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The Vanishing WTI/Brent Spread

The Vanishing WTI/Brent Spread

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.

Related: The Simple Reason For The Oil Price Drop

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.

WTIBrentSpread

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.

Related: Could The Oil Bust Last?

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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  • Richard Thompson on February 24 2015 said:
    Within 10 days the spread has reached over USD 7. Could you suggest why we might be seeing this spread increase again?
  • Walter on February 27 2015 said:
    I was wondering the exact same thing. Though FWIW my own $0.02 is that it's the factors in play in different parts of the world -- recent news in the US include that of a supply glut and stockpiles still building, while in the rest of the world there's more uncertainty about supply and the perception of demand (think Libya and news of falling African production), all of which works towards depressing WTI prices and supporting Brent prices, thus generating the current spread. Assuming I'm correct then as the US shale producers scale down (and the rig counts reduce) and the tensions and uncertainties in Africa and elsewhere ease in the short-ish/medium, we should see the spread narrow again.
  • Mark on March 05 2015 said:
    I think this explanation is leaving out some key parameters. The reason the spread narrowed was a market signal to incentivize traders to store WTI based crudes in Cushing while storage was cheap and plentiful. That way, the traders store the oil for cheap and sell the futures for later delivery. They can continue rolling that contract forward for as long as the contango remains. Without the high spread, and with Brent contango steeper than WTI, there is more incentive to take Brent into refineries and into gulf coast storage. Now that storage in Cushing has filled up close to 5 year highs, the spread has widened back out to once again send the signal that refineries need to take the WTI directly and Brent needs to find a new destination.

    What's even more interesting is that at these prices, oil producers are forced to produce as much as possible just to have the cash flow to stay out of bankruptcy and make payments on loans, which is an incentive to produce even more at low prices. As storage fills up, price will have to go lower to pay for increasingly difficult logistics to get to ever farther storage. As the price goes lower, the urgency becomes even greater. WTI producers that are not able to weather the storm will be forced to shut in production. From the looks of things, producers shutting in is the only thing that will stop the storage from filling up in the next few months. I think WTI stops falling at 35-40 when some producers finally shut in. Brent is seemingly decoupled at the moment from WTI prices because light sweet imports to the gulf coast have almost gone to 0, so the spread could easily end up anywhere from 10-20.

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