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Brent-WTI Crude Increasing price divergence – New Reality

, October 5, 2011, 0 Comments


COMMODITIES : Price divergence between the world’s top oil benchmarks creating a wreaking havoc among energy investor, Traders and Hedgers. Divergence between Western Texas Intermediate oil (WTI Crude) increasing from top global oil references Brent Crude.

The spread which was historically ruling between $4-6 had spiked between $14-$16 in February of this year, and now at more than $20-22 a barrel. Recent reports suggest “Speculative mis-pricing” of  WTI Crude is a major factor among many, behind  the prevailing divergence.

Basic Analysis and Price Difference

Brent Crude is produced out of the North Sea, flows via pipeline into shipping terminals, primarily located in the Shetland Islands. Western Texas Intermediate (WTI) is produced primarily by independent producers in West Texas and flows via pipeline into a pooling point in Cushing, Oklahoma.

Both Brent-WTI are termed as light, sweet crude with a high API gravity and low sulfur content. Because Brent crude oil has a slightly lower API Gravity and slightly higher sulfur content, it is less valuable to refiners in creating gasoline and diesel fuel, and should be priced less, all things equal. As a result, WTI has historically traded at a slight premium to Brent crude.

As chart indicates there was a band in which Price difference between WTI-Brent tend to stay but after December 2010 the parity completely disappeared and with every passing month divergence is  hitting new records. Initially, reason behind the spike in difference between WTI-Brent attributed to worries about the closure of the Suez Canal pushing up the price of Brent and a large glut of oil coming from Canada and North Dakota creating transportation constraints around Cushing, Oklahoma – the place where WTI is priced.

Too much like Gambling

According to whistle-blowing website WikiLeaks – Prince Abdulaziz, Saudi’s deputy oil minister, as describing the WTI market as “too much like gambling”. According to the cables, Saudi officials explained to US diplomats that the shift to a new benchmark would leave the kingdom “less subject to speculative price swings”.

The increasing divergence prompted Saudi Arabia to drop WTI as its benchmark for pricing oil to US customers. In Past Saudi officials have highlighted technical problems with WTI, rather than the influence of speculative price swings, as the reason to drop the benchmark.

The WTI-Brent price divergence meant that companies hedging their exposure to rising energy prices through WTI contracts were left exposed to losses. WTI is the backbone of the CME Ex­change’s flagship crude oil contract, the world’s most liquid oil futures contract, which is often cited as the “real” price of oil.

Is Current divergence a New Normal?

Now a days world over besides WTI, Traders, dealers and analyst also tracks Brent crude movement very closely. While Commodity Traders, Hedgers and investors world over are trying to realign to the fundamental shift of pricing mechanism of oil markets, real question remains unanswered that “What is the real reason behind divergence and how much divergence is considered as “New Normal” ?