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Why Brent, Not US Crude, Is a Better Gauge for Oil Prices

While US crude is usually seen as the best gauge for the direction of global oil prices, the recent tumult in the Middle East and North Africa is now making Brent a more reliable yardstick.

An oil refinery in Elizabeth, N.J. is shown in this aerial photo of Wednesday, Aug. 29, 2007. Oil prices extended their rise above $78 a barrel Wednesday, Sept. 12, 2007 after finishing at a record close the previous session as a production increase from OPEC failed to calm market concerns about the availability of supplies for winter in the Northern Hemisphere. (AP Photo/Mark Lennihan)
An oil refinery in Elizabeth, N.J. is shown in this aerial photo of Wednesday, Aug. 29, 2007. Oil prices extended their rise above $78 a barrel Wednesday, Sept. 12, 2007 after finishing at a record close the previous session as a production increase from OPEC failed to calm market concerns about the availability of supplies for winter in the Northern Hemisphere. (AP Photo/Mark Lennihan)

Normally, US crude carries a higher price than Brent—a heavier crude that comes from outside the US—because of the American oil's higher quality.

But with the current supply glut of US oil and disruptions in the supply of Brent because of violence in the Middle East, that trend has reversed itself. In fact, Brent is now substantially higher than US oil, and the two prices often move in different directions.

Ironically, even though there's an oversupply of US oil—known as West Texas Intermediate, or WTI—problems with getting the crude refined have forced the US to import the more-expensive Brent, which is pushing up US gasoline prices.

So while American consumers looking to determine the direction of gas prices would normally look at US oil prices, they really should be looking at Brent.

"The Brent contract is more reflective of the global tumult that's pushing prices up," says Joe Kilduf, commodities analyst and partner at Again Capital in New York. "The gasoline prices and the diesel, heating oil and jet fuel prices are in line with the Brent price as a feed stock into the various refineries that are producing this very expensive fuel that we're seeing at the pump."

Indeed, prices are rising dramatically at the pump and not expected to drop anytime soon.

While historically high levels of speculation in WTI crudehas helped push the price rise in US oil, the tumult in the Libya and concern that it could spread elsewhere and disrupt oil is the primary culprit for the spike in Brent prices.

Brent is being distributed more widely now because the primary WTI facility in Cushing, Okla., is actually up to capacity with supply but unable to move the oil as readily.

Crude being shipped to the US, which accounts for 70 percent of total domestic supply, is trading in line not with WTI but with the more expensive Brent. That in turn is pushing up prices at the pump past $3.50 a gallon, which analysts at Bank of America Merrill Lynch foresee as the average price throughout 2011.

"In effect, a supply glut around the delivery point of WTI at Cushing, OK has depressed this important US benchmark relative to the price of near-by crude oil blends," the firm wrote in a research note.

"So even if the price of WTI is depressed relative to the price of Brent, the price of gasoline across the United States remains in line with the price of gasoline in Europe. In other words, the benefits of depressed West Texas crude prices in Oklahoma are not accruing to drivers in North America, but to refiners and to pipeline and storage operators in some parts of the Midwest."

The spread between the two had been cut in about half recently as hopes grew for some type of resolution in Libya, where events have proven highly influential on Brent prices.

But Wednesday's trading saw that spread grow as Libya flared with reports of black smoke around an oil terminal, while closer to home inventory figures show the Cushing center awash in oil.

"In a way it's an example of the futures markets working, because that oil is cheaper relative to the Brent oil, which is consumed principally in Europe and Asia and to a degree our East Coast refineries," Kilduf said. "That is more reflective of the geopolitical situation and concerns we're facing with Libyan oil."

BofAML has revised its oil forecast, projecting brent prices to average a daunting $122 a barrel in 2011, a forecast that represents a 42 percent increase from its original projection of $86 a barrel. Moreover, it said the price likely is to test $140 at some point before pulling back.

The forecast is based on expectations that the trouble in Libya, Egypt and Tunisia probably won't be the end of uprisings in the region that will play havoc with energy supplies.

As such, the firm's analysts believe consumers had better get used to the current gas prices.

"While we see a 70% chance of prices being at or below our projections, the list of troubles in the MENA region keeps growing by the day, and we believe there is a 30% chance of substantially higher oil prices than we are projecting," the firm said. "There are simply too many fronts open at this stage and a more severe oil disruption cannot be ruled out."

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