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Understanding Oil Price Differences : The Brent-WTI Divide

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Published : August 20th, 2011
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By the Casey Research Energy Team

There’s more than one price of oil… and lately one of the followers has become the far-and-away leader.

It’s almost funny, how people talk about “the price of oil” as though it is a singular thing. In reality it is far from singular, and in fact events over the past few years have created further complications in what is already a complex game.

Crude oils can display a wide range of characteristics, the most important of which are density and sulfur content. Light crudes have an API gravity rating of 38 degrees or more, while heavy crudes have an API gravity of 22 degrees or less. As for sulfur, sweet crude is commonly defined as oil with a sulfur content of less than 0.5%, while sour crude has more than 0.5% sulfur.

Those characteristics differentiate the approximately 160 types of crude oil – including Alaska North Slope, Bonny Light, Es Sider, and Palanca Blend – traded on exchanges around the world. The names usually refer to geographic locations, as oils from a certain area share similar properties.

Of those 160+ types of crude, two are the most important. Brent North Sea crude, also known as Brent Blend, is a light, sweet crude that is comprised of oil from 15 fields in the North Sea. Brent is traded on the London ICE exchange and can be easily loaded onto tankers and shipped around the world. The other key crude is West Texas Intermediate (WTI), which has traditionally been the U.S. benchmark crude oil. WTI is a slightly lighter, sweeter crude than Brent that is piped from the northern United States and from Canada’s oil sands to the delivery point at Cushing, Oklahoma and is traded on the New York Mercantile Exchange.

Lighter, sweeter crudes are usually more expensive than their heavier, sourer counterparts because they require less processing and produce more higher-value products, such as aviation fuel. For that reason, WTI crude has historically commanded a price premium over Brent crude, and for years WTI was the world’s benchmark oil price, with its price movements mimicked almost instantaneously by other crudes on other exchanges. However, in the last year we have seen that longtime relationship flip. Brent prices are now roughly 25% higher than WTI prices, an historic difference and one that invites some investigation.

There are several issues behind the reversal, but the main one is a glut of crude supplies at Cushing. Over the last 15 or so years, two unconventional sources of crude oil materialized in North America: shale oil and bitumen. Shale oil is trapped in formations of sedimentary rock with low porosity and permeability, and bitumen is the tar-like heavy oil from the oil sands. The technology to recover and refine these oils was developed recently.

By chance, it turns out that these new, major oil sources are located in the northern United States and in Canada, and almost all of the oil from shale plays and from the oil sands is sent to Cushing. The chart below shows crude production in the PADD 2 district, which is the name given to the Midwest region. The Bakken Shale in North Dakota – one of the most significant shale plays in the world – now accounts for almost half of the region’s crude production.

Source: US Department of Energy; Midwest (PADD 2) Field Production of Crude Oil (Thousand Barrels); data are from January 1981 through September 2010

All of this crude from the shales and the oil sands needs to be refined. Only one pipeline connects the oil sands to the west coast, which means the rest of the bitumen has to go to Cushing; within the last year two new pipelines increased the flow of bitumen into Cushing by one million barrels of oil a day. Shale oil from the Bakken only adds to the supply problem.

It is a problem because Cushing is landlocked – it is in the middle of Oklahoma. And there is now simply more oil flowing into the PADD 2 region than its refinery system can handle. The next chart shows how crude stocks at Cushing have been rising steadily and are now approaching total capacity. That forces producers to sell into the cheaper spot market, pushing the average price down.

Source: US Department of Energy; Weekly Cushing, OK Ending Stocks excluding SPR of Crude Oil (Thousand Barrels); current effective storage capacity as of September 2010; all other data are from April 9, 2004 through March 4, 2011

Two things would relieve the supply glut at Cushing: much stronger demand for petroleum products in the United States; and increased transport capacity out of Cushing. While oil demand will continue to increase in the United States, it will rise only slowly. And the biggest capacity addition on the horizon is the hotly contested Keystone XL pipeline expansion, which would add a line from Cushing to the Gulf Coast. Initially targeted for start-up in 2013, the pipeline was recently delayed because of permitting issues.

That means it will be some time before the supply glut at Cushing is relieved. In the meantime, WTI prices will continue to suffer.

The WTI price depression prompted a few changes that will help Brent’s supremacy persist. The big one is that Saudi Arabia, Kuwait, and Iraq all ditched WTI as their official pricing benchmark in favor of a new benchmark known as the Argus Crude Oil Index. The Argus Index is a volume-weighted average price index of deals done for three types of crude – Mars, Poseidon, and Southern Green Canyon – all of which are U.S. Gulf Coast medium sour crudes. And here’s where things get a bit confusing: Even though Gulf Coast crudes are American, they have always been priced according to Brent, not WTI. Brent is more applicable for the Gulf Coast oils, both in terms of quality and because Gulf crudes are seaborne.

So, by switching to Argus, the big Middle Eastern producers essentially switched to Brent, adding to its supremacy.

This year, while supplies climbed at Cushing, supplies of Brent tightened. Production from the North Sea is on the decline. At the same time unrest in the Middle East – civil war in Libya, nigh on civil war in Syria, a revolution in Egypt, and the threat of contagion to other important oil producers – has pushed Brent prices up, while slowing economic recovery (and now the possibility of a return to recession) is reducing oil demand in the United States. Essentially the forces on Brent are exactly the opposite of those acting on WTI.

The take-home is this: The WTI-Brent price disparity will persist for the foreseeable future, as the only real solution to oversupply at Cushing – the Keystone XL expansion – is still sitting on Hilary Clinton’s desk awaiting approval. She, it turns out, is a bit busy these days, so we don’t expect progress on that front to come quickly. Until capacity develops to move crude from Cushing to the Gulf Coast, Brent will remain the crude price that best reflects supply, demand, and sentiment in the global oil market.

[Energy is what makes the world go ‘round, but shifting trends can make it challenging to select energy sectors or specific stocks to invest in. Let the experts at Casey Research help you maximize the profit potential of your energy investments. A three-month trial subscription to Casey Energy Report is risk free.]



Data and Statistics for these countries : Egypt | Iraq | Syria | All
Gold and Silver Prices for these countries : Egypt | Iraq | Syria | All
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Vedran Vuk graduated with a BBA in Economics from Loyola University of New Orleans. Currently, he is pursuing a M.S. in Finance at Johns Hopkins University. He also spent time on a PhD. Economics program. His publications include academic journal articles, book chapter contributions, newspaper columns, and online articles. Prior to Casey Research, he worked in think tanks, government affairs, and corporate governance. Utilizing his experiences with academics, Washington politics, and financial knowledge, Vedran’s analysis often seeks to find the mid-point between these different areas.
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