Why is there volatility in the WTI-Brent crude oil spread?
WTI and Brent used to trade in line, but prices had diverged over the past few years
The spread between West Texas Intermediate (WTI) and Brent crude represents the difference between two crude benchmarks, with WTI more representing the price that U.S. oil producers receive and Brent more representing the prices received internationally. The two crudes are of similar quality and theoretically should price very close to each other. However, the prices had differed greatly 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 created a supply and 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.
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The above graph shows the WTI-Brent spread over the past few years. Note that when the spread moves wider, it generally means that crude producers based in the United States receive relatively less money for their oil production compared to their counterparts that are producing internationally.
Spreads traded slightly wider last week, but have moved sharply tighter throughout 2013
The WTI-Brent spread continued to trade wider last week, moving from $3.11 per barrel to $4.62 per barrel. Despite last week’s wider movement, the spread has moved narrower throughout much of 2013. In early February, WTI traded at points as much as ~$23 per barrel below Brent crude, but the spread had steadily narrowed since then to trade at current levels of near parity. 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.
Over the medium term, 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 the Oklahoma crude hub at Cushing to the Gulf Coast, where a great amount of refining capacity sits. Plus, 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. Increased pipeline capacity and crude transportation by rail have also allowed inland domestic crude to more efficiently travel to refiners on the East and West coasts, which has also backed out Brent-like imports.
Plus, U.S. refineries are running at higher rates, which has caused increased demand for crude. Since spring 2013, many U.S. refineries started to come back online from performing routine maintenance, and the EIA reported that domestic refineries were running crude through their facilities at a rate of ~16.1 million barrels per day. This is a ~2.1 million-barrel-per-day increase over the first week of March. New refining capacity also opened up in the Gulf Coast, helping increase refiners’ demand for crude.
Over the short term, the spread likely moved wider, as lower-than-expected production of crude out of the North Sea has caused the loading of oil cargo to be delayed. Plus, supply disruptions from Libya due to unrest have helped to boost Brent crude prices relative to WTI.
Future of the Brent-WTI spread
When the spread was trading at its widest point, most market participants thought it would close in over the medium term. However, given that the spread has closed so much throughout the year, some feel it 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 $8.84 per barrel in 2013. Year-to-date, it has averaged ~$11.10 per barrel, and roughly 64% of the year has elapsed, which implies that the rest of the year the spread will average ~$4.80 per barrel and so will be roughly flat to current levels.
Again, a wide spread means that companies with oil production concentrated in the United States will realize lower prices compared to their international counterparts. For example, see the table below for a comparison of oil prices realized by U.S.-concentrated companies versus companies with a global production profile.
|2Q13 Average Price Per Barrel|
|BENCHMARK OIL PRICES|
|West Texas Intermediate||$94.12|
|2Q13 Realized Oil Prices Per Barrel (excluding hedge gains/losses)|
|Chesapeake Energy (CHK)||$92.53|
|Concho Resources (CXO)||$89.87|
|Range Resources (RRC)||$83.87|
|Oasis Petroleum (OAS)||$91.15|
|Total Corp. (TOT)||$96.60|
Monitor the spread
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 those mentioned in the above table (CHK, CXO, RRC, and OAS) to realize lower prices on oil compared to international producers. But over the medium term, the spread has closed dramatically and now signals better takeaway capacity for inland U.S. oil. Investors should note that many international names are in the XLE ETF (Energy Select Sector SPDR), an ETF (exchange-traded fund) whose holdings are primarily large-cap energy stocks with significant international exposure.