The real price of oil has been a mystery for the past two years. In Europe, the benchmark Brent crude climbed while North America's benchmark, West Texas intermediate, went in the opposite direction. The result was a mismatch between the two that bore no relation to economic reality.
At one point last summer, the difference, or "spread" between the two crudes went to $27 (U.S.) a barrel and there was no shortage of Wall Street smarties, among them Morgan Stanley, who predicted the gap would go to $40 or $50 a barrel. Cue the hedge funds. Having made a killing when the spread went from $10 to $20, they piled in again, expecting the spread to double once more.
Then the market was hit by a bout of sanity (as always happens, given the appropriate lag time). The big crunch came on Wednesday, when the spread, which had eased from its summer peak, narrowed by $4 within minutes as WTI soared. The gap between WTI and Brent is now only about $10 and could halve if new forecasts prove correct. How many hedgies took a beating when this happened? (Remember Amaranth Advisors? In 2006, it got wiped out when its monster bet on natural gas futures suddenly went sour.)
If hedge funds did take losses as the spread collapsed this week, they can blame Canada's Enbridge and the rise of North America as the world's new energy superpower, a remarkable reversal from its old status as a clapped-out oil producer, forever beholden to OPEC to keep the SUVs rolling.
The immediate trigger for the spread crunch was Enbridge, which announced on Wednesday that it had bought ConocoPhillips' stake in the Seaway pipeline and that the pipeline's flow would be reversed. That means the oil will go from Cushing, Okla., (which bills itself as the "pipelines crossroads of the world," should you be in the need of a different sort of holiday) to the Texas coast and its refineries, ending the supply glut at Cushing that had kept WTI prices artificially low.
With Cushing oil about to shed its landlocked status, the world's oil focus could easily revert from Brent to WTI, a seismic shift in the trading and pricing of oil and all the frills that go with them, notably their futures and options contracts.
Brent, which is based on North Sea oil shipments, is the de facto global standard benchmark. It took off in the 1980s, in reaction to soaring North Sea oil production and to Saudi Arabia's effort to impose its own generally higher pricing on the global market. According to the Houston oil consulting firm Purvin & Gertz, Brent and the derivatives that trade off it are the benchmarks for as much as 65 per cent of the world's crude trade.
But Brent no longer deserves that status, especially after Wednesday's spread collapse pushed WTI back into the global spotlight. That's because the North Sea oil is in irreversible decline – production has dropped by about 40 per cent since 1999 – and is turning into fringe product.
WTI's problem is the opposite. Soaring production from the Alberta oil sands and the new oil-rush states, notably North Dakota, where shale oil is taking off, are flooding into Cushing. The glut led to the record $27 spread in the summer. That surplus will fall away when Enbridge reverses the Seaway pipeline next year and new pipelines (possibly including the Keystone XL pipeline from Alberta) snake from the U.S. Midwest to the Gulf of Mexico coast.
At some point, traders will realize that WTI is the better benchmark than Brent because so much oil is being produced in North America. Canada and the United States will become the fastest growing oil-producing region outside of OPEC during the next five years, according to the International Energy Agency, with an estimated rise in output of 1.5 million barrels a day to 15.6 million.
The Financial Times recently reported that many analysts think the United States alone will surpass Saudi Arabia and Russia to become the world's largest producer of liquid hydrocarbons, which includes crude oil and natural gas liquids such as propane and ethane from shale formations. Indeed, U.S. oil production has been climbing since 2009 after almost four decades of relentless declines.
Add in the surging oil-sands production, whose output could easily double to 3 million barrels a day by 2020, and you have a formula for an emerging oil powerhouse (Canada is already the biggest oil exporter to the United States).
With that status will comes some perks, notably the restoration of WTI as the world's most important oil benchmark. To be sure, Brent won't go away without a fight, but as a benchmark, it does seem destined to B-list status. Blame Canada, with a little help from its shale friends in the United States and a Canadian-inspired U-turn on a Cushing pipeline.
Eric Reguly