London, 22 February 2011

U.S. crude prices have started to catch up with Europe and Asia despite worsening violence and instability spreading across the Middle East -- a sign the arbitrage flow rather than geopolitical risk is reasserting itself as the most important driver of the Brent-WTI spread.

In theory, European and Asian benchmarks are more exposed to the risk of supply disruptions from the Middle East. U.S. crude futures, commonly known as West Texas Intermediate (WTI), are less vulnerable because of the greater impact of captive Canadian pipeline flows.

But the Brent-WTI spread has started to narrow as imports swing away from the United States and refinery rates pick up in the Midwest.

WTI prices were up around $3.50 per barrel for April delivery at 1300 GMT, roughly double the $1.75 gain for Brent. Brent's premium to West Texas Intermediate has plummeted from more than $16 per barrel to just $11 in the last two trading sessions (based on the April futures contract for both crudes) despite the escalating disturbances engulfing the world's most important oil exporting region.

The sudden reduction in spreads comes amid signs Brent's premium has started to reduce the amount of crude arriving in the United States, especially imports into the East Coast ( PADD I) and the Gulf Coast (PADD III) in recent weeks, tightening the market. Combined stocks of crude and products in commercial storage across the United States fell 8 million barrels last week, the first decline for six weeks, according to the Energy Information Administration, the statistical arm of the U.S. Department of Energy.

http://graphics.thomsonreuters.com/ce/CRUDE+PROD.pdf

Given persistent oversupply in the Midwest and heavy discounts for spot WTI, the Brent-WTI gap is unlikely to close completely, let alone revert to the traditional premium for U.S. light sweet oil.

But the record spreads reported in recent weeks seem unlikely to be sustained, as physical cargoes of African and Middle East crudes are reprogrammed from North America to European and Asian refineries. WTI oil prices could rise substantially relative to Brent in coming sessions as positions in the spread (long Brent, short WTI) continue to be unwound.

Ends --

By John Kemp, Reuters market analyst - for Commodities Now.

The views expressed are his own.