Will the Brent-WTI Spread Narrow Further?

Last week, the difference in price between Brent, the global oil benchmark, and West Texas Intermediate (WTI), the main U.S. benchmark, collapsed to its lowest level since early 2011. This so-called Brent-WTI spread is a crucial gauge of profitability among U.S. refiners; the lower it dips, the lower their refining margins, all else being equal.

For much of this year, the spread held above $15, even topping $20 in February. That helped refiners with access to cheap WTI, such as Phillips 66 , Valero , and HollyFrontier , deliver solid first-quarter performances.

Phillips 66 reported a realized refining margin of $13.94 a barrel in the first quarter - the best in the company's recent history- while Valero's refining throughput margin came in at $10.59 per barrel, up from $7.71 per barrel in the same period last year. And HollyFrontier's consolidated refinery gross margin clocked in at $23.32 per produced barrel, a 34% improvement over the year-earlier quarter.

But with the Brent-WTI now having fallen below $10, some investors are rightfully concerned about near-term weakness in these stocks. After all, refining is a highly cyclical business that doesn't necessarily attract the type of long-term investors other, more stable sectors do. With that in mind, let's take a closer look at which direction Brent and WTI prices are likely to head and the implications for refiners and other companies.

What caused the WTI-Brent spread to narrow?
According to Gary Heminger, chief executive of Marathon Petroleum, the main culprits behind the falling Brent-WTI spread have been a weak European economy and a heavy refinery turnaround reason, both of which depressed demand and pushed Brent prices lower.

While the forecast for European economic growth remains bleak, demand for Brent should rise slightly as the refinery turnaround season wraps up, helping push Brent prices up relative to WTI. Fears of supply side shocks in the Middle East and North Africa are another major factor that should lend support to Brent prices in the short term.

Meanwhile, new pipeline projects slated to start up over the course of the year should gradually alleviate the glut of crude oil at Cushing, Okla. - the nation's main oil storage hub - helping relieve the downward pressure on WTI prices.

Last year, Enterprise Products Partners and Enbridge reversed the flow of the Seaway pipeline to flow south from Cushing to refineries in the Houston area. While the project was hailed as a major catalyst to help narrow the WTI-Brent spread, it proved insufficient.

Will new pipeline projects be enough?
However, new projects slated to come on line over the remainder of the year, as well as incremental capacity additions from the reopening of temporarily closed pipelines and refineries, could do the trick this time around. A return to full capacity on Enbridge's Ozark pipeline and the Tulsa East refinery should add around 110,000-120,000 barrels per day of additional capacity from Cushing, according to a recent note by Goldman Sachs.

And major projects including the recently reversed Longhorn Pipeline, which is operated by Magellan Midstream Partners and went into service last month, and the first phase of the Permian Express West Texas-Nederland crude pipeline project, operated by Sunoco Logistics Partners - acquired by Energy Transfer Partners last year - and expected to start up next month, will help divert the flow of WTI away from Cushing and direct it toward refineries along the Gulf Coast area.

However, it remains unclear whether these incremental capacity additions will be enough to offset the staggering growth in U.S. crude oil production, especially from Texas and North Dakota, which shows no signs of slowing down.

For instance, oil production in Texas' Eagle Ford Shale jumped 74% year over year in February, reaching an all-time high. According to Heminger, the new projects simply won't be enough to keep up with the rapid growth in output from these states. "We think you'll see the spread widen back out," he said.

If he's right, Mid-continent refiners' elevated profitability should continue. If he's wrong, on the other hand, and the spread remains narrow, it could spell trouble for some rail companies. Generally speaking, with a spread near $8 per barrel, it likely isn't very profitable to ship crude from North Dakota's Bakken Shale to refineries along the East Coast for most rail carriers.

Midstream companies, on the other hand, are less vulnerable to a narrowing spread, since most of them derive the bulk of their income from stable, fee-based revenues. Energy Transfer Partners is a company that helps alleviate the gluts in supply with its 23,500 miles of transformational pipelines. To see if ETP and its sizable dividend payment could be a good fit for your portfolio, you're invited to check out The Motley Fool's premium research report on the company. Simply click here now for a thorough expert analysis of this midstream company.

The article Will the Brent-WTI Spread Narrow Further? originally appeared on Fool.com.

Motley Fool contributor Arjun Sreekumar has no position in any stocks mentioned. The Motley Fool recommends Enterprise Products Partners L.P. and Magellan Midstream Partners, L.P. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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