The reversed Seaway pipeline has finally come online. Enbridge (NYSE: ENB), along with pipeline operator Enterprise Product Partners (NYSE: EPD), have turned on the taps to feed refineries in the Gulf coast and alleviate the bottleneck of crude oil in Cushing, Oklahoma. Now the big question is, how will this development affect crude oil prices?
Some background
Before answering this question, let's look at some background on the price dynamics of crude oil that were primarily influenced by factors like transportation and storage. For the last 18 months, the West Texas Intermediate (WTI) grade -- the primary benchmark in the U.S. -- has been trading at a discount of up to $25/barrel to the international benchmark of Brent crude. The reason was that production of crude oil in North America (which mainly comprises of the WTI grade) increased -- thanks to the booming shale plays. The storage and delivery point at Cushing readily accommodated this increased supply of crude oil that was brought in through a network of pipelines.
However, the outflow of crude oil from Cushing to the various refineries wasn't as efficient. This created an artificial excess in supply that pushed down the WTI benchmark compared to Brent. Not surprisingly, this turned out to be a huge advantage to refiners such as HollyFrontier (NYSE: HFC) and Western Refining (NYSE: WNR) who could readily avail of this blend. However, the reversal of the Seaway pipeline should ensure that the oil glut at Cushing gets eased, and this in turn should lead to a narrowing in the price differentials between the two benchmarks, ultimately leading to parity.
While all of this sounds good, I believe it's still a little too early to make a call about whether it should lead to a restoration of parity between the benchmarks.
A drop in the bucket
For starters, the reversed pipeline will only bring in 150,000 barrels per day to the refineries in the Gulf Coast. Hardly an amount to reduce the substantial excess in supply at Cushing. The operator, Enterprise Product Partners, plans to bring in additional pump stations, which will increase the pipeline's capacity to 400,000 barrels per day by early next year. I still doubt if that would be enough to bring the two benchmark prices to parity.
The Bakken and Permian reserves are pumping out oil at a phenomenal rate as production levels keep going up. Additionally, a recent Gallup poll suggested that majority of Americans think that the government should approve TransCanada's (NYSE: TRP) Keystone XL pipeline project, which aims to transport bituminous crude from Canada's oil sands to the US. Reasonably speaking, in the long run, the government won't put the nation's energy needs at risk despite the project running into various roadblocks in the short run. In simpler terms, Cushing won't be running out of oil anytime soon.
To reduce the bottleneck, other measures are being taken, too. TransCanada is planning to build a 485-mile pipeline from Cushing to the Gulf coast refineries. However, that plan is only on the drawing board so far.
Not enough
No doubt, these measures will cause the Brent-WTI discount to narrow down. However, there still isn't any solid reason to believe that parity between the two benchmarks will be restored any time soon. Also, investors must keep in mind that most refineries in the Gulf coast are already operating at over 90% capacity utilization, which means the underlying problem may not be simply due to the pipeline infrastructure being found wanting. Maybe it's time to increase the refining capacity in the country.
Foolish bottom line
While all of this is open to debate, there's no doubt that pipeline businesses stands to benefit substantially. As production increases, so will the need for pipelines. For the time being, investors should watch out for more such reversals in the next couple of years.
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