Analyzing the WTI-Brent Crude Spread

Includes: BNO, RDS.A
by: Jaime Macrae

It is making headlines; the WTI-Brent Crude spread soared higher, surpassing the all-time high made in February. Back in February, during the opening of the Keystone Pipeline, which brings crude from Canada's oil sands to Cushing, Oklahoma, the delivery point for WTI crude futures, strained storage facilities and led to a glut of supply that depressed local prices causing a dislocation from other global benchmarks like Brent crude. What is interesting to note looking at recent moves is that this time around, the change in the spread seems to be driven from the other side of the pond.

WTI-Brent Crude Spread (July futures)

(Click to enlarge) Courtesy of Bloomberg

WTI in Cushing (which is landlocked) and Brent crude in the North Sea are not easily arbitraged. As a result, in order to understand the economics driving this spread, it must be broken down into its components. Crude moving between Europe and the United States is typically routed through the Gulf Coast and the cost of transport is currently around $3-$4 per barrel. The most comparable U.S. crude to Brent in the Gulf is the Louisiana Light Sweet crude (LLS). We can therefore break the WTI-Brent spread into two distinct spreads: WTI-LLS, which reflects the difference in quality and the effect of storage capacity issues on the spread, and LLS-Brent, which reflects the supply and demand differentials between the US and Northern Europe.

WTI-LLS Spot Spread

(Click to enlarge) Courtesy of Bloomberg

As we can see, the spread between WTI in Cushing and LLS in the Gulf has remained fairly stable over the past few months, after expanding significantly in February due to the excess supply in Cushing resulting from the opening of the Keystone Pipeline. The stability of the spread indicates that there has been no significant change in the storage situation in Cushing and therefore that the cause of the widening WTI-Brent spread is coming from somewhere else.

LLS-Brent Spot Spread

(Click to enlarge) Courtesy of Bloomberg

Clearly the culprit is the relationship between U.S. crude prices in the Gulf and Northern European prices in the North Sea. This spread typically favours importing crude to the U.S. from Europe, and the historical spread of around $3 or $4 reflects the aforementioned transportation costs. Over the past week however, this relationship has been flipped on its head! Imports will soon turn to exports, as the economics now favour shipping U.S. crude to Europe. This is a historic shift in the marketplace, should it persist.

What is behind this? Certainly the loss of light sweet Libyan crude from the marketplace has not helped, as Europe was particularly dependent on that supply. Add to that some other supply disruptions associated with planned maintenance in the North Sea and Shell's (NYSE:RDS.A) declaration of force majeure on Nigerian Bonny Light exports and it does appear to be a temporary situation that should be resolved sooner rather than later.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.