Energy independence and the WTI/Brent spread

By Jack Malone

America is in the midst of an energy revolution. Crude oil production is up over 40% since the start of 2012 and is currently at levels not seen since May of 1988. The surge continues and is not expected to stop any time soon with North Dakota and Texas leading the way. In fact, if Texas was its own country, it would rank as the 10th largest producer of energy based off of international oil production in October. In mid-2009, Texas was producing less than 20% of America’s domestic crude oil. In January of this year, this figure hit a new record high of 36.2%. A telling chart going around is the weekly U.S. crude oil production chart which shows highs last seen in 1988. The WTI (West Texas Intermediate) vs. Brent spread is an interesting relationship that energy traders have been looking at over the past couple of weeks. Theoretically, the two crude oils share similar qualities and should price very closely to each other. By pure make-up of the products WTI should have a slight premium to Brent. The spread between WTI and Brent crude represents the difference between the two crude benchmarks. WTI typically represents the price oil producers receive in the U.S. whereas Brent reflects prices received internationally. The recent production surge in the U.S. has caused a build-up of crude oil inventories at Cushing, Oklahoma, where WTI is priced. This created a supply and demand imbalance at the hub, causing WTI to trade lower compared with Brent. The above graph shows the WTI-Brent spread from 2009 onwards. Note that when the spread moves wider, it generally means U.S. crude oil producers receive less money for their oil compared with their counterparts that are producing internationally. Libya is close to re-opening four ports that were seized by rebels which will add supplies to Brent. We have recently gone over a support level of -$3.56 and based on this, I am looking for more upside coming. The energy revolution in the United States has created two distinct positives. The first being that U.S. refineries now have access to cheaper crude oil than their overseas competitors, which provides them with highly attractive margins. Secondly, it has insulated the domestic oil market from disruptive geopolitical events like the situation in the Ukraine, to a certain extent. As the United States continues to export refined products, there will be an upside pressure on the WTI vs. Brent spread. Overall, the increased production of U.S. crude has created and will continue to create new jobs and opportunities for U.S. businesses. This should also constitute an important economic trigger: for the first time in a long time, we have money coming in from the energy sector instead of it getting spent on energy imports. North Dakota has the nation’s lowest unemployment rate at less than 3%. The reason for this is the fast growing hydraulic fracking industry. And if projections for increases in Texas oil output are correct, the state could soon surpass Kuwait, the UAE, Iraq, Iran and even Canada to move up in the international oil production rankings and become the world’s fifth largest oil producer. Will we see the WTI vs. Brent spread get back to zero? I would like to think so but only time will tell.

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