Must-know: Why the WTI discount to Brent oil closed wider

Market Realist

Why natural gas traded up while oil traded down on May 30 (Part 1 of 5)

WTI and Brent used to trade in line, but prices have diverged over the past few years

The spread between West Texas Intermediate (or WTI) and Brent Crude represents the difference between two crude benchmarks. WTI represents the price oil producers receive in the U.S. and Brent represents the prices received internationally. The two crude oils share a similar quality. For this reason, they should price very closely to each other. However, the prices have differed greatly between the two crudes because a recent production surge in the U.S. caused a buildup of crude oil inventories at Cushing, Oklahoma, where WTI is priced. This created a supply and demand imbalance at the hub, causing WTI to trade lower than Brent. Before the increase in the U.S. oil production, the two crudes had historically traded in line with each other.

The previous graph shows the WTI-Brent spread over the past few years. It’s important to note that when the spread is wider, it generally means crude oil producers based in the U.S. receive less money for their oil production compared to their counterparts producing internationally.

The WTI-Brent spread widened slightly last week but has been on a narrowing trend over the medium term

The spread between WTI and Brent Crude closed at $6.61 per barrel on May 30, compared to the spread of $6.11 per barrel for the week ending May 23, 2014.

From late April to now, the spread has moved ~$3.00 narrower. One of the drivers may be that inventories have declined over each of the past seven weeks at Cushing, Oklahoma (the crude oil hub where WTI is priced). This could signal that WTI crude oil is moving out of the inland U.S. and towards end refining markets more effectively, with help from new infrastructure coming online.

From mid-April to mid-May, the spread has moved ~$5.00 wider. One reason may be that the escalating tension between Russia and Ukraine helped to boost Brent crude oil prices, as Russia is a major oil exporter. Also, geopolitical events outside the U.S. are more apt to affect Brent crude prices than WTI prices. Meanwhile, U.S. oil inventories had been climbing over the past few weeks, implying strong U.S. oil supplies.

From November 2013 to mid-April 2014, the spread narrowed from ~$16.50 per barrel to ~$4.50 per barrel, as new infrastructure that transports more crude from Cushing to the Gulf Coast opened up—primarily, the Marketlink pipeline operated by TransCanada (TSX). Also, Enterprise Products Partners (EPD) said it would more than double the capacity of its Seaway pipeline in mid-2014. The Seaway pipeline currently brings crude oil from the inland U.S. oil hub in Cushing, Oklahoma, to the Gulf Coast.

The increased transportation capacity from inland U.S. crude production regions to demand centers (such as refineries on the Gulf Coast) is bullish for WTI crude oil prices. The expanded pipeline is reportedly able to move more than 850,000 barrels per day of crude oil. Furthermore, the U.S. Energy Information Administration reported that stocks at the inland U.S. crude hub of Cushing continued to decrease, which may also indicate that U.S. crude produced inland is having an easier time getting to demand centers such as refineries. This can bring WTI and Brent prices closer together.

To read further about the spread and how it might affect investment decisions between companies with production based primarily in the U.S. (such as Chesapeake Energy and Concho Resoruces) compared to those with significant production overseas (such as Exxon and Chevron), please continue to the next part of this series. Note that most of these companies are components of energy ETFs such as the Vanguard Energy ETF (VDE).

Continue to Part 2

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