Streetwise Professor

ConocoPhillips’s announcement of a restructuring plan that would create separate upstream and downstream companies got me thinking again about the Seaway Pipeline, of which CP is a 50 percent owner.  Recall that the company has refused to reverse the flow of Seaway to go from Cushing to the Gulf despite the fact that Midcon prices are far below Gulf prices.

Indeed, since my earlier post, the divergence has increased. At the time, LLS-WTI spreads were about $12-$14, depending on the delivery month: now they are about $16-$18.  (Here’s a link to price quotes on LLS-WTI spread swaps.)  Since the gain to reversal is proportional to the square of the price difference, a 20 percent widening of the spread (which is conservative) corresponds to a 44 percent increase in the social gain to reversing the pipeline.  That translates roughly to about $3 million per day–at a minimum, under the assumption that reversal would completely close the LLS-WTI gap (except for transport cost).  The figure is larger if–as is plausible–the capacity on Seaway (plus Keystone, when that gets on line) is not enough to close the gap.  As I said before, from the perspective of market participants collectively, it is a no brainer as the reversal would pay for itself within days.  Days.

CP’s restructuring announcement therefore raises a very interesting question: where will Seaway go?  Will it go with the upstream operator?  If so, that firm may have an incentive to reverse, though that’s not crystal clear.  Reversal will cause Gulf prices to fall relative to Midcon and Canada: that would reduce the value of CP production in the Gulf and Texas.  If it goes with the downstream entity, that entity will still have no incentive to reverse–unless it is, uhm, persuaded through some Coasean bargain to let the oil flow free.  A third option is that Seaway could be spun off as part of the restructuring.

What will happen?  I don’t know.  The pipeline is a midstream asset, so it’s not obvious whether it sits more comfortably upstream or downstream.  I can say that the economic gains to reversal are even greater now than earlier in the year when I did my original analysis.  The restructuring provides a perfect opportunity for CP to monetize that value, through some kind of deal with producers tributary to the Midcontinent, or Gulf refiners.