Why recent flat oil prices can affect companies' earnings (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. 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 narrowed to ~$6 per barrel last week and the prices between WTI and Brent have generally been moving closer over the past few months
The spread between WTI and Brent crude closed at $6.03 per barrel on June 6, compared to the spread of $6.61 per barrel for the week ending May 30, 2014.
From late November to now, the spread has moved from as wide as ~$19 per barrel to ~$6 per barrel currently. One of the indicators that have caused the spread to move narrower has been continually decreasing inventories 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. 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 Resources) 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).
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