Dueling Oil Benchmarks Converge in Their Price, but Diverge in Their Stories
Crude Measures Reflect Different Market Forces Playing Out in U.S. (as Told by WTI) and Globally (by Brent)
By Jo Craven McGinty
Jan. 23, 2015
The economic ripples caused by the free-falling price of oil in recent months have drawn wider public attention to the daily cost of a barrel of crude.
But the figures traditionally used to convey global oil prices—the West Texas Intermediate and Brent crude benchmarks—measure different things and don’t always line up. Today, for example, a barrel of oil costs $45 and change by WTI and a few dollars more by Brent. At times, the difference between the two has topped $20.
Traders and economists are familiar with the reasons why WTI and Brent differ. For those newly curious about what falling oil prices mean, it’s worth learning what the benchmarks reveal, and how they’ve changed over time.
The basic reason why the numbers diverge is because they are snapshots of oil prices in different places: WTI reflects the U.S. and Brent the North Sea in Europe. At one time, they were equally good benchmarks of global crude. But as domestic production surged, WTI began to reflect the surprising domestic oil glut, which turned out to be more than the existing pipelines could handle.
Crude oil is classified as light, medium or heavy, referring to the density of the liquid, and as sweet or sour based on its sulfur content. Light, sweet oil—which floats on water and is low in sulfur—is prized because it requires less processing to convert it into usable products. WTI and Brent are both light, sweet crude oils.
“If somebody wanted to buy heavier or more sour crude, they could say what’s Brent? OK, I’ll give you Brent minus $2.50,” said James Preciado, who analyzes futures markets and energy prices for the U.S. Energy Information Administration.
Traditionally, prices for the two have tracked closely and they’ve been quoted interchangeably as benchmarks. But the U.S. shale oil boom upended the relationship, throwing the WTI’s usefulness as a global barometer into question.
Before the boom, the U.S. produced about five million barrels of crude oil a day and imported about 18 million barrels. Much of the imported oil moved from the Gulf Coast to Cushing, Okla., a major crude oil hub in North America and the delivery point for WTI.
When the boom hit, domestic production rapidly increased by 4 million barrels a day, flooding Cushing and overwhelming the pipelines, which were not equipped to move large volumes of crude to Texas.
“They could push it upstream but not to the Gulf Coast,” Eric Lee, an energy analyst with Citigroup said. “The storage tanks filled up, and prices dropped significantly.”
Meanwhile, several factors increased demand for Brent crude, keeping its prices high relative to WTI and cementing Brent as the more accurate global benchmark.
“The biggest was the Libyan situation,” said John Felmy, the chief economist for the American Petroleum Institute, referring to the militias that have thrown the country into turmoil and paralyzed its oil industry, as well as losses in other areas like South Sudan. “We lost 3% of the world supply. You might look at it and say 3% is not very much. It can mean a 30% change in prices.”
To address the bottleneck, the 500-mile Seaway pipeline reversed the direction of its flow to carry crude from the Cushing site to Texas. A twin pipeline was constructed, doubling the pipeline’s capacity to about 850,000 barrels a day. And a segment of the Keystone pipeline was built with the potential to transport about 830,000 barrels a day to Gulf Coast refineries.
With WTI crude moving through the pipes, the spread between the benchmarks began to narrow, and displaced imports contributed to the lessening gap.
Countries in “West Africa, Latin America and the Middle East lost market share in the U.S.,” Mr Lee said. “Oil they had exported to the U.S. has to go somewhere else in the world.”
The U.S. still has an oversupply of crude, he added, but for now the rest of the Atlantic Basin—which includes the North Sea—is even more oversupplied, and that is pushing Brent prices down to meet WTI. “It becomes a buyers’ market. There is downward pressure on the price,” Mr. Lee said.
After about six months of steep decline, the two benchmarks are once again more closely aligned, although the U.S. product has lost its status as a global benchmark.
“Nowadays, the WTI is much more associated with U.S. domestic production and U.S. domestic prices,” Mr. Preciado said. “Brent is seen as an international benchmark.”
That doesn’t mean one is more important than the other. But the benchmarks now tell different stories.
http://www.wsj.com/articles/dueling-oil-...1422039795
