Is Oil Signaling a Bullish Turning Point?

In today's Daily Market Commentary webinar, I was asked a very interesting question. "Does the difference between WTI oil and Brent oil prices tell us anything about the future?" 

The recent slide in oil prices started on May 22 and accelerated on the 25th after news that Russia and OPEC may increase production sooner than expected in 2018. Additionally, news that the U.S. administration has requested OPEC to increase production by 1 million bbl/day kept some pressure on the commodity this week as well. However, some traders would point to the spread between West Texas Intermediate (WTI) oil prices and Brent crude prices as evidence that oil is near a bottom — but does the historical evidence back that up? (See also: What is the difference between Brent Crude and West Texas Intermediate?)

WTI was trading at a significant discount ($65.52) to Brent crude prices ($75.38) at the close on Tuesday and was even wider last week. It hasn't been this wide in dollar-terms since 2015. The current ratio between the two benchmark prices (around a 13% discount) hasn't been this wide since February 2016, which was a major bullish turning point for oil prices.

We hate to disappoint, but this looks like a classic type-1 error of detecting a predictive relationship between the spread and subsequent oil price movement. Historically speaking, there isn't a lot of evidence that a large spread has anything to do with emerging demand or rising prices. The spread was much wider than it is now during most of 2011-2013. During that period, oil prices were elevated, but they didn't continue rising with the spread. 

There are a number of factors that can create a differential between WTI and Brent, but one of the most significant is that WTI is priced at a landlocked delivery point in Cushing, Oklahoma. There is still a big bottleneck in getting oil from the middle of the U.S. to the ports on the Gulf. As inventory levels in Oklahoma and Texas rise, the price will fall. It's not a new problem, but it helps to explain the real cause of the wide spread we have seen over the last few days. If production is high, and transportation is crowded, the price of oil in the U.S. will fall relative to Brent because it gets stuck. That is not necessarily a good thing for oil prices and may be a problem for the companies paying to store the commodity while they try to get it to the coast.