of the US/Europe.  Saudi Arabia and Iraq Jan 1 production cuts should start to flow thru to lower deliveries to the US in Feb, which should provide additional support to narrowing WCS less WTI differentials.