Home Market News Why is There Weakness In The Brent-WTI Spread, Despite Tension With Iran

Why is There Weakness In The Brent-WTI Spread, Despite Tension With Iran

by NYSE:USO
oilbarrell
  • Brent-WTI moved lower even though the price of oil climbed
  • The risk is on the upside in the spread
  • BNO and USO are the ETFs that reflect the short-term price action in the two benchmarks

 

 

In the world of crude oil, the two leading benchmark pricing mechanisms that trade on the Intercontinental Exchange and the NYMEX division of the CME respectively are Brent and West Texas Intermediate or WTI. Approximately two-thirds of the world’s producers and consumers price their petroleum using the Brent price, including oil from Europe, Africa, and the Middle East. The United States is now the world’s top producer, and its crude oil uses the WTI benchmark. 

WTI is a lighter and sweeter grade of crude oil, meaning it is easier to refining into gasoline. Brent has a higher sulfur content making it less sweet and more economical to refine into distillate products. 

The price differential between Brent and WTI is both a quality and a location spread, but it is much more. Since the Middle East is the world’s most turbulent political region, the spread is also a barometer of risk in the area. 

 

Brent-WTI moved lower even though the price of oil climbed

Since the Arab Spring in 2010, the price of Brent crude oil has typically traded at a premium to WTI because the political risk in the Middle East rose. At the same time, increasing US production caused the price of WTI to trade at a lower price than Brent, causing the premium to rise.

Source: CQG

The chart of the price of nearby WTI futures minus Brent futures highlights that before 2009, the range in the spread was from a $6.33 premium for WTI to a $3.24 premium for Brent. Since gasoline is the world’s leading oil product, the WTI tended to trade at a premium to Brent. However, the world changed with the political changes in the Middle East, and since 2009, the range has been from a $2.68 premium for WTI to a $27.64 premium for Brent. The Brent premium has typically moved higher when the price of oil rallies. In February 2016, when crude oil fell below $30 per barrel on both benchmarks, WTI briefly returned to a premium. 

In early June, the price of nearby WTI futures fell to a low at $50.60. As the price was falling in late May, the Brent premium moved to $11.59 per barrel, the highest level since 2015. Since then, the price of oil recovered, but the Brent premium moved to around the $6.45 per barrel as of last Friday. 

Four consecutive weeks of inventory declines in the US as reported by the API and EIA led to gains in the price of WTI futures which gained on Brent. 

 

The risk is on the upside in the spread

Meanwhile, the other reason for higher oil prices over recent weeks has been the rising tension in the Middle East. The Trump administration slapped sanctions on Iran and put an end to exemptions that allowed the theocracy to sell petroleum to customers around the world. Iran retaliated with attacks on oil tankers near the Straits of Hormuz, the downing of a US drone, and missile attacks on Saudi sovereign territory. Just last week, an attempt to hijack a British oil tanker only failed because of the increased military presence in the region. Iran has also begun to enrich uranium, which could lead to even more hostilities over the coming days, weeks, and months. As the political temperature rises in the Middle East, supply concerns will increase, leading to gains in the price of oil. Since Brent is the benchmark for oil from the area, we could see price spikes in the Brent-WTI spread.

 

BNO and USO are the ETFs that reflect the short-term price action in the two benchmarks

In the ETF market, the United States Oil Fund, LP (USO) is the ETF that replicates the price action in WTI crude oil on a short-term basis. The United States Brent Oil Fund, LP (BNO) is the ETF that follows the price of the Brent benchmark. A long position in BNO and short position in USO is one way to synthesize the Brent-WTI spread without venturing into the futures markets. 

The Brent-WTI spread declined from $11.59 in late May to the $6.45 per barrel level as of Friday, July 12. The spread is a barometer of political risk, and the potential for a spike back to the recent high or even higher is likely to increase with hostilities in the Middle East. 

_________________________________________________________________________________

About the Author 

Andy Hecht is a sought-after commodity and futures trader, an options expert and analyst. He is a top ranked author on Seeking Alpha in various categories.  Andy spent nearly 35 years on Wall Street, including two decades on the trading desk of Phillip Brothers, which became Salomon Brothers and ultimately part of Citigroup.  Over the past decades, he has researched, structured and executed some of the largest trades ever made, involving massive quantities of precious metals and bulk commodities. Aside from contributing to a variety of sites, Andy is the Editor-in-Chief at Option Hotline.


Source link

Related Articles

Leave a Comment

This website uses cookies to improve your experience. We'll assume you're ok with this, but you can opt-out if you wish. Accept Read More

Privacy & Cookies Policy