Development in crude oil price spreads

The price spread between the two most significant crude oil markers, West Texas Intermediate (WTI) and North Sea Brent, shrunk rapidly in the last few months to the lowest levels since 2011. At certain points in early February of this year, WTI traded as much as $23/b below Brent crude, but the spread has steadily narrowed since then to trade at current levels of near parity as the US marker rallied by more than 25 percent compared with just a 9 percent rise in Brent during this period.

The convergence between the two crude grades shows how improved pipeline networks and the use of rail links, which have facilitated the efficient movement of crude from inland to refiners on the coasts, have helped to unlock a glut at America’s oil-storage hub at Cushing, Oklahoma. The US Energy Information Administration estimated that new projects would provide 1.15 mb/d of additional pipeline capacity to deliver crude from Cushing to the US Gulf Coast, with another 830,000 b/d to move crude directly from the Permian Basin in Texas to the US Gulf. Starting in 2011, the rail volume increased and the total amount of crude oil and refined products being transported by rail was close to 1.34 mb/d during the first half of 2013, up from 927,000 b/d during the first six months of last year. WTI also got a further boost as refiners in the US consumed more crude than at any time in almost eight years. During the week ending 12 July, refiners have processed more than 16.2 mb/d, which corresponds to a refinery utilisation rate of almost 93 percent.

Indeed, inventories in Cushing rose to almost 52 mb at the beginning of the year as a result of oversupply before falling to around 42 mb at the end of July. This decline in stocks has encouraged some money managers to bet on the recovery in WTI prices contributing to narrowing the spread between WTI and Brent. Indeed, money managers have doubled their net long positions by the end of July compared with the same period a year earlier, reaching almost 320,000 contracts. Furthermore, the completion of improvements to BP’s refinery in Whiting, Indiana, which is now absorbing close to 400,000 b/d of the surplus crude, helped to relieve the glut. This surge in Midwest refinery demand, coupled with shortened supply from Alberta, Canada, on upgrader maintenance and pipeline shutdowns had helped the gap to tighten. On the other hand, the fall in Brent crude oil prices due to reduced demand has also contributed to narrowing the WTI-Brent spread.

While the spread has converged significantly and has had a positive impact on US domestic oil producers, the profits from shipping oil by rail are shrinking, making pipeline deliveries more attractive and slowing the demand for train cargoes. Refineries in the US East Coast and eastern Canada that traditionally import foreign crudes from the Atlantic Basin have benefited from growing output from North Dakota, where prices have been cheaper than North Sea Brent and West African grades, enough to cover the cost of rail shipments. However, because the WTI-Brent spreads are narrowing, the economic attractiveness of sending US midcontinent crudes by rail to various trading points has decreased significantly and once these spreads are offset by the additional cost of rail, shippers are more likely to use the new 830,000 b/d pipeline capacity. Moreover, US refiners in the Midwest are losing an advantage they have enjoyed for nearly three years as the gap between WTI and Brent has narrowed considerably. Prior to this, refiners’ margins had benefited from the purchased of low-priced WTI-linked crudes and sale of refined products, such as gasoline and diesel, at prices linked to the more expensive Brent. However, with the drop in the spread, this advantage had been considerably reduced.

Looking ahead, the Brent-WTI spread is expected to widen again as the US Gulf Coast becomes increasingly saturated in light sweet crude grades. A wider price differential will then likely be required to encourage refiners to run lighter barrels at the expense of medium grades. On the other hand, as the tight oil and WTI flowing into Cushing, where WTI is priced, are lighter and sweeter than the North Sea grade, there remains a slight chance that WTI could once again trade at a premium to Brent.

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