Crude Oil Pricing and the West Texas Intermediate Problem

| About: The United (USO)

Kudos to the WSJ for posting a well-researched Page-1 article yesterday on the problems with the West Texas Intermediate [WTI] crude oil contract. Good commodities coverage is rare in the mainstream media, but this one's worth reatding.

Although it doesn’t get into the depths of contango and other issues, Ann Davis’ article does a good job explaining why and how the price for WTI has diverged from other types of oil. The scary part? She cites two oil experts who say that the discrepancies between WTI and other crudes could persist until 2009.

Davis points out that WTI plays a huge roll in government inflation statistics and other measures. If the price stays low compared to other oils, the WTI discount will lead to a false understatement of inflation.

I’m not so sure that traders won’t find a way around this problem. Sure, it’ll take a while for new pipelines to be built to the Cushing, OK, terminus where WTI contracts are settled. That's what's need to handle the increased volume of oil and distribute it to the Coasts where most demand is.

But even before that happens, it seems like arbs should come in and buy the outdated futures contracts in such volume that the prices will drop. When that will happen – and when it will overwhelm the massive indexing money that invests passively in the near-term futures – is anybody’s guess.

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