Crude Oil: Brent Versus WTI

Marc Rich, one of the most influential and controversial commodity traders that ever lived, once referred to oil as the blood that flows through the veins of the world. Crude oil is an energy staple for most inhabitants of planet earth. Besides being one of the most actively traded commodities, the price of crude oil is extremely sensitive to geopolitical events.

When it comes to physical oil, there are different grades.

The most popular traded grades are Brent North Sea Crude (know as Brent Crude) and West Texas Intermediate (known as WTI). Brent refers to oil produced in the Brent oil fields and other sites in the North Sea. Its oil price is the benchmark for African, European and Middle Eastern crude. The pricing mechanism for Brent values roughly two-thirds of the world's crude oil production. Brent is "sweet" crude meaning it has sulfur content below 5%- Brent's sulfur content is 0.37%. The lower the sulfur content the easier and cheaper it is to refine into products, such as gasoline.

WTI, the other major traded crude oil, is the benchmark crude for North America. WTI is sweeter than Brent is.  WTI has a sulfur content of around 0.24%. WTI is a better grade of crude oil for the production of gasoline while Brent oil favors the production of diesel fuels. The NYMEX (New York Mercantile Exchange) division of the CME (Chicago Mercantile Exchange) lists futures contracts of WTI crude oil.

Delivery for WTI crude futures occurs in Cushing, Oklahoma. Brent crude oil futures trade on the Intercontinental Exchange (ICE). Asian countries tend to use a mixture of Brent and WTI benchmark prices to value their crude oil.

Crude oil costs approximately $3-$4 per barrel to ship from Europe to the United States on supertankers.

There are differences in the costs of storing crude oil in European and North American trading hubs. In a normal market, the price difference between Brent and WTI hovers around a $2.50-$4.00 premium for WTI versus Brent. This is due to the lower sulfur content of WTI. However, there are times when this differential favors a premium for Brent- often for political reasons.

Sometimes, because of world events, the spread between these two low sulfur crudes can move violently for long periods. At the start of 2011, the Brent-WTI spread was close to flat. The spread widened during 2011 with Brent trading at a premium to WTI. Around the time that the Arab Spring got underway in Egypt in February of 2011, the spread widened. Fears of a closure of the Suez Canal and a lack of available supply caused Brent crude oil to become more expensive than WTI. As tensions eased so did the spread. Then in late 2011, the Iranian government threatened to close the Straits of Hormuz through which 20% of the world's oil flows each day. Once again, the spread widened this time with Brent trading to over a $25 premium per barrel to WTI.

As the chart illustrates, the price differential between Brent crude oil and WTI crude has become more volatile since 2011.

Additionally, Brent has traded at a consistent premium to WTI then.

Brent and WTI crude have different properties- WTI has lower sulfur content. Therefore, the price differential is a quality spread. Both crudes are also located in different parts of the world, Brent in Europe and WTI in North America. Brent versus WTI is also a location spread.

The nominal price of crude oil is just one factor involved in understanding the crude oil market. The spread between Brent and WTI is a perfect example of how quality and location spreads affect the structure and ultimate pricing of crude oil around the globe.

As an update to this piece, the Brent premium over WTI oil closed on September 8, 2015 at around a $3.60 premium for Brent. The premium has dropped recently for two major reasons. First, the agreement that will result in sanctions coming off Iran will increase the amount of Iranian crude flowing into the market on a daily basis.

Since Brent is the pricing benchmark for Iranian crude, this will depress the price of Brent relative to WTI. The other reason is that U.S. rig counts have dropped over the past year. There is also expanding support for exporting U.S. crude abroad. That means less drilling in the future and less U.S. production on a daily basis. Therefore, Brent will move lower by virtue of more Iranian crude and WTI will strengthen because of less U.S. production and increasing exports. This relationship is one of the key components in understanding the fundamentals of the world crude oil market.