How the crude oil market works: Brent and WTI

Why there are two benchmarks and not one 

Crude oil is not one substance. It comes out of the ground with a different density, a different sulphur content and a different yield of usable products at every field, and a refinery configured for one crude runs poorly on another. A market cannot quote a price for a good it cannot define, so the industry solved the problem by nominating reference grades: a precise specification, at a precise delivery point, against which every other barrel in the world is priced at a stated premium or discount. Two of those reference grades became dominant, and the catalog carries both as Crude Oil Brent and Crude Oil WTI.

Brent refers to a basket of light, low sulphur crudes produced in the North Sea and loaded onto ships. Its defining property is that it is waterborne: a cargo priced against Brent can be sent anywhere with a port, so the benchmark is naturally international, and the great majority of internationally traded crude is priced by reference to it. WTI, short for West Texas Intermediate, is a light, low sulphur North American crude whose futures contract is delivered into a tank farm at an inland town in Oklahoma. Its defining property is the opposite: it is landlocked, so a barrel of it must be moved by pipeline or rail before it can reach a ship.

A third reference matters to the Gulf and is worth naming even though it is not quoted here. Crude sold east from the Middle East is conventionally priced against a Dubai and Oman assessment reflecting medium, higher sulphur grades, and the major regional producers publish an official selling price each month expressed as a differential to that assessment. That is the mechanism by which a benchmark that trades in London or New York reaches a cargo loading in the Gulf.

What the gap between them measures 

The two benchmarks are similar crudes, so the difference between their prices is not principally a difference of quality. It is a difference of location, and it settles at roughly the cost of moving a barrel from where the cheaper benchmark sits to where the dearer one is wanted. When North American production rises faster than the pipelines that carry it to the coast, barrels back up inland, the landlocked benchmark trades at a discount, and the discount widens until it becomes worth paying to move them. When export capacity is ample the gap narrows toward the freight cost alone.

Who trades it 

• Producers, from national oil companies to independent operators, selling forward production that has not yet been lifted in order to fix a price against a development that has already been paid for.
• Refiners, who buy crude and sell products, and whose exposure is to the difference between the two rather than to the level of either.
• Physical trading houses and shipowners, arbitraging the difference between locations and grades, whose chartering decisions turn a price differential into an actual movement of barrels.
• Industrial and transport consumers, principally airlines, shipping lines and hauliers, hedging a fuel cost they cannot avoid.
• Financial participants: funds, index investors and speculators taking the other side of the hedges and providing most of the visible depth.

What moves it 

Supply decisions taken collectively by the largest exporting states are the single most consequential scheduled input. The producer group and its allied countries meet on a published calendar and announce production targets, and both the announcement and the observed compliance with previous targets are read closely, because a stated target and delivered barrels are different quantities. Spare capacity, meaning the volume that could be brought back quickly, is watched alongside the targets: a market with ample spare capacity absorbs a disruption, and a market without it prices one.

Inventory data is the second pillar, and it arrives weekly. United States statistical agencies publish commercial crude stocks, stocks at the benchmark delivery point, refinery utilisation, and product inventories on a fixed weekly schedule, with an industry body publishing its own estimate the evening before. Those releases are the most reliably market moving recurring events in the energy calendar, and the convention is to read the change against expectations rather than the level, together with the composition, since a build in crude alongside a draw in products describes a different situation from a build in both.

Demand enters more slowly and is inferred rather than published in real time, through refinery runs, product cracks, freight rates and the industrial data of the largest importing economies. Geopolitical events affecting production or the shipping routes that carry it, particularly the narrow straits through which a large share of seaborne crude passes, price a probability of disruption rather than an actual loss of barrels, which is why such moves can reverse quickly when the disruption does not materialise. The dollar acts on crude as it acts on every dollar denominated commodity, by changing the cost to a non dollar buyer without any change in the dollar price.

The curve, the expiry and the roll 

Crude is traded overwhelmingly in dated futures, so the reference price is a series of monthly prices rather than a single one. Storage of oil is expensive and physically limited, which makes the curve informative: when nearby months trade above later ones the market is signalling scarcity now, and when later months trade above nearby ones the shape reflects the cost of storing and financing barrels until then. Because storage capacity has a hard ceiling, an oversupplied market can push nearby prices far below later ones, and in one well documented episode an expiring North American contract settled below zero as holders faced delivery with nowhere to put the barrels.

Every futures contract has a last trading day, so an exposure intended to persist beyond it is moved into the following month at that month's price. The cost or credit of that transfer is set by the shape of the curve, not by any view about direction, and it accrues to a continuously held position regardless of whether the price of oil has changed at all.

When it trades 

Both benchmarks trade electronically for the great majority of the day, from the Sunday evening open through to the Friday close, with a daily maintenance break, and the precise session for each instrument is published in its contract specifications rather than being a property of the commodity. Activity concentrates in the European morning, when the physical crude market assesses cargoes, and again in the North American morning, where the weekly inventory release falls. Depth thins in the Asian afternoon, and quoted spreads widen with it.

How a CFD on crude oil settles 

A contract for difference on a crude benchmark references its price and settles in cash. No barrel is lifted, no tank is filled and no delivery obligation arises at any point. The difference between the opening and the closing price is multiplied by the number of barrels the contract covers, and that amount passes between the two parties. Quotes are in US dollars per barrel, and the smallest quoted increment is conventionally one cent.

Profit and loss is calculated on the full notional value while only a percentage of it is posted as margin, so an adverse move is measured against the whole contract and a loss can exhaust the margin posted entirely rather than being limited to it. A favourable move is measured on identical terms. Energy contracts move further in a session than most currency pairs, and margin requirements on them are commonly set accordingly.

Where an oil instrument is written on a dated futures month, it inherits that month's last trading day: it is closed at the prevailing price on the stated date or rolled into the following contract, and that date is published in the instrument's specifications rather than chosen by either party. Where it is written as a continuous contract with no stated expiry, the roll is applied as an adjustment while the position remains open, so the economics of the roll are carried either way. A position held past the daily cut off also carries a financing adjustment for each day it stays open.