Brent – WTI spread at 2-year high, could WTI make a comeback?

Brent crude is the main story today on an otherwise quiet Monday for financial markets. Brent crude has surged in recent trading sessions and hit a two year high of $62.90 earlier on Monday. The key driver for the move higher has been Saudi Arabia.

Brent crude is the main story today on an otherwise quiet Monday for financial markets. Brent crude has surged in recent trading sessions and hit a two year high of $62.90 earlier on Monday. The key driver for the move higher has been Saudi Arabia. Last week the Saudi Arabian oil minister said that he supported another Opec production cut, set to be announced when Opec next meets later this month. This weekend an anti-corruption drive by Prime Mohammad bin Salman has seen the arrest of the well-known champion of capitalism Prime Alwaleed bin Talal among other officials and has rattled investors, stock exchanges across the Middle East have fallen at the start of this week. However, this hasn’t hurt the oil price as yet.

Is Brent acting as a safe haven?

The reason that Brent has rallied even when other Saudi-based assets have struggled, could be two-fold: the extension of the Opec production cut is a powerful driver of oil in the short term, and Brent could be acting as a safe haven in the midst of the confusion around the anti-corruption drive and Prime Mohammad bin Salman’s shifting economic agenda.

The Brent –WTI spread in depth

The most striking thing about the rise in Brent is the spread between Brent and WTI, which currently stands at $6.55 (as you can see in chart1), one of its highest reached since 2015. Interestingly, this spread reached $7 last week before it dipped slightly, suggesting that when the Brent – WTI spread is stretched to the upside, WTI tends to play catch up.

Correlation analysis also backs this up: both the long and short-term correlations between Brent and WTI is above 85%, which suggests a very strong positive relationship. Both Brent and WTI have been moving in the same direction this year, as you would expect (see chart 2), however, since September Brent has been outpacing WTI at an ever faster rate. We believe that even with the potential Opec production cut extension and the anti-corruption drive, this spread is looking stretched and we could see WTI start to play catch up and make an attempt at $58 and potentially $60 in the coming weeks.

Watch out for contagion…

Our caveat to this is that the events in Saudi may yet de-stabilise the entire region. During the Arab spring the Brent- WTI spread widened to above $25 per barrel, thus, if this anti-corruption purge does go further then we could see this spread move substantially higher. On another note, we don’t expect WTI to outpace Brent any time soon. Brent tends to trade at a premium to WTI and WTI has only traded higher than Brent on two occasions in the last 7 years.

To conclude, if the Saudi events are limited in their scope and don’t destabilise the Middle East region then we believe that WTI could play catch up with Brent and the spread between the two may moderate in the coming weeks as the expected extension to the Opec production cut now looks to be fully priced in.

Chart 1:

 

Source: City Index and Bloomberg

Chart 2:


Source: City Index and Bloomberg 

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