munKNEE.com Your Key to Making Money
We use crude oil for everything from running our cars to making plastic.
The need for oil causes conflicts and gives power to those countries that have an abundance of it. Taking all this into account, not too many of us actually know how it’s priced. A lot of us hear how much it costs per barrel or get mad when prices go up at the pump but what’s the method behind the madness? Hopefully, I can shed a little light on the process. Words: 790
So says Jason Jenkins (www.investmentu.com) in edited excerpts from his original article.*
Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!), has edited the article below for length and clarity – see Editor’s Note at the bottom of the page. This paragraph must be included in any article re-posting to avoid copyright infringement.
Jenkins goes on to say, in part:
All Oil is Not Equal
If you drill for oil in different parts of the world, you may get oil, but it…[won’t] be all the same oil….There are varying…[types] of oil based on a number of metrics:
- American Petroleum Institute (API) gravity….[which] is used to compare a petroleum liquid’s density to water. The scale ranges from 10 to 70. “Light” crude oil usually has an API on the higher side of the scale, while heavy oil falls on the lower end of the range.
- Sulfur [sulphur] content…When oil has a total sulfur level greater than .05% it is considered sour… [and when it’s] less than 0.5% [it is referred to as]…sweet.
You can find sour oil in a lot more places around the world – like Canada, the Gulf of Mexico, some South American nations, as well as most of the Middle East – than its sweet counterpart. Sweet crude comes from the good old USA, the North Sea region of Europe, and parts of Africa and Asia.
The industry uses both types, but the sweet crude is the prize pony because it requires less processing in order to get out all of the bad stuff. What to take away? Light and sweet forms of crude oil are strongly desired. The heavier form usually trade at a discount in comparison.
There are 2 Major Crude Oil Benchmarks
[With] over 160 different types of crude oil produced in the world, benchmarks are needed so traders can determine transactional settlement prices…. There are two major benchmarks, West Texas Intermediate (WTI for short) crude oil and Brent crude oil. Both are light sweet crude oils, but WTI is generally sweeter and lighter.What’s are the Differences Between WTI and Brent Crude Oil?
WTI is a crude oil specific to the Midwest region of the United States….There is a glut in the amount of crude oil going to refineries in the Midwest due to an increased supply from Canada and North Dakota’s Bakken Shale [and this] excess supply [is currently pushing prices of WTI down] at the refineries in Cushing, Oklahoma.
Brent reflects the supply/demand balance in Europe. Because of this, many industry analysts believe that Brent is a more global benchmark and reacts more to global events. Think of how the issues in Libya last year and now Syria and Iran pushed Brent prices higher.
Two ETFs, the United States Oil Fund (NYSE: USO), which tracks WTI futures, and the United States Brent Oil Fund (NYSE: BNO), which offers exposure to Brent crude, show the performance difference of the major benchmarks over the last few years. Since its inception in mid-2010, BNO and Brent oil alike have put a beating on WTI with a return around 75% for the fund. In comparison, USO has gained 25% – which isn’t bad.
The graph below gives us a visual of the difference:
Why Does the Future Hold for WTI and Brent?
1. Middle East stability: It’s my belief that volatility in Middle East can account for the difference we’ve seen lately [but the question is just] how long this vast gap in returns can last. If the issues in the Middle East stabilize {that is, no immediate signs of war or revolution) we might see the premiums come back together.
2. Middle East instability: On the flip side, the [Middle East] region has a history of instability so it might be a while before we see the region calm down and Brent fall. If you play the chaos card, take Brent as the best crude option.
3. Changes in benchmarks: Things could also change in the next few years [which could impact the WTI/Brent spread.] Major producers are switching benchmarks or going in a different direction all together. Brazil’s Petrobras (NYSE: PBR)…recently switched its benchmark pricing from WTI to Brent [while] Saudi Arabia, Iraq and Kuwait all shifted their benchmark pricing for U.S. exports from WTI to the Argus Sour Crude Index.
4. Advent of global benchmark: These two benchmarks will become less important as markets will probably seek one global benchmark. The widening WTI-Brent spread is accelerating this trend. However, that’s probably years away from becoming a reality.
Hope this helps.
Good Investing,
Jason Jenkins
*http://www.investmentu.com/2012/May/wti-brent-spread.html (To access the above article please copy the URL and paste it into your browser.)
Editor’s Note: The above article may have been edited ([ ]), abridged (…), and reformatted (including the title, some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. The article’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article.
Related Articles:
1. Brent vs. West Texas Intermediate Crude Oil: Which is a Better Investment?
Beyond the attributes that set West Texas Intermediate Crude (WTIC) and Brent crude oil apart comes the question of which type of crude makes for a better investment. Recent historical data puts that question to rest, as one clear winner emerges. [Read on!] Words: 590
2. Canada’s Oil Sands to Have $520 Billion Impact on U.S. Economy: Here Are the Facts, State by State
Canada is the largest supplier of oil to the U.S. When the U.S. imports oil from Canada, the spin-off economic benefits are substantial. The interactive map of the U.S. below will let you calculate the economic impact generated in each U.S. state from new oil sands projects in Alberta, Canada. Words: 592
3. A Look at the Canadian Oil Sands: the U.S.’s #1 Source of Supply
The third largest source of oil in the world is the Canadian oil sands and the United States already imports more of it from there than from anywhere else. With oil prices on the rise, the controversial oil sands are likely to become even more economically viable, despite experts’ warnings about environmental risks [and the political and environmental gamesmanship to block the Keystone pipeline project from there to refining facilities in the U.S.]. Below are 12 incredible facts about the oil sands. Words: 408
4. Canadian Oil Sands: World’s Single Largest Petroleum Resource and…
The Canadian oil sands are the world’s single largest petroleum resource at 1.7 trillion barrels. With conventional oil supply decreasing, heavy oil projects such as the oil sands become more attractive economically to meet the needs of growing demand. While environmental concerns about the oil sands remain, the options for plentiful, cost efficient, and clean oil sources are limited.
5. The Oil Sands are NOT the “Tar” Sands and 9 More Interesting Facts
The oil sands in northern Alberta are crucially important to the Canadian economy. People from all over the country are traveling there to find work. The news is filled with controversy over proposed pipelines (the Keystone XL and the Northern Gateway) to carry the oil to export markets. Here are 10 things everyone should know about the oil sands. Words: 878