While North American oil producers are relieved to find oil prices off their lows of the year, their European counterparts are sitting in a much better position.
That's because the price of Brent crude futures, an international benchmark, has surged by 30 per cent to above $60 a barrel (U.S.) since hitting its trough in mid-January. West Texas intermediate futures, the North American benchmark, bottomed out two weeks later and have risen by half as much, to trade around $50 a barrel.
Historically, WTI has traded at a slight premium to Brent because it has less sulfur and is therefore less costly to refine. However, the land-locked nature of the North American benchmark, coupled with the shale revolution, has flipped this relationship on its head.
The supply glut in North America has shown few signs of slowing. On Wednesday, the U.S. Energy Information Administration reported that commercial crude inventories rose by 10.3 million barrels in the last week of February, the largest build in nearly 14 years. Cumulative stockpiles total nearly 450 million barrels, their highest level for the first two months of the year in at least 80 years.
"The widening spread between the two oil price benchmarks is nothing but bad news for Canadians," Bank of Montreal senior economist Benjamin Reitzes said in a note. "WTI [and closely linked but further discounted Western Canadian Select] is the price used for most Canadian oil exports. Indeed, Brent accounts for only about 5 per cent of exports."
A relaxation of U.S. restrictions on crude oil exports would be a potential "black swan" for this spread. Indeed, news that Petroleos Mexicanos was discussing importing 100,000 barrels of crude a day from the United States with the Commerce Department led to Brent's premium to WTI briefly turning negative on Jan. 13.
However, most experts believe the gap between Brent and WTI is set to grow in the near term.
"We would expect the spread will stay where it's at or widen into the second quarter," said Jackie Forrest, vice-president at Calgary-based private equity manager ARC Financial Corp.
A slowdown in U.S. oil production would be a likely prerequisite for WTI to make up ground on Brent.
In the event that the gap between Brent and WTI stayed wide, one would expect the top-line results of oil companies who realized the superior price to hold up better – and for these stocks to outperform those of their peers who sell in WTI.
"Canadian energy companies are for sure discounting a narrowing of the spread, more with WTI playing catch-up to Brent," said Martin Pelletier, portfolio manager at TriVest Wealth Counsel. "But with the current situation of supply builds and that being reflected in storage, there's a greater chance of it widening further than narrowing."
Mr. Pelletier highlighted Vermilion Energy Inc., which has much of its asset base outside North America, as a name that stood out among Canadian energy companies as a beneficiary of a material price differential between the two grades of oil for a prolonged period.
While there are a number of other firms that have a majority of their operations overseas, most of these locations come with a large amount of political risk attached.
Whether the stock market discriminates between companies who sell in Brent or WTI depends upon whether investors believe this phenomenon is sustainable.
"How the equity markets view this development is uncertain," said Ms. Forrest. "It's possible that they see through it as a temporary development."