Brent WTI Spread Disappears in Thin Air for now

For the first time in 3 years, the premium of Brent oil (North Sea) over West Texas Intermediate (US crude WTI) has fallen below zero. Despite an increase in both oil benchmarks, the more rapid rise in the price of WTI has dragged down the spread to $-0.54, for the first time since February 2010.

WTI’s underperformance relative to Brent occurring for most of 2012 was widely attributed to the glut of oil supplies in the continental US resulting from shale rock drilling and spare Canadian production, which overwhelmed refinery capacity.

But US oil inventories have hit 7-month lows of 367 million barrels last week as oil processing surged to 8-year highs. Since late May, rising demand from refineries, which have ramped up their processing of cheap crude oil from North Dakota and Canada as well as increased demand for oil derivatives products had began to erode pipeline and storage activity. Stocks at the oil hub of Cushing, Oklahoma, fell by nearly 2 million barrels in 4 days to 46 million barrels, the lowest level of the year.

Once the Brent-WTI spread soared to a record $15.95 earlier this year, there was a growing incentive to transport the oil from Cushing to the Gulf coast. Rail, truck and even pipeline reversals—all led to the narrowing of the spread. But according to estimates of marginal transportation costs out of Cushing, the Brent-WTI spread is expected to return towards the $5 level.

The aforementioned dynamics are seen to be largely temporary as they reflect the increase in WTI, rather than a decline in Brent. As refineries operate near 95% capacity, there is little additional oil they can take on, likely stepping up a fresh glut in the Gulf coast.  The Brent-WTI spread could well stabilise near -1.00 before mounting a gradual recovery in the medium term.

Both Brent and WTI are expected to continue outperforming metals and most commodities as OPEC and Mid East tensions maintain upward momentum in the fuel, while China’s cooling economy weighs on metals and iron ore demand.  Brent is set to retest $110.00 resistance, but renewed pressure is seen re-emerging at $116.0. $105.00 may well become the new medium term support, near the 100-week moving average.