The Brent-WTI spread reached a record level last week, defying predictions that the gap would continue to close. But this isn’t the retro spread of the last couple of years.
When Brent-WTI was at its earlier record wides, the spread between Brent and Gulf Coast crude prices (e.g., LLS) was not that anomalous. Instead, WTI was at a huge discount to LLS. This reflected a bottleneck in getting crude from the Midcontinent to the Gulf.
Now that bottleneck is largely eliminated: LLS is only at a $4 premium to WTI, which is pretty close to marginal transportation costs. The current price structure is that the LLS-WTI spread has normalized, but the LLS-Brent spread has cratered.
So where’s the bottleneck now? Part of it is legal: it is impossible to export crude from the US, except in a limited way to Canada. It is possible to export products, and US refined product exports are at all time highs, nearly 3 times larger than the level of only 8 years ago. (Interestingly, US product exports started their upward trend in 2005, well before the splurge in US oil production.) However, refinery capacity is insufficient to close the gap, and there are logistical constraints that limit the amount of products that can be shipped out. Some simple distillation units are being built to refine crude into products (including fuel oil) that can be exported.
Meanwhile, production issues in Libya and Nigeria are supporting Brent prices.
If the differential persists, it will be interesting to see whether there is pressure to eliminate, or at least relax, the constraints on exports of US crude. I would presume that even if pressure begins to build, there will be a political battle in the US that will likely long delay any such relaxation or elimination. So in the meantime this will be a boon for domestic refiners, and a roller coaster ride for traders. The political, infrastructure, and refining bottlenecks that separate Brent and WTI will not close anytime soon, and the supply shocks on either side of the divide will cause prices to move with considerable independence. A continued spike in US production will weigh on US prices, but can’t be communicated efficiently to Brent prices because of the bottlenecks; similarly, another shock to Nigerian or Libyan production will primarily move Brent.
In some ways, the world oil market, which is conventionally considered a “world” market due to the relative ease of shipping the stuff around the world, is becoming more like the natural gas market, with regional markets separated due to various bottlenecks, and the prices in these markets driven by idiosyncratic supply and demand shocks in those regional markets. The adjustments necessary to ease the bottlenecks in crude are likely cheaper than those in gas, but they won’t take place overnight. And until they do, Brent-WTI will remain a major speculative play.