Trading WTI and Brent 101

CME Group as the exchange of choice

MARCH 19, 2014

Asia Research Team
Research & Product Development

Introducing the Formula Pricing of Crude Oil

Crude oil is not a homogenous commodity. There
are various types of internationally traded crude oil
with different qualities and characteristics. The
light/sweet crude grades usually trade at a premium
over the heavy/sour crude grades.
Crude oil is produced in many different countries.
The pricing for those crude streams is often
determined elsewhere, and each crude oil will trade
as a spread to a core benchmark. This is referred to
as a premium or a discount to a marker crude.
Term or spot sales of crude oil are sold in two ways.
Crude oil may be sold on a fixed price basis.
Alternatively it may be sold on a formula pricing
basis. The formula pricing method links the contract
price of each crude cargo to a benchmark price, and
it is the basis of the current oil pricing system. The
three biggest Crude oil benchmarks are WTI, Brent
and Dubai-Oman.

Brief Description of the WTI and Brent

The WTI contract is the most actively traded Energy

Futures contract in the CME Group suite of Energy
products. The WTI benchmark price is based on a
blended series of crude oils produced in the US midcontinent. Specifically, it is based on the price of
crude oil delivered into Cushing Oklahoma, from the
US Gulf Coast and Upper Mid-Continent, via a series
of inter-connected pipelines.
The Brent is the second futures contract in the CME
suite of oil benchmarks. Unlike WTI, this is a
financially settled Future based on the Brent Index.
The Brent Index represents a basket of reported
prices on the last trading day of the Futures
contract. The reported prices are based on crude oil
production from four different fields in the United
Kingdom and Norwegian North Sea. The main
grades that form the basis of the index are Brent,
Forties, Oseberg and Ekofisk. Collectively these are
known as BFOE.
The WTI and NYMEX Brent Futures contracts are
listed on CME Globex, Clearport and on the NYMEX
Trading Floor. The commodity codes are CL and BZ
respectively.

The West Texas Intermediate (WTI) benchmark is

traded at NYMEX, a wholly owned subsidiary of CME
Group. It is the main benchmark used for pricing oil
imports into the US, and for pricing domestic crude
oil production in North America including Canada.
The WTI is sometimes referred to as Light Sweet
Crude Oil, as it is categorized as a low sulfur sweet
crude oil.

The key highlights of the WTI and Brent contracts

can be found at the end of this report.

Crude Oil Network for WTI

North Sea Crude Complex for Brent (BFOE)

Source of map: EIA

Source of map: EIA

WTI-Brent 101 | March 19, 2014

The third Energy Futures contract listed on CME

Globex is the Oman Crude Oil Futures. This is traded
at the Dubai Mercantile Exchange, in which CME has
a significant stake.

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Crude Oil Demand is Moving East

Role of WTI outside US to be more important

In the 2014 edition of BPs Energy Outlook 2035, the

report confirms what everyone already knows that
energy demand is rising dramatically in the Far East.
By 2035, BP estimated that Asia will account for
70% of inter-regional energy net imports. So the
marginal barrel of crude oil will increasingly be
refined in Asia. This will establish Asia as the key
region for price discovery of crude oil. DME Oman
most closely represents the marginal barrel refined
in Asia-Pacific.
However, the WTI and Brent
contracts are still the most actively traded of all the
major Energy Futures contracts.

In North America, the shale (or tight oil) revolution

could increasingly nudge the US to consider relaxing
restrictions of Crude Oil exports out of the US. If
such a structural change occurs, it would impact the
development of benchmarks in the Atlantic Basin.

Brent benchmark used by Asian producers

Financial participants and commercial players in the

US and Europe are active on the Brent and WTI
crude oil Futures markets. Pricing is embedded
directly or in-directly into physical contracts in both
the upstream and downstream markets.

Brent (more specifically Dated Brent) is the

traditional price reference for crude in Europe and
Africa. Ultimately, price of Brent is established in
Europe. The fundamentals that affect the supply of
BFOE crude are more localized to the North Sea. In
Asia, the Platts Dubai market is more established.
Nevertheless, the Crude oil complex is vast. While
the main flat price discovery process remains in
the hands of a few global crude benchmarks, interlinked markets have developed, to aid the price
discovery process in the physical market. In Asia,
one of the most actively traded spreads is the BrentDubai swap.
Meanwhile, there are increased flows of North Sea
crude into the Asian markets. The global relevance
of Brent has increased in recent years and much of
that growth has been in Asia. Some oil producing
countries in Asia have adopted Brent as the basis for
their crude oil sales, at the expense of Tapis and
Minas.

As a result of the development of tight oil, US crude

oil is becoming very prominent. WTIs role as a
benchmark for Oil is assured. Its role could become
a lot more significant in the future, should there be
changes to the physical trade flows of Crude oil from
North America.

Justification to use WTI & Brent in Asia

The Middle East remains one of the biggest Crude oil
producing regions. However, much of the Crude sold
from the Middle East is under long-term supply
contracts. Practically no spot markets exist, except
for the Platts Dubai-Oman and DME Oman. Currently
the major Middle Eastern crude oil producers set
their Official Selling Prices into Asia based on the
Platts Dubai and Platts Oman assessments. Backed
by strong growth in the traded volumes of Oman
crude, DME Oman is also vying to be the East of
Suez benchmark.
Having said that, price levels of the main crude
benchmarks are set in the futures markets; swaps
and forwards are the financial layers that provide
the link between the price of the futures and the
price of the physical.

Energy* Liquids Consumption by Region

(million tons)
North America
Europe & Eurasia

1990

2000

2012

2015E

923

1,062

1,017

1,014

1128

929

880

854

Middle East

174

243

376

395

Asia Pacific

665

999

1,389

1,460

Source: BP Energy Outlook 2035 (* includes all oil liquids)

WTI-Brent 101 | March 19, 2014

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Price Reporting Agencies such as Platts, Argus, ICISHeren actively assess the values of the spot market.
Spot markets usually trade relative to a benchmark,
and will adjust relative to the benchmark, depending
on supply and demand of the physical. The WTI and
Brent are the most liquid crude benchmarks.

WTI and Brent Trading 101

Trading WTI and Brent on CME Globex

The crude oil that is extracted from the ground in

Texas is not the same as the oil extracted from the
North Sea. The crucial differences are density (called
the API gravity) and the sulfur content (which is
what the market is referring to when talking about
sweet and sour crudes). Traders will price the
different types of oil on the world market based on
these factors, against the WTI and Brent benchmark
grades.

NYMEX WTI (Commodity code CL) is a deeply liquid

futures contract and remains a core benchmark for
the entire Americas and Canadian regions. The
contract is traded on CME Globex. A series of OTC
contracts based on WTI, or as spreads to WTI, have
been listed for clearing on CME Clearport.

WTI traditionally traded at a small premium to

Brent. This is because WTI is sweeter and lighter
than Brent, and because the US was historically the
marginal consumer of crude. However, changing
global demand patterns and geopolitical factors have
caused Brent to be priced significantly higher than
WTI for long periods since the global financial crisis.
Such events have included the recent Libyan crisis,
the Iranian nuclear stand-off, the Asian imports of
North Sea crude, the Japanese nuclear issues, and
localized factors such as the logistical constraints in
the US mid-continent.

NYMEX Brent (Commodity Code BZ) is arguably

more representative of the international price of
Crude Oil. The BZ contract is financially settled
based on the ICE Brent Future, and is homogenous
with the ICE contract. This means that a trader can
hedge an open position on ICE by using BZ on CME.
There is no risk of disconnection between the two
markets.
BZ is listed on CME Globex and a series of Brent
related derivatives contracts are listed for clearing
on CME Clearport. BZ futures volumes have grown
rapidly since it was re-launched on CME Globex in
January 2013. The average daily volume (ADV) is
currently around 50,000 lots. There is a wide mix of
customer segment involved on a daily basis and
volumes represent about 7% of the volume traded
on ICE Brent Crude Oil Futures. Open Interest, a
measure of the number of open contracts in the
market was 60,000 lots in January 2014.

Brent Crude Oil Last Day Financial Futures (BZ)

Average Daily Volume and Open Interest

Light Sweet Crude Oil (WTI) Futures

Average Daily Volume and Open Interest

70,000

1,500,000

Number of Lots

1,000,000
500,000

Open Interest

50,000
40,000
30,000
20,000
10,000
-

Nov-13

Jan-13

Jun-13

Aug-12

Oct-11

Mar-12

May-11

Jul-10

Dec-10

Feb-10

Apr-09

Sep-09

Jun-08

Nov-08

60,000

Jun-08
Oct-08
Feb-09
Jun-09
Oct-09
Feb-10
Jun-10
Oct-10
Feb-11
Jun-11
Oct-11
Feb-12
Jun-12
Oct-12
Feb-13
Jun-13
Oct-13

Number of Lots

2,000,000

ADV (Barrels per Day)

Open Interest

Source: CME Group

ADV (Barrels per Day)

Source: CME Group

Key Characteristics of Crude Oil Benchmarks

Crude Oil Futures Traded on CME Globex

Benchmark

WTI

Brent

Dubai

Futures

WTI

Brent

WTI-Brent

API Gravity

39.6

38.06

31

Product Code

CL

BZ

CL-BZ

Sulfur Content

0.24%

0.37%

2%

Settlement Type

Physical

Financial

Financial

WTI-Brent 101 | March 19, 2014

| CME GROUP

WTI vs Brent is a Popular Spread Trade

Cost Benefits of Trading the Spread on Globex

The WTI-Brent spread (CL-BZ) can also be traded on

CME Globex as a single instrument. Trading the
spread on Globex is straight forward and reduces
the likelihood of only trading one side of the spread
without the other (legged). This means that you
will not get filled on one leg of the trade at one
price, and get filled on the other leg of the trade at a
later time, when the price has moved against you.

There are also transaction costs benefits of trading

the WTI and Brent on CME Globex. NYMEX Brent is
FREE there are no exchange fees for screen
trading. This means that where a WTI-Brent spread
trade (CL-BZ) is done, no fee is charged on the
NYMEX Brent leg of the spread trade.

The advantage of trading the spread on CME Globex

is that our implied engine increases the chances of
fulfilling an order, and makes inter-product
spreading simple. Because the calculation is done on
our matching engine you cannot get legged.
Both the WTI and Brent have been observed to be
very responsive to macroeconomic news and
movements in foreign exchange. Thus there is great
interest amongst investors to trade not only the
outright WTI and Brent prices, but also the WTIBrent spread.
There are many articles which talk about the trading
of Brent futures, WTI futures as well as trading the
WT-Brent price spread futures. So this article will
refrain from repeating the trading strategies here.
Instead, the article will illustrate the macroeconomic
developments which have provided traders with
opportunities to carry out WTI-Brent spread trades
in the recent past.

Our objective is to incentivize traders when they

intend to trade spread products between NYMEX
Brent and CME Groups other Energy benchmark
products, such as the WTI and the DME Oman.
There are also benefits of Margin Offset for spread
trading of NYMEX products. For firms running sizable
spread positions, the benefits of margin offsetting
are significant. Typically, youll receive 80% margin
discount on spread positions between our major
products, such as Brent and WTI.
As the table illustrates, you could potentially save
80% in initial margin, and 90% in trading fees on a
WTI-Brent spread trade, when both legs are done on
CME Globex.
Margin offsets apply, not only between crude oil
spreads, but also for spreads between Crude and
Refined products if you are trading a crack-spread.
There are other incentive schemes related to the
trading of crude oil products. Please contact us for
more information.

Example of Margin Offset Benefit:

Initial Margin on a 200 lot WTI-Brent Spread

WTIICE Brent

USD 1,200,000

WTINYMEX Brent

USD 264,000

Trading Fee for a 200 lot WTI-Brent Spread Trade

Each leg on a different exchange

USD 432

Both legs on CME Globex

USD 30

Source: CME Group

WTI-Brent 101 | March 19, 2014

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Recent Developments affecting WTI-Brent

Trading the WTI and Brent Forward Curves

While the markets generally assume that the WTI

and Brent benchmarks would move in tandem with
one another, they have on several occasions in the
past, diverged from each other due to regional
political and macroeconomic conditions.

There are also ample opportunities to trade the

forward curves on the individual benchmark futures.
As the chart shows, the WTI forward curve has
exhibited changes in shape along the curve, such as
the steepening from January 2013 to August 2013.
The WTI forward curve has also shown parallel
shifts, such as the price decline along the entire
curve between August 2013 and January 2014.

For example, from early-2011 to mid-2012, the

crude oil revolution in the US and Canada boosted
production
capacity.
As
a
result,
logistical
constraints developed in Cushing. This caused the
spread between WTI and other crude oils to widen to
more than $10 (it hit a high of $27 in October
2011). After the pipelines at Cushing were reversed
and the logistics in the US Mid-West normalised, the
WTI-Brent spread narrowed again, to almost parity
in August 2013.
By November 2013, the spread widened again when
production in the North Sea was interrupted. And
more recently, gunmen blew up a pipeline in Iraq.
This caused the WTI-Brent spread to widen to $15
currently.

It could be argued that the first illustrated shift is

due to the easing of the pipeline flow at Cushing,
thus enabling the WTI spot price to increase. As the
backwardation steepened, the cost of carry also
became less. The second illustrated shift could
arguably be the result of the structural increase in
oil exports from the US as a result of the shale
revolution. So there are opportunities to trade on
the WTI and Brent futures individually.

Disruptions in North Sea supply have repeatedly

boosted Brent prices over the past year. Meanwhile,
the increase in output of WTI crude, combined with
the unlocking of tight oil in the US is causing the
price of WTI to be depressed. Volatility in the WTIBrent spread will probably provide ample trading
opportunities over the short to medium term.

Data source: Bloomberg

Data source: Bloomberg

Data source: Bloomberg

WTI-Brent 101 | March 19, 2014

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Conclusion

Contracts at a Glance

CME Group is the exchange of choice for trading

crude oil derivatives. We have futures contracts on
all the major oil benchmarks WTI, Brent (and DME
Oman).

NYMEX Light Sweet Crude Oil (WTI)

There are significant transaction and margin cost

savings for carrying out the WTI-Brent spread
trading, as well as the WTI and NYMEX Brent
outright futures trading, on the CME Globex
platform.
The futures and associated spread contracts on
these crude oil products are traded on CME Globex
with excellent liquidity. For more information on the
products and incentive schemes, please contact Alan
Bannister
(Alan.Bannister@cmegroup.com)
or
Patrick Chan (Patrick.Chan@cmegroup.com).

Commodity Code

CL

Contract Unit

1,000 barrels

Minimum Fluctuation

$0.01 per barrel

Settlement Type

Physical (Cushing)

Available Option Types

American style, calendar spread,

crack spreads, average price,
European style and daily

NYMEX Brent Crude Oil Last Day Financial Future

Commodity Code

BZ

Contract Unit

1,000 barrels

Minimum Fluctuation

$0.01 per barrel

Settlement Type

Financial

Available Option Types

American style, calendar spread,

European style

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their lifestyles. And only a portion of those funds should be devoted to any one trade because they cannot expect to profit on every
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should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to
any one trade because they cannot expect to profit on every trade.
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WTI-Brent 101 | March 19, 2014

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