Will the real price of oil please stand up?

July 21, 2011
oil

By Christopher Swann
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Oil is a quintessential global commodity. But the price of the black stuff has got harder to grasp thanks to the gap between the two main benchmarks — Brent and WTI. Contrary to market expectations, this gap could widen over the coming year as ever more U.S. crude is stranded at home. This will delight U.S refiners. Questioning about the true price of oil, however, could get louder.

Market benchmarks for oil were never perfect measures of world crude prices. Crude oil comes in different qualities, and costs of transport impacts buying decisions. Dominant producers like Saudi Arabia –- seeking absolute control of pricing – pretend their oil is not even traded, but bought at the price it decides is right. The Brent benchmark, based on shipments of North Sea oil, emerged in the 1980s partly as a way of skirting this problem.

But in recent years both Brent and WTI — West Texas Intermediate, a U.S. oil similar in nature to the North Sea crude –- have faced challenges. Does either reflect the global price of oil? Flagging oil production from the North Sea led to upward pressure on the price of Brent. Some wonder if trades are deep enough to constitute effective price discovery. True, Platts, custodian of the Brent benchmark, has worked hard to keep the price relevant by bringing new fields into the calculation and looking at prices over a longer time frame. The decline in North Sea output –- down 40 percent since 1999 according to Citi -– still makes its life difficult.

As for WTI, inadequate pipeline infrastructure makes it difficult to get the stuff out of North America — and that depresses its price, especially when demand is also weak. Its problems could also get worse before they get better. Output from North America is growing faster than expected. Canadian producers, for example, recently said output will grow from 2.7 million barrels a day to 3.4 million by 2014 and North Dakota production is surging. Meanwhile efforts to build new pipelines are mired in political controversy.

Financial markets believe the trading discount of WTI -– which is near its $22 record -– will narrow over the coming year to $12 as these problems are resolved. This is starting to look over optimistic. Citi estimates the WTI-Brent spread could widen to as high as $40 this year. That would be a bonanza for U.S. refiners like HollyFrontier and Marathon Petroleum that use captive U.S. oil and sell products that are linked to the Brent price. But it is becoming ever trickier to see either benchmark as a truly representative price for oil.

Comments

We need to drill all our own until we transition into alternatives! Creates jobs, stimulates the economy with thge billions we send to others, we’re more environmentally repsonsible (now) than 3rd world countries, and we’re sick and tired of dying/fighting for oil when we’re sitting on 50+ years worth in Prudo Bay alone! Also, we need the price/supply stability and we’re years away from substitutes if ever! Drill baby drill is wise and correct! Honesty is the best policy!

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