Commodities

Oil Prices Keep Falling, But a Strange Gap Persists


Oil Prices Keep Falling, But a Strange Gap Persists

Oil prices are down more than 20 percent since mid-March. Yet that hasn’t erased a strange anomaly in the market: the gap between two essentially identical types of oil. North American light, sweet crude, also known as West Texas Intermediate, trades just below $84 while its international equivalent, known as Brent, is priced at $97.

Why would two similar products sell for such different prices? The problem is getting hold of WTI and connecting supply with demand. The gusher of new domestic oil production coming out of shale deposits in North Dakota, Texas, and Oklahoma has outstripped the country’s pipeline capacity to move it around. The result is a supply glut that has built up in the middle of the country, lowering the price of WTI. Refineries along the Gulf Coast would love to get their hands on more cheap domestic crude, but they can’t simply call an oil supplier and have a load of cheaper WTI delivered whenever they want. While pipeline projects to solve the problem are just getting underway, there’s still no easy way to get large quantities of WTI down to the country’s refining hub along the Gulf Coast. So refiners remain trapped, forced to keep taking more expensive imported oil.

The discrepancy has lasted a lot longer than most people thought. Although they’ve traded within a dollar of each other for the bulk of the past 20 years, starting in August 2010, WTI began trading below Brent by about two to three dollars. By February 2011, the spread widened to $20 as domestic production ramped up and turmoil hit the Middle East with the Arab Spring, spooking markets with concerns over threats to supply. The gap peaked at $27 last October, when Brent was trading at $114 and WTI was close to $87. The gap is currently about $13.

One of the big debates in the oil market right now is how tight that spread will get over the next half a year. Opinions vary considerably. The energy guys at Goldman Sachs, led by analyst David Greely, think that by the end of 2012 the price of WTI will be just $5 below Brent, largely because new pipeline projects, such as the recently reversed Seaway, will allow more domestic crude to reach refineries along the Gulf Coast, making WTI more valuable. In essence, the more domestic crude that reaches the Gulf Coast, the stronger the floor beneath the price of WTI becomes.

At the same time, though, domestic production shows no sign of abating. The number of oil rigs drilling in the U.S. has risen to 1,400 from 984 last June, a 43 percent increase. That extra supply should provide an equally strong (if not stronger) ceiling on the price of WTI. As a result, many analysts think the WTI-Brent spread will persist in double-digits for the foreseeable future. “Five dollars is not likely,” says Fadel Gheit, an analyst at Oppenheimer. “And even if it does go to $5, it’s not going to stay there.” Gheit points out that as long as WTI stays above $70, drilling companies can still make money producing new wells, which in turn, he says, will keep WTI anywhere from $8 to $12 below the price of Brent.

This price gap has created an arbitrage opportunity for some enterprising oil traders. For those who can buy domestic oil cheaply and have the means—either by leasing barges or rail cars—to move it down to the Gulf Coast, they can make money by selling it to refineries at a higher price. The tighter that spread, the trickier that trade becomes. Yet $13 is still a big enough window to make it work.

Philips_190
Philips is an associate editor for Bloomberg Businessweek in Washington. Follow him on Twitter @matthewaphilips.

The Good Business Issue
LIMITED-TIME OFFER SUBSCRIBE NOW

Sponsored Financial Commentaries

Sponsored Links

Buy a link now!

 
blog comments powered by Disqus