Determining the Type of Crude Oil
Not a day goes by without oil making headline news, but rightfully so as crude oil remains the world’s single largest source of energy and is produced in some of the world’s most chaotic regions. The price of crude becomes a cost to most of the world’s industry, and that cost is passed through the economy and drives global trade. With the advent of biodiesel and ethanol blends, even the price of various agricultural markets are directly affected by the price of crude oil, making it potentially the most single important market to mankind in our lifetimes.
Crude oil, however, comes in various types, from different regions of the world, and in some cases very different chemical properties. Crude is simply a blanket term used to describe the thick, unprocessed black liquid that is extracted with oil rigs and pumps; but not all crude is created equal. Some crude types are easier to refine into gasoline and diesel fuel, specifically the low-sulfur light sweet varieties, than crude with higher sulfur contents. The chemical properties of each crude type make a difference in its use throughout global industry.
The Impact of Location on Crude Oil
Yet another determining factor in crude oil’s price, is where it came from, where it is going, and how it got there. Commodities in general, typically do not get consumed at their point of production. In almost every pricing model, a commodities price generally takes into consideration costs associated with storage and transportation, and crude is no different. Outside the fact that various crude types typically come from similar parts of the world, the transportation associate with moving the unrefined crude oil from those places to the consumer (typically refiners) has costs, and that cost gets passed down the production price chain. Most land based oil production also has constraints on the volume that can be transported, a pipeline for example can only handle so much at one time, so there are constraints on land locked production. On the contrary, sea based crude rig production is able to move the oil drilled at sea more freely around the world.
With so many factors that determine a crude type, there are three main benchmarks to which the world classifies its “black gold”: Brent, WTI (West Texas Intermediate), and Dubai. Dubai and Persian Gulf crude oil is generally some of the higher sulfur, somewhat heavier, and considered sour; giving it a lesser grade than WTI or Brent. Dubai and Persian Gulf crude is also primarily bought by Asian consumers, and generally not considered as important as the other two benchmarks in determining price.
Crude Oil Types: Brent and WTI
Establishing the differences in each crude benchmark, also helps determine its use within the economy and in turn, who the end consumers are for each benchmarks production. While there are dozens of different oil benchmarks, the majority pegged their price to one of the two primary benchmarks:
Brent Crude Oil
Brent: the most widely used benchmark for oil prices globally, with approximately two-thirds of all crude oil contracts referencing the Brent benchmark. Brent now is used to refer to crude from four different oil fields in the northern hemispheres oceans: Brent, Forties, Oseberg and Ekofisk. Brent crude is also a light sweet variety, and is preferred for refinement into diesel and gasoline. With the majority of the Brent crude benchmarks supply coming from sea based rigs, it’s much more accessible and easily freighted worldwide to meet global demand.
WTI (West Texas Intermediate Crude Oil aka ‘Light Sweet Crude’)
WTI (West Texas Intermediate): aka “Light Sweet Crude”, Cushing, WTI refers to oil drilled from the wells in the United States and sent via pipeline to Cushing, Oklahoma. Land locked production and supply chain, limits the flow of crude through to the global market. This also makes it more costly to export WTI crude from the US interior, leaving most of the WTI production refined for US consumption. The WTI crude variety continues to be the main benchmark for US production and oil consumption.
The Difference Between Brent and WTI Crude Oil
The moral of the whole story is the Brent benchmark VS. the WTI benchmark is essentially a comparison of the global oil market with the US oil market. This spread can be effected by any of the above mentioned market conditions or economic shifts associated with each benchmarks production, but it can also be affected by the value of the US Dollar as well. When comparing relatively similar products from two different areas of the world (like Brent and WTI), with two different currency values, the relative value of one currency to the other becomes drastically important when comparing each benchmark price. The Brent-WTI spread should reflect those currency adjustments as well, with part of their relative price being the exchange rate of the underlying currencies.
What to Consider when Trading Crude Oil
It’s important to consider, when trading any commodity, the full dynamic of supply and demand that is driving the economic incentive to own or liquidate commodities throughout the world. Commodities will also tend to be stockpiled in places of origination and production, before being drawn to areas of high demand (usually where there is little or no production) and sometimes need to travel far and wide. Crude is no different than any other commodity in this regard, with one exception: it’s literally the energy source for that same system of logistics that keeps the entire global economy flowing.
The crude oil market is not as simple as it looks. Not all crude is equal, and not all crude meets the requirements of futures contracts. Futures were designed to regulate and facilitate a standard contract for the delivery of a specific commodity, and US oil futures utilize the WTI grade as their benchmark. Price of all US oil follows the WTI benchmark, and subsequently the world’s largest economy is also associated with this particular commodity. One thing is for certain: it’s important and worth understanding the dynamics of what makes the global oil trade tick, because it effects… everything.
All roads lead back to crude.
