Brent-WTI spread causes concerns about oil benchmarks to resurface; Ice and Nymex defend use for futures contracts The increased spread between the two main crude oil benchmarks has prompted a repeat of criticisms about the use of West Texas Intermediate (WTI) and Brent crude as global oil price markers. The spread has hit a record high over the past week, as the price of Brent crude passed $100 per barrel – a peak not seen since September 2008 – while WTI remained around or below $90 per barrel. Traditionally, WTI trades at a premium to Brent but the relationship has reversed before, for example, the previous record was a spread of -$11.56 per barrel in January 2009. According to a recent research note from Barclay Capital: “Currently, WTI spreads are so far away from any sustainable equilibrium that they imply a mounting degree of market breakdown.” Walter Zimmermann, vice-president and chief technical analyst at United-Icap, says the Brent-WTI spread is broken and has “lost its moorings”. “And when a big ship has lost its moorings it can be pushed about by the slightest breeze. With a strong enough gale the ship is easily wrecked,” he wrote in a report published this week. Such adverse conditions stem from the “financialization” of the energy markets, according to Zimmermann, with the spread following financial market volatility that, combined with speculation, spells chaos for the energy market. According to Zimmermann, every major turn in the Brent-WTI spread over the past five years has coincided with a major reversal in the financial markets. For example, when the US housing bubble burst in May 2007, the Brent-WTI spread went to $5.49 per barrel, and when the US dollar peaked in November 2008, the spread went to -$3.69 per barrel. Others highlight additional factors driving prices. For example, Bill Bathe, chief executive of energy management company US Energy Services, points out that correlation between oil and gas prices has also contributed to the wider spread. “Europe is experiencing a very cold winter at the moment, which has pushed up gas prices. Because of the correlation between oil and gas prices, that increase has contributed to the increase in the price of Brent crude.” On the other hand, the price of gas in the US has remained around $5 per mmBtu, roughly half European prices. “This has put a damper on WTI compared to Brent because the alternate fuel, natural gas, is much cheaper in the US.” The increased spread between the two prices has prompted a repeat of criticism levelled at the benchmarks when the spread has widened in the past. Some commentators argue WTI’s delivery point in Cushing, Oklahoma causes price dislocation issues when North American supply builds up – because the location is land-locked, there are limited options for moving the fuel elsewhere. But Joe Raia, managing director, energy and metals products at CME Group, owner of the New York Mercantile Exchange (Nymex) and its WTI futures and options contracts, says: “We believe WTI is responding properly to global supply and demand fundamentals, and provides more transparency than any other crude oil contract, particularly with the reporting requirements for open interest holders and real-time Department of Energy statistics for the Cushing market.” According to the CME Group, its WTI futures contract saw record volumes of 1,472,088 contracts on January 28, 2011, compared with the previous record of 1,423,536 contracts on April 13, 2010. On the other hand, concerns have been voiced about declining production in the North Sea and the implications for liquidity in the Brent market. Zimmermann says: “Brent suffers from the opposite problem [to WTI]. As North Sea production steadily and inexorably declines it gets easier and easier for a single trader to have an out-sized impact on the benchmark price.” Paul Wightman, oil product manager at the Intercontinental Exchange (Ice), which prices its main crude futures contract relative to Brent, adds that many independent analysts view it as the most globally representative benchmark due to the reliability of its relative pricing relationships, the number of players trading it and the number of physical crude streams in producing regions such as West Africa and Asia Pacific that price relative to Brent. The Ice and price reporting agency Platts both estimate roughly 70% of global crude oil trades relative to Brent. “Certainly when compared to Brent, a relatively small amount of physical crude prices relative to WTI,” Wightman says. “It’s not for Ice to say that one benchmark is necessarily better than the other, but the global market has overwhelmingly chosen Brent as its preferred reference price for physical crude. And I think there are a number of reasons why: it’s seaborne, thus it’s transportable to a number of different locations and it’s not land-locked.” CME Group chairman Terry Duffy and chief executive Craig Donohue defended WTI’s status as a global benchmark in a letter to the Financial Times printed on February 2. The letter concluded: “No single instrument can hope to reflect such a large market as crude oil and one that contains such diversity in both geography and differences in the underlying commodity.” ...
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