Analys
Brent and WTI – A tale of two benchmarks
Brent and West Texas Intermediate (WTI) are two globally recognised oil benchmarks. When market participants refer to the price of oil, they typically refer to one or the other or both. But despite having quite similar chemical properties, there are important distinguishing features between the two. Financial markets recognise these differences and, as a result, price the two differently. The two benchmarks have contrasting features in terms of where the oil is produced, how it is stored and transported and the way it is traded in international markets. These differences not only explain the historical price discrepancy between the two, but also help us understand why the two have behaved differently during the coronavirus pandemic and the ensuing market volatility. This article will contrast the distinguishing features between the two and, after developing a new lens to view the two benchmarks, replay the recent episode when WTI prices crashed into negative territory. The article will conclude by outlining the forces which will shape the fluid commodity going forward.
Same, same, but different
In ‘A tale of Two Cities’ by Charles Dickens, Sydney Carton sacrifices his life to save Charles Darnay, who is married to the woman Carton loves, by taking his place in prison moments before he is taken to the guillotine during the French revolution. He is able to pull off this selfless act of bravery thanks to the uncanny resemblance between him and Darnay. Similarly, most people would not be able to tell the difference if a barrel of WTI was replaced with one for Brent given the likeness between the two. Both Brent and WTI are referred to as light and sweet. They are ‘light’ in terms of the American Petroleum Institute (API) gravity. Having an API gravity greater than 10 makes them light and allows them to float on water, while an API gravity of less than 10 would have caused them to sink. Similarly, both have low sulphur content making them ‘sweet’ and easy to refine (See Figure 01).
But while Carton and Darnay looked alike, they were distinctly different individuals. Brent and WTI too, despite their resemblance, have their disparities. Brent Crude is extracted from the North Sea. Oil production from Europe, Africa and the Middle East tends to use Brent as its main benchmark. This accounts for around two-thirds of internationally traded crude oil. The Organisation of the Petroleum Exporting countries (OPEC), an intergovernmental organisation comprising 13 key oil producing countries as well as their 10 partner countries (collectively referred to as OPEC+), also typically use Brent as their oil price benchmark. In contrast, WTI is sourced primarily from Texas and most oil production in the US uses WTI as its main benchmark.
Brent and WTI have always traded at different prices giving rise to the Brent – WTI spread (Figure 02). Purely in terms of quality, WTI has a slight edge over Brent on account of its lower sulphur content making it moderately ‘sweeter’ and thus easier to refine. For this reason, WTI ought to theoretically trade at a premium over Brent. For a large part of the first decade of this century, WTI did indeed trade at a premium, i.e. the Brent – WTI spread was negative. Over the last decade however, the shale revolution in the US has brought large volumes of oil into the market making the US one of the largest oil producers in the world. The shale revolution refers to a combination of technological improvements and financial infrastructure enabling the US to produce oil from low-permeable shale, sandstone and carbonate rock formations in larger quantities than ever before. The shale oil industry has grown rapidly since 2011 and accounted for 63% of total US crude oil production in 2019 (according to the US Energy Information Administration). In line with economic principles of demand and supply, as the total volume of oil production increased in the US, this put downward pressure on WTI. The Brent – WTI spread has generally been positive in the last decade.
Another reason for the Brent – WTI spread is the logistical challenge for the US to transport oil from landlocked production hubs through a network of pipelines and to ship it overseas. This impinges on the overseas demand for oil from the US (WTI). In contrast, Brent is produced at or closer to sea making it easier for it to reach its overseas destinations. The US is however investing heavily in its pipeline infrastructure to enable it to send large vessels of oil from its shores to international buyers. Several such infrastructure projects are expected to be completed by 2021-2022 when we might see an increase in demand for WTI and thus a narrowing of its spread with Brent.
The historic WTI crash
The explanation above of the spread between the two benchmarks omits any discussion about the unprecedented spike on 20 April 2020. This section will unravel the story behind the anomalous occurrence.
On Monday 20 April 2020, markets witnessed a historic crash in WTI prices (Figure 03). The crash occurred a day before the active Nymex WTI futures contract was due to expire. This contract, meant to deliver oil between 01 May and 31 May, crashed into negative territory as oil storage in the US became very tight. With the coronavirus pandemic causing considerable oil demand destruction putting entire countries in lockdown and bringing economic activity to a grinding halt, the reduction in oil production was not enough to balance the market creating a supply glut. The main delivery and settlement point in Cushing, Oklahoma was approaching its storage limit with any additional capacity likely already leased out or earmarked for other purposes. This acute pressure, so close to contract expiry at the point where contracts settle, contributed to the negative price. Those taking physical delivery from the expiring futures contract were being paid to take the oil and find a place to store it. The May contract expired the following day in slightly positive territory. When the June contract became the active contract upon the May contract’s expiry, prices recovered further as the issue of June deliveries creating the same problem was less worrying, at least at that point.
But Brent did not endure a similar crash. The main reason for this is that WTI, traded on the New York Mercantile Exchange (NYMEX), is a deliverable futures contract. Thus, upon expiry, the holder of the futures contract takes delivery of the underlying, i.e. barrels of oil. Brent however, traded on the Intercontinental Exchange (ICE), has a cash settlement procedure whereby the holder of the futures contract need not take delivery of the underlying upon expiry. Therefore, storage issues create a more direct risk to investors in WTI futures.
Outside of this idiosyncrasy pertaining to futures trading, the two benchmarks generally move with a high degree of correlation (Figure 04). At the peak of the coronavirus pandemic’s acceleration in April, a third of global oil demand was wiped out. Soon thereafter, major oil producers Saudi Arabia and Russia engaged in a price war. This created a double shock for oil as the suppliers opened the floodgates at a time when demand had just crashed. Both benchmarks experienced severe price weakness. But as policy decisions from OPEC+ can be expected to impact Brent prices more than WTI, the deal reached by the group at the start of April to cut suppliesprovided slightly more cushioning to Brent.
What happens next?
With a deeper understanding of the drivers of the two benchmarks, historic and recent price behaviour makes more sense. But the all-important question is, “what happens next?”. The fate of oil prices rests heavily on how quickly the world can overcome the pandemic and get the economic engines firing again. Volatility in oil prices may persist in the coming weeks, or even months, until uncertainty with regards to the pandemic and lockdowns diminishes. The relative price behaviour of WTI and Brent during this period will depend on the degree to which producers in the US and OPEC+ cut supplies to balance the market.
We however hope to paint a more optimistic picture of the world in the second half of this year. Oil prices may not recover quickly to where they were in February this year due to an overhang of excess supply, a fractured OPEC+ and a dented global economic engine. Nonetheless, after all the pain, the world will eventually return to some semblance of normalcy. Manufacturers will switch their machines on again, cars will return to the roads and aeroplanes will return to the skies. Once again, oil is expected to be in demand. And while one protagonist had to sacrifice himself to save the other in the tale told by Dickens, we expect both mainstays from the tale of two benchmarks to rise again when the crisis is over.
Mobeen Tahir, Associate Director, Research, WisdomTree
DISCLAIMER
This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
Analys
Brent on a rollercoaster between bullish sanctions and bearish tariffs. Tariffs and demand side fears in focus today
Brent crude rallied to a high of USD 75.29/b yesterday, but wasn’t able to hold on to it and closed the day at USD 74.49/b. Brent crude has now crossed above both the 50- and 100-day moving average with the 200dma currently at USD 76.1/b. This morning it is trading a touch lower at USD 74.3/b
Brent riding a rollercoaster between bullish sanctions and bearish tariffs. Biden sanctions drove Brent to USD 82.63/b in mid-January. Trump tariffs then pulled it down to USD 68.33/b in early March with escalating concerns for oil demand growth and a sharp selloff in equities. New sanctions from Trump on Iran, Venezuela and threats of such also towards Russia then drove Brent crude back up to its recent high of USD 75.29/b. Brent is currently driving a rollercoaster between new demand damaging tariffs from Trump and new supply tightening sanctions towards oil producers (Iran, Venezuela, Russia) from Trump as well.
’Liberation day’ is today putting demand concerns in focus. Today we have ’Liberation day’ in the US with new, fresh tariffs to be released by Trump. We know it will be negative for trade, economic growth and thus oil demand growth. But we don’t know how bad it will be as the effects comes a little bit down the road. Especially bad if it turns into a global trade war escalating circus.
Focus today will naturally be on the negative side of demand. It will be hard for Brent to rally before we have the answer to what the extent these tariffs will be. Republicans lost the Supreme Court race in Wisconsin yesterday. So maybe the new Tariffs will be to the lighter side if Trump feels that he needs to tread a little bit more carefully.
OPEC+ controlling the oil market amid noise from tariffs and sanctions. In the background though sits OPEC+ with a huge surplus production capacity which it now will slice and dice out with gradual increases going forward. That is somehow drowning in the noise from sanctions and tariffs. But all in all, it is still OPEC+ who is setting the oil price these days.
US oil inventory data likely to show normal seasonal rise. Later today we’ll have US oil inventory data for last week. US API indicated last night that US crude and product stocks rose 4.4 mb last week. Close to the normal seasonal rise in week 13.
Higher last week and today as sanctions bite harder than recession fears. Brent crude gained 2% last week with a close on Friday of USD 73.63/b. It traded in a range of USD 71.8-74.17/b. It traded mostly higher through the week despite sharp, new selloffs in equities along with US consumer expectations falling to lowest level since 2013 (Consumer Conf. Board Expectations.) together with signals of new tariffs from the White House. Ahead this week looms the ”US Liberation Day” on April 2 when the White House will announce major changes in the country’s trade policy. Equity markets are down across the board this morning while Brent crude has traded higher and lower and is currently up 0.5% at USD 74.0/b at the moment.
New US sanctions towards Iran and Venezuela and threats of new sanctions towards Russia. New sanctions on Venezuela and Iran are helping to keep the market tight. Oil production in Venezuela reached 980 kb/d in February following a steady rise from 310 kb/d in mid-2020 while it used to produce 2.3 mb/d up to 2016. Trump last week allowed Chevron to import oil from Venezuela until 27 May. But he also said that any country taking oil or gas from Venezuela after 2 April will face 25% tariffs on any goods exported into the US. Trump is also threatening to sanction Russian oil further if Putin doesn’t move towards a peace solution with Ukraine.
The OPEC+ to meet on Saturday 5 April to decide whether to lift production in May or not. The OPEC+ Joint Ministerial Monitoring Committee will meet on Saturday 5 April to review market conditions, compliance by the members versus their production targets and most importantly decide whether they shall increase production further in May following first production hike in April. We find it highly likely that they will continue to lift production also in May.
OPEC(+) crashed the oil price twice to curb US shale, but it kicked back quickly. OPEC(+) has twice crashed the oil price in an effort to hurt and disable booming US shale oil production. First in 2014/15/16 and then in the spring of 2020. The first later led to the creation of OPEC+ through the Declaration of Cooperation (DoC) in the autumn of 2016. The second was in part driven by Covid-19 as well as a quarrel between Russia and Saudi Arabia over market strategy. But the fundamental reason for that quarrel and the crash in the oil price was US shale oil producers taking more and more market share.
The experience by OPEC+ through both of these two events was that US shale oil quickly kicked back even bigger and better yielding very little for OPEC+ to cheer about.
OPEC+ has harvested an elevated oil price but is left with a large spare capacity. The group has held back large production volumes since Spring 2020. It yielded the group USD 100/b in 2022 (with some help from the war in Ukraine), USD 81/b on average in 2023/24 and USD 75/b so far this year. The group is however left with a large spare capacity with little room to place it back into the market without crashing the price. It needs non-OPEC+ in general and US shale oil especially to yield room for it to re-enter.
A quick crash and painful blow to US shale oil is no longer the strategy. The strategy this time is clearly very different from the previous two times. It is no longer about trying to give US shale oil producers a quick, painful blow in the hope that the sector will stay down for an extended period. It is instead a lengthier process of finding the pain-point of US shale oil players (and other non-OPEC+ producers) through a gradual increase in production by OPEC+ and a gradual decline in the oil price down to the point where non-OPEC+ in general and US liquids production especially will gradually tick lower and yield room to the reentry of OPEC+ spare capacity. It does not look like a plan for a crash and a rush, but instead a tedious process where OPEC+ will gradually force its volumes back into the market.
Where is the price pain-point for US shale oil players? The Brent crude oil price dropped from USD 84/b over the year to September last year to USD 74/b on average since 1 September. The values for US WTI were USD 79/b and USD 71/b respectively. A drop of USD 9/b for both crudes. There has however been no visible reaction in the US drilling rig count following the USD 9/b fall. The US drilling rig count has stayed unchanged at around 480 rigs since mid-2024 with the latest count at 484 operating rigs. While US liquids production growth is slowing, it is still set to grow by 580 kb/d in 2025 and 445 kb/d in 2026 (US EIA).
US shale oil average cost-break-even at sub USD 50/b (BNEF). Industry says it is USD 65/b. BNEF last autumn estimated that all US shale oil production fields had a cost-break-even below USD 60/b with a volume weighted average just below USD 50/b while conventional US onshore oil had a break-even of USD 65/b. A recent US Dallas Fed report which surveyed US oil producers did however yield a response that the US oil industry on average needed USD 65/b to break even. That is more than USD 15/b higher than the volume weighted average of the BNEF estimates.
The WTI 13-to-24-month strip is at USD 64/b. Probably the part of the curve controlling activity. As such it needs to move lower to curb US shale oil activity. The WTI price is currently at USD 69.7/b. But the US shale oil industry today works on a ”12-month drilling first, then fracking after” production cycle. When it considers whether to drill more or less or not, it is typically on a deferred 12-month forward price basis. The average WTI price for months 13 to 24 is today USD 64/b. The price signal from this part of the curve is thus already down at the pain-point highlighted by the US shale oil industry. In order to yield zero growth and possibly contraction in US shale oil production, this part of the curve needs to move below that point.
The real pain-point is where we’ll see US drilling rig count starting to decline. We still don’t know whether the actual average pain-point is around USD 50/b as BNEF estimate it is or whether it is closer to USD 65/b which the US shale oil bosses say it is. The actual pain-point is where we’ll see further decline in US drilling rig count. And there has been no visible change in the rig count since mid-2024. The WTI 13-to-24-month prices need to fall further to reveal where the US shale oil industry’ actual pain-point is. And then a little bit more in order to slow production growth further and likely into some decline to make room for reactivation of OPEC+ spare capacity.
The WTI forward price curve. The average of 13 to 24 month is now USD 64.3/b.
The average 13-to-24-month prices on the WTI price curve going back to primo January 2022. Recently dropping below USD 65/b for some extended period.
Brent has defied bearish equities for three days but is losing its stamina today. Brent gained 0.3% yesterday with a close of USD 74.03/b, the highest close since 27 February and almost at the high of the day. It traded as low as USD 73.23/b. Brent has now defied the equity selloff three days in a row by instead ticking steadily higher. A sign of current spot tightness. This morning however it is losing some of its stamina and is down 0.5% at USD 73.7/b along with negative equities and yet higher gold prices.
The new US Iran sanctions is creating frictions in getting its oil to market and helps keeping oil market tight. Part of the current tightness is due to the new US sanctions on Iran which. Ships containing 17 mb of its oil now sits idle east of Malaysia waiting (Bloomberg) for ship-to-ship transfers with China teapot refineries the normal final destination. But the latest US sanctions has probably made these refineries much more cautious. More friction before Iranian oil is reaching its final destination if at all. Tighter market.
Lower Saudi OSPs for May is expected. A signal of a softer market ahead as OPEC+ lifts production. Saudi Aramco is expected to reduce it official selling price (OSPs) for Arab Light to Asia for May deliveries by USD 2/b. A measure to make its oil more competitive in relative to other crudes suppliers. It is also a sign of a softer market ahead. Naturally so since OPEC+ is set to lift production in April and also most likely in May. If Saudi Aramco reduces its OSPs to Asia for May across its segments of crudes, then it is a signal it is expecting softer oil market conditions. But news today is only discussing Arab Light while the main tightness int the market today is centered around medium sour crude segment. A lowering of the OSPs for the heavier and more sour grades will thus be a more forceful bearish signal.
Front-end backwardation may ease as the Brent May contract rolls off early next week. The Brent May future will roll off early next week. It will be interesting to see how that affects the front-end 1-3mth backwardation as it is shifted out into summer where a softer market is expected.
Brent is boring like crazy with 30dma annualized volatility of just 21%. Waiting for something to happen.
Brent crude has defied three days of bearish equity markets and ticked higher instead. Caving in a bit this morning with yet another day of bearish equities and bullish gold.
Brent on a rollercoaster between bullish sanctions and bearish tariffs. Tariffs and demand side fears in focus today
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