Why different oil markers are priced differently

(Published October 22, 2015)

Crude oil prices reflect the interplay of various market and non-market forces – supply, demand, political events, physical qualities, etc. The chart below tracks the spot prices of Brent oil and West Texas Intermediate (WTI), two of the leading oil markers, calculated on quarterly basis since 2007. Data were derived mainly from the US Energy Information Administration (US EIA) and were supplemented with figures from GlobalPetrolPrices.com for Q3 2015. While Brent is recognized as a global benchmark defining directly or indirectly prices of 60% of oil traded globally, WTI is the leading marker in North America.

Why do we see a price difference (spread) appearing and disappearing between the benchmarks? In late 2010 and early 2011, WTI started trading at a reduced price compared to Brent. The US market began saturating with crude oil and hence the depressed price of WTI and the spread with Brent. There are several main reasons for the oil glut.

First, domestic US crude oil production soared as a result of technological advances and the wide-spread application of hydraulic fracturing (fracking) that released previously hard-to-get oil deposits. In 2014, average US output stood at 8.7 million barrels a day (mb/d), up from 5.3 mb/d in 2009. The number of drilling rigs increased from an average of 278 in 2009 to 1527 in 2014. Low oil prices have taken their toll in the form of decreasing drilling activity. In March 2015, the latest month for which the US EIA has published official data, the rig number stood at 857.

Second, major supply disruptions of the 1970s, now known in the textbooks as oil shocks, forced the US government in 1975 to adopt a policy of no crude oil exports. It was a tool to address national security concerns. Now, this policy is somewhat relaxed. It is possible to swap a shipment of US light crude for the same quantity of oil from, say, Mexico (which would not represent net exports) after approval of the federal administration. However, the ban on crude exports is still largely intact. In October 2015, the US House of Representatives voted to lift the ban, however, the Obama administration argues that such decision is not needed at this moment.

Much of the crude oil extracted today in America is lighter than existing refineries can process. A more liberalized export regime would allow not only for increase in trade, but also for better utilization of refining capacity.

Third, market access, transport and distribution costs are also factored in prices. In North America for instance, there is not sufficient infrastructure (mainly pipelines) able to carry the oil excess. It is noteworthy to mention that when the southern extension of the Keystone XL system was commissioned in January 2014, the spread between WTI and Brent narrowed. This was a direct result of an increased ability of Canadian and US oil to reach refineries. From there, the oil is able to proceed to world markets in the form of refined products.

The following chart shows a selection of oil markers and their price movements in wider historical perspective. Data are derived from BP's Statistical Review of World Energy 2015. For the most part crude oil benchmarks travel in concert which stands as an evidence that the oil market is truly globalized.

The physical characteristics of oils are also crucial when it comes to pricing. Crude oils are priced based on their density and sulfur content. Oils that have low density and low sulfur content are classified as light and sweet. They have relatively high quality and usually require less complex refining. Thus they are generally more expensive. Conversely, crudes with high density and high sulfur content are known as heavy and sour. They have relatively low quality and come cheaper.

More articles on crude oil:

What is driving crude oil prices

What is a crude oil benchmark

Historical prices of crude oil (1861 - 2014)

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