Trouble In Pipeline USA
An oil glut in Cushing is sending shockwaves through the global marketplace.
Like huge watchful sentinels, towering tanks filled with oil or filling quickly with oil loom over Cushing and its immediate vicinity. Oil is less abstract here than it is in the rest of Oklahoma, where despite the state’s history in the energy sector, “black gold” is more often seen as an irredeemable boogeyman than it is as an industry that employs millions of people worldwide. Oil is a palpable presence in Cushing, even were one to pay no attention to the miles and miles of tank farms, storing oil from all across North America. In fact, it might be easier to see every one of the fewer than the 10,000 Cushing residents than it is to see every tank in every high-security tank farm.
“If you were to fly over Cushing, I’m not sure that you wouldn’t miss the community for all the tanks,” Brent Thompson, executive director of the Cushing Chamber of Commerce, told National Public Radio recently.
Oil and Cushing have been attached for generations. In recent years, however, culminating in today’s economic environment, it has become a troubling marriage within the industry and one that has some asking if Cushing’s days as Pipeline USA might just be winding down.
Welcome to the Boomtown
A wildcatter named Thomas B. Slick began an oil boom on March 17, 1912, when he brought in a gusher east of the town. Cushing became a center for oil exploration and production from nearby oil fields. At one point a couple of different refineries helped cement the town’s role as an energy epicenter. As the oil fields began to run dry, beginning in the 1940s, production and refining became less important. However, by then a maze of pipelines and tanks had been built and Cushing had become the nation’s pipeline crossroads. It was this status that led to the New York Mercantile Exchange (NYMEX) naming Cushing the price settlement point for West Texas Intermediate (WTI) light “sweet” crude futures contract in 1983 – the benchmark price.
Over the course of its century-long relationship with the oil industry, Cushing might not have grown much, but it has prospered.
“As it was yesterday and in the past, (the oil industry) is extremely relevant to Cushing, and it plays a very significant role in the economy,” says Thompson. “That role has increased in the past year or so. As they have built more (storage) tanks, the owners have added manpower, which has increased expendable incomes and had a major economic effect. I think they are hiring as many local people as they can who are qualified. It all adds to our tax base. Our schools are almost to the point that if state funds were to go away, we’d be all right.”
But even the most expert industry insiders assert that understanding the oil industry is no easy thing and that predictions are precarious.
“Historically, Cushing has been the center point for oil in America,” says Mike Cantrell, president of the Oklahoma-based Domestic Energy Producers Alliance (DEPA).
“Historically, it has been where prices are set. What’s changed is that asset has become a liability.”
A Funny Thing Happened on the Way to the Refinery
Oil isn’t like other products or even like other commodities. Its price and availability are not entirely market-driven. Into that equation one must weigh the roles of a global cartel, the dynamic of varying grades and means of extraction, the effects of limited supply, geopolitical realities and even the role of investment speculators. In the end, one might say, it is more akin to Nixon’s “beast”-like national security entity than it is to, say, corn.
“No one really understands how the oil markets work,” says Brad Carson, director of the National Energy Policy Institute and University of Tulsa professor.
“It’s not understood because the reserves are underground; no one knows where or how much is there. Plus, financial markets are involved. It’s not a market that’s freely traded – it’s controlled by a cartel.”
But experts do generally agree on the situation in Cushing. Perhaps that’s because it’s one of the more easily fathomed aspects of the industry nationwide.
Fundamentally, the future of the validity of the WTI Cushing benchmark price is in question because the amount of oil arriving at the pipeline crossroads of the world has been setting records, while relatively very little is being piped out. In fact, there are currently no outflow pipes at all to the massive refineries on the Gulf Coast. So instead of being shipped off and transformed into useful form, most of the oil being piped into Cushing is, instead, being warehoused in massive and constantly expanding tank farms.
“Crude can get in and can be shipped to some places, but not south,” Carson says. “That has led to the glut in Cushing. There is simply more coming in than can affordably be shipped out. The result is the storage that’s going on in Cushing. And then spot prices fall.”
Cantrell says that industry figures began seeing a problem with the imbalance in Cushing several years ago and that “we began worrying in 2009.”
“The first thing that started the glut is that no new refineries have been built in many, many years,” Cantrell says. “Most recently the flow of Canadian oil coming to Cushing has contributed to the problem.”
Canada is the largest foreign exporter of oil to the United States, accounting for some 2.5 million barrels of oil a day. That number has only been increasing in recent years because of new findings, Alberta’s rich oil sands and a controversial new means of extracting oil from once-daunting topographies. Also contributing to the increased inflow have been the early phases of a new pipeline system connecting Canadian crude to U.S. oil flashpoints. TransCanada’s $13 billion (when complete) Keystone system had an immediate effect on oil prices at the Cushing hub.
“As soon as we opened up the first phase of Keystone, prices instantly dropped,” says TransCanada spokesperson Shawn Howard.
Although an imbalance between intake and outtake at Cushing is the reason most cited by experts for the current glut, other factors also come into play.
“ConocoPhillips has one of the largest refineries in the U.S. (in the Midwest), and they have a line from the coast to Cushing, but they aren’t reversing it for outflow,” Cantrell says.
According to a Dow Jones Newswire report, Conoco could almost immediately alleviate a portion of the Cushing glut with a reversal of its Seaway pipeline, but it appears not to be in the company’s financial interest at the time.
If there is one other factor contributing to the bottleneck in Cushing, it is this: There is plenty of room for oil to be stored, and that capacity is increasing constantly. The energy transporter and distribution giant Enbridge has mammoth holdings in tank farms in Cushing, as does Tulsa-based Magellan Midstream Partners, among others. Both have expanded their holdings in recent months.
“In response to the marketplace demand for it, we’re building more merchant storage in Cushing,” says Enbridge Inc. spokesperson Larry Springer.
“Various entities have contracted with us for storage, and mostly they are long-term contracts. This is our third round of new tank construction.”
Furthermore, Springer says he is well aware that the handful of other companies that own Cushing oil tank farms are busily expanding, too.
In an email in response to an inquiry about the company’s recently expanded role in Cushing oil storage, Magellan Midstream Partners’ director of government and media affairs, Bruce Heine, wrote, “We are currently building 4.25 million barrels of crude oil storage in Cushing, which is underpinned by long-term commitments by our customers. The project is currently on schedule and expected to be operational in phases beginning second quarter 2011, with the final tanks in service by the end of 2011. If we obtain appropriate commitments from our customers in the future, we will be happy to build additional storage.”
Magellan Midstream Partners did not reply to requests for follow-up information.
Whatever the exact combination of influences has been, Cushing’s oil glut has brought down the price of Cushing oil. It is perhaps ironic that the simple rule of supply and demand comes into play in the complex world of oil prices, but it does. Contributing to the irony is that, in this case, depressed regional oil prices might not be a good thing, however counter-intuitive that might seem with gas prices hovering close to $4 a gallon.
Economic Well-being Doesn’t Grow On Tank Farms
There are a couple of problems with depressed crude prices in Cushing, and there are numerous entities that can be hurt by it.
“You could argue that the real loser is Cushing’s status as oil benchmark,” Carson says. “As the WTI price becomes severed from other benchmark prices, the less important it will be. Anyone selling oil denominated by WTI benchmark prices will get hurt.”
Carson explains that global benchmark prices should be roughly comparable.
“Brent Crude and Louisiana Light, for example, should be about equal, but WTI has gotten out of whack because of the glut,” he says. “Oklahoma producers are competing in a global market, except the price (of WTI) is artificially low. Companies selling will take a hit because of the WTI benchmark.”
The price difference between the coasts and Cushing has ranged to $20-plus less inland. The result has been damaging to regional oil interests. But the real threat might still be on the horizon, when producers simply bypass Cushing in order to go to market where they will get higher prices. The effects could be devastating to Cushing and to Oklahoma and regional providers who would have to pay more to transport product with no assurance that they could make up the difference in coastal sales.
“Right now it is costing Oklahoma $70 million a year in lost tax revenue and $700 million in negative economic impact,” Cantrell says.
Still, there appears to be no obvious villain when it comes to the precarious position of Cushing and WTI-denominated crude. Insiders agree that most parties warehousing oil are legitimately in the industry.
“We don’t discuss who our customers are, but they are a mix of producers, refiners and others who store and sell oil for purposes,” Springer says.
Carson says that the only parties he sees with any potential benefit from the Cushing glut are the owners of the tank farms. But, of course, they are only responding to demand.
Cantrell says that some of the held oil is surely owned by speculators holding onto it to earn greater returns in the future. But that percentage would seem to be minor considering that estimates are that Cushing is housing a whopping 10 percent-plus of the U.S. inventory. Furthermore, even industry entities reserve oil to take to market later, and it has not before resulted in a glut such as that in Cushing today.
In another bit or irony, residents of the inland western U.S. region might enjoy slightly lower gas prices – in exchange for the damage to the entire regional energy sector. Should producers eventually bypass Cushing, the gas price differential could rapidly fade away.
Outflow is the solution to the Cushing glut, and if the White House approves its plans, TransCanada has committed to addressing that situation with its Keystone XL phase. In late March, Cantrell says that the company agreed that it would construct the pipeline component connecting to the gulf coast before other additional components. It was a victory considering that DEPA had long been afraid that American oil wouldn’t have that access.
Howard says that the White House’s delay in approving the Keystone XL project is a contributing factor to the oil glut. In the end, he says, the company believes that everything comes down to market demand.
“As the U.S. economy recovers, demand will go up again,” Howard says.
Whether it is a result of a timely international pipeline, of several market forces, or even if it’s because of entirely unforeseen prompts, Brad Carson believes that the arcane oil market will re-set itself.
“WTI will get back in line with Brent,” he says. “Over time, it will balance out. It always has. If I had a bunch of trucks, I might go (haul some oil).”
In the meantime, construction of new and expanded oil tanks in Cushing goes on, and Pipeline U.S.A. is booming.
“We’re rolling,” Thompson says. “Once building stops – and no one knows when that will be – we’ll continue to be here. It will still be better than it was before.”