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Why 2 similar grades of oil trade at different prices

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WTI and Brent used to trade in line, but prices had diverged over the past few years

The spread between West Texas Intermediate (or WTI) and Brent crude represents the difference between two crude benchmarks, with WTI more representing the price oil producers receive in the U.S. and Brent more representing the prices received internationally. The two crude oils share a similar quality, and theoretically, should price very closely to each other. However, the prices have differed greatly between the two crudes because a recent production surge in the U.S. 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 the U.S. oil production, the two crudes had historically traded in line with each other.

2014.05.09 - WTI-Brent LT

The above graph shows the WTI-Brent spread over the past few years. Note that when the spread is wider, it generally means crude oil producers based in the U.S. receive relatively less money for their oil production compared to their counterparts producing internationally.

2014.05.09 - WTI-Brent ST

The WTI-Brent spread traded slightly narrower last week, but is ~$4 wider since mid-April

The spread between WTI and Brent crudes closed at $7.93 per barrel on May 9, compared to the spread of $8.66 per barrel for the week ended May 2, 2014.

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Since mid-April, the spread has moved ~$4 wider. One reason may be that escalating tension between Russia and Ukraine helped to boost Brent crude oil prices, as Russia is a major oil exporter. Also, geopolitical events outside the U.S. are more apt to affect Brent crude prices than WTI prices. Meanwhile, the U.S. oil inventories had been climbing over the past few weeks, implying strong U.S. oil supplies.

From November 2013 to mid-April 2014, the spread narrowed from ~$16.50 per barrel to ~$4.50 per barrel, as new infrastructure that transports more crude from Cushing to the Gulf Coast opened up, primarily, the Marketlink pipeline operated by TransCanada (TSX). Also, Enterprise Products Partners (EPD) said it would more than double the capacity of its Seaway pipeline in mid-2014. The Seaway pipeline currently brings crude oil from the inland U.S. oil hub of Cushing, Oklahoma, to the Gulf Coast.

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The increased transportation capacity from inland U.S. crude production regions to demand centers (such as refineries on the Gulf Coast) is bullish for WTI crude oil prices. The expanded pipeline is reported to be able to move more than 850,000 barrels per day of crude oil. Furthermore, the U.S. Energy Information Administration reported that stocks at the inland U.S. crude hub of Cushing continued to decrease, which may also indicate that U.S. crude produced inland is having an easier time getting to demand centers such as refineries. This can bring WTI and Brent prices closer together.

The latest EIA short-term report expects the 2014 spread to be just under ~$10 per barrel

On May 6, the U.S. Energy Information Association, in its latest “Short Term Energy Outlook” report, noted that it expects the spread between WTI and Brent to average ~$9.67 per barrel over 2014, compared to ~$9.27 per barrel in the previous report. The forecast takes into account the increasing pipeline capacity from the Midwest into the Gulf Coast, helping boost WTI prices to trade in line with Brent, as well as continually increasing domestic production of crude oil.

Background: The WTI-Brent spread over 2013

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WTI had been trading as low as $23 per barrel under Brent in February of 2013. Over the course of the year, the spread narrowed due to several factors. First, increased midstream infrastructure has come online, facilitating 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. Second, 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 allowed inland domestic crude to more efficiently travel to refiners on the East and West coasts, which has also backed out Brent-like imports.

U.S. refineries began running at higher rates earlier in 2013, which caused increasing demand for crude oil. Since spring 2013, many U.S. refineries started to come back online from performing routine maintenance. The EIA reported that in July, domestic refineries were running crude oil through their facilities at a rate of ~16.3 million barrels per day through June 2013. This is a ~2.1 million-barrel-a-day increase over the first week of March. Plus, new refining capacity opened up in the Gulf Coast, helping increase refiners’ demand for crude.

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So the spread between WTI and Brent closed in throughout 2013, until the two crude oils traded nearly at par in mid-July. In late August and early September, the spread widened to nearly $8 per barrel. This was partly because supply from Libya had dropped sharply due to the unrest. Plus, the escalation of tensions in Syria had caused traders to take bullish bets on Brent crude’s international oil benchmark. Perhaps, this also drove the price differential between WTI and Brent. Since then, fears about Syria eased somewhat, and production from Libya started to recover, so that spreads closed in again to ~$3 per barrel in mid-September.

After that, data continued to show growing U.S. crude oil production—particularly from areas such as the Bakken in North Dakota and the Permian in West Texas. Accompanying the crude production growth were increasing stocks of crude inventories—particularly at Cushing, a major crude hub in Oklahoma. In 4Q13, Cushing inventories rose for seven weeks straight after several months of steep decline. This was a signal that inland crude production flowing into Cushing may have started to overtake the existing takeaway capacity, which would have depressed WTI crude oil prices compared to Brent prices. During this period, the spread gradually widened to levels as wide as ~$19 per barrel in late November before closing 2013 at ~$12 per barrel. The spread narrowed on account of the opening of the southern portion of TransCanada’s Keystone XL pipeline and stabilizing tensions in the Middle East.

The spread’s effect on oil companies

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When WTI trades below Brent, this generally means companies with oil production concentrated in the U.S. will realize lower prices compared to their international counterparts, as WTI is the U.S. benchmark and Brent is the international benchmark. For example, see the data given below for a comparison of oil prices realized by U.S.-concentrated companies versus companies with a global production profile.

1Q14 average price per barrel

Benchmark oil prices

West Texas Intermediate $98.61

Brent $107.87

1Q14 realized oil prices per barrel (excluding hedge gains/losses)

Domestic producers

Chesapeake Energy (CHK) $93.60

Concho Resources (CXO) $92.35

Range Resources (RRC) $85.13

Oasis Petroleum (OAS) $89.66

International producers

Total Corporation (TOT) $102.10

Exxon Mobil (XOM) $99.82

Chevron Corporation (CVX) $96.78

From an investment point of view, if Brent is expected to continue to trade significantly above WTI, investors might favor buying oil names that receive crude prices closer to the Brent benchmark than the WTI benchmark. Generally, this would represent oil names with more international production relative to domestic (U.S.) production.

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 above (CHK, CXO, RRC, and OAS), to realize lower prices on oil compared to international producers. But over the medium term, the spread over 1Q14 has been significantly lower on average than over 4Q13.

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