15 September 2020
• The collapse in North American oil supply tightened differentials and WTI-Brent, and supply is unlikely to recover quickly
• As demand normalizes, WTI-Brent, inland-coastal, & Mid-Cush spreads should stay tight, but WCS-WTI and Bakken-WTI face risks
• Stalled or regressing demand, weak OPEC+ compliance, US elections, and the ongoing hurricane season present risk to our views
The recent oil selloff puts North American supply at risk…
The oil price collapse in March and April has completely altered the outlook for North American supply (see Pressing reset on medium term oil supply). US crude oil output fell 2.7mn b/d or 21% from March to May as E&Ps shut-in wells and ceased completion activity (see Doing the oil market's dirty work). Production has since partially recovered on restarted wells, but we expect it will decline into year-end and remain subdued in 2021. In Canada, shut-ins and accelerated oil sands maintenance cut output by roughly 900k b/d over the same period, but oil sands restarts are still underway and should lift output into year-end. After a period of stability, WTI dipped to $37/bbl this week, likely making E&Ps reluctant to boost activity and presenting downside risks to US output.
…further supporting our view for tight basis differentials
From light to heavy, sweet to sour, or north to south, excess pipe and refining capacity has led to tighter differentials across North America (see When the fracking stops). Now we see modest downside risk to WCS and Bakken diffs on Canadian output restarts and DAPL uncertainty. Lower light crude supply north of Cushing should keep WTI relatively firm, perpetuating the roll-down in Midland-Cushing spreads, especially as PADD 2 runs normalize. Inland-coastal spreads like WTI-MEH and Midland-MEH should remain tight on ample pipe, sluggish supply, and rebounding refinery demand. Recently, the WTI 1-6 spread has reflected concern over oil balances and potential run cuts, but we are optimistic about the demand recovery and expect runs to continue to improve. Lower oil output and higher runs should strengthen WTI timespreads and support WTI-Brent.
Several risks could wake differentials up from hibernation
Refining margins should remain weak for some time as refiners test the markets ability to absorb additional fuel. This could lead to run cuts, especially if the demand recovery stops or regresses due to a 2nd wave or an economic downturn. OPEC+ compliance plays a huge role in the rebalancing process and decisions to overproduce could lead to weaker timespreads and WTI-Brent. Depending on who is under-complying, this could also positively impact light-heavy and sweet-sour spreads like LLS-Mars and Brent-Dubai. The US elections also present downside risk to US supply, which could lead to even tighter US differentials. Last, hurricane season is still underway and presents numerous risks to production, exports, and refinery operations, which could create risks to differentials and timespreads in both directions.