Crude Price Divergence: What Do We Learn from Oil Futures Prices?

 

Takeaway

  • In the past month Brent Blend crude has traded significantly higher than WTI
  • Looking to oil futures tells us this difference is expected to decline, but will not be eliminated in the near future

Written in collaboration with Malcolm Wardlaw.

The most actively traded commodity in the world — crude oil — can vary greatly in terms of grade and variety. Because of the importance and complexity of the market, people who sell and buy crude oil need common references to compare blends and prices; the benchmarks they use — marker crudes — fill this need.

The two most commonly traded marker crudes in the world are Brent Blend and West Texas Intermediate. Brent is produced out of the North Sea and flows via pipeline into shipping terminals, primarily located in the Shetland Islands. West Texas Intermediate is produced primarily by independent producers in West Texas and flows via pipeline into a pooling point in Cushing, Oklahoma. Both crude oils are termed light, sweet crude with a high API gravity and low sulfur content. Because Brent crude oil has a slightly lower API gravity and slightly higher sulfur content, it is less valuable to refiners in creating gasoline and diesel fuel, and should be priced less, all things equal. As a result, WTI has historically traded at a slight premium to Brent crude.

We do, however, observe times when Brent trades at a premium to WTI. This is due in part to transportation and storage constraints at Cushing, Oklahoma, which can temporarily depress the price of WTI relative to Brent. This slight difference tends to reverse rather quickly, but in the past month Brent has traded significantly higher than WTI, hitting a record $16/bbl last week. Various explanations have been floated for this phenomenon in the press, including worries about the closure of the Suez Canal pushing up the price of Brent and a large glut of oil coming from Canada and North Dakota creating transportation constraints around Cushing, Oklahoma (the location where WTI is priced).

The following chart graphs the difference between the price of a Brent futures contract and the equivalent maturity contract on WTI over the last six months and over the last two years. One can see a clear increase in the price difference over the last month. Even more striking is that the price increase is not just in the prompt month contract, which is often used to approximate the spot price. The difference remains above $5 out to the fourth month (currently the July contract), and remains above $3 even one year out.

The chart indicates that the difference in price between WTI and Brent is not unusual in the past 2 years, the magnitude and expected persistence is unusual. This persistence indicates that whatever supply or demand factors that are driving Brent higher than WTI are not likely to be eliminated over the next several months. If the disconnect between WTI and Brent crude is being driven because of capacity constraints in pipeline transport or Midwest refining, the futures market is telling us that this is more than just a temporary problem.

Disclaimer

The views expressed are those of the author and not necessarily The University of Texas at Austin.
 

About The Author

Sheridan Titman

Walter W. McAllister Centennial Chair in Financial Services, McCombs School of Business

Sheridan Titman is a professor of finance at The University of Texas at Austin and a research associate of the National Bureau of Economic...

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