West Texas Intermediate and North Sea Brent: What’s the difference between these two global crude oil benchmarks?
So you’ve decided to try your hand at commodities investing, and you think the energy sector might match your objectives. Specifically, you’ve identified crude oil as your market of choice. Early in your research, you spot more than one type of crude oil traded on U.S. exchanges—West Texas Intermediate (“WTI”) and North Sea Brent (“Brent”) crude.
You notice that both have comparatively different trading volumes depending on the contract months. You also notice that although Brent and WTI prices are correlated, meaning that they tend to move together, there are times when Brent is more expensive than WTI and vice versa.
Now you must stop and ask yourself:
"WTI and Brent crude are both referred to as light and sweet crude oils," says Stephanie Lewicky, Senior Manager, Futures & Forex at TD Ameritrade. But what do these terms mean, exactly?
"To begin with, there are many different types of crude oil and crude oil blends in the world, and they’re typically classified according to their capacity to be refined into gasoline," she says. “Crude oil that is lighter in density is easier to refine into gasoline. Conversely, oils with heavier densities are more difficult to refine."
API gravity is a standard measurement to classify oil density that was developed by the American Petroleum Institute. With numbers falling between 10 and 70, the lighter the oil, the higher the API gravity number. For example, oils in the high API gravity range—light oils—will often float on water; correspondingly, these oils are easier to refine. Heavy oils in the lower range of API gravity scores will begin sinking in water.
What about the term sweet? “This has everything to do with crude oil’s sulfur content," says Lewicky, “and the cutoff is 0.5%. Sulfur content higher than 0.5% is considered sour; lower than 0.5% is considered sweet. The sweeter the oil, the easier it is to refine into gasoline and other petroleum-based products," she says.
So, crude oil that is both light and sweet is easier to refine. And these two qualities make up the benchmark for premium oils. WTI and Brent crude, both recognized as light and sweet, constitute premium benchmarks in the global crude oil market.
Now, consider the differences between the two.
Futures on these major crude oil benchmarks are listed on U.S. and European exchanges.
The prices of both WTI and Brent are highly correlated. Although each has a different price, they both fluctuate together, diverging and converging within a relatively tight range.
WTI crude is lighter and sweeter than Brent, and it’s had a historical premium over Brent of around $2.50 to $4. But this hasn’t always been the case. And for the last several years, Brent has commanded a premium. What might have contributed to this price inversion? (See figure 1.)
One short answer is that quality isn’t the only consideration. Location, delivery logistics, and global supply and demand also play a part. “The WTI delivery point is Cushing, Oklahoma," says Lewicky. “It’s a landlocked area, which is centrally located around the major oil fields, but far from where most oil and refined products—gasoline and petrochemicals, for example—are ultimately destined," she says.
In 2011, amid tensions in the Middle East, fears of a Suez Canal closure caused Brent prices to trade at a premium to WTI. The spread widened further as Iran threatened to close the Strait of Hormuz, a shipping route through which 20% of the world’s oil was transported. By the end of 2011, Brent traded $25 above WTI.
In 2015, the Brent-to-WTI spread dropped because of events in the U.S. and the Middle East. Iran, whose oil is benchmarked to Brent crude, agreed to increase flows into the market. This created more supply, which caused Brent prices to move lower. At the same time, U.S. rig counts declined while its WTI export activity increased. The decrease in U.S. oil production and supply, thanks to its increased exports, pushed WTI prices higher relative to Brent, but the conversion was short-lived. Brent has traded at a premium since early 2016.
By the middle of 2018, the Brent-over-WTI spread had widened to more than $6 a barrel. Many analysts attributed this to distribution bottlenecks in the U.S. and competition from Canadian oil.
"Because crude oil impacts markets and industries worldwide," says Lewicky, “financial news outlets and traders across the globe closely monitor the rising and falling prices of crude oil futures."
And although West Texas Intermediate and Brent crude are two highly correlated commodities—their prices tend to move in a similar fashion— each crude oil benchmark might respond differently to geopolitical, local, and economic forces.
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