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WTI-Brent continues to close, trading at tightest levels since January 2011

Ingrid Pan, Sr Energy Analyst

International producers receive a price closer to Brent crude, while U.S.-based producers receive a price closer to WTI crude, so higher relative Brent prices favor international producers (and vice versa)

The spread between West Texas Intermediate (WTI) and Brent crude represents the difference between two crude benchmarks. WTI more represents the price that U.S. oil producers receive, and Brent more represents the prices received internationally. In brief, the prices differ between the two crudes because a recent surge in production in the United States has caused a buildup of crude oil inventories at Cushing, Oklahoma, where WTI is priced. This has created a supply and demand imbalance at the hub, causing WTI to trade lower than Brent. Before this increase in U.S. oil production, the two crudes had historically traded in line with each other.

The above graph shows the WTI-Brent spread over the past few years. Note that when the spread moves wider, crude producers based in the United States receive relatively less money for their oil production compared to their counterparts producing internationally.

The WTI-Brent spread continued to move narrower last week from $5.60 per barrel to $4.50 per barrel

The WTI-Brent spread traded narrower last week, moving slightly, from $5.60 per barrel to $4.50 per barrel. In early February, WTI traded at points as much as ~$23 per barrel below Brent crude. But the spread has steadily narrowed since then, to trade at current levels of around ~$5 per barrel. The significant tightening of the spread since February has been positive for domestic oil producers (relative to international producers), as it means the discount domestic producers receive to international crudes has been decreasing. From a very long-term perspective (five years and over), the spread is wide, as WTI and Brent crudes have historically traded roughly at par.

Over the medium term, the spread has closed significantly, moving from over $23.00 per barrel to ~$4.50 per barrel currently, as increased infrastructure has helped to move crude more efficiently

The spread has narrowed due to several factors. Firstly, increased midstream infrastructure has come online that has facilitated the movement of crude from inland to refiners on the coast. One notable example is the expansion of the Seaway Pipeline in January 2013, which allows more crude to flow from Oklahoma crude hub Cushing to the Gulf Coast, where a great amount of refining capacity sits. Additionally, Sunoco’s Permian Express Pipeline and the reversal of Magellan Midstream Partners’ Longhorn Pipeline are allowing more crude from the Permian Basin in West Texas to flow directly to the Gulf Coast. Increased pipeline capacity and crude transportation by rail have allowed companies to transport inland domestic crude more efficiently to refiners on the East and West coasts, which has also backed out Brent-like imports.

At current levels, experts have mixed opinions on where the spread will trade in the medium term

When the spread was trading at its widest point, most market participants thought it would close in the medium term. However, given that the spread now trades at roughly $5 per barrel, some feel the spread may remain where it is or widen back out from here. For example, the EIA (U.S. Energy Information Administration) notes in its monthly report titled “Short Term Energy Outlook” that it expects the spread to average $11.40 per barrel in 2013. Year-to-date, the spread has averaged ~$13.50 per barrel. Plus, roughly 50% of the year has elapsed, which implies that over the rest of the year, the spread will average ~$9.30 per barrel and will therefore widen from current levels.

Again, the effect of a wide spread means that companies with oil production concentrated in the United States will realize lower prices compared to their international counterparts. For example, see the table below for a comparison of oil prices realized by U.S.-concentrated companies versus companies with a global production profile.

1Q13 Average Price Per Barrel
West Texas Intermediate $94.36
Brent $112.64
1Q13 Realized Oil Prices Per Barrel (excluding hedge gains/losses)
Chesapeake Energy (CHK) $95.23
Concho Resources (CXO) $82.49
Range Resources (RRC) $85.46
Oasis Petroleum (OAS) $93.33
Total Corp. (TOT) $106.70
ConocoPhillips (COP) $105.97

Why investors should monitor the spread

Investors may want to monitor the spread, as a wider spread may make international producers more attractive relative to domestic producers. The difference between Brent and WTI has caused domestic producers such as those mentioned in the table above (CHK, CXO, RRC, and OAS) to realize lower prices on oil compared to international producers. But over the medium term, the spread has closed dramatically, signaling better takeaway capacity for inland U.S. oil. Investors should note that many international names can be found in the XLE ETF (Energy Select Sector SPDR), an exchange-traded fund whose holdings are primarily large-cap energy stocks with significant international exposure.

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