The WTI Crude Oil Contract is Losing Relevance

by Tony D'Altorio Natural Riches Natural Riches

The WTI Crude Oil Contract is Losing Relevance

by Tony D'Altorio, Investment U Research

Thursday, February 17, 2011

For many years, the US-based West Texas Intermediate (WTI) crude oil contract has been the world's top oil benchmark. The most liquid of its kind, it is often cited as the "real" price of oil.

But WTI is quickly becoming irrelevant in that capacity. Other global benchmarks such as Brent crude oil, which is based on North Sea oil, and Dubai crude oil contracts seem to be taking its place instead.

With Egypt in an uproar, Brent blend crude oil futures pushed oil over $100 a barrel as it more accurately reflects supply concerns. Meanwhile, WTI lagged badly behind, weighed down by its own oddities.

WTI used to always trade above Brent oil because of its higher quality and lower sulfur content. But it costs significantly less now.

In fact, last week, the price difference between the two hit over $16 a barrel. In just two weeks' time, it had doubled.

Why WTI Is Becoming Irrelevant

The price difference between WTI and Brent oil has been building for some time. That's why, two years ago, Saudi Arabia dropped WTI as its benchmark for pricing oil to U.S. customers.

In the past, the Saudis have always highlighted technical problems as the reason behind that move. But really, they - like much of the world - think Wall Street speculators dictate the contract far too often.

Saudi Deputy Oil Minister Prince Abdulaziz even said the WTI market was "too much like gambling."

Certainly, Wall Street does factor into the contract's ups and downs. But there are also solid, fundamental reasons why it lags behind global markets and may never be a global benchmark again.

It is set by local conditions in Cushing, Oklahoma. WTI is stored in massive facilities there before delivery into America's pipeline system.

Unfortunately, that complicates everything from hedging energy costs to investing in commodities.

Valero Energy (NYSE: VLO), the largest independent U.S. oil refiner, admits it "underestimated" the price spread between the WTI and Brent oil futures. Valero added that WTI has "almost become irrelevant as an oil benchmark."

Commodity index investors who bet $42 million on it also came out on bottom. While Brent rose 5.6% over the last month, the Texas blend declined 2.1%.

Cushing Oil Surplus

Cushing, Oklahoma is known as the "pipeline crossroads of the world." Yet it has no such thing to move oil beyond nearby refineries... only pipelines that bring it into town.

That has caused its oil inventories to rise to 38.3 million barrels. This glut will probably soon worsen when a new pipeline extension adds another 155,000 barrels a day from Canada.

Then there are the trains coming from the Bakken oil fields in North Dakota, each one carrying 72,000 barrels. North Dakota recently became the U.S.'s fourth-biggest oil producing state.

It hit a record 355,000 barrels of high quality, light crude oil a day in November... double that of 2008.

That increase forced oil companies to hire trains to move what they can't squeeze into pipelines. Drillers in North Dakota now use new technology - similar to that used in shale gas fields - to tap the oil-rich Bakken geological formation.

The bonanza boosted supplies in the region around Cushing to the highest level in three decades. It didn't matter that refinery demand for oil remained roughly steady.

A Pattern Reverse for Oil

Cushing might just be in store for decreased business before it knows it though. Some oil-filled trains are already beginning to bypass it for Gulf Coast destinations such as Saint James and Louisiana, where oil prices are higher.

Pipeline companies are also responding with projects on the drawing board to connect Cushing to Gulf Coast markets. But these projects will take time...

The International Energy Agency recently stated that, with "few relief valves" to cut the inventory overhang in Cushing, the gap between WTI and Brent "may persist for months [or years] to come."

In other words, any investors who want direct exposure to the true global crude prices should stick with Brent. More specifically, they should check out the United States Brent Oil Fund (NYSE: BNO).

The ETF is specifically designed to track the movements of Brent crude oil futures. As of now, it owns 133 of the April 2011 futures.

Good investing,

Tony D'Altorio

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