Betting on Brent | FT Alphaville

Betting on Brent

The contango is widening, floating storage is on the increase, and Brent’s premium to WTI is intensifying by the day (note chart below) — which means only one thing: stocks at Cushing, the physical delivery point for the WTI  Nymex contract, must be reaching a critical level (again).

WTI/Brent spread - FT

Harry Tchilinguirian, commodities analyst at BNP Paribas, wonders if the above means the market should now expect a return of the extreme pricing relations of Q1′ 09 — when WTI’s relevance as a benchmark began to be questioned due to the extreme disparities that appeared between it and Brent crude prices.

Certainly, some similar trends are already appearing in the charts, notes Tchilinguirian:
Cushing Stocks vs WTI Spreads - BNP Paribas
WTI spreads - BNP Paribas

But Tchilinguiran also notes there might be another reason for the WTI-Brent spread blowing out again — the lack of a driving season in the US this year on account of the recession. As he explains (our emphasis):

WTI’s historical premium relative to Brent has an economic function: that to offset transportation costs and attract a light-sweet crude oil westwards during the US summer driving season. Among the main reasons behind the increase in the relative price is that historically, the marginal US refiner left to meet gasoline demand at the seasonal high point of consumption was less complex in its operations.

As such, the simple refinery would seek a lighter grade of crude to maximise its output of gasoline. This year, there is no summer driving season as a high unemployment rate undermines US consumer confidence. Additionally, with increases in conversion capacity in the past couple of years, the need to rely on the marginal Brent-related barrel to meet light product demand has lessened in favour of more medium quality crude.

That, alongside the ongoing availability of cheap floating storage  — which abated the extremities of the previous Cushing-induced contango according to Tchilinguirian — should, he suggests, limit the contango this time round. Alongside that, there’s also the issue of North Sea maintenance and reduced output from Brent constituent crude oils (Brent Forties Oseberg and Ekofisk).  As he sums up:

As long the availability of VLCCs remains inexpensive, then the marginal cost of storage, that fundamentally shapes the depth of the contango, can be expected to be contained. Equally, storage capacity at Cushing appears to have risen relative to Q1, and more capacity is due over the balance of the year and next, pushing upwards the operational limits at the hub.

Valuation of dated Brent will be supported by reduced output of its constituent crude oils, notably in August with field maintenance in the North Sea. These seasonal developments offer the potential for more WTI weakness relative to Brent. Finally, potential shifts of floating storage out of the North Sea in favour of the US Gulf Coast can be also be a contributing factor for a weaker WTI spread to Brent.

Which means, for the time being at least,  there’s every reason for Brent to trade at a considerable premium to WTI.

Related links:
It’s all about Cushing
– FT Alphaville
‘WTI about as useful as a chocolate oven-glove’
– FT Alphaville
A Brent with no North Sea oil? – FT Energy Source