WTI-Brent spread hits 'weakest level'

June 27, 2011
Energy prices fell sharply June 15 with the August North Sea Brent contract dropping more than $6/bbl, wiping out "all gains of the last 15 trading days" and closing its price spread vs. West Texas Intermediate to "the weakest level" since March, said Olivier Jakob at Petromatrix, Zug, Switzerland.

by Sam Fletcher, Senior Writer

Energy prices fell sharply June 15 with the August North Sea Brent contract dropping more than $6/bbl, wiping out "all gains of the last 15 trading days" and closing its price spread vs. West Texas Intermediate to "the weakest level" since March, said Olivier Jakob at Petromatrix, Zug, Switzerland.

In London, the expiring July contract for North Sea Brent crude dropped $3.06 to $117.10/bbl. "The drop was much more pronounced in the more actively traded August Brent contract, which plunged by $6.34/bbl" to $113.01/bbl, said James Zhang at Standard New York Securities Inc., the Standard Bank Group. July benchmark US crudes fell $4.56 to $94.01/bbl June 15 on the New York Mercantile Exchange. The August contract dropped $4.60 to $95.26/bbl. Oil prices recovered marginally June 16 but fell again June 17 with front-month WTI and Brent contracts ending the week at $93.01/bbl and $113.21/bbl, respectively.

In Houston, analysts at Raymond James & Associates Inc. said the European debt crisis and worries over a weakening US economy contributed to the price drop.

Paul Horsnell at Barclays Capital in London, said, "Sovereign debt concerns and a general cross-market macroeconomic unease have returned to the fore as drivers of short-term oil prices, taking a degree of market attention away from changes in oil market fundamentals. Those fundamentals are still tightening, with sharp reductions in the prospects for non-OPEC supply and resilient global demand." Earlier Brent-WTI spreads at record levels above $23/bbl were "unjustifiable," said Horsnell, "but the underlying drivers of the dislocation looked set to become entrenched."

The June 15 sale-off started with a correction in the Brent-WTI spread. By closing, the Brent premium to WTI for August was down by $1.74 to $17.75/bbl, with the WTI contract losing more than $4/bbl in the New York market. Zhang reported the calendar spread between Brent's August and December contracts in London dropped to $1.06/bbl.

Refining margins

"The price fall came after a consistent decline in refinery margins since the beginning of May," said Zhang. Margins for simple hydroskimming refineries in northwest Europe are "in deep negative territory." Those of more complex cracking refineries have diminished over the past 6 weeks. "Because refineries are price-takers, when they face negative refining margins, they have to reduce their crude run rates to minimize losses. Consequently, we've seen sluggish demand for crude in the European region over the past few weeks," said Zhang. He said, "Another signal that demand should move lower lies in the premium for high quality West Africa (WAF) crude over Brent, which has been declining despite the recent force majeure over Bonny Light cargoes declared by Royal Dutch Shell PLC. The premium of Bonny Light over Brent has fallen from $3.92/bbl at the beginning of April to…$2.22/bbl."

Meanwhile, crude cargoes are diverting to Europe, exacerbating demand weakness on that continent, "since the US offers an unattractive destination following the further widening in the WTI-Brent spread," said Zhang. "Unlike the previous occasion in mid-February when the WTI-Brent spread hit the $20/bbl level, domestic US waterborne crude, such as Light Louisiana Sweet (LLS) crude failed to catch up with Brent. Consequently, many WAF cargoes are uncompetitive for US refineries and are diverted to Europe instead, which further weighs on the European market."

He foresees near-term weakness in the oil market driven by sluggish demand. "Coming into the third quarter, demand is expected to be strengthening by a seasonal pick-up, which should support the oil market in the medium term together with tightening crude supply," Zhang said.

Zhang said, "So far this month we saw a series of negative and worse-than-expected data, especially out of the US. As far as commodities are concerned, we believe global macroeconomic data [are] revealing two trends—manufacturing is slowing and final product inventory is building. At the same time final demand is either slowing or weak. A build in product inventory and slowing final demand is not a positive signal."

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