by Karvy Commodity Research Desk
There are about 160 crude oils that are traded internationally. They vary in terms of their characteristics & quality. Majorly two crude oils West Texas Intermediate (WTI) and Brent are those whose prices are reflected in other types of crude oil. WTI crude oil is a high quality crude and is excellent for refining for maximizing of Petrol (Motor Spirit). It is light crude with API gravity of 39.6 degrees and contains nearly 0.24% of sulphur, marking it as sweet crude. This set of characteristics, combined with its production location (US), makes it an ideal crude oil to be refined in the United States.
Brent is actually a combination of crude oil from 15 different oil fields in the Brent and North Sea areas. It is a reasonably light and sweet crude oil with API gravity of 38.3 degrees and about 0.37% of sulphur.
Brent blend is ideal for making Motor Spirit (Petrol) and middle distillates. Brent crude production is also on the decline, but it remains the major benchmark for other crude oils. Prices for other crude oils are generally priced as a differential to Brent, i.e., Brent + / -.
However, the trend has been reversed since last three years, i.e. WTI have lost its premium on Brent oil. The trend has been reversed due to supply shortage of North Sea (Brent) oil and rising WTI stocks.
Brent is continuously holding premium to WTI, though WTI used to maintain a premium due to its superior quality. In February 2013, the historical spread between Brent and WTI crude oil climbed above $ 23, highest level in last two months.
Reasons behind the widening Spread..!
The average range for the spread between Brent and WTI was $ 5 to 10 till beginning of 2011. However, introduction of Keystone pipeline Phase -2 in February, 2011 which runs from Steel City, Nebraska, through Kansas to Cushing, Oklahoma created greater volumes of Canadian Crude oil in Cushing and made WTI prices to fall
Secondly, increase in US domestic production which is near 7million barrels per day. The significant and rapid tight oil production in the US was witnessed. Tight oil is produced from shale and very low permeability rocks.
Two important tight oil are Bakken formation in North Dakota and Montana, and the Eagle Ford shale in south Texas, accounted for 84% of total tight oil production in November 2011. Oil production from the Bakken formation is currently about 1.5 times larger than that from the Eagle Ford
There were no pipelines to move this high volume of crude, which exceeded the demand from Midwest refiners and Cushing to Gulf Coast refineries. The difference between Brent and WTI started rising from an average $ 2 per barrel in December 2010 to an average $ 15 per barrel in February 2011. The WTI discount reached a high of about $ 29 per barrel in September 2011.
How does Brent oil play the role in US market..!
Brent crude can be substituted for WTI to meet delivery obligations against New York Mercantile Exchange Light Sweet Crude Oil futures contracts. Prior to 2011, Brent could be economically brought into the United States by tanker and moved by pipeline from the USGC to Cushing, Oklahoma. On average, Brent crude oil traditionally sold at a small discount to WTI, reflecting marine and pipeline transportation costs.
Reversal of Sea Way Pipeline:
Start of Seaway pipeline
Limitation in Seaway pipeline revealed
North- Sea maintenance
Project start on Seaway Pipeline reversal & lower Cushing stock
Higher Cushing Stocks weigh on WTI
Sea Way Pipeline
The Spread between the two bench marked crude oil started narrowing down when talk on reversal of Seaway pipeline flowed in to the market. Enbridge Enterprise Product Partners agreed to reverse the pipeline enable it to transport oil from Cushing, Oklahoma to the U.S. Gulf Coast.
Objective behind this reversal was to accelerate access to Gulf Coast markets, reduce transportation costs, improve both producer and refiner economics and hasten the development of North America's crude oil reserves. Thus Brent – WTI differentials averaged to $ 9 barrel in December 2011 by falling from $ 27 in October 2011.
Gradually market realized that the Seaway reversal with capacity of 150,000 bbl/day would be insufficient to clear the bottleneck between Cushing and the US gulf Coast, and then WTI discount rose back to an average $19 per barrel in 2012.
Till December 2012, the monthly average Brent-WTI differential has ranged from $ 13 per barrel to $ 19 per barrel and made a high near $ 24. Thereafter a sharp fall near $ 15 in Brent- WTI spread was witnessed in January 2013 as Enterprise Product Plc started delivery of crude from Cushing to Gulf region.
However, the trend could not continue for long as EPP cut its Seaway pipeline oil deliveries by more than half after a major refinery in Sweeny, Texas, reduced demand while it undergoes maintenance. It has reduced the flow of its newly expanded 400,000 barrel-a-day pipeline to 175,000 barrels a day because its Jones Creek storage terminal was filled to capacity. These terminal constraints on the seaway pipeline will last until late 2013.
Though reversal of Sea way pipeline is not enough to drag down the bottle neck of crude oil stocks in Cushing, gradual fall in stocks level is witnessed from June month onwards. In recent past, stocks level is at 49 million barrels, down by more than 6 percent from June, 2012 (after Seaway Pipeline Reversal) till December beginning. There are two main reasons for this fall, 1) Seaway pipeline reversal worked to remove the glut of storage and 2) US Summer driving demand which reflected on higher refinery input in last three months. Gasoline demand has been increased by more than 6% to 9.61 million barrels per day in August.
Summer driving season from July to September created more demand for finished motor gasoline. Thus, demand from refineries increased to meet the consumer demand.
More than 1 % rise in crude oil input to refineries is seen from May end to August. Active hurricane season was also another reason for the refineries to increase their capacity utilization in order to meet the future demand.
However, stocks level started piling up due to increase in the US crude oil production and lower winter demand. Though Seaway started delivering from Cushing to Gulf region, its capacity was limited till 1,75,000 barrels /day. So, again the spread climbed above $ 23 in first week of February.
Conclusion..!
Currently Brent- WTI spread is below $ 21 in international market, whereas in MCX it has come down below Rs. 1,100. We expect crude oil prices to come under pressure in short run on concern of increasing uncertainty of the major oil consuming nations. Secondly, with the end of winter season demand is expect to come down whereas supply is expected to increase majorly from Non OPEC countries in the coming quarter.
The US production is at last two decades high which is expected to increase further and will add storage level in Cushing, WTI delivery centre. Additionally, Seaway pipeline is under projected capacity (less than 4,00,000 bdp). Therefore, early plan of Enbridge and Enterprise to increase the Sea way pipe line's capacity to 8,50,000 bpd from 4,00,000 bpd is expected to get delayed by another year.
Approval of Keystone pipeline XL (Phase III & IV) will be another political issue, which is expected to get delayed ahead of the spending cut plan in May 2013.
Besides, we have to keep in mind about increasing shale production of Canada and depletion of North Sea production which may add premium on Brent oil. Therefore, fall in Brent oil expected to get limited and the spread may widen further in near term.
Trade on Spread:
As we have discussed prices of these crude oils are related to quality differences, but some other factors can also influence the price relationships e.g. supply and demand. For example: ideally on every Wednesday the US Energy department releases weekly inventory report which shows US crude oil stocks including stock report of Cushing, major WTI delivery centre.
So, if inventory increases with low or no demand then it will pressurize on WTI prices more. Therefore, one should take advantage of this opportunity by taking buy position in Brent and sell in WTI oil contract. On an average, the spread moves Rs.40 to Rs. 50 in a day. So, an intraday trader can take the opportunity by understanding other economic and geopolitical factors.
Prepared by:
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Aurobinda Prasad
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Head of Research
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Smitarani Tripathy
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Energy Analyst
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“Karvy House”, 46, Avenue 4, Street no. 1, Banjara Hills, Hyderabad – 500034
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