Forces affecting the Brent-WTI spread

Forces affecting the Brent-WTI spread

There is always much hype regarding the price of oil as it affects all of us on the planet. Lately however, there has been large emphasis on future oil prices pertaining to Brent Crude and WTI(Western Texas Intermediate) crude. It seems as though the separation between these two oils have increased in size to record numbers of late. There are certain factors that influence the price of these two oils which provides us with a more detailed understanding of why the spread between the two oil classes continues to occur which will be brought to attention in this article.

Before diving into the specifics it’s important to understand the differences between the two oil classes and how this can affect the refining process.

Brent crude is a sweet light crude that is sourced from the North Sea which contains 0.37% sulpher, has an API Gravity(weight compared to water) of approximately 38.06 and a specific gravity(density compared to water) of around 0.835.

West Texas Intermediate (WTI) is used as the benchmark for oil pricing and is a sweet-light crude just like Brent crude but with an approximate API of around 39.6 and a specific gravity of around 0.827 which is lighter than the Brent crude and also sweeter containing 0.24% sulfur.

*When API gravity is greater than 10, oil is light and floats, when less than 10, oil is heavy and sinks.

Oil once extracted is either transported to a refinery via water by barges, tankers or by land- pipelines, trucks, trains and converted into different products like petrol, lubricating oil, diesel, fuel oil and bitumen. If there is an excess amount of oil it is stored in an oil hub such as the popular Cushing hub in Oklahoma. The refining process can be quite scientific but there is a certain standard of expected sulphur content, meaning higher sulphur oil is more difficult to refine. The lower the sulphur content the easier it is to refine, the more product is created. Heavy oil can contain up to 4.5% sulphur such as the Western Canadian Select which is much cheaper and trades in the range of 25-35 per barrel on the futures market.

Now the big question is if the Western Texas Intermediate is superior oil in comparison to the Brent Crude, why is the Brent Crude trading at levels nearly 20% higher than WTI?

Decrease In Production of North Sea Brent Grades

Production coming out of the North Sea is at the lowest in over a decade due to ageing oilfields and infrastructure maintenance. The estimated fall in production for Brent crude is in the 150,000-200,000 barrels per day which is much higher than predicted. The decrease in supply of Brent Crude has been a factor for the oil trading above WTI.

Demand for North Sea Grades

As supply and production of Brent Crude has decreased to record lows the demand has been strong for North Sea grades from countries in Asia like South Korea and China. A free-trade agreement between the European Union and South Korea was formed and entered into force in July 2011 which eliminated nearly all duty on trade imports and eliminated tariffs for industrial and agriculture goods going into South Korea which has increased oil demand from the country.

*This was the European Union’s first trade deal with an Asian Country.

High production from Bakken oil shale formation

On the other hand we have the exact opposite happening with American oil production such as production from the Bakken oil shale formation which has topped 600,000 barrels per day up 69% from the prior year. North American oil production is set to continue increasing and going the opposite direction of North Sea Brent.

High stockpiles in Cushing

OPEC recently reported that Crude inventories out of Cushing are at an all-time high of 43.4 million barrels approximately 35% higher than a year prior. The available supply and increase in production takes away the value of the commodity as seen in recent prices and contributing to the spread between Brent Crude.

Current Infrastructure Constraints

America is currently expanding their pipeline and transportation infrastructure to meet the increasing production and stockpiles of oil to refineries to create product and improve exports which will even out demand and help narrow the gap between Brent crude. Projects such as the Seaway pipeline expansion in 2013 will play a crucial role in oil transportation increasing transportation from 150,000 barrels per day to 400,000 barrels per day which will increase the flows going out of Cushing Oklahoma to the Gulf Coast. Infrastructure and transportation will play a large role in narrowing the gap but it will take time and until than the gap between Brent crude and WTI will remain apart and perhaps further separate. As pipelines expand other means of transportation is seen increasing such as rail tank car traffic out of the Bakken shale play and barges transporting oil down the Illinois and Mississippi rivers to the gulf coast which has helped make a difference and will continue to help as pipelines further expand in 2013.

This has been a quick summary explaining the reasons behind the separation between WTI and Brent Crude. The spread between these two oil classes is expected to narrow at some point according to a recent OPEC conference but the spread between WTI and Brent crude is likely to persist by ongoing constraints in infrastructure, increasing production from the Bakken play and slow production out of North Sea coupled with increasing Asian demand for North Sea oil grades.

Stay tuned for the OPEC meeting on Dec.12 to hear more about 2013 production. This announcement will have an affect on the price of oil going forward.

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