Russian-Ukrainian tension should affect Brent oil more than WTI

Market Realist

Key ways to trade oil and gas price movements on Ukraine tension (Part 5 of 5)

(Continued from Part 4)

Oil variety

Oils of different grades and sold at different locations receive different prices. The generally accepted benchmark for U.S.-produced oil is WTI-Cushing. WTI is West Texas Intermediate crude, a grade of light sweet crude. Cushing represents a location in Oklahoma that’s a major trading hub for crude oil and also where price settlement is determined for WTI crude contracts on the New York Mercantile Exchange. Basically, because so much crude flows through this point and because the most liquid oil futures contract is based on crude priced here, market participants look at WTI-Cushing as the main reference point when thinking about U.S. crude prices.

While WTI-Cushing is considered the benchmark for U.S.-based crude, Brent is considered the benchmark for international crudes. Note that Brent represents a grade of light sweet crude sourced from the North Sea. WTI and Brent had historically traded close to par with each other, as they’re similar in quality. However, over recent years, WTI crude has traded at times at a steep discount to Brent crude. This is because U.S. oil production has increased rapidly over recent years, owing to the shale boom and application of technologies such as horizontal drilling and hydraulic fracturing. While crude oil is an international commodity, the increase in U.S. crude supply caused the U.S. benchmark of WTI to fall relative to Brent. This is because the takeaway capacity for much of the new U.S. crude production was limited, limiting local demand and depressing WTI prices.

The risk of increased conflict between Russia and Ukraine, or geopolitical instability in Eastern Europe in general, is that there could be some threat to Russia’s ability to produce or export oil. In this case, Brent crude prices should theoretically be more affected than WTI crude prices. WTI crude prices should theoretically be cushioned by U.S. oil production, which continues to grow. Plus, because U.S.-produced crude oil is currently not allowed to be exported by law, U.S. crude oil demand is generally limited to U.S. refineries (note that refined products such as gasoline and diesel can be exported). So heightened fear over Russian oil supplies should theoretically drive Brent oil prices higher relative to WTI and cause the spread between the two crudes to widen.

The Brent grade of crude oil is investable through the United States Brent Oil Fund (BNO), which holds a mix of front month Brent oil futures and U.S. Treasurys. The price movements of WTI-Cushing are investable through the United States Oil Fund (USO), which holds a mix of front month WTI oil futures, or through the United States 12 Month Oil Fund (USL), which holds equal weights of the first 12 months of WTI oil futures and U.S. Treasurys. It’s also possible to use an ETF such as the United States Short Oil Fund (DNO) or the ProShares UltraShort DJ-UBS Crude Oil (SCO) to take a short position in oil, as this fund holds U.S. Treasurys and is simultaneously short a portfolio of WTI crude oil futures.

Note that commodity prices can be extremely volatile, so these ETFs can be risky investments. Plus, these ETFs’ performance can differ significantly from the performance of the underlying commodity. To find out why, and for more on trading commodity price movements, see How to trade rising natural gas prices and falling oil prices.

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