Is WTI Still the World's Benchmark?
By Steve McMane, Trader, Crude Oil and Refined Products, Suncor Energy Inc.
There has been a significant amount of press lately on the dislocation in International Crude Oil market prices this year. The NYMEX WTI futures contract for delivery in Cushing , Oklahoma has really lost its luster as the global oil benchmark price. Right now the North Sea Brent light sweet contract on the ICEGlobex electronic trading platform is trading significantly over WTI (prompt month WTI trading approximately $6.50 cents back of prompt month Brent on May 24 th ) when historically Prompt Brent trades $1.50 under Prompt WTI. The long term price spread of $1.50 is the cost of moving Brent cargos into to the Gulf Coast ports where refineries prefer light sweet because it is cheaper to refine into gasoline and products. WTI crude is also a higher grade of light sweet, thereby trading at a premium due to this superior quality over Brent, but this appears to be changing.
WTI has long been viewed as the global benchmark for which the world’s crude oil prices are indexed against, largely due to the fact that the US is the number one consumer of crude oil products in the world. A very real shift is now beginning to take shape. Traders now seem to view the Brent contract as a better proxy for the world’s crude oil, and the WTI contract is being perceived as a more local price due to pipeline logistics in Cushing Oklahoma . The Brent contract is increasingly used to proxy Russian, many Asian crude oil barrels, as well as some Middle Eastern/African crude oil. The commodity markets are transacting ever higher volumes of the Brent contract and the WTI contract open interest (the measure of total contracts outstanding) remains flat. So is the Brent contract replacing WTI as the global benchmark for oil prices, and if so what do risk managers need to consider?
Three main theories are put forward to explain the strength in Brent verses WTI:
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Significant heavy crude supply and logistical bottlenecks at Cushing Oklahoma.
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Increased acceptance by international trading community that Brent is better suited to represent global crude oil as the benchmark.
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Strength in international currencies against the US Dollar give competing countries a more level playing field to bid competitively for oil against the US refiners.
Point one is the real driver of the spread value. Currently the US has plenty of crude stock in storage at Cushing. However the stock is largely heavy crude that has been shipped down from Canada . Light sweet is the preferred crude for refining product into Gasoline and Distillates; products that the US is severely lacking right now due to untimely refinery outages so far this year. Cushing is having a difficult time drawing down these heavy stocks as refiners are paying up for light sweet to quickly reduce the lack of gasoline supply heading into peak demand season. Until more heavy crude can be run into the refineries and reduce the crude supply overhang, WTI weakness against the Brent which does not have the same storage logistics will continue.
Point two and three have more to do with the increase in the global players in the oil market, such as China and India , and the producing countries that sell crude and products to these growing nations. Brent is a water-borne crude that can readily be shipped to anywhere in the world for the right price. WTI is a land locked crude that is almost exclusively used as a refinery feedstock in the US and is really not exported out of the country. You can’t blame a Middle Eastern company for not wanting to price their barrels against a Midwestern US delivered contract when those barrels are headed for Chinese consumption. When the US was the only game in town a few decades ago, indexing barrels to WTI made sense, but times change and other big players have serious demand needs to sustain their rate of growth.
The US has seen a dramatic devaluation of their currency over the past three years and this has had some affect on US refiner’s ability to bid for import barrels. Even with refinery margins at extremely profitable levels, the cost of bringing in barrels has grown substantially due to the relative value of the US Dollar. Other countries which have seen their currency appreciate in relation to the US now have more bargaining power and they can competitively bid for these barrels. The Light Sweet barrel is coveted most all over the world and the Brent barrels can be delivered to anyone’s doorstep, while the WTI barrels can not be shared.
These three points may help explain why Brent is trading a premium to WTI, but what does this mean for a risk management shop? First is pricing, especially if the company has any global exposure. It is another index to track and another market to understand. Middle offices have to be able to identify which price hubs are traded against WTI and which are traded against Brent. Volatility and correlations for Brent are now different than for WTI even though they are an almost interchangeable crude type. Pricing patterns suggest that international geopolitical events affect Brent prices more significantly than WTI. An increase in Brent exposure can have a material impact on the companies VaR. Credit quality and tracking could increase as a host of new global players can be introduced as potential counterparties. This puts more pressure on the credit group to grant and closely moniter limits with these international players.
Is this WTI/Brent price change a short term anomaly or fundamental change in perception within the global crude market? The long dated crude prices show that beyond 2009, the market prices revert back to the long term standard of WTI trading $1.50 over Brent. The curve suggests that this price action is just a near term anomaly and once the gasoline supply is replenished and more pipeline capacity can be built to move heavy volumes from Canada down to the US Gulf Coast we will get a return to long term price actions. If we do not see those fundamental changes in the next two years then we could expect a long term sustained shift in the price trends.