For the first time, the world’s most liquid crude oil futures contract is priced with US oil.
The central theses
- The Intercontinental Exchange (ICE) Brent crude oil contracts will now include West Texas Intermediate (WTI) crude oil in their price calculations.
- It is the first time Brent prices have included oil from a source outside the North Sea.
- The change reflects declining trading volumes in North Sea Oil and increasing volumes in WTI.
Crude oil futures contracts based on the ICE Brent Index include prices for West Texas Intermediate (WTI) Midland crude oil as of June 1st. The inclusion marks the first time that Brent crude prices, which are used as a benchmark for global oil markets, include the price of oil produced outside the North Sea.
WTI, a slightly sweet crude similar to the five North Sea crudes currently included in the Brent basket, has served as a benchmark for domestic oil since U.S. oil futures began trading on the New York Mercantile Exchange in 1983.
Today, about 80% of all oil market transactions are traded as Brent crude. The inclusion of oil from the world’s largest economy and oil producer should make Brent a more accurate measure of global oil prices.
How oil futures work
Oil futures contracts play a key role in world markets and are based on spot oil prices, which is the price of physical oil delivered to a specific destination. Oil futures allow suppliers and buyers of physical oil to hedge the cost of their supplies, protecting themselves from price fluctuations.
For example, a crude oil producer can sell a futures contract in June for delivery in September and receive an immediate payment. If the spot market price for crude oil in September exceeds the futures contract price received three months earlier, the producer can sell its physical oil to an independent spot market buyer, such as a refiner.
The producer can then use the proceeds of the spot sale to buy back the futures contract it has sold, completing that trade and reaping the difference between the two.
However, if the spot market price in September is below the forward price at which the producer sold in June, the producer can simply deliver the oil according to the terms of the futures contract.
Crude oil buyers can similarly hedge their forecast oil needs. Meanwhile, financial traders who have no intention of selling or buying physical oil participate in the futures market, buying and selling contracts at a profit. In doing so, they provide liquidity for both the physical oil and futures markets.
reasons for the change
Declining stocks of North Sea crude oil have caused Brent prices to become less reflective of the overall global market.
Daily traded volumes of the five North Sea crudes that make up the Brent basket have fallen 18% over the past two and a half years.
Texas oil now accounts for a larger share of the world’s oil trade than ever before. Russia’s invasion of Ukraine and subsequent US and European sanctions on Russian oil have boosted demand for US oil. U.S. crude oil exports averaged 3.6 million barrels per day in 2022, a record high and a 22% increase from 2021.
WTI crude, delivered against Brent contracts, accounts for the additional cost of transporting crude to Rotterdam, Holland — the delivery point for the contracts — from the US Gulf Coast as opposed to the nearby North Sea.
Unclear pricing implications
The impact of the change on both US crude oil futures based on WTI and Brent futures remains unclear.
Brent’s global benchmark status means Brent futures typically trade at a premium to WTI futures, but that spread narrowed at the end of April to its lowest level in a year, $2.76 a barrel-to-the-next Date of delivery.
Since then, the range has widened again. The Brent contract for July delivery rose 2.4% to $74.32 a barrel on Thursday, compared with a 2.3% gain for the comparable WTI contract to $70.10.
A narrowing spread usually discourages international buyers from considering WTI crude. Traders will be watching to see if inclusion in the Brent price index changes this traditional relationship.
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