The spread between two key oil benchmarks vanished for the first time in over a year and a half.
On January 13, WTI briefly traded higher than Brent crude, marking a significant milestone in the oil trade. Why did this happen?
Oil is a fungible commodity, energy analysts like to say, so it basically sells for the same price across the globe. While that is mostly true, there are significant regional differences for crude oil.
WTI is a price that provides a benchmark at which oil produced in much of the United States trades. There are other more minor benchmarks within the United States – Mars Blend, or South Louisiana Sweet, for example – but most of them are more or less tied to the WTI benchmark plus or minus some regional discrepancies based on quality and transport costs.
Brent on the other hand, is a leading international benchmark. Again there are other benchmarks around the world, but they are largely hitched to Brent, plus or minus a few dollars per barrel to reflect regional differences.
Historically the two benchmarks traded in concert. But WTI began trading at a discount to Brent a few years ago because there was a glut of oil trapped within the United States. Shale production had surged in such a short period of time that the markets couldn’t soak it all up. That occurred for three basic reasons.
The first reason is that there was inadequate pipeline infrastructure in the right places to handle the oil. The need for new pipeline capacity largely explains the fight over Keystone XL. The southern leg of Keystone – called the Gulf Coast pipeline – relieved a bottleneck of oil supplies in Oklahoma heading for the coast. When it began operations in early 2014, the WTI/Brent spread narrowed as the pipeline relieved overflowing oil inventories, allowing crude to flow to its final destination on the Gulf Coast.
A dearth of pipeline capacity is also part of the reason why Canadian oil benchmarks, like Edmonton Par and Western Canadian Select, trade even lower than WTI. Canadian oil has much further to travel to world markets (reducing its value), and without Keystone XL and other similar pipelines, Canada’s oil sector can’t be fully realized. The discount between the benchmarks lends credence to arguments environmental groups cite in blocking the pipeline – blocking pipelines forces Canadian crude to trade at a discount, reducing its value and thus slowing development.
While Keystone XL is merely the most (in)famous oil pipeline, other pipelines have been constructed in recent years that have relieved the glut. That has caused the WTI/Brent spread to gradually narrow over the past 12 months.
The second major reason for the WTI/Brent spread is the ban on oil producers in the United States from exporting oil. But that too is changing. The Obama administration has given approval to several companies to export ultralight forms of oil, which is slowly eroding the export ban.
On January 13, Reuters reported that Shell had received approval from the Commerce Department to export condensate – ultralight crude oil that has undergone minimal processing. As a result, oil exports from the U.S. are set to increase.
Finally, a growing glut of oil worldwide has Brent crude dropping at an even faster rate. Reuters reported that storage for Brent at sea is starting to fill up, creating a surplus of supplies in the Atlantic region.
Taken all together, the news proved critical for the WTI/Brent spread. The markets erased the gap between the two benchmarks for the first time since July 2013.
In other words, there is a shrinking difference between WTI and Brent. Growing pipeline capacity is allowing more and more WTI to reach its destination, and a weakening export ban will mean more American crude will comingle with Brent on the world market.
These developments are more or less permanent, meaning that the days of a large WTI/Brent spread are likely over.
By Nick Cunningham of Oilprice.com
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