London, 12 January 2011

Standard Bank: The front month WTI/Brent spread settled at $6.50/ bbl on Tuesday, the lowest level since February 2009 and amid the height of financial crisis. For the most part of 2010, WTI traded at a discount to Brent, with the average of the spread for 2010 as a whole, coming in at negative $0.76/bbl.

There have been three main reasons that have put pressure on the spread. Firstly, US demand had been lagging behind the emerging markets, whose imports are more likely to be priced on a Brent basis. Secondly, Cushing continues to be constrained by its landlocked location. Thirdly, the flow of investment money is shifting from WTI to Brent.

Since April 2010, Cushing crude inventories have remained at historically high levels. Our storage model suggests the build in Cushing inventory is also set to continue, given the positive return on storage for WTI. In addition, the Phase Two of the Keystone project is expected to come into operation during Q1 this year. It will increase the crude pipeline capacity from Canada to Cushing. According to the DOE, Cushing has a storage capacity of 45.8mb as of 30th September 2010, versus the current 36.6mb current inventory level. However, it has been reported that Cushing capacity should be as high as 56mb.

With the increasing liquidity in Brent, many major commodity indices increased their exposure to Brent at the expense of WTI. The on-going annual re-balancing of the S&P GSCI is set to raise the contract production weighting in Brent by 6.3%, from 5,889 to 6,263, while reducing that of WTI by 3% from 14,756 to 14,314. The much stronger term structure in Brent is also another attraction to passive investors, in terms of avoiding roll yield losses.

The latest outage of Trans-Alaska pipeline predominantly affects refineries around the West Coast of the US, whose alternative crude imports are priced mostly on a Brent and Oman related basis. This is yet another factor reinforcing the relative weakness of WTI versus Brent.

The spread is likely to narrow when the Trans-Alaska pipeline returns to normal services. However, the spread will nevertheless remain under pressure for the coming months due to slow pick-up in US demand and Cushing storage constraints.

Ends --

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