NYMEX WTI is the most liquid commodity future in the world. So far this year the exchange traded an average 125 MMb/d in the prompt contract alone. The NYMEX crude price is so ubiquitous that it also underpins the domestic US crude spot market. Differences between futures and physical trading as well as the delivery mechanism that links the two markets, make pricing physical WTI complicated. Today we begin a two-part look at US spot crude pricing.
A couple of weeks back we looked at the new Platts marker price for Eagle Ford (see Clash of The Titans) and wondered whether a US crude price could be based on anything other than the West Texas Intermediate (WTI) benchmark. For the moment WTI remains dominant – largely because of its close links to the CME NYMEX crude futures contract. WTI is the primary crude specified for delivery to Cushing, OK under the NYMEX futures contract. [Other crudes can be delivered against the NYMEX contract but they are not always easy to physically deliver to Cushing]. As a result the daily settlement price or “close” for the nearby NYMEX crude futures contract acts as the benchmark price for the US domestic crude oil spot market.
Recall that WTI crude is produced in the West Texas Permian Basin. In our blog series on the Permian (see The New Adventures of Good Ole Boy Permian) we reviewed how WTI is delivered into the large storage and trading hub at Cushing, OK on two major pipelines – the Plains All American Basin pipeline (450 Mb/d capacity) and the Occidental Centurian Pipeline (175 Mb/d capacity).
Spot market trades are bilateral transactions between buyers and sellers of physical crude oil for short-term delivery. In practice spot delivery means anything up to a month away. Because traders want the most accurate value for their crude, they prefer to link their pricing to the heavily traded NYMEX futures market that is hard to manipulate and easy to hedge. Understanding spot crude pricing for WTI and other US domestic grades therefore requires an understanding of futures pricing and the differences between futures and physical crude markets.
In theory the terms and conditions for physical crude oil trades are entirely custom to each transaction. Traders can literally agree on anything to decide the price. In practice, however, the majority of trades follow fairly standard terms that any two counterparties can feel comfortable with. Most crude transactions take place under long-term contracts that last for years. The contract defines the general conditions of the trade including the volumes to be transacted every month, delivery location, product specification, credit terms and conditions, payment terms and pricing mechanism. Once the contract is set up then subsequent transactions simply reference the contract terms. The pricing mechanism in these contracts contains several pricing elements that normally include the following: