Brent Crude Set to Take Over as Global Standard

Energy

Published: November 20, 2012 12:57 pm

The long-standing reign of West Texas Intermediate (WTI) crude as the international benchmark for crude oil pricing has been eroding for a couple of years. Now, there is a virtual certainty that WTI will be replaced next year by Brent crude as the international standard.

The S&P GSCI commodities index has already raised its weighting on Brent to 22.34% of the index beginning in January, and lowered the weighting of WTI from nearly 31% to 24.71%. The reason is simple: there are more Brent barrels available. Higher volume means more liquidity and more opportunities for trading.

The problem with WTI is that it is landlocked within the U.S., and pricing is settled at Cushing, Oklahoma, where there is limited pipeline availability to move WTI. Virtually none is loaded on tankers for sale anywhere else in the world, and notwithstanding recent projections from the International Energy Agency, it is not likely that significant volumes of WTI will ever be sold abroad.

The situation is even more lopsided in futures, where Brent futures traded on the InterContinental Exchange (NYSE: ICE) now outnumber WTI futures traded on the Nymex by about 30,000 contracts a day. The combined volumes on both exchanges still favors WTI, but Brent is rapidly closing the gap according to a report at CNBC.com.

The options market is where Brent has made its largest gains although it still trails WTI by a substantial margin. The CNBC.com report notes that both Southwest Airlines Co (NYSE: LUV) and Delta Air Lines Co. (NYSE: DAL) have switched to Brent to hedge their exposure to jet fuel prices.

Brent trades today at a spread of about $23 a barrel higher than WTI. That gap, due in large part to increased production in the U.S. and a lack of infrastructure to move WTI out of the Midwest, is expected to close with WTI prices rising to meet Brent pricing. Oil producers will welcome the shift, refiners will not, and U.S. drivers will end up paying higher prices at the pump. It may take a while for this all to shake out, but the first big step has already been taken.

Paul Ausick

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