Investing News

Benchmark Oils: Brent Crude, WTI, and Dubai

<p>Getty Images, David McNew / Staff</p>

Getty Images, David McNew / Staff

Understanding Benchmark Oils

The many types of crude oil and the different sites from which it’s extracted means buyers need an easy way to value the commodity based on quality and location. There are dozens of oil benchmarks, but price is most often pegged to one of three.About two-thirds of all global crude contracts reference Brent Blend. Brent refers to oil from four fields in the North Sea. Its crude is light and sweet—ideal for the refining of diesel fuel, gas and other high-demand products. And since it’s water borne, it’s easy to transport long distances.West Texas Intermediate, or WTI, refers to oil extracted from U.S. wells and sent via pipeline to Cushing, Oklahoma. Being land-locked, WTI is more expensive to ship around the globe. It’s light and sweet, ideal for gasoline, and the main benchmark for U.S. oil.Dubai/Oman is a Middle Eastern crude, slightly lower grade than WTI or Brent. Coming from Dubai, Oman or Abu Dhabi, it has heavier sulfur content, making it more sour. It’s the main reference for Persian Gulf Oil delivered to the Asian Market.Buyers use crude oil futures to lock in prices for months or years and minimize the risk of sudden increases. Those contracts are tied to oil benchmarks. Brent contracts trade on exchanges such as ICE Futures Europe, while WTI contracts are mainly sold on the New York Mercantile Exchange. 

Reviewed by Charles Potters

Open a newspaper and there’s a good chance you’ll find a news story about the price of oil going in one direction or the other. To the average consumer, it’s easy to get the impression that there’s a singular, worldwide market for this crucial energy source; however, this isn’t the case and the quality of crude oil varies around the world, depending on where it’s from. As such, there are a few different classifications of crude oil, each that serves as a different financial benchmark for the substance.

Key Takeaways

  • Crude oil is a naturally occurring liquid made from the remains of animals and plants from millions of years ago.
  • After processing, crude oil is turned into the different oil products we use today, such as gasoline, petroleum, diesel, and more.
  • The different crude oil deposits around the world vary in quality.
  • The three primary classifications of crude oil are Brent, WTI, and Dubai.
  • Brent is from the North Sea, WTI from the U.S. (Texas, Louisiana, and North Dakota), and Dubai from areas in the Gulf region of the Middle East.
  • All three function as benchmarks for prices of oil around the world.
  • These commodities are traded on financial exchanges, such as ICE and CME, via futures.

The Differences in Crude Oil

There are different types of crude oil—the thick, unprocessed liquid that drillers extract below the earth—and some are more desirable than others. For instance, it’s easier for refiners to make gasoline and diesel fuel out of low-sulfur or “sweet” crude than oil with high-sulfur concentrations. Low-density, or “light” crude is generally favorable to the high-density variety for the same reason.

Where the oil comes from also makes a difference if you’re a buyer. The less expensive it is to deliver the product, the cheaper it is for the consumer. From a transportation standpoint, oil extracted at sea has certain advantages over land-based supplies, which depend on the capacity of pipelines. 

Because of these factors, buyers of crude oil—along with speculators—need an easy way to value the commodity based on its quality and location. Benchmarks such as Brent, WTI, and Dubai serve this important purpose. When refiners purchase a Brent contract, they have a strong idea of how good the oil will be and where it will come from. Today, much of the global trading takes place on the futures market, with each contract tied to a certain category of oil.

Because of the dynamic nature of supply and demand, the value of each benchmark is continually changing. Over the long term, a marker that sold at a premium to another index may suddenly become available at a discount.

The Main Benchmarks

There are dozens of different oil benchmarks, with each one representing crude oil from a particular part of the globe. However, the price of most of them are pegged to one of the following three primary benchmarks:

Brent Crude

An estimated 80% of all crude contracts around the world reference Brent crude, making it the most widely used marker of all. These days, “Brent” actually refers to oil from five different fields in the North Sea: Brent, Forties, Oseberg, Ekofisk, and Troll. Crude from this region is light and sweet, making it ideal for the refining of diesel fuel, gasoline, and other high-demand products. And because the supply is waterborne, it’s easy to transport to distant locations.

West Texas Intermediate (WTI)

WTI refers to oil extracted from wells in the U.S. and sent via pipeline to Cushing, Oklahoma. The fact that supplies are land-locked is one of the drawbacks to West Texas crude as it’s relatively expensive to ship to certain parts of the globe. The product itself is very light and very sweet, making it ideal for gasoline refining, in particular. WTI continues to be the main benchmark for oil consumed in the United States.

Dubai

This Middle Eastern crude is a useful reference for oil of a slightly lower grade than WTI or Brent. A “basket” product consisting of crude from Dubai, Oman, and Upper Zakum, it’s somewhat heavier and has higher sulfur content, putting it in the “sour” category. The Dubai benchmark is the main reference for Persian Gulf oil delivered to the Asian market.

Note

Brent is the reference for about 80% of the oil traded around the world, with WTI the dominant benchmark in the U.S. and Dubai influential in the Asian market.


Source: IntercontinentalExchange (ICE)

Importance of the Derivatives Market

Crude Futures

There was once a time when buyers would primarily purchase crude oil on the spot market—that is, they’d pay the current price and accept delivery within a few weeks. However, after the oil crisis of the late 1970s, refiners and government buyers began looking for a way to minimize the risk of sudden price increases.

The solution came in the form of crude oil futures, which are tied to a specific benchmark crude. With futures, buyers can lock in the price of a commodity several months, or even years, in advance. If the price of the reference crude rises significantly, the purchaser is better off with the futures contract. Many futures are settled in cash, although some allow for physical delivery of the commodity.

Brent, WTI, and Dubai futures are available on ICE and CME.

Crude Options

In addition to futures, market participants can also invest in options that are linked to a particular crude benchmark. These derivatives are another important way to help mitigate price risk. Should the value of a certain crude marker skyrocket, the owner of a call option would have the right— though not the obligation—to buy a specific number of barrels at a pre-determined price.

Speculative Trading

However, not all futures or options tied to a crude benchmark are used for hedging purposes. Speculators are also major players in the market, betting that changes to supply or demand will drive the price of certain crude products higher or lower.

Investors can also gamble on what will happen to the difference, or spread, between two benchmarks. Participants typically analyze the fundamentals of a specific oil source and guess whether the gap between two markers will widen or close. Like traditional oil options, these “spread options” are available on major exchanges. 

Trading tends to be particularly heavy when one of the two benchmarks undergoes unusual volatility. For example, NYMEX WTI-Brent spread options on CME Globex experienced record trading volume from 2011 to 2013 after a glut in U.S. crude sent WTI prices in a tailspin relative to Brent.

What Is Made From Crude Oil?

The different products made from crude oil include kerosene, diesel, petroleum, jet fuel, liquefied petroleum gas (LPG), heavy fuel oil, petrochemical feedstock, solvents, and lubricants.

What Is the Difference Between Brent and WTI?

The difference between Brent and WTI crude oil is where they come from and their composition, Brent crude comes from the North Sea and WTI comes from the U.S., primarily Texas, North Dakota, and Louisiana. Additionally, their sulfur content is different, which determines if one is sweeter than the other. WTI has less sulfur than Brent, making it sweeter, and, therefore, easier to refine.

Is Saudi Oil Brent or WTI?

The oil from Saudi Arabia is neither Brent nor WTI. It uses the Dubai/Oman benchmark when it prices its oil but its deposits are not from the Dubai/Oman fields.

The Bottom Line

The market for crude is incredibly diverse, with the quality and original location of the oil making a major impact on price. Because they’re relatively stable, most crude oil prices worldwide are pegged to the Brent, WTI, or Dubai benchmarks.

Read the original article on Investopedia.

Articles You May Like

Revenge of the Apes: 3 Reddit WallStreetBets Stocks That Could Pop Next
Op-ed: How activist investors are deactivating with proxy battle losses
3 AI Stocks to Buy on the Dip May 2024
The 2028 Millionaire’s Club: 3 EV Charging Stocks to Buy Now
3 Tech Stocks You Haven’t Heard of That Can Quadruple by 2026