Guest Post: Explaining The WTI-Brent Spread Divergence

Tyler Durden's picture

Submitted by John Aziz of Azizonomics,

Something totally bizarre has happened in the last three years. Oil in America has become much, much cheaper than oil in Europe. Oil in America is now almost $30 cheaper than oil in Europe.

This graph is the elephant in the room:

3 year brent spread

And this graph shows how truly historic a move this has been:

brent-WTI-spread

Why?

The ostensible reason for this is oversupply in America. That’s right — American oil companies have supposedly been producing much, much more than they can sell:

This is hilarious if prices weren`t so damn high, but despite a robust export market for finished products, crude oil is backing up all the way to Cushing, Oklahoma, and is only going to get worse in 2013.

Now that Enterprise Products Partners LLP has let the cat out of the bag that less than a month after expanding the Seaway pipeline capacity to 400,000 barrels per day, The Jones Creek terminal has storage capacity of 2.6 million barrels, and it is basically maxed out in available storage.

But there’s something fishy about this explanation. I don’t know for sure about the underlying causality — and it is not impossible that the oil companies are acting incompetently — but are we really supposed to believe that today’s oil conglomerates in America are so bad at managing their supply chain that they will oversupply the market to such an extent that oil sells at a 25% discount on the price in Europe? Even at an expanded capacity, is it really so hard for oil producers to shut down the pipeline, and clear inventories until the price rises so that they are at least not haemorrhaging such a huge chunk of potential profit on every barrel of oil they are selling? I mean, that’s what corporations do (or at least, what they’re supposed to do) — they manage the supply chain to maximise profit.

To me, this huge disparity seems like funny business. What could possibly be making US oil producers behave so ridiculously, massively non-competitively?

The answer could be government intervention. Let’s not forget that the National Resource Defence Preparedness Order gives the President and the Department of Homeland Security the authority to:

(c)  be prepared, in the event of a potential threat to the security of the United States, to take actions necessary to ensure the availability of adequate resources and production capability, including services and critical technology, for national defense requirements;

(d)  improve the efficiency and responsiveness of the domestic industrial base to support national defense requirements; and

(e)  foster cooperation between the defense and commercial sectors for research and development and for acquisition of materials, services, components, and equipment to enhance industrial base efficiency and responsiveness.

And the ability to:

(e)  The Secretary of each resource department, when necessary, shall make the finding required under section 101(b) of the Act, 50 U.S.C. App. 2071(b).  This finding shall be submitted for the President’s approval through the Assistant to the President and National Security Advisor and the Assistant to the President for Homeland Security and Counterterrorism.  Upon such approval, the Secretary of the resource department that made the finding may use the authority of section 101(a) of the Act, 50 U.S.C. App. 2071(a), to control the general distribution of any material (including applicable services) in the civilian market.

My intuition is that it is possible that oil companies may have been advised (or ordered) under the NDRP (or under the 1950 Defense Production Act) to keep some slack in the supply chain in case of a war, or other national or global emergency. This would provide a capacity buffer in addition to the Strategic Petroleum Reserve.

If that’s the case, the question we need to ask is what does the US government know that other governments don’t? Is this just a prudent measure to reduce the danger of a resource or energy shock, or does the US government have some specific information of a specific threat?

The other possible explanation, of course, is ridiculous incompetence on the part of US oil producers. Which, I suppose, is almost believable in the wake of Deepwater Horizon…

 

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ziggy59's picture

So, The oil market is broken too?

Spider's picture

May just be anti-inflationary oil price manipulation to keep the price of oil cheaper via derivatives.  Thus keeping inflation at bay for a while - but you cant do it to the worldwide market so the focus is just on the US market - but my guess is no better than yours...

Buckaroo Banzai's picture

How about: oil and gas is one of the few markets that still attracts capital in this stupid ZIRP environment. Because it's the most fundamental building block of the North American economy, and besides food it's right at the bottom of the Hierarchy of Needs. There's a shit-ton of money that needs to get put to work, the stock market is at all-time highs, and the gold market has a fucking boot on its neck. Where else you gonna go?

Dear Infinity's picture

Look at this post from back in June: http://comparesilverprices.com/metals/death-of-purchasing-power-usa-gas-... the graphic is telling -- this is pure DEATH of purchasing power, being lauded as a normal market dislocation, but the truth is much more insidious.  

LawsofPhysics's picture

Indeed, I'll only add that isn't there still quite a bit of oil under American Soil?  Yes I realize that internation companies must go get it, but someone still has to sell them the lease or allow access. How much oil under that sovereign E.U.soil again?

EscapeKey's picture

Oil trading is so manipulated it's commonly referred to as "the asylum".

imapopulistnow's picture

This conspiracy post is absurd. 

Why is WTI priced below international? 

Because someone figured out how to pump oil out of tight sands in North Dakota and Texas, resulting in 1.3 million barrels a day more than thought possible just 3 years ago - and growing at a rate of nearly 1mbd additional each year.

Because it takes multiple years to add new pipelines due to environmental studies, NIMBY law suits, permit delays, eminent domain proceedings and construction times.

Because pipelines are further delayed by politics.

Because railroads are hestitant to load up with too many tank cars knowing that lower cost pipelines will eventually be built.

Author needs to give this one up.  Go back to your grassy knoll/truther/birther theories.

imapopulistnow's picture

I'll add, if this conspiracy theory is true, then Canada must be "all in" as their oil sells for $26 a barrel less than WTI.

http://www.cmegroup.com/trading/energy/crude-oil/western-canadian-select...

Nice compliant and docile folks those Canukers...

Truth is the pipelines that they planned to ship their oil south are either loaded with North Dakota crude or delayed by 4 years and likely will never be built (Keystone)

imapopulistnow's picture

Similarly, the energy sources that will renew the industrial base (Allah and Obama willing) are natural gas and natural gas liquids.  Once again, the technology of extraction changed so rapidly that the stuff is being over-produced. 

Recall 5 years ago, the big oils were seeking permits for LNG import terminals due to an NG shortage.  Today they are seeking permits to convert these facilities into LNG export terminals - a process that takes about 10 years to accomplish.

But the excellent news is that the USA will be a low-cost producer of NG/NGLs for decades and those industries that rely on NG/NGL either as a feedstock and or energy source will re-shore and flourish.  Think plastics, fertilizer, iron and steel, metal forming and refining.  Heck even bakers benefits (just not enough to save the Twinkee though)

Matt's picture

Very little oil is actually WTI anymore. It is an index.

The low-grade oil that comes from Bakken and Tar Sands are discounted because they are lower quality.

Canadian Tar Sands are discounted further due to some wierd rules in NAFTA.

Different oil needs different refineries. Obama blocked a big part of Keystone XL, which is having it's route moved away from a bunch of sandy, erosion-sensitive land over top of a large aquifer.

This is a big part of the backlog. Also, demand may be collapsing due to the fact that, contrary to what they say, there is no recovery. Unemloyed people don't need to drive as much. Less shipping and freight means less fuel burning.

Why are the oil companies producing if there is such a congestion? I bet similarly to shale gas, they are producing on credit and need cash flow to service their debt.

Also, Brent is likely higher due to actual issues involving acquiring Brent, refining, etc. That is to sya, this is not just an issue of cheap WTI, but also of expensive Brent.

Just Ice's picture

Bakken oil is primo light sweet (excellent quality, not "low-grade" as implied by your post).  WTIC is not "cheap" at 97-98/bbl (where it's currently trading in front months).

Matt's picture

So, you feel that the price spread between WTI and Brent is purely due to Brent being expensive?

You are correct, I  was wrong about the quality of Bakken oil, I was under the impression it was a lower grade, heavy oil. Thanks for the correction. 

Just Ice's picture

I don't trade Brent so don't give much thought to it.  In general, geopolitical vagaries suggest a ~10-20 premium for Brent (high end of that range, obviously whenever traders are pounding the tension drums wrt threats of war in mideast...a tiresome yet unending meme through the years despite lack of serious supply disruptions during a myriad of conflicts in the area).  I would place "fair value" of Brent at 90-100/bbl and wtic @ 70-80/bbl.  While some marginal wells in the Bakken need 80-90/bbl crude to break even, the majority mint $ with it selling in 70's.  Saudi is fine with Brent at $90 (not because their cost of production requires that but rather their political promises to mollify the people do).  Recall in 2006, height of housing boom with things humming along here in US, wtic was trading in 60's.  Since then, production's increased and demand's plummetted.

Technically, some traders are looking at 90-100 range in wtic thus currently trading near top of range...others have 90/93 to 97/100 inside/outside range, same effect...others have market in a bull trend period so long as >95 and looking for continued upside.  Personally, I'm looking at this being top of range and an eventual break of range to downside to resume trend it was in before interrupted last summer, (Draghi's "big bazooka" promise that sent all risk-on trades bounding north).  I am currently short from mid-97's (Apr contract) and hopeful hourly chart morphs into a nice M-top here.

Technical Difficulty's picture

I'm fairly certain that the answer is because US oil companies need to meet revenue targets. Demand is flat or down, yet there is still expectations to increase revenue. The (short term) solution is to sell more barrels which get stockpiled, which influences the price, (although not as much as you think. Ever watch the market after inventories are released?) which causes them to have to sell more barrels, etc etc. CEO will be long gone by the time it's an issue. Inflation is on their side, however, and keeps the game going.

beachdude's picture

Bonzai, Ignore the boot on your neck or simply don't consider it as such, and use this as time on your side... an extended buying opportunity.

max2205's picture

Tanker rates are so cheap...sell it to the EU!?

Remember when JPM had half the worlds oil supply on tankers floating around....guess they sold that huh.....

Matt's picture

1. pipeline congestion

2. different refineries for different oil

RockyRacoon's picture

(d)  improve the efficiency and responsiveness of the domestic industrial base ...

If they could do this, they woulda already done it.  Ergo: they can't.

Buckaroo Banzai's picture

WHAT "domestic industrial base"???

Encroaching Darkness's picture

The idea that a government composed of the likes of Menendez, Reid, Obama, Biden, Napolitano, Sibelius, Geithner, Holder et. al. being able to "improve" anything, anywhere, at all, is the reason it's all going to hell in a handbasket now.

The fact that legislation was written, passed and is being implemented based on such a laughable premise is proof that Satan has a sense of humor. You just have to look for it.

Tijuana Donkey Show's picture

No, it's always been "fixed." 

Au_Ag_CuPbCu's picture

I really need to get off this centrally planned, manipulated planet!

11b40's picture

Maybe the better choice of words is corrupted instead of broken.  After all, it is the digital age.

akarc's picture

Maybe not so much. I would have to look up the link from awhile back, but I seem to remember that the military is not so convinced that peak oil has not arrived.  Both the Navy (most especially the Navy) and the Air Force have put a great deal of energy (excuse the pun) into investigating alternative fuels.

Remember many fracked oil wells decline fairly rapidly and the cost of getting the oil that is there has increased.  Yeah we have a hell of a surplus at the moment. But then we are in a major global economic, recession, depression, whatever they want to call it now days.

What happens to all that backed up oil if all of a sudden, real growth kicks in. Yeah I know, prob not in my future, but still..............

Or maybe a war??? Oh no, were pulling out of Afghanistan and h ave learned our lesson.

 

TwoHoot's picture

Anyone that ignorant about the US oil business shouldn't be allowed to write about it.

RockyRacoon's picture

His daddy used to work at a service station, so he's a frickin' genius. 

TwoHoot's picture

Logistics and infrastructure.

Vashta Nerada's picture

The reason WTI is so much cheaper than Brent is because of logistics.  It is easier and cheaper to put Brent on the East Coast than WTI.  Thank you, Feds and EPA.

Imminent Crucible's picture

The US government might be forcing a stockpiling of oil because they're planning to involve us in a big war? Preposterous. This nation doesn't like wars, we even elected a Nobel Peace Price Winner to manage the four wars we had going during the election.

And let me say he's doing a hell of a job. Added a couple, even.

Aziz should be ashamed of himself. Never trust a guy whose name can be pronounced by opening a pop bottle slowly.

DaveyJones's picture

...and oil and war have never been connected

and the petrodollar is a hoax

and torture is designed (and proven) to bring out the truth

theprofromdover's picture

I thought Obammo said stockpile at Cushing and if the speculators start messiing around with the oil price (like they did in 08/09) dump it on the open market. There was no reason for a divergence in price between sweet Texas crude & Brent. Only good intervention he ever did.

 

Janice's picture

Oh, I'd love a glazed donut right about now.

falak pema's picture

the spare nut! I think she deserves it! Where is Lance's canadian alias?

On WTI/Brent  spread we need the Flak to shyster this thread with his meistery.

apberusdisvet's picture

The answer could be the onset of martial law; lots of gas needed to transport millions to the FEMA (extermination?) camps

Ident 7777 economy's picture

 

 

 

FAT CHANCE Pilgrim; who is going to provide the entertainment, sow the seeds for wheat production, plow the G D roads when it snows for TPTB ...

 

THAT'S the big problem with STUPID conspiracy theories like that - too many functions (think PLUMBING and who OPERATES THE SEWAGE PLANT) are performed by the AVERAGE PERSON who would also end up in your fantasy FEMA camp ... and TPTB would have to do their own PLUMBING and SEWAGE PLANT operating.

 

CLEARLY, you have not thought this through.

 

 

 

 

 

 

tickhound's picture

In one of my doomer thought experiments they let the really really good little bitches do the sewage work.

semperfi's picture

Why? A: because our guys in the U.S. are better at manipulation, deception, price-rigging, price-controls, etc - you know, corruption !

pcrs's picture

if they are not selling it for more in the foreign markets, they must be banned from doing so or heavily taxed.

ParkAveFlasher's picture

And yet, gasoline is at all time highs. 

Hubbs's picture

Gas at all time highs for this time of year which in theory would contribute to increase cost of doing business and therefore putting a damper on business expansion...but but but I thought government was trying to stimulate business. So is the fear of inadequate petrol to run the military machines now greater than the fear of driving up business costs /worsening the recession?

espirit's picture

...cause they can.

There, fixed it.

caShOnlY's picture

(d)  improve the efficiency and responsiveness of the domestic industrial base to support national defense requirements...

"improve the efficiency" .. ????

Oxy moron = Government and efficiency.  

The most uneffecient, wasteful entity on the planet is going to govern effeciency in the private sector?  fUkmE. 

 

Canadian Dirtlump's picture

I can tell you that being a business manager of a pipeline company, the oil companies here have all been told by the department of doo doo to keep a bunch of shut in production for the advent of an as yet unnamed cataclysm. I would think that companies in the US havebeen told the same.

 

Translation - prices are still so high that everyone has massive programs going. Short of a price crash (which in theory COULD happen but is as likely as me growing a 4th ball) it ain't gonna stop.