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Brent-WTI Crude Price Spread: An Ever-Changing Dynamic In Commodity Futures

Brent-WTI Crude Price Spread: An Ever-Changing Dynamic In Commodity Futures


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Abstract

The price spread between the world’s most traded crude oil blends and the most actively traded commodities in the world generally track one another, but divergences often reflect technical, supply/demand, or geopolitical issues. Over the course of history, the spread between Brent crude and WTI blends has grown, shrunk, crossed paths, and reversed again countless times. As a result of reduced U.S. pipeline constraints, ongoing OPEC+ production cuts, and China purchasing record amounts of WTI crude oil, the spread between Brent and WTI crude oil prices has begun to shrink close to zero. The future may hold a reversal giving WTI prices the upper hand.


Key Points

  • Prior to 2007, the difference in futures price between WTI and Brent crude price normally remained within $2/bbl of each other. During this time period it was not unusual for WTI to receive a premium price compared to Brent.

  • From Q2 2007 through 2015 Brent prices sold at a premium to WTI. Geopolitical concerns in the Middle East paired with a massive influx of WTI crude on the market from the shale revolution in 2011 caused Brent crude futures to receive a major premium of up to $10-$25/bbl through 2015.

  • The combination of Iranian export agreements for Brent, additional U.S. exports for WTI, and a falling rig count in 2015 cratered the premium for Brent prices. WTI pipeline constraints over the next 4 years allowed a Brent differential recovery to nearly $10/bbl before crashing again due to the 2020 Saudi-Russia price war and COVID pandemic. 

  • OPEC+ and the U.S. currently control over 75% of global production. Reduced output from OPEC+ cuts and uneconomic U.S. production will create a squeeze on supply/demand between the two benchmarks which should further close the Brent-WTI spread moving forward.

  • Chinese imports of U.S. WTI crude has grown since the start of 2020 from 0.4% to 7% of the country’s total imported crude with an agreement to purchase $52.4 billion worth of oil and LNG by the end of 2021. This reallocation of market share has potential to reverse the historic price spread over the last 3 years and value WTI at a premium to Brent.

Introduction

The price spread between the world’s most traded crude oil blends and the most actively traded commodities in the world generally track one another, but divergences often reflect technical, supply/demand, or geopolitical issues. Technical issues can include lifting and transportation costs while geopolitical issues mainly involve exporting crude oil to the Asian markets where Brent and West Texas Intermediate (WTI) crude benchmarks compete. The major difference between Brent crude and WTI is that Brent originates from oil fields in the North Sea between the Shetland Islands and Norway, while WTI is sourced from U.S. oil fields, primarily in Texas, Louisiana, and North Dakota [1]. Since both Brent and WTI blends are light and sweet they are ideal for refining into gasoline, but Brent transportation costs are significantly lower because it is produced near the sea. In contrast, WTI is mainly produced in landlocked areas, making transportation costs more onerous [1]. There has been a trend, due to advancements in oil drilling and fracking, that WTI price has traded cheaper than Brent crude oil. Prior to the American shale revolution in 2011 when the U.S. began significantly increasing production, Brent crude tended to chart very close to WTI and sometimes would be cheaper [10]. Since that point a divergence began to occur. Theoretically, if crude oil was based solely on global supply and demand principles with the same market conditions, the price spread between the two would remain constant. However, because of recent technical advancements, supply/demand imbalances, and geopolitical influences, the spread between the two blends is closing once again after years of remaining apart. With reduced U.S. pipeline constraints, ongoing OPEC+ production cuts, and China purchasing record amounts of WTI crude oil, the spread between Brent and WTI crude oil prices will continue to shrink. 


Historic Spread 

Over the course of history, the gap between Brent crude and WTI blends has grown, shrunk, crossed paths, and reversed again countless times. That being said, there has been an established trend between the two. Through the end of Q1 2007 the spread between the two remained in lockstep, alternating from time to time, but always hovering near $2/bbl with WTI typically taking a premium [3,4]. During Q2 2007 Brent took a premium over WTI before the two again remained in near perfect lockstep through the end of 2010. At the start of 2011 the spread blew wide open with Brent taking a $10-25/bbl premium to its higher grade counterpart until Q1 2013. Figure 1 shows this large increase in the foreign benchmark until 2017 when market forces eventually brought about convergence again. 

Figure 1: Brent/WTI Price Spread 2005-2020 [3,4] 

The spread widened during 2011 with Brent trading at a premium compared to WTI around the time that the Arab Spring, an uprising across much of the Arabic region, began in Egypt in February of 2011 [5]. Fears concerning the closure of the Suez Canal and a lack of available supply caused Brent crude oil to become more expensive than WTI, but as tensions eased over the canal’s operation the price difference was reduced. In late 2011 the Iranian government threatened to close the Straits of Hormuz, through which approximately 20% of the world’s oil flows each day [5]. Once again the spread widened as Brent soared to a $25 per barrel premium higher than WTI [5]. Therefore, the initial spike that occurred in 2011 was geopolitical and drove the differential to new heights. This premium for Brent dropped in 2015 due to an agreement struck with Iran allowing the country to export more oil [5]. It increased the amount of Iranian crude flowing into the market on a daily basis, but since Iran prices its oil through the Brent benchmark it depressed the commodity price. Additionally, U.S. rig counts dropped during this period and the removal of restrictions for exporting U.S. crude abroad in December 2015 meant more U.S. production on the global market [10]. Brent prices dove as more Iranian crude reached the global market while WTI jumped because of falling U.S. production and increased exports. Thus, the dramatic moves in spread during 2015 were largely influenced by global supply and demand constraints with support from technical hindrances. With the wild price swings of April 2020, the spread has once again narrowed so much that WTI has the possibility of overtaking Brent’s premium in the near future. 


Technical Advancements – Transportation & Pipeline Constraints 

In 2015, a surge in U.S. shale oil production led to constrained pipeline capacity which limited the ability to move oil to the coast for export. This caused a fall in WTI price relative to Brent and a surge in the Brent/WTI spread [6]. When pipeline space is constrained, exploration and production companies compete for scarce pipe capacity by cutting prices to obtain access [7]. Since it is a localized issue, this weighs on WTI prices and not those of Brent with the result of widening the spread [7]. As new pipeline capacity became operational, WTI got a lift in price leading to a narrower spread during a convergence in 2015 through 2016 as shown in Figure 1. Price differentials again began to expand with Brent holding nearly a $10/bbl premium for almost a year beginning May 2018 largely due to pipeline constraints. Since transportation costs greatly increased during this time, WTI price was driven down as a rush of shale production continued to compete to enter the market highlighted by pipeline bottlenecks. Many of those constraints were eased in the fourth quarter of 2019 as additional pipelines from the Permian basin to refineries and export terminals on the U.S. Gulf Coast became operational [6]. When transportation costs are driven down as a result of additional domestic pipeline capacity, WTI prices are boosted and the spread closes. Pipeline protests and shutdowns have made headline news since the start of 2020 with the potential for failed pipeline projects to drive down WTI prices. The swift decline in domestic production as a result of global supply and demand constraints has created fewer pipeline capacity restraints and kept the benchmark spread reduced. 


Supply/Demand Constraints – OPEC+ Cuts

Another major factor in the tightening Brent/WTI spread since the dramatic spike in April 2020 has been from global supply and demand constraints. Since OPEC uses Brent as their pricing benchmark, this pricing mechanism dictates the value for roughly two-thirds of the world’s crude oil production [5]. This means OPEC and its allies have the ability to influence oil prices for those volumes outside of a free-market setting since they have a plan in place to reduce production through April 2022 in an attempt to curb the global supply/demand imbalance. With the United States controlling over 10% of global supply, OPEC and the United States account for over three-quarters of the globe’s production. As a result, Brent and WTI prices have begun to come together since a narrow spread indicates a tighter balance of supply and demand [7]. The opposite also remains true. This was seen when the spread hit an all time high in 2011 because U.S. supplies boomed, but the market demand remained light. As the world now continues to bring a significant portion of global production off the table to control supply and demand, this will force the spread between Brent and WTI to further close. 


Geopolitical Issues – Chinese Crude Imports

Even with the support of OPEC controlling production from some of the world’s most powerful producers, there arises a possibility that the spread could be reversed in the near future. Looking back, the spread collapsed in 2016 when the U.S. removed their oil export ban. The premium for Brent prior to that year existed as a result of surging shale output that ended up trapped in the U.S. because of a ban on crude exports. Once U.S. exports re-opened to global borders, the spread shrunk through 2017 [8]. Initially in 2016 the wide price differential led to a surge in exports, and as the gap between WTI and Brent shrank a rebalancing of crude sourcing eventually put a ceiling on exports. A similar rebalancing act is occurring today as China has been shifting where it imports crude.

Figure 2: Chinese Crude Oil Import Destinations [9] 

Earlier this year China agreed to buy U.S. crude as part of a broader deal meant to ease rising trade tensions between the two world powers [9]. The Trump administration agreed to cut some tariffs on Chinese goods in exchange for purchases of American farm, energy and manufacturing exports. As a result, the United States accounted for 7% of Chinese crude imports through mid-September, up from 0.4% in January [9]. Meanwhile, market share for Saudi Arabia, China’s biggest traditional supplier, fell to 15% from 19% in the same period [9]. Figure 2 shows this growing allocation of U.S. crude imports to China at the expense of other producers. With the United States opening the door to new export opportunities, the price of WTI is further supported from increased demand. Additionally, the growing entrance into China, the world’s largest importer, eliminates others from that market meaning as demand increases in the United States it is falling in many other countries. Based on recent tanker data, U.S. exports to China are expected to reach as many as 700,000 barrels per day by the end of October and may stay at such equivalent levels for some time [9]. After all, Beijing agreed to purchase $52.4 billion worth of oil and liquefied-natural-gas from the U.S. by the end of 2021 [9]. Some analysts suggest that after some Chinese refineries retooled their plants to process U.S. grades, they may continue buying. A foothold in the Chinese market gives U.S. shale companies an outlet that had previously been closed off when the U.S.-China trade fight was in full swing last year and a leg up on other global producers. The result could see a shift in the price spread between the world’s most traded crude blends in the near future, with the possibility of WTI beginning to outperform Brent. 


Conclusion

A narrow spread indicates a tighter balance of supply and demand as the difference between Brent and WTI moves closer and closer to zero. That is exactly what the world is currently experiencing. On the technical side, new pipelines have increased connections around the U.S. to ease bottlenecks and allow more U.S. oil to reach its destination. With reduced domestic production in response to decreased demand during the global pandemic and historically low prices, the United States has experienced limited pipeline restrictions ensuring there are fewer pipeline capacity issues forcing producers to cut prices. As a result, easier, cheaper transportation has allowed for WTI price support, and the spread has closed. It was further supported by the world unilaterally making historic production cuts in light of global demand destruction related to the pandemic. With the United States and OPEC controlling over 75% of the world’s production, economic factors and output curbs have helped to balance supply and demand. Geopolitical changes in the immediate future may tip the scales against Brent and put a premium on WTI crude oil. With the world’s largest importer, China, importing WTI crude oil again, domestic market share has been boosted. As demand is taken away from many Middle Eastern and Brent producing countries, this may put a premium on WTI crude in an attempt to make Brent more appealing to Asian market participants. 

The upcoming elections will have a dramatic influence on the spreads between domestic WTI crude oil and foreign Brent crude. The difference in benchmarks could be drastically reduced or reversed depending on if the United States is able to export more of its oil while also using it for domestic consumption. In this scenario, it is completely plausible that WTI may begin trading at a premium to Brent. On the contrary, if oil no longer leaves U.S. borders in favor of an immediate green future, the Brent-WTI spread will widen. Currently, technical and global supply/demand constraints are converging the spread between West Texas Intermediate and Brent crude after several years of separation, and in the near future the impact of geopolitical issues have the potential to flip the script in favor of the lighter, sweeter WTI blend. 


References 

[1] https://www.investopedia.com/ask/answers/052615/what-difference-between-brent-crude-and-west-texas-intermediate.asp 

[2] http://www.commodityresearchgroup.com/brentwti-spread-explained-by-the-eia/# 

[3] https://www.investing.com/commodities/brent-oil-historical-data

[4] https://www.investing.com/commodities/crude-oil-historical-data 

[5] https://www.thebalance.com/crude-oil-brent-versus-wti-808872 

[6] https://www.worldoil.com/news/2019/8/6/eia-forecasts-narrowing-brent-wti-spread-on-reduced-pipeline-constraints 

[7] https://www.barrons.com/articles/brent-crude-oil-prices-west-texas-51567711727 

[8] https://www.businessinsider.com/oil-wti-brent-spread-shrinking-why-2018-2 

[9] https://www.wsj.com/articles/u-s-boosts-crude-sales-to-china-forcing-saudis-to-find-other-markets-11601895481

[10] https://www.eia.gov/todayinenergy/detail.php?id=11891

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