Not The Same Oil

Published on Tuesday, 06 March 2012 22:17 Written by Todd Shriber

Have you ever read a story about oil prices, say here on TradersHuddle, and wondered why West Texas Intermediate, the oil traded here in the U.S., and Brent crude, the oil traded in London, have different prices? Don’t worry, you’re not alone. A lot goes into this equation. Weak demand, refinery outages bottlenecks at storage facilities and myriad other issues can pressure WTI even while Brent prices surges and vice-versa.

The current spread between the two contracts is just over $17 per barrel in Brent’s favor. That’s wide by historical standards but not as wide as the $23 per barrel chasm seen in June 2011. What’s interesting about the spread is that analysts often encounter difficulty in explaining it and that neither Brent nor WTI accounts for most of the world’s oil supply. Even combined, the two oil varieties account for a relatively small percentage of global oil consumption.

These days, part of the reason why the spread may be so wide and may continue to widen is because is because even a spread of $5 or $8 per barrel can be a compelling reason for an oil company or major oil-producing nation to start pricing its crude in whatever contract is more expensive. Over the past several years when the Brent/WTI spread has been noticeably wide, it has almost always been wide in favor of Brent. Logically speaking, oil producers want to make more money so they opt to continue using Brent, not WTI, as their benchmark.

It’s also important to note WTI has been declining relative to world oil prices. Starting shortly after the beginning of 2011, Brent rose about 1.5% relative to world oil price–while WTI dropped below the world average oil price, according to the Oil Drum.

Expect the spread to remain wide for the foreseeable future. BENTEK Energy, a leading energy markets information and Analytics Company, recently published a report that said the price differential will average minus $14 over the next five years. Despite the addition of new pipelines, no guarantee of that happening, "supply growth is expected substantially to outpace pipeline and refinery increases and lead to the return of deep WTI price discounts to Brent in 2015 and 2016," BENTEK said in its report.

It’s not unreasonable to see this condition persisting, particularly if the U.S. is able to boost oil production at the Bakken, Eagle Ford, Utica and other shale plays. That’s added supply coming online, and it will diminish the price of WTI. That’s good for companies and consumers, not for traders that short Brent and go long WTI.

To that, the U.S. Brent Oil Fund (NYSE: BNO) remains the preferred option over the U.S. Oil Fund (NYSE: USO), which tracks WTI, going forward.