Before you can consider benchmarks used in the valuation of crude oil, you need to know a little about the science. Crude oil is a liquid resource found deep in the earth where it develops over hundreds of years. Crude oil is not the end product but just the basic resource. In its natural form, crude oil does not have any use. Instead, it gets refined and processed into various useful commodities. The refining process, which begins with distillation, determines the quality of the final product. Crude oil is generally refined into gasoline, heating oil and residual fuel oils. Each of these classifications has a different weight and value.
Important: Sulfur content is a very important measure of crude oil. The amount of sulfur in the oil, determined by weight, classifies it as sweet or sour. Any crude oil with less than 0.5% sulfur is considered sweet. More sulfur than that indicates a sour crude. The combustion of oil with high sulfur contents results in higher levels of pollution, so sulfur is usually removed in the refining process.
To precisely value crude oil, workers would need to test each barrel for various characteristics. Quality and content differ between reservoirs, and there are hundreds of crude oil fields around the world. Because each of these fields mines crude oil with different characteristics, benchmarks are established to make the process of valuation a little more manageable.
There are three main benchmarks used as reference prices for crude oil:
- Brent Blend — The most popular and widely used crude oil benchmark, Brent Blend is light, sweet oil that comes from four oil fields in the North Sea. Transporting Brent Blend oil is more straightforward than other types of oil because it is water-borne. You can easily refine diesel fuel and gasoline from Brent Blend oil, and these are some of the most high-demand petroleum products.
- West Texas Intermediate (WTI)— The main benchmark for U.S. oil, WTI comes from wells and goes into a pipeline that ends in Cushing, Oklahoma. It is a light, sweet oil landlocked and best suited to transportation by pipeline. It is ideal for gasoline refining.
- Dubai Crude — Crude at this benchmark is a lower quality than Brent Blend or WTI. This light, sour oil is mostly mined in the Middle East and transported to Asia across the Persian Gulf. The Dubai benchmark is significant because it represents one of the only opportunities for investors in Middle East oil. Most oil mined in the Middle East is sold directly to end users and valued using other benchmarks.
(The difference in price between Brent and WTI is called the Brent-WTI spread.)
Brent and WTI serve as the basis for most of the oil prices in the U.S. and Europe, but there can be a significant discrepancy in value between different supplies of crude oil. It’s useful for investors to know more than the top three when it comes to crude oil benchmarks. A barrel of crude oil is equal to 42 U.S. gallons.
Let’s go on to our main topic:
What is West Texas Intermediate (WTI)?
WTI is the main oil benchmark for North America as it is sourced from the United States, primarily from the Permian Basin. The oil comes mainly from Texas. It then travels through pipelines where it is refined in the Midwest and the Gulf of Mexico. The main delivery and price settlement point for WTI is Cushing, Oklahoma.
The hub has 90 million barrels of storage capacity and accounts for 13% of U.S. oil storage. The inbound and outbound capacity is 6.5 million barrels a day. Cushing is known as “The Pipeline Crossroads of the World.”
West Texas Intermediate (WTI) is a crude oil that serves as one of the main global oil benchmarks as discussed. WTI is known as a light sweet oil because it contains 0.24% sulfur, making it “sweet,” and has a low density, making it “light.” It is the underlying commodity of the New York Mercantile Exchange’s (NYMEX) oil futures contract and is considered a high-quality oil that is easily refined.
For finding investment opportunities in this sector,
Read this: Drilling Investment Opportunities in the Oil and Gas Sector
WTI Vs Brent Crude
Nearly two-thirds of oil contracts globally use Brent as a benchmark so WTI is not the most commonly used benchmark globally, that honor goes to Brent. Both, however, are considered high-quality oils and are therefore the two most important oil benchmarks in the world. As mentioned, WTI has a sulfur content of 0.24%, whereas Brent has a sulfur content of 0.37%. The lower the sulfur content of an oil, the easier it is to refine, making it more attractive. A sulfur content below 0.5% is considered sweet. WTI is ideal for gasoline whereas Brent is ideal for diesel.
Theoretically, WTI crude should trade at a premium to Brent crude, given the quality, but this is not always the case. While the two crude oil varieties can trade at similar price points, each one has its own unique supply and demand market, and therefore its price reflects its individual market fundamentals.
Since the shale boom in the U.S., which resulted in a production increase of WTI, the price of WTI has gone down and usually trades at a discount to Brent. Furthermore, transporting WTI overseas to Brent crude’s market could come at a cost that would make WTI unable to compete with Brent crude in terms of pricing.
The major difference between the crude oils Brent Crude and West Texas Intermediate is that Brent Crude originates from oil fields in the North Sea between the Shetland Islands and Norway, while West Texas Intermediate is sourced from U.S. oil fields, primarily in Texas, Louisiana, and North Dakota. Both Brent Crude and West Texas Intermediate are light and sweet, making them ideal for refining into gasoline.
During times of crisis, the spread blows out as political uncertainty leads to surges in Brent Crude prices. West Texas Intermediate is less affected because it is based in landlocked areas in the United States.
The Historic Crash & Its Reason
“No one in America wants oil in the short term,” Jeffrey Halley of Oanda told clients on Monday.
US oil prices plunged, falling below $0 Monday to $-37.63 a barrel. That’s the lowest level since NYMEX opened oil futures trading in 1983. The extreme pressure on the WTI contract for May highlights ongoing concerns about the supply and demand dynamics plaguing the oil market.
Reason: Oil storage facilities are at risk of overflowing, raising the chance that some oil producers in the United States and Canada could start paying customers to take crude off their hands. Investors are particularly worried about storage reaching capacity in Cushing, Oklahoma, the main US hub. This hub has reached its 70% capacity and still adding 5 million barrels a day, every week from the last 5–6 weeks. If it continues to fill like this then it will reach to its full capacity in the next 3–4 weeks as nobody wants to take physical delivery of oil.
The June futures contract for WTI is trading around $22 per barrel, but that’s still sharply lower on the day. Brent crude futures, the global benchmark, fell 8% Monday to $25.81 per barrel.
Effect on Indian Economy:
Though WTI May futures expire on April 21, there will still be volatility in prices. But this does not mean that June futures do not have a scope of a similar situation.
Though it is obvious that India will benefit from such a situation as India’s oil import bill may halve if current crude price hold, given that it is the second-biggest oil consumer but the current environment of a lockdown does not help take the advantage even if we reopen soon. The current import of oil has reduced by almost 50% in volume to 2.3 mn bbl/day from 4.2 mn bbl/day. This will take a long time to normalize for the benefit to reflect.
Indian upstream companies like ONGC, Oil India may have to post losses as their production cost of Brent crude is around $31 /barrel and the market price is around $26 /barrel.
India Strategic Petroleum Reserve (SPR) is only 37 million barrels that is equivalent to 13–16 days usage at the current rate of consumption. India will not benefit much from these prices as the import volumes are also impacted by a large portion.
Saudi Arabia, Russia, and other producers tried to prop up prices with a deal last week to slash production by 9.7 million barrels per day in May and June, the deepest cut ever negotiated. But that isn’t expected to soak up the supply glut caused by evaporating demand for energy.
Join Free Marketnotes telegram channel to get more useful articles like this, straight into your inbox: Join here