How not to speculate on the WTI and Brent oil spread

In crude oil price, there is an ongoing rise in the gap between WTI and Brent oil spot. An investor should watch out for the pitfalls when trying to profit from this spread. I will present here a couple of these pitfalls one should avoid.

In the last several months Brent crude oil price (spot) has picked up and increased more than WTI spot price. As an example, as of January 28th the spread between Brent and WTI was 10.32 USD/b.

Some analysts consider that there are ways in which one could profit from this spread by using other indexes to try and predict the direction of this gap.

Brent oil originates from the North Sea, and as such is mostly exported to Europe, while WTI oil is based in Texas and southern Oklahoma, i.e. its price pertaining to the North America crude oil market.

Thus, it makes sense that there will be competing theories on how this spread is calculated, and, in turn, how to profit from it by examining the variables affecting this spread.

The main variables are, among others, the crude oil stocks in US, the Euro/USD rate, the differences in the consumption of oil between Europe and US, the growth rates of these two regions etc.

Let’s examine a couple of these variables and see if they are related to this spread of Brent oil minus WTI oil prices.

See below the graph of the monthly average changes of Brent oil minus WTI oil prices between the years 1998 and 2010.

Crude oil price, gap between wti and brent 1998-2010

The graph shows that up to 2006 for most of the time WTI was higher than Brent crude oil price.

Since 2006 and even more so in 2007, the gap switched and Brent oil price was higher than WTI crude oil price, in which the peak came in February 2009 with an average gap of 4.23$/b.

There could be some macroeconomic changes affecting this spread and recent years, such as the changes in Euro/USD. Let’s check it out:

Crude oil price wti to brent ratio and EURO USD 1999-2010 The graph above shows the yearly changes (1999-2010) in EURO/USD and the ratio of WTI/Brent (in percentages, instead of usd/b).

I changed the view from spread in $/b (i.e. Brent minus WTI ) to ratio (i.e. WTI/Brent) because the latter seem to have a better correlation to the Euro/usd index.

The graph doesn’t seem to provide much information as to any trend or relation between the two sets. The linear correlation, however, of these two data sets present a strong positive correlation of 0.57 between the yearly percent change of the WTI/Brent ratio and Euro/USD.

This finding, however, isn’t what we need to make us rich in the short run…this finding might prove valuable for long term investing.

Therefore we need to examine the monthly basis:

The graph below shows the monthly changes in EURO/USD and the ratio of WTI/Brent during 2010.

Crude oil price wti to brent ratio and EURO USD 2010

Again, we need to check the correlations between the two:

The chart below shows the correlation for the years 1999-2010 between the two sets (remember on a monthly basis).

Correlation of EURO USD to Crude oil Price Brent-WTI ratio 1999-2010

The chart shows that there is no consistent correlation between crude oil price WTI/Brent ratio and the Euro/USD rate.

Therefore, it seems hard to use the Euro/USD (which is also an unknown) to predict the changes in the spread between Brent oil and WTI oil prices.

Let’s move on to crude oil stocks in the US and it effect on the spread. The logic behind this effect is that changes in petroleum stocks present changes in supply and demand for oil, which could influence the WTI crude oil price and consequentially the spread.

The graph below shows the oil stocks during 2010 and the ratio of WTI/Brent.

Crude oil price, wti brent RATIO AND US crude oil stocks 1999-2010

When examining the linear correlation for the entire period (on a yearly scale) there is some negative correlation of -0.38. When examining, however, the monthly scale there is, again, a much smaller correlation of 0.059% for the entire period, with inconsistent correlation, e.g. in 2010 a -0.26 correlation while in 2009 it is 0.18.

In conclusion, there is little evidence to support using any of the major commonly known indexes such as Euro/USD to predict the changes in the spread between Brent oil and WTI oil prices. Some of these indexes could affect the spread, but they are very volatile and their relation to the gap isn’t necessarily linear nor is it consistent so an investor could rely on it.

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