THE BRENT/WTI SPREAD The price differential between the two most widely traded crude oil benchmarks is a critical location and quality spread. Over the last decade, significant events have increased the volatility of the Brent/WTI spread.

“A century ago, petroleum – what we call oil – was just an obscure commodity; today it is almost as vital to human existence as water”. It would be difficult to describe the importance of oil in the global economy, better than the Scottish novelist James Buchan does.

Most of the time, when people talk about oil, they are making reference to crude oil. Crude oil is defined as an unprocessed petroleum product – or, in other words, oil in its raw and natural form. Once extracted, crude oil needs to be refined to produce usable petroleum products for industry and consumers such as gasoline, heating oils, jet fuel and diesel. Crude oil is a mixture of hydrocarbons that exist as a liquid in underground geological formations. However, crude oil itself is not really useful. The various components of crude oil have different chemical characteristics and therefore need to be separated. As they’ve got different boiling temperatures, this can be achieved through a process called fractional distillation.

Although more than 100 crude oil benchmarks are available in the world, Brent and West Texas Intermediate - better known as WTI - are the two main benchmarks used for crude oil pricing.

Originally Brent referred to oil extracted from the Brent oilfield located in the North Sea between Scotland and Norway. When it was discovered by BP in the 70’s, the naming standards for the UK oil industry were to choose a name of a bird in order of development. As the Brent oilfield was the second developed, it was named after a bird than began with the second letter of the alphabet: the brent goose. However, as production began to decline, Brent started to be exposed to potential price squeezes. To mitigate market manipulation and increase the number of cargoes available, the industry has been adding alternative grades of oil that can be delivered in the case of Brent not being available at its market value. In 1990, Brent crude was combined with Ninian crude, creating the Brent blend. Between 2002 and 2007, three additional North Sea oilfields - Forties, Oseberg and Ekofisk – were added to Brent to create the BFOE. More recently, Platts announced that cargoes of Norway’s Troll crude oil will be included in its Brent price assessment.

Once extracted, Brent is transported to a floating vessel called a Floating Production Storage & Offloading where it can be stored and produced. The oil can then be offloaded directly onto oil tankers and transported across the world by sea. The oil can also be transported to an onshore oil terminal and then sent to refineries by pipeline. Brent crude is produced near the sea making transportation costs lower than WTI which is produced in landlocked areas primarily in Texas, Louisiana and North Dakota.

Once extracted from the ground, WTI is transported via pipeline to Cushing, Oklahoma which is one of the largest oil hubs in the world. The oil can then be stored or sent to refineries by pipelines mostly in the gulf coast region where it will be refined before being transported up to the end-user. WTI is used as regional benchmark for North America while Brent – which is easier and cheaper to transport to distant locations – is considered as a global benchmark. Brent is used as a pricing benchmark for about two thirds of the crude oils contract around the word.

Crude oil prices vary depending on a number of factors, one of which is quality. When we talk about quality for crude oil, we refer to how easy and cost- effective it is to refine it into petroleum products such as gasoline or diesel. Sulfur content is the main indicator of quality for crude oil. Any crude oil with a sulfur content below 0.5% would be considered as “sweet” while crude oil with higher sulfur content are referred as “sour”. Sour crude oils generally required more work as they contains more impurities that need to be remove before being refined. As a result, most sour crude oil generally trades at a discount to sweet crude oil.

6 | ADMISI - The Ghost In The Machine | July/August 2019

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