By Luke Jeffs
Brent has been the international crude oil benchmark for decades but a recent change to the make-up of the North Sea barrel will likely affect how firms trade and hedge the commodity.
Commodity index firms Platts and Argus added on May 2 West Texas Intermediate (WTI) Midland to the basket of crude oils used to calculate Brent for deliveries dated June 2023, the first time a US barrel has contributed to the European benchmark.
This decision is not particularly controversial, and came after two years’ of consultation by the index firms that involved the world’s top oil producers, users and traders.
The problem is the North Sea fields that were being used exclusively to calculate the price of Brent have been drying up for decades, raising questions about the long-term viability of Brent as the international standard.
The inclusion of WTI Midland, a seaborne light sweet crude similar to Brent, is a neat solution then, as US crude exports have increased over recent years and particularly in the past 18 months as Europe has cut its reliance on Russian energy.
Joel Hanley, global director of Crude & Fuel Oil Markets at S&P Global Commodity Insights, said: "The addition of WTI Midland, the first non-North-Sea oil into the Brent complex marks an important milestone in the more than 35-year history of the Platts Dated Brent benchmark.
“Dated Brent has long been the marketplace's chosen global yardstick against which other grades of oil are measured. Its continued evolution to reflect six crude grades shows its ability to adapt to changing market fundamentals and serve global markets well into the future."
More controversial than the decision to change the make-up of Brent, however, is what it means for trading flows in the coming months and years.
Intercontinental Exchange’s ICE Futures Europe is home to the Brent crude oil futures contract which traded 19.6 million lots in April, according to that group. ICE Futures Europe, based in London, also has a smaller WTI market, including a physically-delivered WTI Midland contract underpinned by 4 million barrels of supply capacity into two terminals.
The New York Mercantile Exchange, part of CME Group, is the main market for the WTI Cushing crude barrel, the US standard that traded over 15 million lots in April, according to the exchange.
NYMEX also has a cash-settled WTI Midland contract, various Brent crude oil products and spreads between Brent, WTI Midland and other WTI products.
Interestingly, both firms have reported increased demand for their oil products in recent months.
Intercontinental Exchange said in late May open interest in its Brent crude oil futures and options is up 32% this year to over 5 million lots and average daily trading volume in the European crude benchmark is now 1.2 million contracts.
CME Group said at the same time open interest in its futures linked to the US WTI benchmark passed 500,000 contracts for the first time on Friday May 19.
The Chicago-based group also said open interest in its Argus contracts has increased almost 50% this year as the market has prepared for the inclusion of the WTI Midland barrel in the Dated Brent complex.
Jeff Barbuto, global head of oil markets at ICE, said the inclusion of WTI Midland in the Brent complex has given the North Sea standard a new lease of life: “We are bullish about this development which comes after several years of consultation by Platts and ICE to ensure that we understood correctly the market feedback. Now we are up and running, and Midland cargos are being delivered into dated Brent, Brent now has more than double the physical capacity underlying the derivatives contract based on an extra million or so extra barrels of WTI Midland, which is ultimately good for Brent.”
He added: “Brent has been evolving for decades and it is clear that Brent has retained its global benchmark status as a waterborne crude with ample supply and natural outlets to anywhere in the world.”
Peter Keavey, managing director, global head of energy and environmental products at CME Group, agrees the Brent change is timely: “When Brent had a reduced underlying physical capacity, something had to be done to make Brent more robust but I would tend not to draw any major conclusions at this stage because most of what is happening is a validation of the pattern of the last few years.
“Imports of WTI into Europe did not start this month, rather they have been ongoing for years. The Price Reporting Agencies (PRAs) will tell you that WTI sets the incremental price the majority of the time so this just validates what is already happening,” Keavey added.
CME said traders have reacted to the Brent change by trading more WTI products generally, so that is WTI Cushing, the US domestic barrel, and the WTI Midland.
Keavey said: “Average daily volume and open interest have grown both in the underlying WTI Cushing global benchmark but also in the Gulf Coast trade. We have two major financially-based Argus Gulf Coast crude contracts - WTI Midland and WTI Houston. We launched those in 2018 when the pricing of US exports became much more important.”
He added: “They were stable for several years but they have grown significantly over the last six months to the extent that they have now passed 500,000 lots of open interest. That means the third largest crude oil trading market in the world today is the US Gulf Coast.”
Barbuto says ICE Brent has taken a small market share from WTI Cushing this year: “If we look at the market share statistics, Brent’s market share compared to WTI Cushing has increased from about 50% at the end of last year to 56% in May, reflecting the clear move away from WTI Cushing towards Brent.”
ICE's global head of oil markets is also keen to stress that it is WTI Midland not WTI Cushing that delivers into the Brent barrel. “When we talk about WTI, most people think of WTI Cushing which is a blend of domestic crude grades delivered into Cushing, Oklahoma. What is being delivered here is WTI Midland which is a very different, light sweet crude delivered directly from Midland, Texas in the Permian Basin to the USGC for either export or to domestic refineries.”
Barbuto said ICE is seeing more firms taking physical delivery through the ICE Midland WTI (HOU) contract as well as an increase in the use of Exchange for Physicals.
Keavey said the change to Brent solidifies the US’ status “not just as a major exporter but also as the freely traded marginal pricing barrel”. He added: “This is a developing market. This change is new but it has been talked about for a long time. The most obvious outcome is that it positions WTI as the price-setting physical and financial grade for crude.”
The CME Group global head of energy and environmental products concludes by suggesting the Brent change has attracted more attention because of global macro-economic factors. “There is an enormous amount of interest today because there are geopolitical concerns, in Europe for example, as well as economic concerns out of Asia so there has been an increase in macro-event management tools such as short-term options, which are our fastest growing product,” Keavey said.
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