Vast condensate production potential presents major market challenges

Eagle Ford production is likely to rival Bakken production levels in 2013 based on EAI, Inc.’s latest North American Shale Fairway Crude Supply, Logistics , Refining and Pricing Outlook study update and basin production tracking. EAI, Inc. is projecting Eagle Ford production to exit 2012 at 610 to 660 MBPD and to increase to 800 to 900 MBPD of liquids (crude and condensate) production in 2013. Production in North Dakota, which is dominated by the Bakken, was averaging 728 MBPD in September of this year and EAI, Inc. is forecasting ND production to approach 900 MBPD in 2013.

Eagle Ford hydrocarbon production grades from NGL and condensates to light crude grades. EAI, Inc.’s estimate for Eagle Ford liquid production by grade for December 2012 is estimated at 314 MBPD light (36-42° API), 135 MBPD very light (42-50° API) and 110 to 160 MBPD condensate (50° API plus). This was estimated by EAI, Inc. analysts via examination of current well level production statistics in the Eagle Ford. A recovery in natural gas prices would tend to broaden the ‘liquids fairway’ and contribute to longer term condensate supply. However, increasing condensate production is faced with increasing market and logistical challenges.

The combination of Eagle Ford, Permian, Gulf of Mexico and Inland supply growth will result in a growing overhang of supply exceeding Gulf Coast refining capability to process this type of crude once similar light crude imports are displaced. Light sweet and sour crude streams imported by Gulf Coast refiners are averaging 1300 MBPD in 2012. The growing condensate stream will tend to overshoot crude blending limitations and accelerate saturation of the Gulf Coast refining market. EAI, Inc. anticipates growing transport of Eagle Ford crude to the Northeast U.S. refining market but limited by the availability and cost of Jones Act Tankers.

Exports of crude and condensate (liquids at STP that have not been processed through distillation units) to foreign markets requires that a license be issued to the exporting company by the Department of Commerce with only Canadian export destinations currently being approved. At least two major oil companies have applied for licenses (one approved) to export light shale crudes to refineries in Canada and initially targeting Eastern Canadian refiners.

The petrochemicals market represents an alternative market outlet for condensate but currently cannot compete domestically with NGL-derived feedstocks that are in growing supply from newer shale plays. EAI, Inc. is also forecasting growth in the Western Canadian condensate market for bitumen blending and transport. All of these options are likely to be pursued to diversify market options and maximize wellhead netbacks for producers.

Insights into Brent, WTI Cushing, and Bakken Pricing

EAI, Inc. (Energy Analysts International) has announced the release of its North American Shale Fairway Crude Supply, Logistics, Refining and Pricing Outlook study which includes an assessment of likely short term and long term inland crude pricing relationships including WTI at Cushing versus Brent laid into the U.S. Gulf Coast.   The relationship between Brent crude pricing laid into the Gulf Coast market (as a benchmark), LLS at St. James and inland crude hubs such as Cushing, Clearbrook, and Edmonton is undergoing fundamental changes that will continue to make crude marketing, supply planning, and trading very dynamic especially over the next four years.  On a global scale, Western Hemisphere crude supply growth coupled with U.S.-Canada gasoline consumption declines, a slowing Asia Pacific market, and continued refinery rationalization in the Atlantic Basin will continue to have a significant impact on the light and heavy sweet crude market length that will spill over into the light sour and medium sour grade pools.   Some of these impacts are already being observed with Brent currently priced at $2.00 under LLS at St. James.

Crude pricing at North American inland hubs is undergoing major shifts as transportation capabilities and market access changes occur and production basin crude clearing prices shift accordingly.   Bakken crude clearing prices have increased relative to WTI at Cushing in response to growing transportation capabilities and movements to Gulf Coast, East Coast, and West Coast markets.  Bakken crude at the Clearbrook distribution hub has been periodically trading at a premium to WTI Cushing during the 4^th-quarter 2012.  Denver-based energy specialists EAI, Inc. (Energy Analysts International) expect Bakken crude prices to increasingly be set by the Northeast light crude market netback to Clearbrook and key Bakken distribution hubs like Alexander, ND.

Approximately 350 MBPD of Bakken crude currently moves to markets outside of the U.S. Central Corridor (PADD II) with much of this supply being transported to the U.S. Gulf Coast crude market at St. James, Memphis, and more recently the Houston market.  Although most of the Bakken crude supply bypasses the Cushing market, it continues to impact the Gulf Coast market outlet for Cushing crude along with growing supply from Eagle Ford, Permian Basin, and offshore Gulf of Mexico production areas. This will result in the Gulf Coast light-medium crude market being saturated by the 2015 to 2017 timeframe.  Increasing quantities of domestic light sweet crude being substituted for medium sour and heavy crude grades will result in another level of discounting that will help cover rail economics to alternative coastal markets for inland light crudes.

As detailed in its latest “North American Shale Fairway Crude Supply, Logistics, Refining and Pricing Outlook” study, EAI, Inc. has defined several distinct pricing phases for Bakken-WTI Cushing and Brent/LLS Gulf Coast pricing relationships including 1) the current Cushing to Gulf Coast transportation access limitation which will extend through much of 2013, 2) an open pipeline phase where WTI Cushing-Brent Gulf Coast differentials attain the most narrow levels and, 3) a Gulf Coast market saturation phase which will persist post 2015. This latter period will result in a re-widening of WTI Cushing-Brent Gulf Coast crude spreads to levels less than what we have witnessed over the last 20 months but representing a significant discount that will continue to drive rail movements to the coasts and advantageous inland refinery margins.

Saturation of light and medium grade crudes in the Gulf Coast refining market will contribute to the Cushing crude length along with increasing Permian Basin crude supply beyond pipeline capacity to the Gulf Coast, increasing local crude production from plays such as the Mississippi Lime formation, and surplus light crude from the Rocky Mountains including the Denver-Julesburg, Niobrara and Powder River Basins.  Ramp-up of heavy crude use in the Midwest by 2014 will also result in displacement of southern sourced light crude adding to effective supply length for Cushing.

Total NA Shale Fairway crude production is forecast to increase by over 50 % from 8.35 million BPD in 2012 to 11.4 and 12.6 million BPD by 2016 and 2020, respectively. This includes over 1.5 million BPD of heavy crude blends in Western Canada, 0.7 million BPD of medium sour from the U. S. GOM and the balance generally light sweet crude and some condensate. The primary contributors to the NA Shale Fairway production gains include heavy and light production from Western Canada and light crude/condensate from the Bakken, Eagle Ford, Permian Basin, Granite Wash, Rocky Mountain Niobrara-DJ, Mississippi Lime and Utica development areas.

Over the next two years, there will be continued transportation challenges to move this growing crude supply to the appropriate markets which EAI, Inc. has defined by production basin, transport corridor and refining market. Additional take-away capacity is needed and/or underway across all of these production areas. Rail will play an increasing role in moving these crudes to higher valued markets with approximately 30 refinery/crude hub locations identified by EAI, Inc. either in operation or being developed. Long haul rail is expected to play a continued role in crude transport as some traditional pipeline corridor markets hit their limits on capability to absorb additional light crude supply.

The light/medium NA Shale Fairway crude network is expected to transition from being logistically constrained to refinery-market constrained over the 2015 to 2017 timeframe as domestic supply displaces most if not all foreign marine supply coming into the Gulf Coast. NA Shale Fairway light incremental crude markets will incur higher transportation costs to expand access to the Eastern Seaboard and West Coast markets, and crude grade substitution discounting in the U.S. Gulf Coast. This North American transition coupled with slowing global demand growth and continued closure of Atlantic Basin refineries will result in a growing light crude bubble on the order of 2-3 million BPD that will impact both global Brent crude pricing as well as the WTI crude price benchmark at Cushing.

Permian Basin crude supply, which includes the benchmark WTI crude stream, is undergoing dramatic shifts as part of these production-logistical dynamics. This will result in major and lasting changes for WTI crude price fundamentals and potentially the focal point for distributing and trading WTI crude. EAI, Inc. is forecasting Permian Basin crude production to increase by over 45 % with some of this incremental crude more aligned with West Texas-New Mexico Super Sweet in quality. EAI, Inc. has projected future Cushing- Gulf Coast pricing differentials as well as price outlooks for other NA Shale Fairway internal and external crude hubs (Guernsey, Clearbrook, Edmonton, Puget Sound, etc.) driven by incremental transportation capacities and costs, increasing light crude penetration into the medium and heavy crude pools, and downward pressure on Brent Crude prices laid into the U.S. Gulf Coast subject to Middle East turmoil and upsets.