Crude oil is an important source of energy for the world economy. Aside from being one of the most actively traded commodities, crude oil prices are highly vulnerable to geopolitical and weather events.
The global crude oil market revolves around investor expectations of supply and demand, and oil prices are extremely volatile and heavily impacted by consumer and investor attitude. As a result, worldwide events such as the COVID-19 epidemic can send shockwaves through the industry.
The Two Most Prevalent Grades of Crude Oil
Different grades of physical oil exist, with two of the most heavily traded being Brent North Sea crude, commonly referred to as "Brent crude," and West Texas Intermediate, known as "WTI." Brent crude originates from the Brent oil fields and other locations in the North Sea.
Brent crude serves as the pricing benchmark for African, European, and Middle Eastern crude oil. Its pricing mechanism influences the value of approximately two-thirds of global crude oil production.
The sulfur content in crude oil determines the level of processing required for refining into energy products. "Sweet crude" refers to crude oil containing less than 1% sulfur.
Benchmarks and Trading Markets
WTI crude oil serves as the primary benchmark for North American markets, with futures contracts listed on the NYMEX division of the CME. Delivery for WTI crude futures is centered in Cushing, Oklahoma.
On the other hand, Brent crude oil futures are traded on the Intercontinental Exchange (ICE) and are recognized internationally, leading to varying delivery locations depending on the country.
Given the international recognition of both benchmarks, Asian countries commonly utilize a combination of Brent and WTI benchmark prices to assess the value of their crude oil.
Factors that influence benchmark pricing
The divergence in properties between Brent and WTI crude oils creates a pricing gap known as the "quality spread," while their geographic locations in Europe and North America respectively result in a "location spread." The nominal price of crude oil is just one facet in understanding the crude oil market.
As per insights from CME Group, the operator of the NYMEX commodities market, the WTI/Brent Spread is influenced by four primary factors:
Levels of crude oil production in the United States.
Supply-and-demand dynamics of crude oil in the U.S. market.
Operations related to North Sea crude oil.
Geopolitical factors affecting the international crude oil market.
How World Events Can Affect Crude Oil Prices
Political upheavals, weather phenomena, and global health crises have consistently served as significant disruptors in the oil market.
According to the February 2021 report by the IEA, it was projected that demand would regain 60% of its losses from 2020 throughout the year. However, despite a resurgence in demand, subsequent Covid-related lockdowns in China and supply disruptions stemming from Russia's conflict with Ukraine prompted the IEA to revise its forecast, anticipating a slight deceleration in demand growth and an uptick in prices by May 2022.
Examining the evolution of the Brent-WTI spread over the past decade provides insights into how global events can lead to prolonged periods of significant divergence. At the outset of 2011, the spread between Brent and WTI was relatively narrow.
During 2011, the spread widened as Brent began to trade at a premium over WTI. This divergence coincided with the onset of the Arab Spring, notably the unrest in Egypt starting in February 2011, which fueled concerns about potential disruptions to oil supply routes, including the Suez Canal. Subsequent easing of tensions surrounding the canal's operations contributed to a narrowing of the spread.
Later in 2011, heightened geopolitical tensions emerged as the Iranian government threatened to close the Straits of Hormuz, a critical chokepoint through which a significant portion of global oil shipments pass. This threat led to further widening of the spread, with Brent commanding a premium of up to $25 per barrel over WTI.
In 2015, the premium for Brent decreased due to two primary factors. Firstly, an agreement was reached with Iran, allowing for increased oil exports, which influenced Brent prices as it serves as the pricing benchmark for Iranian crude. Secondly, concurrent declines in U.S. rig counts signaled a potential reduction in future U.S. production levels, bolstering WTI prices amidst burgeoning support for U.S. crude exports. Anticipation of these market dynamics alone was sufficient to induce price fluctuations.
Additionally, weather-related events have historically exerted significant pressure on oil prices. The impact of hurricanes in 2005, which led to the shutdown of refineries and production facilities, resulted in sharp price increases.
In summary, the interplay of geopolitical developments, weather disturbances, and health crises underscores the inherent volatility of the oil market, with each factor capable of precipitating significant fluctuations in prices and spreads between different crude oil benchmarks.
What is ICE Brent Crude?
ICE Brent Crude is a specific type of futures contract offered by the Intercontinental Exchange (ICE), representing 1,000 barrels of Brent crude oil. Traded in U.S. dollars, this contract is available on exchanges in New York, London, and Singapore.
Where is Brent crude oil refined?
Brent crude oil is refined globally by various refineries that purchase the crude. However, since it originates from drilling sites in Northwest Europe, a significant portion of refining occurs in that region.
How much gasoline is produced by one barrel of crude oil?
The refining process typically yields about 20 gallons of standard automobile gasoline and up to 12 gallons of diesel fuel (also known as "heating oil") per barrel of crude oil. A standard barrel contains 42 gallons of crude.
What is WTI Cushing spot?
WTI Cushing spot refers to West Texas Light Sweet Crude oil contracts that are delivered in Cushing, Oklahoma. The term "spot price" denotes the current market price for a commodity, so the Cushing spot price is the prevailing rate at which a barrel of oil deliverable in Cushing can be bought or sold.
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