Brent –NYMEX spread reflects localized market dislocations

The NYMEX crude oil contract reflects the price of WTI delivered to Cushing Oklahoma. Brent is a international reference for North Sea oil that is closer to the light sweet crude coming out of Saudi Arabia. WTI delivery is to a land-locked delivery point tied to a pipeline intersection. It is hard to get oil out of Oklahoma and to the coast so that it can be sold on the international market. Hence, if there is a strong increase in US onshore production as well as more oil coming down from Canada it cannot leave the US. The result is oversupply and a dislocation relative to other oil prices. In fact, the price of oil along the gulf coast better reflects the international price and not the NYMEX price.

In politics, it is often said that everything is local. The same may be said for commodities. Regardless of what is going on in the macro economic environment. Futures will have a localized component that can dominate the broader demand and supply for a commodity. This is one of the key reasons for why contract specifications are so important in the futures markets. The failure of futures contracts will often be associated with contract deliver issues which causes wide fluctuations in the basis of difference between cash and futures.

We expect that this differential will not go away anytime soon, so there is an opportunity for new futures markets to develop. The chance of failure is high, but there will be a growing demand for new options. This dislocation of the US market from the rest of the world also occurs in natural gas. Oddly, all of this fragmentation between the US and the rest of the world is occurring at a time when the rest of the world is becoming more dominant to commodity markets.