The ever-narrowing price gap between the world's twin crude oil benchmarks – Brent and West Texas Intermediate – has profound consequences across the supply chain for various stakeholders in the oil industry, including producers, refiners, traders and even consumers.
The futures prices of WTI and Brent oil over the past 13 years are heading much closer.
On June 30, 2011, Brent commanded a premium of $17.06 a barrel against WTI on futures exchanges. Fast forward to today, that premium has dwindled to a mere $3.14.
The narrowing gap is largely beneficial for US producers as they benefit from higher relative prices for WTI-priced crude, while European sellers of Brent-linked crudes may see reduced premiums.
However, the case is reversed for consumers.
“A wider spread often means lower prices for US consumers and higher prices for European consumers, while a narrower spread tends to align these prices more closely,” says Marc Pussard, head of risk at APM Capital.
Changes in the Brent-WTI spread can ultimately create major rifts that affect the prices of petrol and other refined products globally.
“This dynamic could influence production strategies and investment decisions in different oil-producing regions,” says Mohamed Hashad, chief market strategist at Noor Capital.
For example, a narrower spread means more challenges for oil producers who market Brent-linked crudes.
“Lower value added in Brent may leave less margin for producers based in regions such as the North Sea, Africa or even some parts of the Middle East, squeezing their profit margins,” says Mr Hashad.
Seismic shift
WTI is from the US while Brent crude comes from the North Sea in Europe.
Brent, which is traded on the Intercontinental Exchange, also known as Ice, is the world's most widely used reference for oil buyers, sellers, and traders.
WTI, which is traded on the Nymex futures exchange, is the preferred measure and price benchmark for crude oil in the US and accounts for a 20 per cent share of the world's global crude benchmarks.
Another distinction between the two lies in their sulphur content, with WTI having a lower level compared with Brent, thus making it easier to refine than its North Sea rival.
This variance, coupled with various logistical, regulatory and demand influences, frequently results in disparities in pricing.
For example, a noticeable gap emerged between Brent and WTI prices from 2011 to 2014, attributed to the surge in US shale oil production and the presence of transport obstacles within the US.
As bottlenecks began to form, WTI prices took a hit as they were discounted to account for the increased expenses of transporting barrels to market due to the lack of sufficient pipeline capacity.
“As the shale revolution ramped up last decade, US light sweet production produced in the Bakken, Permian and other shale plays had few outlets to international markets, since US law at the time prohibited crude exports,” says Aaron Brady, executive director of crude oil research at S&P Global Commodity Insights.
That changed towards the end of the last decade with the US making significant progress in addressing infrastructural challenges, resulting in a reduction in the spread and a rise in WTI prices.
The narrowing price differential, or spread, between the two benchmarks over the past decade is an indicator of the gradual “shift in the global oil market towards a greater dependence on the US [WTI] oil”, We Empower chief executive Andrea Zanon told The National.
“The US becoming the world's largest oil producer and expanding its infrastructure has narrowed the gap between WTI and Brent.
“This puts the US in a lead role influencing trading, policy, transparency and, ultimately, clear price signals.”
Who is affected?
WTI is the primary benchmark for oil pricing in North America, with prominent oil producers such as ExxonMobil and ConocoPhillips closely tied to it.
There are a few exceptions that are linked to Brent. For instance, Chevron prices the majority of its equity crude production based on Brent.
The same applies for European companies, with Brent the predominant benchmark for Shell, BP and TotalEnergies.
Most Middle East sour crude is priced against the Dubai Benchmark, which is priced against Brent.
The narrowing of the spread largely turns out to be beneficial for oil producers based in the US as they are able to compete effectively internationally.
Consequently, higher WTI prices lead to more profits and possibly larger market shares for them.
“For oil producers, the WTI-Brent spread is crucial for determining profitability. A wider spread, where WTI is cheaper than Brent, often indicates an oversupply of US oil, reducing profitability for producers linked to WTI,” says Vijay Valecha, chief investment officer at Century Financial.
“Conversely, a narrower spread can signal tighter US supplies or higher demand, potentially increasing revenues for these producers.”
The spread can have an impact on Opec’s decisions, analysts say.
One notable instance where Opec's decisions were influenced by a narrowing Brent-WTI spread was during the early 2010s, particularly around 2011 to 2014 when the spread widened significantly.
“Opec monitored these developments closely because the spread indicated how competitive US crude oil was in the international markets. A wider spread made US export of oil more attractive, potentially threatening Opec's market share,” says Mr Pussard.
“Thus, Opec, and Saudi Arabia in particular, made the decision to maintain high production levels in 2014, despite falling prices, to protect market share against the rising US shale oil industry.”
For oil refiners too, narrower spreads can have significant implications.
For example, from 2011 to 2014, the significant increase in the price difference created opportunities for refineries outside the US to benefit from cheaper WTI crude.
“The price spread encouraged US crude exports to Asia, where refineries sought to diversify their supply sources,” said Mr Pussard.
“Asian refineries, notably in South Korea and Japan, imported more WTI crude, benefitting from the lower prices and thus optimising their refining economics.”
Consumers are affected too by the widening spread.
When Brent rises, refineries pass on the costs to end consumers, Mr Valecha says.
However, for consumers in the US, the widening price difference is advantageous.
“When the spread between Brent and WTI widens, US consumers could benefit from lower gasoline prices, though the extent of this benefit depends on how much of the cost savings are passed on by refineries,” he adds.
“Conversely, a narrower spread can negatively impact consumers by reducing potential price relief.”
On the other hand, regions where Brent pricing prevails may experience more consistent or slightly lower prices.
Can WTI overtake Brent?
The narrowing trend is expected to continue as long as the US remains a net oil exporter and continues to expand its pipeline capacity, which, in turn, would reduce the cost of transporting its landlocked oil extracted from Texas and other locations in the Midwest to the US Gulf Coast for exports.
WTI’s “influence over global benchmark pricing has grown and will likely continue growing going forward”, says Emma Richards, associate director for oil & gas at BMI, a Fitch group company.
“The spread will likely narrow further with time … We now forecast the annual average spread to fall to around $2 a barrel within the next three years, down from over $4 a barrel currently.”
However, analysts caution that it still too early to judge whether WTI will overtake Brent to become the leading crude benchmark.
Going forward, key factors to watch out for are US crude production, geopolitical events and economic conditions affecting global supply and demand that will influence both benchmarks – potentially widening or narrowing the spread.
