Brent Oil Cheapens, the Plot Thickens


"Monday's market action kicked the WTI roll back to half of its July peak. . ."

Last week, the oil market turned around for a lot of traders. A larger-than-expected drawdown in U.S. crude stocks sent prices for West Texas Intermediate [WTI) oil soaring Wednesday. The oil off-take set the stage for another turnaround as well.

After a month of inversion, WTI's market price started to claw back in earnest from its discount to North Sea Brent crude. And finally, on Monday, WTI changed hands at a premium to the European benchmark.

Both Brent and WTI are classified as light, sweet crudes, but WTI is just a little lighter (less viscous by a couple of gravity degrees) and a little sweeter (less sulfurous by a percentage point or so) than the North Sea oil. That makes WTI easier to refine into gasoline and accounts for its typical premium over Brent. Since 1987, WTI has, on average, traded at a barrel cost $1.44 higher than Brent.

Historically, the market self-corrects from short-term supply/demand imbalances. From time to time, when Brent slips into premium, U.S. refiners begin processing cheaper WTI and less Brent. Demand for Brent thus declines while WTI demand rises, all of which puts downward pressure on Brent prices relative to WTI.

This summer, the price inversion lasted a month, as refiners, facing weak U.S. fuel demand, were simply putting crude into storage rather than processing it.

The three-month roll in WTI futures was worth as much as $4.64 a barrel at the end of July, offering a 15.6% annualized return for a cash-and-carry operation. That was a far better return than could be earned from cracking crude.

Monday's market action kicked the WTI roll back to half of its July peak, knocking out the carry trade and pushing prices above the Brent benchmark.

Contango's still here. The WTI market's natural affinity for backwardation hasn't yet manifested itself this year and it's anyone's guess whether it will. Until it does, you can't say we've fully recovered from the demand destruction wrought last year.

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