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Jan 25, 2024

World's Top Oil Futures Contract Adds U.S. Benchmark

U.S.-based West Texas Intermediate is factored into the price of Brent crude

U.S.-based West Texas Intermediate is factored into the price of Brent crude contracts for the first time

Joe Raedle / Getty Images

For the first time, the world's most liquid crude oil futures contract is being priced with U.S. oil.

Crude oil futures contracts based on the ICE Brent Index include prices for West Texas Intermediate (WTI) Midland crude as of June 1. The inclusion marks the first time Brent crude prices, considered the benchmark for global oil markets, will account for the price of oil produced outside the North Sea.

WTI, a light sweet crude similar to the five types of North Sea crude currently comprising the Brent basket, has served as the benchmark for domestic oil since U.S. oil futures began trading on the New York Mercantile Exchange in 1983.

Today, about 80% of all oil market transactions are priced as Brent crude. The inclusion of oil from the world's largest economy and largest oil producer should make Brent a truer measure of global oil prices.

Oil futures contracts play a key role in global markets and are based on cash market oil prices, meaning the price of physical oil being delivered to a certain destination. Oil futures allow suppliers and buyers of physical oil to hedge the cost of their deliveries, protecting them from price fluctuations.

For instance, a crude oil producer in June can sell a futures contract for September delivery and receive immediate payment. In September, if the cash market price for crude oil exceeds the futures contract price received three months earlier, the producer can sell its physical oil to an unrelated cash market buyer, such as a refinery.

The producer then can use the proceeds of the cash market sale to repurchase the futures contract it sold, closing out that trade and pocketing the difference between the two.

However, if the cash market price in September falls short of the futures price at which the producer sold in June, the producer simply can deliver the oil according to the terms of the futures contract.

Buyers of crude oil can hedge their expected oil needs in a similar fashion. Meanwhile, financial traders with no intention of selling or acquiring physical oil participate in the futures market, buying and selling contracts for a profit. In the process, they provide liquidity to both physical oil and futures markets.

Falling supplies of North Sea crude have made Brent prices less reflective of the entire global market.

Daily trade volume of the five types of North Sea crude composing the Brent basket has fallen 18% in the past two-and-a-half years.

Meanwhile, Texas oil makes up more of the global oil trade than ever before. Russia's invasion of Ukraine and subsequent U.S. and European sanctions on Russian oil have boosted demand for U.S. oil. U.S. crude oil exports averaged 3.6 million barrels per day in 2022, a record high and a 22% increase from 2021.

WTI crude delivered against Brent contracts will take into account the extra cost of shipping crude to Rotterdam, Holland—the delivery point for the contracts—from the U.S. Gulf Coast as opposed to the nearby North Sea.

The impact of the change on both U.S. crude futures based on WTI and Brent futures remains unclear.

Brent's global benchmark status means Brent futures typically trade at a premium to WTI futures, but that spread narrowed to its lowest level in a year, $2.76 per barrel for the nearest delivery date, in late April.

Since then, the spread has widened again. The Brent contract for July delivery rose 2.4% Thursday to $74.32 per barrel, compared with a 2.3% gain to $70.10 for the comparable WTI contract.

A narrowing spread usually discourages international buyers from considering WTI crude. Traders will eye whether its inclusion in the Brent price index alters that traditional relationship.

Intercontinental Exchange, Inc. "Brent Crude."

U.S. Energy Information Administration. "What countries are the top producers and consumers of oil?"

Reuters. "Explainer: Will WTI Midland's inclusion in dated Brent affect oil markets?"

U.S. Energy Information Administration. "In 2022, U.S. crude oil exports increased to a new record, 3.6 million barrels a day."