U.S. Energy Information Administration - EIA - Independent Statistics and Analysis

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This Week in Petroleum

Release date: November 21, 2018 | Next release date: November 28, 2018

Recent changes introduced in U.S. and Middle East crude oil futures markets

Several changes to crude oil futures markets this year have expanded the scope of available contracts for market participants. Two new light, sweet crude oil contracts for delivery in Houston, Texas, began trading recently, expanding hedging and trading opportunities for Permian producers, U.S. Gulf Coast refiners, and foreign purchasers of U.S. crude oil. Also, Saudi Aramco, Saudi Arabia's state-owned oil company, began using the Dubai Mercantile Exchange's Oman contract for determining a portion of its Asian official selling price (OSP). Although not expected to disrupt the roles of West Texas Intermediate (WTI) at Cushing, Oklahoma, or North Sea Brent as benchmarks, the new contracts as well as a major oil producer now using the Oman contract could alter current financial trading for crude oil.

The WTI Cushing crude oil contract on CME Group's New York Mercantile Exchange (NYMEX) has the most trading volume and open interest of all energy futures contracts for physical delivery in the United States. Last month, the InterContinental Exchange (ICE) launched a Permian WTI futures contract with physical delivery in Houston. CME Group launched a similar contract on November 5, after which these two contracts have traded at similar prices, averaging approximately $6.50 per barrel (b) more than the WTI Cushing price and about $3.50/b less than the Brent price through November 20 (Figure 1). Under normal market conditions, the spread between Houston and Cushing WTI crude oil would typically reflect the pipeline transportation cost to ship crude oil from Cushing to Houston, whereas the price spread between Houston and Brent reflects the cost of loading and shipping crude oil for export from Houston. The ICE and CME front-month contracts have averaged 61 and 192 contracts traded daily, respectively, from November 5 through November 20. In contrast, Cushing WTI and Brent traded daily averages of 654,164 and 334,012 contracts, respectively, during the same period.

Figure 1. Crude oil front-month futures prices

Although the physical qualities specified in WTI Cushing and the two new Texas contracts are similar, the new delivery location in Houston presents different market dynamics. With physical delivery on the U.S. Gulf Coast, market participants can trade U.S. light, sweet crude oil more effectively with international light, sweet crude oils, such as Brent, using the new Houston contracts than with using WTI Cushing. Because Cushing is landlocked and lacks incoming pipeline capacity from the U.S. Gulf Coast, waterborne crude oils cannot effectively reach the trading hub for arbitrage opportunities. By removing these location and movement considerations, a crude oil futures market on the U.S. Gulf Coast could reduce basis risk. Basis risk occurs in this case when market participants that trade spot crude oil on the U.S. Gulf Coast and traditionally use WTI Cushing futures for financial hedging are subject to independent price drivers that affect the Midwest crude oil market specifically, causing different financial outcomes than intended.

Many market participants could adopt one of the WTI Permian futures contracts to manage their crude oil price exposure, especially if a sufficient level of trading develops. In recent years, pipelines have been built directly from the Permian region to the U.S. Gulf Coast, with several more planned to be online by the third quarter of 2019. Many U.S. oil producers operate in the Permian region and could sell barrels against one of the contracts. In addition, the Texas Gulf Coast refinery region is home to almost 5 million barrels per day of refinery capacity, suggesting a potentially large diversity of contract buyers. Overseas purchasers could also use the contracts for financial risk management because Houston and other nearby areas are where most U.S. crude oil is loaded for export.

Outside of the United States, the Dubai Mercantile Exchange's (DME) Oman crude oil futures contract recently experienced unusual price volatility. Given the anonymity of market participant trades in exchanges, the exact cause of the recent volatility is unknown, but a contributing factor could be Saudi Aramco's new use of the Oman contract, which started in October. In July, the company announced plans to change its methodology for establishing the OSP to Asian customers. Originally, Saudi Aramco determined the price of its crude oil as a differential to the monthly average prices of Dubai crude oil and Oman crude oil as determined by S&P Global Platts, a price reporting agency. The company still uses this methodology for the Dubai portion of its assessment, but it changed the Oman portion to the DME's Oman average front-month price beginning with October trading.

During the last week of September, the Oman 1st–2nd spread (the difference between front-month prices and second-month prices) increased from 90 cents/b on September 21 to a peak of $5.50/b on September 26, settling at $3.31/b on September 28, the day of front-month expiration (Figure 2). During the same period, the Brent 1st–2nd spread declined from 56 cents/b on September 21 to settle at -1 cent/b on September 28 and WTI Cushing declined from 41 cents/b to 19 cents/b. Rapid and volatile price moves can occur when a lack of liquidity exists—ample buyers and sellers available to take the other side of a trade. Without sufficient liquidity, some sellers of the contract that wanted to close their positions (through buying) may have had to pay a significant premium to where the contract had been recently trading. Using the Oman contract as a way to hedge the Saudi Aramco OSP appears to still be under development, at least in these first months of use.

Figure 2. Crude oil futures 1st–2nd month spreads

Other Middle Eastern countries' refining and marketing arms, such as Iraq's Oil Marketing Company (SOMO) and Kuwait National Petroleum Company, have discussed potentially using the Oman contract for their pricing, and Saudi Aramco's recent use could lead to an increase in participation. Similarly, if more Asian refiners begin trading Oman futures, sufficient liquidity could develop to prevent such volatility near contract expiration dates.

U.S. average regular gasoline and diesel prices decrease

The U.S. average regular gasoline retail price decreased nearly eight cents from last week to $2.61 per gallon on November 19, 2018, up four cents from the same time last year. Midwest prices fell nearly 10 cents to $2.42 per gallon, Gulf Coast prices decreased nearly 8 cents to $2.31 per gallon, East Coast prices fell nearly 7 cents to $2.55 per gallon, Rocky Mountain prices decreased over 6 cents to $2.83 per gallon, and West Coast prices fell more than 5 cents to $3.35 per gallon.

The U.S. average diesel fuel price decreased nearly 4 cents from last week to $3.28 per gallon on November 19, 2018, 37 cents higher than a year ago. Midwest prices fell nearly five cents to $3.22 per gallon, West Coast and Gulf Coast prices each fell four cents to $3.77 per gallon and $3.05 per gallon, respectively, and Rocky Mountain and East Coast prices each fell nearly two cents to $3.36 per gallon and $3.30 per gallon, respectively.

Propane/propylene inventories decline

U.S. propane/propylene stocks decreased by 2.0 million barrels last week to 81.8 million barrels as of November 16, 2018, 1.9 million barrels (2.3%) lower than the five-year (2013-2017) average inventory level for this same time of year. Gulf Coast inventories decreased by 1.0 million barrels, East Coast inventories decreased by 0.5 million barrels, and Midwest and Rocky Mountain/West Coast inventories each decreased by 0.2 million barrels. Propylene non-fuel-use inventories represented 4.4% of total propane/propylene inventories.

Residential heating oil prices decrease, propane prices remain flat

As of November 19, 2018, residential heating oil prices averaged almost $3.32 per gallon, 3 cents per gallon less than last week's price but 49 cents per gallon higher than last year's price at this time. The average wholesale heating oil price for this week averaged almost $2.19 per gallon, 9 cents per gallon less than last week but 14 cents per gallon higher than a year ago.

Residential propane prices averaged $2.42 per gallon, up slightly from last week and less than one cent per gallon higher than a year ago. Wholesale propane prices averaged almost $0.91 per gallon, nearly 9 cents per gallon more than last week but almost 22 cents per gallon lower than a year ago.