Brent crude oil versus West Texas Intermediate (WTI) is the spread to keep tabs on at the moment. The spread is a distillation of the complexities of the Opec/US shale rivalry with the energy blocs’ strategies to gain market share boiled down to two headline numbers: BCO and WTI.
The dynamics between these two benchmarks track the fortunes of oil supplied from the US fields compared with the European fields. With the US administration currently in a protectionist frame of mind, the domestic oil industry has a lot of political backing and incentive to expand production levels. Perhaps more important than even the political will is the lifting of the ban on US oil exports in 2015 to 2016. As a result, US oil exports are on the rise, and so is demand for WTI crude.
WTI ran at a lower value than Brent for several reasons. Foremost was the ban on US crude exports matched with an emergent shale oil industry. This led to a glut of oil within the US and higher demand for oil sourced in other areas, like the North Sea. Before 2015, the spread was so wide it often ran into double digits. In December 2013, it hit a peak of $16.30 per barrel. Contrast that with recent developments and even the news that US oil production has hit the 10 million barrels per day mark failed to significantly widen the Brent-WTI spread. In the final week of last month, it fell to $2.77 per barrel, compared to a peak of $6.24 in the first week of January.
Brent and WTI come closer to convergence the more the US exports oil to global markets. What this means for Opec is that its supply-cut policy doesn’t cover all the bases because US exports are not under its control. Opec is left with some options and the law of diminishing returns; the markets have priced in the cartel’s supply-cut policy and it now appears to have short legs, given US shale’s sprint forward.
One option is to deepen supply cuts, which would possibly boomerang because the US domestic market would have another opportunity to fill the gap with product. Supply-cut extensions may have the same effect without the expected drawdown in crude oil by the end of this year. Opec has realised the extent of US oil production but appears uncertain as to what to do next. It is a classic Catch 22, do nothing and the oil price may plummet again because of a potential glut; make more cuts and US shale has an open invitation to sell to Opec’s customers.
While Opec may be satisfied that it has reached its target price of around $65, it didn’t bargain on the boost that supply cuts had on the US oil industry. Should Brent be overtaken by WTI, US oil could end up leading the key benchmarks, with Brent playing second fiddle.
Looking ahead into the second quarter, the Brent-WTI spread is also the one to watch for clues to market sentiment. It’s a two-horse race with Brent still in the lead but looking over its shoulder at WTI bearing down at speed. Should WTI pull ahead, we may expect Opec to mull new measures to check US shale and keep some measure of control over the benchmarks. Without a significant development like that, the benchmarks spreads will likely continue to tighten and prices may stay range-bound between $60 and $70 per barrel.
Hussein Sayed is the chief market strategist at FXTM