In February this year, crude oil watchers noticed that the US market was not moving to the fluctuations in global prices. So much so, the price differential between the West Texas Intermediate (WTI), based at Cushing in Oklahoma, and London’s Brent, started widening. By mid-July, the differential peaked to $23 a barrel from $2-3 earlier; it’s now in the range of $20.
In India, where a combination of Brent and Dubai-Oman crude decides the economics of the oil sector, many started wondering whether to drop Brent from the so-called Indian crude oil basket and get WTI instead. After all, it would give an advantage of $20 a barrel to the index that gives a 35 per cent weightage to Brent.
Experts and oil professionals reject the proposition outright. The reason is the same as what global oil watchers usually point to — WTI is not a barometer for the global oil market. “It is a localised inland index and quite disconnected to global trade,” says Victor Shum, managing consultant, Purvin & Gertz, an international energy consultancy.
WHY WTI STUCK
What caused the WTI, that is traded on the New York Mercantile Exchange, to fall and stagnate despite pressures of supply from Libya was the coming into operation of the second phase of the Keystone pipeline (a system to transport crude from the Athabasca Oil Sands in northeastern Alberta, Canada, to refineries in Illinois and Oklahoma, and further to the US Gulf Coast). The connectivity brought an additional 56,000 barrels per day (bpd) of crude oil into Cushing, a major crude oil marketing, refining and storage hub. “The WTI demand is mainly driven by some of the mid-sized refiners in that region, who were not able to absorb the additional quantities,” says Praveen Kumar, senior consultant and head of the South Asia Oil & Gas Team at FACTS Global Energy.
With Cushing being a land-locked region, increased supply from the pipeline added to inventories and depressed prices. Further, the US government also released some of the crude oil inventories. Alongside, the Libyan crisis impacted supply to Europe. WTI had historically always traded at a dollar or two premium to Brent. Instead, what started happening in February was that Brent prices got pushed upwards, while increased crude storage pressed WTI downwards. That explains the record price range between the two.
In July, US landlocked WTI posted the smallest monthly increase, up by $1.05 a barrel to $97.26, though Brent crude posted the largest monthly increase at $2.85 to $116.88, reflecting ongoing scheduled and unplanned shut–ins of North Sea supplies. According to Paris-based International Energy Agency in its recent report, relatively stronger prices for Brent led to a further widening of the WTI discount to the North Sea crude, to averaging just over $22 a barrel in early August, compared with an average $19.62 in July and $17.82 in June.
This situation reversing to a smaller gap between the two prices does not seem likely till 2013-14, when new pipelines from Cushing would come up, facilitating faster evacuation of crude. “The range may go back to $15 or so in the short term but this will continue till pipelines are built to other locations like the US West Coast,” says Shum. Stating the differential is here to stay, Kumar predicts Brent may drop to $100 a barrel by year-end, while WTI may trade at $85.
EFFECTS The coming up of the Keystone pipeline system has given the US a two-way advantage. With a current capacity of 591,000 bpd, Canadian oil, mainly flowing from oil sands, replaced some of the Mexican, Venezuelan and West Asian heavy crude in the US. In fact, a study conducted by Ensys Energy for the US department of energy’s Office of Policy and International Affairs clearly says that growing Canadian oil sands’ imports and US demand reduction have the potential to very substantially reduce US dependency on non-Canadian foreign oil, including from West Asia. “Canadian oil sands’ imports do not change significantly under the low-demand outlook,” the study, done last year, concluded. Indicating that shrinkage in demand would only cut reliance on crude imported from outside North America.
The lower price level of WTI also helps refiners in the region, who register better margins than those depending on Brent. “The American refiners will benefit since the US imports diesel to Europe and even to Latin America during the driving season,” says Kumar. Though Reliance Industries Ltd also sells petro products in the US and Europe, this variation does not pose much of a threat to it. “RIL refineries are very sophisticated and can process heavy and sour crude sourced from Mexico and Venezuela, that are sold at a discount to WTI. The company benefits from the arbitrage,” he adds.
The benchmark Indian basket, that has averaged $107 a barrel in August so far, is $2 lower than Brent. It comprises Dubai-Oman crude for the sour grade and Brent for the sweet grade, in the ratio of 65.2 and 34.8, respectively. Kumar says if at all anything should be taken out from the basket, it is Dubai crude. “Dubai as a traded crude is almost ‘dead and buried’ but lives on as a marker – its production has declined and is less than 100,000 bbl/day. Oman’s production is much more than this (nearly nine times) and that is why a Dubai:Oman mix is there, as there has to be some production volume as well."
Kumar says it is possible for the Indian government to just look at the Brent:Oman price to price its crude basket, as in terms of quality it will still get the right result (Brent for light sweet and Oman for heavy/medium sour). Also, Dubai and Oman are similar when it comes to price, unlike the wide differentials between Brent and WTI we’re seeing now. But Dubai is still the benchmark for refiners in Asia and that is why it remains in that basket.
