Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

It's that special time of the year when world leaders come together for the sole purpose of bringing Manhattan to a state of total gridlock. Yet, as you may have heard, the divide between America and the rest of the world looks wider than it has in years.

That's right, we're talking crude oil spreads. The front-month Brent contract -- the international benchmark -- is trading more than $5 a barrel above West Texas Intermediate, the biggest premium since the summer of 2015:

Disunited Nations
Brent's premium to the U.S. benchmark oil price is at its highest level in more than two years
Source: Bloomberg

That isn't all. The two benchmarks appear to be expressing fundamentally different views about the state of supply and demand.

The Brent futures curve is sloping downward -- called "backwardation" in industry jargon -- indicating a tighter balance. WTI, meanwhile, is sloping upward, with near-term futures trading at a marked discount to those dated further out.

You can see the difference here in this chart showing the spread between the six-month and first-month futures for both benchmarks:

Black Mirror
Longer-dated Brent futures now trade at a premium to the first month, while the shape of the WTI curve is the opposite
Source: Bloomberg
Note: Spread between sixth-month and first-month futures prices.

This is partly due to the market's hangover from Hurricane Harvey. As of Tuesday evening, five of the 20 refineries affected by the hurricane were still not running or in the process of getting back into production, according to IHS Markit.

In its weekly update, released Wednesday morning, the Energy Information Administration said Gulf Coast refineries ran at 73 percent of their operating capacity last week, up from 61 percent the week before but still below the 90 percent-plus levels that would be normal at this time of year.

Less refining means less use for crude oil. Disruption to ports like Corpus Christi has also slowed exports. Hence, last week saw another 4.6 million barrels of crude flow into storage tanks. Since the last week of August -- coinciding with Harvey's landfall -- 15 million barrels have gone into storage, representing a reversal of about a fifth of the fairly sustained outflow that's taken place since the end of March.

That hurricane-inspired glut, and the availability of cheap storage after all the outflows, explain's WTI's weakness.

Conversely, fewer U.S. barrels are heading onto the global market, and OPEC is steadily pushing out the potential timeline for its supply cuts, which have helped to drain stocks outside of the U.S. in particular (and where storage, especially on tankers, is usually more expensive anyway). And positive revisions to global economic growth, such as by the International Monetary Fund in July, have centered on Europe and Asia rather than the U.S.

Taken altogether, this explains why the international Brent benchmark has risen and its curve now slopes down.

Barring any unforeseen hit to demand, and assuming OPEC's next meeting with fellow cutters later this week is a non-event, what happens next depends to a large degree on WTI and the U.S. exploration and production industry tied to it.

As I wrote here, Harvey's impact highlighted the re-emergence of the U.S. as a big swing factor in the global oil trade and its relative resilience to Atlantic storms compared with a decade ago. Exports of crude oil, while subdued compared to this summer's levels, recovered further last week toward the million-barrels-a-day mark. With Brent commanding almost $6 a barrel more than WTI, anyone able to get their barrels to the coast and ship them overseas would be crazy not to do so.

That alone should help to close the spread somewhat. The other factor brings us back to those WTI futures.

The whole curve now trades above $50 a barrel and is actually backwardated from mid-2018 through 2020:

Nifty Fifty
The WTI futures curve is now firmly embedded above the important $50 level
Source: Bloomberg

This is a marked shift upward from a month ago; and, as I wrote here, that $50 level tends to be a threshold above which U.S. E&P firms start to hedge future production -- which could inject renewed impetus into production growth.

That, more than anything, would start to weigh on Brent prices, as concerns about frackers drilling -- and, especially, completing -- wells re-emerged. Late October and early November will be an especially telling period as Harvey's impacts will be far behind the industry and E&P firms will be updating investors on their growth plans and hedging books as they report third-quarter results.

If Brent is to make a run at $60 a barrel, the corollary would be a WTI price of at least $55, with 2018 futures nudging $60 themselves -- a relative windfall for anyone in West Texas. That essential linkage in the market suggests international exuberance would be tempered by the American variety, and possibly quite quickly.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in New York at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net