The spread between West Texas Intermediate (WTI) and Brent crude represents the difference between two different crude benchmarks, with WTI being more representative of the price that U.S. oil producers receive and Brent being representative of the prices received internationally. In brief, the prices differ between the two crudes because a recent surge in production in the United States has caused a buildup of crude oil inventories at Cushing, Oklahoma where WTI is priced. This has created a supply/demand imbalance at the hub causing WTI to trade lower than Brent. Before this increase in U.S. oil production, the two crudes had historically traded in-line with each other. The above graph shows the WTI-Brent spread over the past few years. Note that when the spread moves wider, it means that crude producers based in the U.S. receive relatively less money for their oil production compared to their counterparts that are producing internationally.
The WTI-Brent spread was roughly flat last week, moving slightly from $8.42/barrel to $8.53/barrel, In early February, WTI traded at points as much as ~$23/barrel below Brent crude, but the spread had steadily narrowed since then to trade at current levels of ~$8/barrel. The significant tightening of the spread since February has been a positive for domestic oil producers (relative to international producers), as it means that the discount they receive to international crudes has been decreasing. From a very long-term perspective (5+ years), the spread is wide as WTI and Brent crudes have historically traded roughly at par.
The spread has narrowed due to several factors. Firstly, increased midstream infrastructure has come online that has facilitated the movement of crude from inland to refiners on the coast. One notable example is the expansion of the Seaway Pipeline in January 2013, which allows more crude to flow from Oklahoma crude hub Cushing to the Gulf Coast, where a great amount of refining capacity sits. Additionally, Sunoco’s Permian Express Pipeline and the reversal of Magellan Midstream Partners’ Longhorn Pipeline are allowing more crude from the Permian Basin in West Texas to flow directly to the Gulf Coast. Additionally, increased pipeline capacity and crude transportation by rail have allowed inland domestic crude to be more efficiently transported to refiners on both the East and West Coasts, which has also backed out Brent-like imports.
When the spread was trading at its widest point, most market participants thought that it would close-in in the medium-term. However, given that the spread now trades at roughly ~$8/barrel, some feel the spread may remain where it is or widen back out from here. For example, the EIA (U.S. Energy Information Administration) notes in its monthly report titled “Short Term Energy Outlook” that it expects the spread to average $12.72/barrel in 2013. Year-to-date it has averaged ~$15.00/barrel, and roughly 40% of the year has elapsed which implies that the rest of the year the spread will average ~$11.25/barrel and will, therefore, widen from current levels.
Again, the effect of a wide spread means that companies with oil production concentrated in the U.S. will realize lower prices compared to their international counterparts. For example, see the below table for a comparison of oil prices realized by U.S.-concentrated companies versus companies with a global production profile.
|1Q13 Average Price Per Barrel|
|BENCHMARK OIL PRICES|
|West Texas Intermediate||$94.36|
|1Q13 Realized Oil Prices Per Barrel (excluding hedge gains/losses)|
|Chesapeake Energy (CHK)||$95.23|
|Concho Resources (CXO)||$82.49|
|Range Resources (RRC)||$85.46|
|Oasis Petroleum (OAS)||$93.33|
|Total Corp. (TOT)||$106.70|
Investors may want to monitor the spread as a wider spread may make international producers more attractive relative to domestic producers. The difference between Brent and WTI has caused domestic producers, such as the ones mentioned in the above table (CHK, CXO, RRC, OAS), to realize lower prices on oil compared to international producers, and despite the medium-term positive catalyst (from the view of domestic producers) of a narrower spread, from a longer-term perspective the spread remains wide. Therefore, international producers receive significantly more revenue per barrel than domestic producers. Additionally, many international names can be found in the XLE ETF (Energy Select Sector SPDR), an ETF with holdings primarily in large-cap energy stocks with significant international exposure.
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