The spread between WTI (NYMEX) and Brent (ICE) has seen a drastic widening recently. Historically speaking, WTI tends to trade USD 1.30 higher, but currently Brent exceeds WTI by USD 15. The historical premium of WTI vs. Brent is due to the fact that the quality of Brent is slightly inferior, which means that the refining process is more costly.
We believe that the record levels that spreads have reached are due mainly to the political premium. The following chart highlights the fact that the divergence began around the time of the protests in Egypt at the end of January. Brent is the referential unit for almost 65% of all oil transactions worldwide, but production amounts to only 1.5mn barrels/day – i.e. less than 2% of global production . Also, production has been receding drastically for years, which also pushes the price. On top of that the market is much less transparent given that, in contrast to the USA, no inventory data are available, and there is no spot market. Nevertheless, Brent is gradually becoming more accepted, seeing that it is considered the benchmark price in Europe, Asia, and the Middle East. To this extent, the events unfolding in the Middle East weigh decidedly heavier on the price of Brent than on WTI.
Brent vs. WTI
Sources: Datastream, Erste Group Research
In addition, the relative weakness of West Texas Intermediate is not so much based on any form of weaker demand but rather on massive imbalances in Cushing, where WTI is delivered. At the moment an unusually high number of refineries are undergoing maintenance work. The petrol inventories in the USA are at their highest level in more than 20 years, i.e. the supply in the market is by far enough to meet demand. This scenario is also confirmed by the gradually intensifying contango in WTI. These structural problems should last until the end of summer, after that the spreads should come down again. Due to the CoT positioning we expect the divergence between Brent and WTI to perish in the long run at the expense of Brent.
US crude oil inventory levels
Source: EIA
Backwardation/contango
The premium on the forward market has recorded a drastic decline in recent months, with the forward curve flattening gradually since 2010. On 6 December Brent futures were traded in backwardation for the first time in two years. This means that futures with shorter maturities are more expensive than those with longer maturities. In other words, holding a position generates profits instead of costs. The forward structure curve is by default the long investor’s best friend.
That is of course nothing extraordinary; in the (long-term) past Brent has more often than not been traded in backwardation. Backwardation occurs mainly in tight markets, whereas contango represents an indicator of oversupply on the market. Therefore we believe that the futures may remain in backwardation for an extensive period of time. We also expect inventories to decrease by a substantially stronger degree than anticipated, and as a result we envisage OPEC to step up production at the next meeting in June in order to ensure a sufficient supply for the market.
NYMEX Crude forward market curve
Source: Mazamascience.com
The IEA has increased its forecast yet again. The agency now expects a global consumption of 89.1mn barrels/day in 2011, which would be tantamount to an increase of 1.6%. The EIA also expects an increase of almost 1.4mn barrels/day to 89mn barrels/day. On the other hand, production is only expected to reach 88.1mn barrels/day, which leads to only two conclusions: either Saudi Arabia increases its production, or the inventories are gradually drawn down.
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By. Ronald Stoeferle of Erste Group
Erste Group is the leading financial provider in the Eastern EU. More than 50,000 employees serve 17.4 million clients in 3,200 branches in 8 countries (Austria, Czech Republic, Slovakia, Romania, Hungary, Croatia, Serbia, Ukraine). As of 31 December 2010 Erste Group has reached EUR 205.9 billion in total assets, a net profit of EUR 1,015.4 million and cost-income-ratio of 48.9%.
