WGO – What’s going on in Brent-WTI? [updated]

Posted by Izabella Kaminskaon Jun 15 10:10.

First there was Cushing syndrome. Then there were Brent market antics. Now, nobody knows what’s going on in the Brent-WTI spread.

The difference between the two contracts has (once again) reached record levels. This time the spread  traded as wide as $21 per barrel. For now, however, most analysts remain stupefied as to the reason behind it.

One thing they do agree: it’s not down to Cushing Syndrome. Storage capacity at the Oklahoma delivery point is hardly full.

Olivier Jakob of Petromatrix wrote on Wednesday:

We have a new name for the Brent-WTI spread, we call it the WGO, and WGO stands for “What’s Going On?”. The first lazy answer to explain the recent surge in the Brent premium to WTI is to blame it on the Cushing glut. However if we did have a weakening of the WTI spreads earlier in the year which did explain then some of the Brent premium to WTI, the WTI spreads have been flat since March and in a contango which is far from extreme. The current premium of Brent to WTI cannot be explained by the WTI side of the equation.

A point which was echoed by Goldman Sachs on Tuesday (our emphasis):

The recent collapse of the WTI-Brent spread raises something of a puzzle in that the usual suspects, the logistical issues surrounding the WTI delivery point in Cushing, Oklahoma, are not to blame. It is true that the logistical issues at Cushing are responsible to a large extent for the wide discount of WTI to Brent this year. However, the recent June decline of $7.77/bbl has been primarily driven by the weakening of US Gulf Coast light-sweet crude oil prices relative to Brent crude oil prices, not a Cushing bottleneck.

Though the Goldman analysts did have a theory.

If anything, they said, the collapse in the spread (which is expressed as a negative figure) could be due to America’s other light sweet crude grade, Louisiana light sweet (LLS) — which can be shipped — being sought after abroad.

They came to the conclusion by looking at the LLS-Brent spread.

Since LLS and Brent are a similar quality, and both can be moved by tanker, the LLS-Brent spread is mainly a reflection of shipping costs. The recent collapse of the LLS-Brent differential to minus $5.45 per barrel — indicating a rare premium for Brent — suggests that the usual arbitrage (which sees light sweet crude head to the US) has been flipped.

Indeed, as the analysts noted: “the market is now directing light-sweet crude oil away from the US Gulf Coast and toward Europe and Asia.”

Which basically means the US is reducing imports of light sweet crude — a rare scenario in the market.

The dynamics are very evident when you look at the charts below. Note the stable relationship between WTI and LLS versus the shocking and sudden collapse of the LLS-Brent spread in June:

What’s even more interesting, however, is that the arbitrage flip is only apparent in the light-sweet crude market. Which means that while the US is reducing light sweet crude imports, it is still geared to encourage imports of more sour heavy crude types

Indeed, as Goldman noted:

First, the flipping of the transatlantic light-sweet crude oil arb is being driven by the relative weakness of LLS than the strength in Brent. The prices of light-sweet crude oils in Asia and Africa, have both mirrored the recent strength in Brent. Second, the flipping of the arb is a feature of only the light-sweet crude oil market. The pricing of sour crudes continues to direct sour crude oil to the US Gulf Coast, however, this needs to be watched as the Mars-Dubai spread turned negative on Monday.

All of which seemingly suggests that it is the Brent market’s strength which is once again driving the WTI-Brent spread widening.

Though not all agree.

In Olivier Jakob’s opinion, there are reasons not to believe it’s all down to the Brent market:

The second lazy answer to explain the record Brent premium to WTI is to blame it on extreme tightness in the European crude oil market. While it is true that the Forties supply stream has suffered from continued delays this is not new news and the timespreads in Brent have also been very stable since March. Brent is in backwardation but is a mirror image of the WTI contango and the Brent backwardation is not extreme and has not been significantly widening compared to the levels of recent months.

Jakob, for the record, doesn’t believe it’s anything to do with the Libyan conflict either — differentials for west African crude continue to weaken and are even trading at pre-Libyan revolt levels.

While still mystified, he does, however, see some possible influence from the commodity funds:

All of this makes it very difficult to provide a fundamental explanation for the blow up of the Brent premium to WTI by more than 6$/bbl during the period of the Goldman roll. We are not sure at all if there is a direct causality here, but we just observe that the Brent premium to WTI exploded during the roll of the indices. The rolls ended on Monday and Brent started to lose some of its premium to WTI on Tuesday. Is this the beginning of a reversal? Unfortunately we cannot be sure of that because we are not fully clear on the type of flows that were behind the surge these past few days.

For now, all we can do is wait and see how the situation plays out.

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