The role of benchmarks in the global crude market

According to the US Energy Information Administration (EIA), the Brent-WTI spread, the difference between the front month futures price of North Sea Brent crude oil and that of West Texas Intermediate (WTI) crude oil, narrowed to US$ 2.00/bbl as of 15 October, after reaching a 2014 high of US$ 14.95/bbl in January. The spread declined in the first quarter of the year primarily as a result of changes to crude oil infrastructure in North America that caused WTI prices to rise. The spread averaged US$ 6.53/bbl from March through September.

The more recent narrowing of the spread since September is largely the result of declining Brent prices caused by a combination of lower demand and increased supply. Economic growth in Asia and Europe has been lower than expected. Sustained increases in Libyan crude oil production plus higher US crude production that has backed out US imports are raising crude supply in the global market, the EIA reports.

Changes in the Brent-WTI spread not only reflect the relative strength or weakness in the markets for Brent and WTI, but the spread also affects the prices of many other types of crude oil that use these two crude as reference points, or benchmarks, for establishing market prices.

A benchmark crude is a specific crude oil that is widely and actively bought and sold, and to which other types of crude oil can be compared to determine a price by an agreed upon differential. The agreed upon differential takes into account a number of factors, including quality characteristics such as API gravity or sulfur content, transportation costs from production areas to refineries, and regional and global supply and demand conditions, including refinery utilisation. Use of the benchmark makes it easier for buyers and sellers to price the variety of crudes that are produced around the world.

The most widely used benchmarks are associated with crude oil that has stable and ample production; a transparent, liquid market located in a geopolitically and financially stable region to encourage price discovery; adequate storage to encourage market development, and/or delivery points at locations that allow arbitrage opportunities in world markets so that prices reflect global supply and demand.

Brent

Brent is the most widely used global crude oil benchmark, and includes four separate light, sweet crude streams that are produced in the North Sea: Brent and Forties (produced offshore the UK) as well as Ekofisk and Oseberg (produced offshore Norway). In 2013, Brent crude oil loadings averaged 0.86 million bpd, representing approximately 1% of total world crude oil production of 76 million bpd. Brent is used to price light, sweet crude oil that is produced and traded not only in Europe, the Mediterranean and Africa, but also in Australia and some countries in Asia.

WTI

West Texas Intermediate is a light, sweet crude oil produced in the US that is priced at the crude oil trading hub of Cushing, Oklahoma. WTI is used as a benchmark for other types of crude oil produced in the US, such as Mars, a medium, sour crude produced in the Gulf of Mexico, and Bakken, a light sweet crude produced in North Dakota. WTI is also used as a benchmark for imported crude oil that is produced in Canada, Mexico and South America.

Dubai/Oman

This is the third major benchmark crude. The prices of Dubai and Oman crude, both of which are medium, sour, are often averaged together to create a benchmark that is typically used to price crude oil produced in the Middle East and exported to Asian markets. Dubai crude oil production has steadily declined for more than two decades, and in 2013 was only 34 000 bpd. Aa result, Oman crude oil, which reached 940 000 bpd of production in 2013, has been used to support the continued use of Dubai crude as a benchmark. Saudi Aramco uses the Dubai/Oman benchmark when determining the price of its crude oil sold for delivery to Asia. Brent and Dubai crude oil prices tend to be correlated, in part through the Brent/Dubai Exchange of Futures for Swaps, a highly traded, over the counter instrument that allows traders to convert to and from a Brent crude oil futures contract and a comparable forward month Dubai crude oil swap.

According to the EIA, the Brent-Dubai/Oman spread has narrowed in 2014 as the price of Brent has decline, like the Brent-WTI spread. AS the spread narrows, Brent and Brent-priced crude, like the West African Bonny Light and Qua Iboe produced in Nigeria, become more competitive in Asian markets compared with Middle East crudes, like Arab Light. Saudi Aramco recently announced that it would lower the November 2014 differential to the Dubai/Oman benchmark for Arab Light crude oil delivered to Asia. As a result, Arab Light crude will price at a discount to the Dubai benchmark for a second consecutive month, which has not happened since the end of 2010.

Adapted from a press release by Emma McAleavey.

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