Trading the financial markets is like any business endeavor—there are nuances to the game which vary across different geographical regions of the globe.
For example, equity options aren’t yet widely available in the mainland Chinese financial market. As of now, equity options are basically only traded on one product in China: the China 50 ETF.
And while equity options are readily available on the stock exchange in Hong Kong, there’s also a heavy volume in warrants—the latter being a product that most U.S.-based traders wouldn’t have much experience dealing with.
Along those same lines, the crude oil market varies slightly across international borders.
In the United States, the standard crude oil futures contract is associated with what’s commonly referred to as “West Texas Intermediate” (WTI). WTI is a specific grade of crude oil known as “light and sweet crude” due to its relatively low density and low sulfur content. These characteristics make the application of WTI most suitable for utilization as gasoline or diesel fuel.
West Texas Intermediate (/CL) is also the standard benchmark for oil futures on most exchanges in the United States, which is another reason this grade of crude is so well known in the region.
Looking across the pond, the picture changes slightly as it relates to the crude oil market in Europe and other parts of the world. Outside of the U.S., the highest volume futures contracts are generally underpinned by “Brent crude.”
Brent gets its name from the Brent oilfield, which is located in the North Sea. And the North Sea variant doesn’t take a backseat to WTI—in fact, approximately two-thirds of the world’s internationally traded crude oil changes hands under a contract associated with Brent.
While Brent is also a light and sweet grade of the world’s best known fossil fuel, it does vary slightly from WTI. Brent crude has more sulfur than WTI (0.37% vs. 0.24%), which slightly impacts its commercial utilization. Brent crude can be refined into kerosene and jet fuel, as well as gasoline and diesel.
And while the above information is certainly important, it’s the spread between the prices of Brent and WTI which typically attracts the most attention from commodities and futures traders.
In this case, the term “spread” refers to the absolute difference between the market prices of Brent and WTI, as well as a potential pairs trade that can be structured using these two well-known benchmarks.
According to a recent episode of Futures Measures on the tastytrade financial network, the historical spread between the prices of Brent and WTI has ranged between a low of $2.68 and a high of $27.88 since 2010.
Given that both WTI and Brent trade according to the standard crude oil benchmark quantity, one barrel, there’s good reason to wonder why the spread has ranged to such an extreme degree. At first look, one might believe this discrepancy is related to the ultimate application and use of each type.
However, according to the U.S. Energy Information Administration (USEIA) and most other experts, that simply isn’t the case. Prevailing opinion in the energy sector suggests that the spread between WTI and Brent is related to logistics constraints in the WTI supply chain.
In a nutshell, the quick expansion of oil production in North America (the U.S. and Canada) has far outpaced the capacity and growth of associated pipeline infrastructure. That means much of the WTI-grade crude oil in North America must be transited via rail, which adds greatly to the cost as compared to pipeline-based fulfillment. This problem is exacerbated by the fact that Brent crude produced in the North Sea and the Middle East is also extracted in close proximity to seaborne transit.
Because of these market realities, Brent crude is actually believed to be more sensitive to news developments affecting the energy sector when compared to the relatively less-accessible WTI.
Traders active in the crude oil marketplace are therefore advised to monitor not only WTI futures (/CL), but also Brent futures (/BZ). Moreover, traders may even consider a pairs trade involving both, especially if the spread were to reach one of the historical extremes highlighted previously.
The current spread between Brent ($59.46) and WTI ($53.95) is approximately $5.51, which is significantly closer to the lower end of its historical trading range. Traders seeking to learn more about trading this spread are are encouraged to review the complete episode of Futures Measures when scheduling allows.
Additional information is also available in the tastytrade LEARN CENTER.
Sage Anderson is a pseudonym. The contributor has an extensive background in trading equity derivatives and managing volatility-based portfolios as a former prop trading firm employee. The contributor is not an employee of luckbox, tastytrade or any affiliated companies. Readers can direct questions about topics covered in this blog post, or any other trading-related subject, to email@example.com.