As US Crude Production Rises, The WTI Benchmark Becomes Less Relevant

The US Department of Energy reported a large drop in crude oil stocks last week. As expected, a great deal of that decline was driven by a drop in crude imports - a trend that has been ongoing for some time now (see discussion). The chart below compares 2012 US imports with that in 2011.

And in spite of that drop in inventory, the US crude oil market is extremely well supplied for this time of the year.

As crude oil supplies stay at unusually high levels due to domestic production, the US oil market is becoming more decoupled from the global energy markets. One can see this effect in the persistently elevated Brent-WTI spread (see discussion).

A year ago it was believed that as the Seaway Pipeline begins moving crude from Cushing Oklahoma to the Gulf of Mexico (with the flow's direction now reversed), the price of the two crude oil markets should converge (Brent and WTI represent the same type of crude, just delivered to different locations). That has not occurred, and the Brent-WTI spread remains in the $20/barrel range.

With US imports declining, the US crude is increasingly viewed by oil traders as less representative of the global oil market. Commodity indices and asset allocators are rebalancing out of WTI and into Brent (see discussion). The best evidence of this effect can be seen in the futures trading volumes. For the first time in history, more Brent than WTI futures have been traded during 2012.

EIA: One of the many effects of the well-documented disconnect between the prices of Brent and West Texas Intermediate (WTI) crude oils has been the increase in trading volume for Brent futures. In 2012, for the first time, more Brent futures contracts traded on the Intercontinental Exchange for the year as a whole than WTI futures contracts traded on the New York Mercantile Exchange.

Going forward Brent will continue to dominate as the global benchmark for crude oil (which is unfortunate for our friends at the CME). U.S now pumps oil at the fastest rate in nearly two decades (using horizontal drilling and fracking), making the nation less vulnerable to price shocks. Even compared to 2011, the contrast in production levels is quite impressive.

At the same time, markets in Europe and Asia are still constantly at risk of supply disruptions due to geopolitical risks. And anyone trying to hedge against these risks will increasingly employ Brent (instead of WTI) futures, options, and swaps.