The explanation for the spread is actually fairly easily explained, as it is by Canadian economist Jeff Rubin and Platt’s below. The reality is that the WTI price is basically no longer a reliable indicator of oil prices
Just which price is the world benchmark for oil these days?
If you ask the folks over at the New York Mercantile Exchange (NYMEX), the answer is West Texas Intermediate (WTI), which is priced at the storage tanks in Cushing Oklahoma, where all expiring NYMEX oil contracts must be settled either through the purchase or sale of physical crude.
But West Texas Intermediate is trading at an all-time discount to other grades of oil. Last week, it was trading at a record $12 per barrel discount to competing European Brent Crude. Until the Egyptian uprising captured the market’s attention, the two prices were actually heading in opposite directions with WTI sinking to a two-month low of $85 per barrel, while Brent was within a dollar of triple digits.
The divergence is no mystery. Unlike Brent crude from the North Sea, which can be shipped to refineries pretty much anywhere in the world, oil in storage at Cushing can only be absorbed by refineries in the U.S. Midwest. With nowhere else to go, WTI is not even an accurate barometer for oil prices in the U.S. market, let alone the global market. For example, the price spread between it and Light Louisiana Sweet on the Gulf coast is as big as its spread with Brent. And by all accounts, the spread between WTI and Brent is going to become even bigger, rendering the former increasingly irrelevant as a global pricing benchmark.
It is largely new crude from the Alberta oil sands piling up at Cushing these days, often coming in much faster than local refineries can process it. And within a couple of months, there is going to be another 150,000 barrels a day of Alberta crude coming down Transcanada Corp.’s newly completed arm of its Keystone Pipeline that will connect Cushing with the flow of oil sand crude from Hardisty, Alberta.
Until TransCanada can connect the ever-increasing flow of crude from the oil sands to refineries on the Gulf of Mexico (not likely before 2013), there is going to be a bigger and bigger disconnect between WTI and global crude demand as more oil piles up at Cushing.
As that happens, the oil industry and the investment community will look to Brent as the new benchmark for global oil prices. Soaring purchases of Brent crude contracts have already driven the European oil benchmark to the highest level in five months against NYMEX oil futures contracts as more investors bet it is a better indicator of global demand.
So don’t be fooled by bloated inventories of Canadian crude held in storage in the middle of nowhere. Check out the Brent March futures contract if you want to know where world oil prices are trading.
And when you do, you may just find you are already in a world of triple digit oil.
If the NYMEX light sweet crude oil contract is dying, and is irrelevant because its Cushing delivery point is drowning in oil that can't move to the US Gulf refining centers, it has a strange way of showing it. Open interest at this point is slightly more than it was at the beginning of 2010.
But that doesn't cover up the bewilderment that the oil industry is expressing at the Brent/WTI spread, which on Wednesday climbed above $11 before falling back slightly. Still, Brent was a little more than $2 over WTI in early December, and now it's double digits. This is a relationship that for years, when Brent exceeded WTI, it was newsworthy. Now the only thing newsworthy about it is the double-digit size of Brent's premium to the Cushing-based barrel.
We've been covering the spread heavily this week, and here are a few takeaways:
· When the Brent/WTI spread goes wacky, there's always a debate: is it that WTI is too weak, or Brent too strong? In this round, there's little doubt that WTI's weakness is creating much of this movement. Refining margins in the Midwest relative to WTI have been extremely strong, a sign that the crude is not keeping up with the strength of the products. WTI is also lagging behind the benchmark product contracts on NYMEX: the RBOB gasoline blendstock contract and the No. 2 heating oil contract. But those contracts have moved largely in line with Brent, which makes sense. Atlantic Coast products are made from crudes usually priced relative to Brent, not WTI. So as Brent blows out against WTI, the NYMEX product contracts are going along for the ride.
· So with that out of the way, why is WTI so weak? It's actually a positive story for the North American oil market, because WTI is weak in part because of...more North American oil. Crude from Canada's oil sands and the North Dakota-Saskatchewan-Montana Bakken Shale are filling pipelines and taking lots of oil into the Cushing delivery point. When it gets there, it is greeted by an ever-expanding amount of crude storage. So why don't producers send the oil into other markets, where prices are higher? Because they can't. Outside of some capacity to take Canadian crude to the Pacific Coast and export it to Asia or the US West Coast, there simply aren't any options except to move it through various pipelines--Enbridge, Express -- into the US Midcontinent.
· But the end of that may have gotten a boost this week. TransCanada said it has enough shipper interest to proceed with a 150,000 b/d pipeline spur from Cushing to its proposed Keystone XL pipeline. But Keystone XL still awaits the decision of the US State Department.
· It's been said that WTI is disconnected from the rest of the world market, and to a degree it is. But you don't get those sorts of spreads without something happening. And one place it's happening is on the Capline, the 1.2 million b/d pipeline that runs from the Gulf Coast up to the refineries in Chicago. As Platts Matt Cook and Lucretia Cardenas reported recently, it's running at no more than 40% of capacity. It previously carried crude from all over the world into Chicago; now, it carries none, as Chicago and the Wood River-Patoka area near St. Louis is well-fed by Bakken and Canadian crude. (Hmmm...could Enbridge be extended to link up with a reversed Capline, and start sending Canadian crude due south to Louisiana area refineries?)
· It's not easy to move off a benchmark. So Gulf Coast crudes still trade as a differential to WTI, despite all the moaning about WTI's value. The market simply adjusts. The differential of Mars crude, the most important Gulf Coast sour grade, has moved about $7.65/b since early December, going from about 90 cts less than WTI to $6.75/b over. LLS, the chief sweet grade on the Gulf Coast, has moved the most, from a $4.40 premium to WTI to a $12.55 premium, a jump of about $8.15/b. Meanwhile, after Thursday's craziness, the Brent/WTI spread is wider by about $8.30/b. So other US grades tied to WTI are trying to adjust to the Brent/WTI movement.