The single most widely traded spread in the global oil complex is the WTI/Brent spread and the change in the relationships between these two global marker crude oils has implications to both crude oil and refined products on a global basis. It is also the most important spread in setting all of the various pricing interrelationships among the many different crude oil grades as well as for refined products inside and outside the US. Brent (North Sea crude oil) and WTI (US indigenous crude oil) are the industry’s two main benchmark crude oils which the majority all of the crude oils around the world are priced against.
This spread is not only traded heavily by the speculative community, it is also traded by the oil industry asset trading sector or those that actually are responsible for all of the physical crude oil acquisitions around the world. It is also a spread that can be traded on NYMEX as part of the regulated futures arena, as well as the cleared over the counter system on CME Direct. Volumetric activity for the spread is continuing to grow, as is liquidity with relatively narrow bid/offer ranges.
Although the spread does respond well to various technical analysis techniques, this is a very fundamentally driven spread with the same fundamentals driving the direction of the spread for many years. The main fundamental drivers of the spread are:
There are other minor fundamental drivers but the aforementioned list of drivers is the focus of this paper. Understanding the aforementioned spread directional drivers may provide decent signals when trading this spread.
There has been a major transition that has taken place in the US and Canadian crude oil markets that has had a major impact on the direction of the spread since about 2008. The US crude oil revolution has resulted in a significant increase in US domestic crude oil production as a result of the successful technologies applied to the main shale oil regions of the US - i.e. Bakken, Permian, Eagle Ford, Niobrara, Haynesville and Marcellus. The drilling and production success in these regions coupled with a significant increase in the availability of Canadian crude oil for the US has significantly changed the dynamics of the US oil industry.
The US logistics system was designed and built as a south to north pipeline system. This system was designed around the large crude oil reserves and production level in the Gulf region (in particular Texas) of the US as well as the large volume of imported crude oil that entered to the US to supplement US indigenous production for the main refinery centers in the Gulf and PADD 2 region (mid-west). The west coast has mostly consumed California and Alaskan crude oil and supplemented by imports while the east coast refining system has been dependent on offshore imports.
With a significant increase in US domestic crude oil production and a surge in Canadian imports the south to north logistics system created a huge bottleneck in the Cushing area (also the delivery location for the NYMEX WTI contract). Cushing stocks built strongly as the intake capacity to Cushing far exceed the takeaway pipeline capacity. This resulted in a huge overhang of crude oil and thus had a very depressing impact on the price of WTI, especially relative to Brent.
Over the last two years the mid-stream industry has done a fantastic job in increasing the crude oil takeaway capacity out of Cushing by building new pipelines and reversing several south-to-north pipelines that were no longer needed. In addition rails deliveries of crude oil from Canada and North Dakota have also played a large role in adjusting the logistics system to accommodate the oil shale revolution taking place.
Cushing stocks are now back down to the level they were at prior to the onset of the surge in crude oil supplies from the US and Canada. In fact Cushing is now a transition area feeding both the PADD 2 and PADD 3 regions. Crude oil coming into Cushing supplies a combination of PADD 2 refineries that are connected to Cushing via pipeline as well as sending crude oil down to the Gulf Coast refineries. There should not be a large build up in crude oil in the Cushing region unless the market moves into a strong contango and economics justify building crude oil facilities. Inventory levels in Cushing will find a normal operating level needed by the PADD 2 refiners.
In regard to the main drivers, US crude oil production and imports from Canada are projected to continue and grow well into the future. This trend will support the main changes that have taken place in the logistics system and most importantly in the crude oil acquisition pattern for the US refining system which brings me to the main directional driver… Cushing crude oil stocks.
The following chart shows the relatively strong correlation between inventory levels in Cushing and the WTI/Brent spread. This is a weekly chart to coincide with the weekly release of EIA Cushing inventory data.
In spite of the major transition that has taken place in the slate of crude oil for the US refining system as well as the in the logistics system the correlation between the direction of Cushing inventories and the spread remain solidly in place.
Over the last several years as the logistics have changed the relationship between PADD 3 (Gulf region) crude oil stocks are also starting to be a reasonably correlated directional driver of the WTI/Brent spread as shown in the following chart.
Source: Charts provided by DTN
With Cushing crude oil stocks now back to the pre-surplus normal operating range level and with Cushing acting more as a transition areas between PADD 2 and PADD 3 the relationship of PADD 3 inventories are also now driving the spread.
On the other end of the spread (Brent side) the two main general areas that have an impact on the spread is production levels of crude oil from the North Sea. From time to time severe weather impacts the flow of crude oil out of the North Sea. During periods of time when flow is impeded it has a tendency of strengthening the Brent side of the spread irrespective of what is going on in the US. In addition when there are geopolitical interruptions in the flow of crude oil from various locations (i.e. Libya, Nigeria, Middle East, etc.) it has a stronger impact (generally upside) on the Brent side of the spread and has a tendency to offset any bearish spread signals coming from the US side of the spread.
There are three sources of inventory data that are released at different times of the week. Genscape reports Cushing crude oil stocks at 9 AM on Monday. This is a subscription service. The subscribers of this report certainly set their positions in the WTI/Brent spread if a signal presents itself. The API issues its Cushing inventory data late on Tuesday afternoons - also for a subscription fee. However, this data tends to be broadcast via several news services and on Twitter. Finally the most comprehensive and free inventory data is released mid-morning on Wednesday by the EIA. All of these data sources are in close agreement for Cushing crude oil inventories. Finally the inventory data points are always as of the previous Friday.
The above are the main price drivers of the spread.
This spread has a high level of liquidity to allow for relatively easy entry and exit as well as a high level of volatility. Furthermore as you can see from the charts presented in the paper the spread tends to trend for extended periods of time allowing for many entry and exit points during the course of a trend.