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Brent Versus WTI - Why so Wide

By Bruce Krasting | Thu, 08 September 2011 04:06 | 5

We set another record yesterday. This one has me scratching my head. The Brent WTI spread widened to $27.22. That’s never been seen before.

There are some partial explanations for this phenomenon. Brent is lighter in grade and justifies a somewhat higher price. But not $25.

Brent vs WTI

Another consideration is the increasing flow of crude from the Bakken field in North Dakota. This crude often heads to Cushing, Oklahoma, and therefore creates a supply glut. The WTI price should be lower than Brent based on this. But, one again, $25 seems out of whack. The smart guys up in NDAK are also sending crude by trains to the Gulf area where prices are higher.

Another consideration is that WTI is a hedging mechanism for algo computers. When there is announced evidence of a slowing economy the markets all react. If economic activity is in decline it makes “sense” that crude should trade lower. Computers that are trying to move risk around buy bonds and sell crude. The WTI contract is the place for this type of market force to be settled.

So which price is right for crude? Is it Brent or is it WTI? The answer, to me, is that Brent is the benchmark to look at. WTI (and the futures pricing behind it) has little to do with the cost of petroleum in the US. Consider this chart of LLS crude. This is the pricing for ‘sweet’ crude for cash delivery at the Gulf of Mexico.

Diagram 2

What is very clear is that the cost of crude used by US refiners to produce gasoline has nothing to do with the WTI price. LLS pricing has been running a $3-4 premium over Brent for some time now. That, to me, makes perfect sense.

A shipment of Nigerian crude (sweet) has two destinations. One is Rotterdam, the other is the GOM (Louisiana offshore delivery). The shipping cost for GOM delivery of a VLCC (1mm barrels of crude) is about $4/Brl higher than for European delivery (4-6 extra days of transit). Therefore a pricing matrix where LLS is equal to Brent +$4 is consistent.

The price of gasoline for much of the country is driven by crude pricing in the Gulf; not Cushing, Oklahoma. At yesterdays closing price for LLS the price of gas is going higher in the USA. So another big drag on the economy is in front of us.

Some thoughts on this.

A few months back the smart folks at the Department of Energy tried to influence the LLS pricing by releasing crude from the SPR. That worked, for about a week. The LLS/WTI spread was about $15 at the time. Given that it is much higher today I think it is possible that D.C. will again choose to sell some more of the strategic holdings of crude in an effort to create a cheaper cost for gasoline. If the DOE was in for a penny in June then they should be in for a pound (or two) right now. One can be sure that the interventionists in Washington are teeing this up as I write.

I can’t come up with a logical explanation for the huge WTI/LLS pricing differential. With a spread of $27 one could fill up a few hundred-car trains in Oklahoma and ship the excess crude to the Gulf. With the spread as wide as it is, a train full of crude could drive back and forth across the continent a few times before getting to the final destination and still end up cheaper that $27. So what gives?

I smell manipulation in this. What it comes down to is that the price of crude that we actually use to make gas has little to do with the price of crude that is traded on the exchanges. Why?

We know the US economy is broadly in decline. We know that $4 gas is a factor that will accelerate the downward economic forces. We know that $115 crude (lls/Brent) will translate to $4 gas at the pump. We know that the “deciders” love to intervene to “fix” things that are broken.

My conclusion? The DOE will be doing Round II of SPR sales. This will happen in the near future. When that happens some fat cat oil companies will make a bundle (they did last time). But like the SPR sales in June there will be no lasting effect on market prices. Gas is going up in price, and it’s going to stay high. Just another gloomy factor in an already gloomy economy.

By. Bruce Krasting

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  • Anonymous on September 08 2011 said:
    This is what I call an excellent article on an important topic. I've heard talk about the decline in the oil price, but that talk always focuses on WTI. A weighted average of WTI and Brent should still result in an oil price of $100
  • Anonymous on September 08 2011 said:
    "Computers that are trying to move risk around buy bonds and sell crude."Dear Mr Krasting, you've just introduced me to the notion that something called an algo computer can buy and sell all on its own without human intervention? Is this the case in reality or am I misreading what you've just written? If this is the case, could you or someone please explain to me how this has come about and what it means?Thank you
  • Anonymous on September 09 2011 said:
    You are reading too much, Philip. Computers aint relevant in this discussion, although I am sure that they are somewhere in the background.Someday I might decide to write a paper on the exact scientific reason for that spread. Writing that paper would be easy for me of course, although being paid for it is another matter.By the way, all this talk about computers doing this and that - that's some variety of populism, isn't it?
  • Anonymous on September 28 2011 said:
    No manipulation. Too much Canadian and Mid Continent crude with nowhere to go but PADD II inventory. Rail is an expensive and limited way to move crude. A single rail car can only carry 5-700 barrels and can take a month or two to round trip to the Gulf and back. A fleet of hundreds of cars is required to move 5000 bbls a day. To compress the spread you need crude pipeline capacity south out of Cushing or higher refinery runs in PADD 2. PADD II is running at 90+% with the most recent data at 95%. Not much left there. I expect the WTI weakness versus Brent to persist until the commercial crude stocks in PADD II come down. The spread would expand if there are any large, prolonged refinery outages in PADD II
  • TJ on March 14 2012 said:
    You are right to "smell manipulation". When a US Domestic Oil Man is selling his WTI for 30.00 a Barrel to the refineries and the refinery then sells it at the Brent prices they pocket the the difference. Pure Profit. WallStreet has a vested interest in keeping our Domesitc Oil (WTI) prices low so they can profit. Start digging into who really owns the refineries (investors) and let us know what you find. My friends are capping there wells because they can't afford to keep them open. Supply is up, demand is low and WTI is being manipulated. Why can't we sell American Crude(sweet) on the open market? Our prices reflect Global Market when we are only permitted to sell to domestic refineries.

    Another discussion point ... Keystone 2 ...will not help anything!

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