The Changing Meaning of Oil Price Benchmarks

Oil analysts and the press refer to various types of crude oil. The oil industry classifies crude oil (unrefined oil) first by the location of its origin. Other factors are its weight (light, intermediate or heavy) and its sulfur content: sweet or sour. Sweet crude is low sulfur and sour crude is high sulfur. Sour crude oil requires much more refining than sweet crude oil. Oil companies like, Western Pipeline Corporation; determine the molecular characteristics of the crude oil they drill so that it can be classified to use as a pricing reference. These pricing references are referred to as Crude oil benchmarks.

There are about 161 different internationally traded crude oils. Two crude oils which are either traded themselves or whose prices are reflected in other types of crude oil include
West Texas Intermediate and Brent. Brent crude oil comes from fields in the North Sea and has more sulfur than WTI so it is considered inferior. In the United States WTI has been the benchmark pricing term most referred to as it’s a low sulfur, light sweet crude oil ideal for producing gasoline which most U.S. refineries were designed to process. Production of WTI has been declining for years but it is still the major benchmark in North America. It is the underlying commodity of New York Mercantile Exchanges oil futures contracts. However, North Sea Brent crude oil is also mentioned alongside WTI in the US news today.

Brent crude oil has become the world benchmark for oil pricing and is the price most traders follow closely. Brent oil production from the Middle East, Europe and Africa flowing west is most often priced off the price of Brent crude. Brent crude oil affects more people than WTI during supply disruptions. Historically, WTI crude prices have been higher than Brent crude due to its lower sulfur content. The typical price difference had been $1 less per barrel. However, in the last two years, Brent has increasingly traded at a premium to WTI.

In 2007, Brent crude futures have been trading higher than WTI. Depletion of the North Sea oil fields is considered to be one factor causing this. Another factor is pipeline logistics in the US. Most West Texas crude travels one way via pipelines to refineries. If there is a shortage of demand upstream oil supply will back up at downstream hubs. This occurred in Cushing, OK, a major hub, in April 2007 with a weekly increase in supply of 8 million barrels. This caused a reduction in price of up to $3 per barrel for short term contracts.

These changes are causing the two main crude oil benchmarks to dislocate from each other and it’s likely that crude oil benchmarks in the future will grow even farther apart making crude oil pricing more difficult.