In the last few months, Brent Crude and WTI Crude have rallied sharply in global oil markets. One only needs to look at the chart below to understand the extent of the rally.
In the Bloomberg Chart, CO1:COM (Brent Crude) rallied 44.17% and CL1:COM (WTI Crude) rallied 49.86% since Jan-21. That makes oil one of the best commodity classes in terms of 2021 returns. We will not get into why crude is up, which is well documented. We focus on understanding the difference between WTI Crude and Brent Crude and the indications that they give you. Here are 8 questions you always wanted to ask.
1) What is the essential difference between Brent Crude and WTI Crude?
Brent Crude and WTI Crude are the two largest trading classifications of crude oil. While there are many more such oil classifications, Brent and WTI are the global benchmarks. Brent is oil that is drilled out of the North Sea adjoining the UK and Norway while WTI Crude is extracted in the US. Predominantly, US oil is concentrated in Texas, North Dakota and New Mexico. The US uses West Texas Intermediate (WTI) as the benchmark.
2) Is Brent more popular among oil traders or WTI Crude?
It is estimated that nearly 60% of all crude in the world is priced in terms of Brent Crude, with only the US and Canadian oil being priced in WTI crude. The reason Brent is more popular as an oil benchmark is that it is a more efficient representative of oil prices. While Brent oil wells are in the sea, WTI oil wells are landlocked. US oil has to be moved by rail, so the pricing of WTI becomes relatively inefficient compared to Brent. Since Brent Crude is largely sent via sea, it is more economical and better reflects oil prices.
3) How is light crude oil different from heavy crude oil?
The classification of crude as light or heavy is based on the density of oil. The standard is the API gravity stipulated by the American Petroleum Institute. API gravity ranges from 10-70 and higher API gravity means lighter crude. Light crude has low density and floats in water while heavy crude has higher density and sinks in water. WTI crude is considered relatedly lighter compared to Brent Crude which his heavier. Typically, light crude is suited for gasoline while heavy crude is suitable for diesel.
4) What is the difference between sweet crude and sour crude?
Another popular classification of crude is sweet versus sour crude. That is based on sulphur content. Oil with low sulphur content is considered sweeter while oil with higher sulphur content is considered sour. For sulphur content, the benchmark is 0.5%. Lower than 0.5% sulphur content is considered sweet crude and higher than 0.5% is sour crude. Sweet crude is more suited to premium petroleum products. The crude classification normally ranges from Heavy Sour Crude to Light Sweet Crude. Brent Crude is sour and heavier while WTI crude is sweeter and lighter.
5) Why is Brent more popular among traders than WTI Crude?
The reason 60% of the trade is concentrated in Brent is that the pricing of Brent is more efficient as all the Brent oil extraction rigs are located in the sea and hence transport by sea becomes easier and more economical. Brent reflects core price of oil better than WTI Crude.
6) Where doe Brent Crude and WTI Crude trade?
While WTI Crude trades on the NYMEX, Brent Crude is heavily traded in ICE Futures, London. Most crude trades globally are benchmarked either to WTI Crude or to Brent Crude. The second difference is that WTI crude trades for mandatory delivery and hence there are storage and transport issues involved in determining the price. In case of Brent, trades are cash settled on ICE. In India, MCX benchmarks its crude settlement to NYMEX WTI Crude.
7) Why is WTI Crude at a discount to Brent Crude?
Till 2011, Brent and WTI crude were almost at par. Post 2011, the US started becoming a major player in oil. The higher transport costs entailed in WTI Crude pegged it at a discount to the Brent Crude. However, this discount keeps changing. For example, since the start of 2021, the spread between WTI Crude and Brent has substantially narrowed, which explains why returns on WTI Crude are better than Brent in 2021.
8) Why did WTI crude become negative in April 2020, while Brent remained in positive?
In April 2020, the price of WTI Crude touched $(-37/bbl). WTI crude was actually in the negative. That is because WTI crude contracts are for mandatory delivery. In the midst of the pandemic, refiners did not have storage capacity, pipelines were full and there was no storage space in Cushing, Oklahoma. Hence long traders not wanting to take delivery of oil just dumped contracts even at negative price. Since Brent is cash settled, it did not face that problem.