The spread between the world's two benchmark crude oil markers – Brent and WTI – is currently hovering at US$6/b. This is the widest gap between the two for a long while, first breaching the tight US$2/b spread range since 2015 in the run up to Hurricane Harvey as traders fretted that widespread refinery closures along the US Gulf would impact US crude consumption.
Those refineries have come back online, but the spread is still persisting. It is so large that India's Reliance – an opportunistic buyer if there was any – bought a massive million barrel cargo of US crude oil last week. All across Asia, key buyers are taking advantage of this new arbitrage window to stock up on (cheaper) American crude, some for the very first time. Indian refiners – notably state refiners IndianOil, HPCL and BPCL – are leading the way, with buyers from South Korea, Japan, Thailand and Singapore also in the fray. Chinese activity is still minor, but one has to imagine they can't be that far behind.
When the Brent-WTI spread hit its all time high at US$28/b in September 2011, there was a similar enthusiasm for US crude. Volumes then, however, weren't readily available. The WTI discount to Brent then was because oil generated from the burgeoning US shale revolution was trapped in Cushing, Oklahoma – the main price settling point for WTI – at a time when global demand was soaring. In other words, the discount was due to the inability of sufficient WTI volumes to make it into the wider market. The oil was there, but midstream infrastructure to ship it to Houston and from there to the wider world, was inadequate. A rush to expand existing pipelines and build new ones – transportation by train was even used at one point to clear volumes – occurred, and when it did by 2014, the Brent-WTI spread had decreased. The lifting of the US crude export ban in 2015 narrowed things even further, to a range of US$2-3/b.
In 2017, that lack of infrastructure is no longer there. Supply has caught up with the ability to meet demand, and as US oil exports soared, WTI prices have closed the gap with Brent, which is used as the main international marker, including Middle Eastern grades. In such a competitive scenario, we would expect both benchmarks to move towards parity.
But even before Hurricane Harvey reared its head, the Brent-WTI spread was already growing. The circumstances this time are different. On the Brent side, there is a ‘fear premium' being priced in; tensions in the Middle East – between Qatar and the rest of GCC, tensions between Iraq and its Kurdish province – have been raising the spectre of supply disruptions. More significant though is that on the WTI side, there is now once again an abundance of supply. But unlike before, that supply can make it to market. Which is why we are seeing such strong volumes of US crude exports. Some six million barrels are earmarked to be shipped from the US to Asia for November so far; up from usual monthly shipments of 2-3 million barrels. The cheap prices are enticing, but Asian refiners are being forced to look further afield for crude as OPEC and some non-OPEC sellers have been cutting availability as part of their supply freeze.
US crude exports reached an all-time weekly high at the end of September. That jump in demand should naturally reduce the spread. The Brent physical market is tight, meaning that Brent's strength is not artificial but demand driven. A break towards US$60/b appears possible soon. But a look over the future curve indicates that the current Brent-WTI spread will persist through October 2018, having doubled since May 2017. This suggests that the sheer amount of supply coming out of the US will negate demand drivers to keep WTI significantly lower than Brent, where supply is a lot steadier.
That's good news for Asian buyers, as the avenue of cheaper US crude remains open to them for far longer. With OPEC likely to extend, or even deepen, the supply freeze beyond the current deadline of March 2018, Brent-linked crude volumes will be in short supply. The distance from Houston to Yokohama, Singapore or even Paradip is vast - VLCCs have to go through the Suez as the Panama Canal is too narrow – but at current and projected spreads, well worth the distance.
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