“Brent/WTI at $8,” noted JPMorgan Global Energy Strategy’s daily oil market commentary last Friday. “Amazing!”
Oil nerds know the score but to the uninitiated, JPM’s referring to the price differential between two benchmark crude standards.
London Brent crude is within striking distance of $100 a barrel milestone. It’s not there quite yet. As of 11.15 a.m. Singapore time this Tuesday, the quote is $97.52/barrel. Compare that with the front-month U.S. light, sweet crude WTI contract trading at $90.95/barrel – a $6.57/barrel discount to Brent.
Late last week, Brent’s premium over WTI was even higher. On Friday, the February delivery Brent crude contract expired pushing the Brent-WTI spread to over $8 a barrel. That’s the highest in 23 months, which is why JPM and the analyst community is taking note and delving deeper into its implications for the market.
Right now, the narrative is about how long such a wide disparity can last, is it an aberration or reflective of fundamentals? Brent and WTI have long slugged it out for the title of world crude oil benchmark. You could say it’s been the enduring grudge match in the market’s recent history. Critics of WTI as a global standard argue that the main delivery point for Nymex futures in Cushing, Oklahoma is too local, subject to distortions and not compatible with an internationally traded benchmark.
They do have a point. Inventories there have risen 18 percent since early November — when TransCanada started a pipeline bringing Canadian supplies to the region — and stockpiles hit a record in February 2009. The Cushing delivery point in Oklahoma has such a propensity to clog up due to limited capacity and one-way crude flows, writes Izabella Kaminska in the Financial Times, that the market has even coined a term for it — “Cushing syndrome”.
"Crude oil is destined to go up ... It will cut through $100 like a hot knife through butter."
Meanwhile across the Atlantic, Brent crude futures are widening the gap against WTI. The price moves in London on the ICE Futures Europe exchange are being driven by fundamentals, said Platts' senior oil analyst, Linda Rafield. “The WTI/Brent spread reflects high demand for North Sea grades in Europe and a more than ample supply at Cushing,” Rafield said, though adding she believes the distortions will be temporary.
Societe Generale analysts Michael Wittner and Stephanie Aymes elaborate further, highlighting the structure of the Brent futures market, where the contract months for later delivery cost less than earlier ones. “The Brent forward curve is in backwardation, indicating a tight physical market,” they observe. “In contrast, front-month prices for NYMEX WTI have been under pressure. The structure of the WTI forward curve has also weakened.”
In fact, Platts data shows that the front-month/second-month ICE Brent crude futures contracts are in their most prolonged period of backwardation since mid-2008.
“It is not a technical aberration, the fundamentals are clear,” Lawrence Eagles, head of commodities research at JPMorgan Chase & Co., said of the Brent-WTI spread.
Disruptions in Norwegian production areas in the North Sea have contributed to the rising premium for Brent, Eagles said.
Norway's oil and gas producer Statoil said its Snorre and Vigdis fields in the North Sea were shut on Jan. 11 after a gas leak. The North Sea fields — which jointly produce about 157,000 barrels per day — were shut after gas leaked into the air on the Snorre A platform during a well shutdown. “Further, it is worth keeping an eye on the unrest in Tunisia — not a big producer, but in the current environment a disruption to 82,000 b/d is material,” Eagles said.
Will the divergence between Brent and WTI continue to remain at these elevated levels? Wittner and Aymes at Societe Generale say the blowing out of the Brent-WTI spreads is partly explained by market already pricing in a couple of bearish themes related to future U.S. supply — the startup of the Keystone Phase II pipeline, otherwise known as the Cushing Extension, and planned U.S. refinery maintenance.
Perhaps if the market is pricing in these themes now, it may possibly mean their impact is limited when they actually become material. That may limit the downside pressure on WTI and possibly contain the spreads.
That said, “the bottom line for WTI is that Cushing stocks are climbing, and higher crude supply and lower crude demand make that trend likely to continue,” Societe Generale said. That leaves potential for the spread to widen.
As for $100 a barrel? It’s just a matter of time, says Mark Waggoner, president of brokerage Excel Futures. “Crude oil is destined to go up,” he said. “It will cut through $100 like a hot knife through butter.”