Global oil-price benchmarks are not

foolproof
By Javier Blas

Published: August 17 2010 17:01 | Last updated:

More than one flavour: hundreds of different types

of crude are traded globally
August 17 2010 17:01

What is the oil price? For years, the answer has been
provided by one of the two leading global
benchmarks – Europe’s Brent or US-based West
Texas Intermediate (WTI).

Investors usually track both of these yardsticks and

pour money into Brent and WTI futures. However,
in spite of their popularity, they represent only a
fraction of the hundreds of different types of crude
traded globally on the physical and financial oil
market.

The International Crude Oil Market Handbook, a

traders’ bible, lists almost 200 types of crude, from
Kutubu of Papua New Guinea to Caño Limón of Colombia.

For most investors, the long list of crude streams is just a collection of exotic names that are
of little use beyond the murky world of oil traders and refinery executives. But some are now
slowly discovering that WTI and Brent, in spite of the fact they are likely to reign for years as
the main benchmarks, also have their problems. And in commodities, problems usually mean
less money.

The main issue is that both of these types of crude are closely tied to the supply-and-demand
conditions of the regions where they are produced and stored: Texas and Oklahoma in the US
for WTI, and the North Sea for Brent. An additional challenge for WTI is that its source area
is landlocked, which makes it more complicated to transport to global markets.

WTI forms the basis for the light, sweet futures contract traded on the New York Mercantile
Exchange (Nymex), the most popular oil future. But as institutions from the International
Energy Agency to Opec nations, including Saudi Arabia, have noted, from time to time it
disconnects from the global market.
The US Energy Department, for example, says the US oil benchmark “does not always
exactly follow the broader oil market”, adding in a report published in June this year, Keep an
Eye on More than WTI, that “temporary discontinuities in WTI relative to the prices of other
crude oils occur occasionally”. These discontinuities could lead to prices showing smaller
increases than those of other benchmarks, or to prices falling faster, as happened in 2008.

“Typically, different crude benchmark prices tend to move in the same direction, even during
short-term price swings. But recently, WTI has exhibited larger swings than other crudes,”
says the Energy Information Administration, the department’s analytical arm.

Traders, bankers and analysts have attributed the exaggerated decline and subsequent increase
in WTI prices to localised supply conditions at the pipeline hub of Cushing, Oklahoma, the
delivery point for the Nymex WTI contract.

“Storage at Cushing is inaccessible by tanker or barge, and few outflowing pipelines exist.
Hence, excess crude oil can be slow to dissipate once a glut develops,” the EIA says.

It was precisely because of erratic price movements in WTI due to storage challenges in
Cushing that Saudi Arabia decided last year to drop the US benchmark as its reference for
sales in the US for the first time since 1994, replacing it with a basket of crudes from the US
Gulf of Mexico.

Traditionally, Brent trades at a discount of $2 a barrel to WTI, but since 2007 it has traded
briefly at a premium of up to $10 a barrel due to problems with WTI.

Brent is not foolproof, however. From time to time, the North Sea blend of different crudes –
in reality, Brent nowadays is a mix of Brent proper, Forties, Oseberg and Ekofisk – also
detaches itself from global oil market trends. This is a significant complication, as Brent is the
base of the ICE Brent futures contract.

The price discontinuities usually occur during the North Sea oil fields’ traditional summer
maintenance period, which reduce supply sharply, tightening Brent even if the oil market
supplies are loose. Brent prices on those occasions can move well above comparable crude
streams. The problems are exacerbated when unplanned outages coincide with the seasonal
maintenance. That was the case in July and August this year, when Brent prices moved
sharply higher while other crude-oil benchmarks were showing signs of weakness.

For both Brent and WTI, the complexity of physical production and storage means market
participants such as oil companies and big trading houses are at a significant advantage to
investors. An oil company, for example, would know of an outage in the North Sea that would
cut supplies earlier than investors such as pension or hedge funds. In Cushing, physical
traders would know the level of stocks well ahead of other financial participants, allowing
them to sell or buy ahead of others.

Trading of the Nymex WTI and ICE Brent futures contract has remained brisk over the years,
with volumes near record levels. But these ongoing challenges and analysts’ concerns are a
reminder to investors that crude-oil trading is far more complex than the fate of two isolated
benchmarks – even if they are the most popular ones.