Brent

Yesterday the Intercontinental Exchange Brent premium to WTI NYMEX closed at $9.31/Bbl, its lowest value since January 2012. Spread watchers have long anticipated this narrowing but it throws a spanner in the economics of crude by rail shipments from North Dakota. Today we suggest that the Brent/WTI spread may have narrowed before crude supply fundamentals justify the move and that it could widen again quickly to $15 or higher.

Last week (see Sailing Stormy Waters) we reviewed limited market options for Western Canadian heavy bitumen crude producers. The US Gulf Coast is the only viable market with significant refinery capacity to process these crudes. At the moment there is limited transport infrastructure in place to get them there. As a result prices are being heavily discounted in the over supplied Midwest market. The Canadian benchmark Western Canadian Select (WCS) price traded this January at a discount of more than $38/Bbl to the US benchmark West Texas Intermediate (WTI). Today we examine how much prices are likely to improve once the pipelines are built.

The physical market for Brent, Forties, Oseberg and Ekofisk (BFOE) represents the delivery mechanism for ICE Brent Futures and is linked to crude oil contracts worldwide. This year the  trading in the BFOE forward market has been limited to just 20 cargoes a month from the Forties stream. Today we describe producer’s efforts to increase market liquidity.

This is Part 3 in our series on the physical Brent crude market. What follows will make more sense if you read Part 1 and Part 2 first. In Part 1 we explain that the Brent crude used as a benchmark for international pricing that underlies the ICE Brent futures contract – is made up of crude oil produced in dozens of different North Sea fields and delivered to market in four different streams – Brent, Forties, Oseberg and Ekofisk (BFOE). In Part 2 we explain the linkage between the small Brent physical crude market that trades in 600 MBbl parcels costing upwards of $60 MM at today’s prices and the Brent ICE futures contract that trades in 1000 Bbl lots. Prices in the two markets are linked together by a cash settlement process using a Brent Index price based on forward trades in the physical market. The Brent Index settlement is an exchange for physical  (EFP) mechanism that ensures convergence between futures and physical markets.

The convergence mechanism in futures markets used to be something taken for granted in international crude trading. Futures exchanges like ICE and the CME NYMEX were considered an add-on service for the oil industry to hedge price risks - secondary to the physical market. That was the old days. Now futures trading volumes dwarf physical market transactions (in Part 2 we showed that ICE Brent futures trades 500 times the physical BFOE crude production volumes each day). Nevertheless the futures contracts still have to relate back to underlying physical crude oil prices in order to function efficiently. That can sometimes cause unexpected results.

North Sea Brent crude plays a critical rolet in setting world oil prices. Here in the US, most folks pay more attention to West Texas Intermediate (WTI)  - the North American equivalent benchmark. We regard Brent as just a figurehead for the international market and rarely look beyond the Brent/WTI spread. Yet Brent crude assessments based on physical trades or the ICE Brent futures market are used directly or indirectly to price 70 percent of world oil. Today we begin a “deep dive” series explaining how the Brent crude market operates.

By the end of this week (Friday January 11, 2013) Phase 2 of the Seaway Reversal pipeline project that delivers crude from Cushing to Houston is supposed to have come online - expanding pipeline capacity from 150 Mb/d to 400 Mb/d. Phase 1 of the project was eagerly anticipated by the market but since then (June 2012) the narrowing in price differentials between WTI Cushing and Brent expected by much of the market has not materialized. Today we explain why Seaway Phase 2 is only one factor in today’s complex US crude market evolution.

Alaska North Slope (ANS) crude production has been in decline since 1987. Once producing over 2 MMb/d this prolific field averaged just 520 Mb/d in 2012. At the same time refiners on the West Coast who previously relied on ANS are beginning to get access to domestic shale crude and might be consuming Canadian crude exports from British Columbia in a few years’ time. Today we explain the impact on West Coast crude pricing.