One Reason for Recent Brent-WTI Spread Narrowing Originated Outside the US - InvestingChannel

One Reason for Recent Brent-WTI Spread Narrowing Originated Outside the US

For the first time in some 2.5 years Brent-WTI spread (discussed here) has traded around $5/barrel. The two types of crude oil represent nearly the same product but have been trading at a wide spread due to difficulties of transporting sufficient amounts of North American crude from Cushing Oklahoma, where WTI is settled, to the Gulf of Mexico where it could be delivered to major US refineries or shipped elsewhere as a replacement for the more expensive Brent crude. These delivery challenges have been significantly reduced in the past couple of years. At the same time some technical issues in the North Sea have been resolved to stabilize Brent pricing.

Bloomberg: – The drop in the gap between Brent, a gauge for more than half the world’s oil, and WTI shows how improved pipeline networks and the use of rail links have helped to unlock a glut at America’s oil-storage hub at Cushing, Oklahoma, in line with a prediction made by Goldman Sachs Group Inc. as long ago as February 2012. WTI rose 5.2 percent in the first half of this year. Brent dropped by 8.1 percent as North Sea supplies have stabilized following oilfield maintenance.

“The spread is coming in on anticipation that we’re going to see pipelines get built and more rail capacity put in place,” said Bill O’Grady, chief market strategist at Confluence Investment Management in St. Louis, which oversees $1.4 billion. “There is now a likelihood that not only will U.S. imports drop further, but that the country will be exporting before long.”

But there is one question that still remains unanswered. A major portion of the spread compression to $5 has taken place just in the past few weeks. Moreover, the volatility of the spread has fallen dramatically.

It is highly unlikely that the market just came to a realization in mid-June that “improved pipeline networks and the use of rail links have helped to unlock a glut at America’s oil-storage hub at Cushing”. The transport dynamics in the US have been improving for some time – so why should the spread collapse now?

Something else happened in mid-June that started this steady decline. It was the Iranian elections.

CNN: – Iranian centrist candidate Hassan Rouhani won the Islamic republic’s presidential election Saturday after campaigning on a “hope and prudence” platform in which he appealed to traditional conservatives and reform-minded voters alike.

Rouhani spoke of reforms without threatening Iran’s supreme leader or its institutions, of which he is a product. The former national security council chief promised an environment with greater personal freedoms and even indicated he would free political prisoners and jailed journalists.

The outcome of this election greatly reduced the risk of a major conflict with Iran, thus lowering the “Iran premium” priced in Brent-WTI spread. This premium existed because a military clash with Iran would impact Brent (and similar regional blends) supply and pricing to a far greater extent than WTI. This change also opens the door for a potential lifting of the sanctions against Iran, making supply disruption risks even lower. Given Iran’s nuclear work, the risks are clearly still there, but the market is perceiving them to be materially reduced.

While the transport fundamentals in the US have definitely driven the spread lower over the past year, it was the elections results in Iran that precipitated the rapid collapse in this widely watched spread.

SoberLook.com

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