The Brent-WTI spread

On May 2, 2017, WTI (West Texas Intermediate) crude oil (UCO) (USO) (OIIL) (USL) active futures were trading at a discount of $2.8 per barrel to Brent crude oil (BNO) active futures. On April 25, 2017, the spread was at $2.54 per barrel.

The Brent-WTI Spread: What Does It Suggest?

Although far below its 2011 peak, the Brent-WTI spread has risen since OPEC’s (Organization of the Petroleum Exporting Countries) deal in November 2016. A reduction in global crude oil supply outside the United States, driven by OPEC’s cuts and accompanied by rising US supply, could explain why the Brent-WTI spread has expanded.

More recently, the spread may have expanded due to optimism surrounding OPEC’s extension of production cuts into 2H17, while US crude oil production keeps climbing, even as US inventories reach near record highs.

What’s impacting the Brent-WTI spread?

Historically, WTI and Brent crude oil have traded close to each other, but WTI is easier to process. It’s also produced in the United States, the world’s largest demand center. For the most part, WTI has been trading at a small premium to Brent.

Around 2011, US oil production started booming due to high prices and technological advances that unlocked vast shale deposits. Rising production from Canada also contributed to a rise in North America’s supply.

Previously, US crude oil couldn’t be exported. Also, there wasn’t enough transportation capacity to get booming inland supplies to the main demand center for oil on the US Gulf Coast, which has most of the refining capacity in the United States.

Turning point

By October 2011, US crude oil production had risen to 5.9 million barrels per day, its highest level since July 2002. In the meantime, countries such as China gained dominance as demand centers for crude-derived fuels. In October 2011, WTI crude oil active futures were trading at a discount of $27.88 per barrel to Brent oil active futures—a record high.

After various oil pipeline projects became functional in 2013, the spread gradually narrowed. The US removed the ban on domestically produced oil exports in December 2015, and as a result, the Brent-WTI spread flipped into negative territory for the first time in five years.

On January 15, 2016, WTI crude oil active futures were trading at a premium of $0.48 to Brent crude oil—the highest premium since August 16, 2010.

How does the Brent-WTI spread drive energy stocks?

The spread between Brent crude oil (BNO) and WTI crude oil (UWTI) prices impacts US upstream producers (XOP), midstream transporters (AMLP), and downstream refiners (CRAK).

When US WTI crude oil is cheaper than Brent crude oil, it means that US upstream producers receive less money than their international counterparts for each barrel of oil they produce. However, the situation is more profitable for downstream US refiners because their input costs are lower in this situation.

If WTI’s discount to Brent is deep enough to cover shipping and transportation costs, it could also be an opportunity for upstream or midstream companies to seek higher prices outside North America via exports. So far in 2017, US crude oil exports averaged levels ~93.5% higher than they were during the same period in 2016.

For a deeper understanding of US upstream companies, check out Market Realist’s primer on the upstream industry.

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