For the first time in nearly three years, major benchmark crude oils resumed some normalcy in their pricing, as those of the American West Texas Intermediate (WTI) and the North Sea Brent converged towards their historic relationship.

In fact, WTI posted higher prices in the futures market on July 19 at just above $108 while Brent settled lower. Strong demand in the US among other factors brought about this change.

Historically, WTI being the better crude with respect to both API gravity and sulphur content trades at a premium of $1 to $2 a barrel over Brent. The short periods where Brent posted higher prices were either attributed to strong demand in the US or a temporary reduction in North Sea production or both.

The two crude oils are the major price benchmarks. The dissociation between their pricing relationship started in 2007 as the premium shifted gradually in favour of Brent over WTI and in early 2009, WTI traded at a $10 a barrel discount to Brent. Some producers, including Saudi Arabia, stopped using WTI in pricing their oil sold to the US.

Differential

The differential between WTI and Brent reached almost $28 a barrel in October 2011 and the former became what was described as a “broken benchmark”. Even the US government used other domestic crude as a reference to price its sales from its strategic reserves.

What caused the anomaly is that the storage capacity at Cushing, Oklahoma — the pricing point for WTI — was limited and the same situation applied to the pipeline capacity out of Cushing to the refineries. Coupled with a reduction in demand in the US, there was no way for landlocked WTI except to lose ground on the price. Of course refiners were happy as they bought cheap crude and sold the products at prices approaching the international.

But work was going on to correct this where as recently as February 2013, Brent traded at a $23 premium to WTI but later started falling noticeably. Increased pipeline capacity from Cushing to the US Gulf refineries came on stream and eased the downward pressure on the price at a time when Brent lost some ground as a result of stagnant, or falling, demand in Europe as well as reduced deliveries to the US east coast due to the rise in light shale oil production and its delivery by rail to these refineries.

The 670-mile Seaway Pipeline delivering crude from the US Gulf to Cushing has been reversed to ship oil southward to the Gulf refineries at the rate of 1.2 million barrels a day. At the same time, the Gulf Coast Pipeline Project, a 485-mile pipeline with a capacity of 830,000 barrels a day, is expected to be operational by the end of 2013 and will connect Cushing to the Texas refineries.

Railway deliveries from the fields are bypassing Cushing directly to the refineries and easing the storage in Cushing.

The storage capacity at Cushing also witnessed a significant increase from about 55 million barrels in late 2010 to about 75 million barrels in mid-2012. Stocks at Cushing have fallen to 46 million barrels currently from 52 million in January amid a general fall of US stocks.

The premium of WTI was short-lived and Brent traded at a premium of $2.7 a barrel on July 25. This brought on the question as to whether the spread will widen again. To start with, earlier forecasts were for the spread to narrow but no one expected it to fall to such low levels.

Era of the US discount ending

Some analysts are of the opinion that “the era of the US discount was ending”. Phil Flynn, of Price Futures Group in Chicago, has said: “I think the trend is going to continue because the quality of US crude is high, and it’s coming from a country that’s a major user of oil with an economy that’s doing better than the alternatives right now.”

In early July, economists at Capital Economics expected the spread to “disappear completely.”

Other analysts say that although inventories at Cushing are at their lowest level this year, they are at their highest in five years and therefore further increase of US production may pressure WTI price again.

Therefore, the infrastructure of pipelines and rail deliveries has to improve further. In its June 2013 Short-Term Energy Outlook, the Energy Information Administration (EIA) “forecast the Brent-WTI price spread to average $11/b in 2013 and decline to an average $8/b in 2014.”

In selecting a marker to price their oil, producers may have to wait longer before a definitive trend in differentials takes hold.

— The writer is former head of the Energy Studies Department at the Opec Secretariat in Vienna.