As prices slump, Nymex oil seen losing relevance

With WTI futures below international prices, are they a 'broken benchmark?'
By Moming Zhou, MarketWatch -- Feb. 17, 2009

NEW YORK (MarketWatch) -- A build-up in inventories at the delivery point for Nymex crude futures has pushed prices of the oil benchmark to an unprecedented discount to a rival futures contract -- which is calling into question Nymex oil's role as an international price-setter.
West Texas Intermediate crude, the oil that the New York Mercantile Exchange uses as a benchmark, is trading at its largest discount ever to Brent crude, the European benchmark.

That's a reversal of the norm: WTI usually trades at a higher price because of its superior quality. Because WTI is lighter and contains less sulfur than many types of crude, it costs less for companies to refine it into oil products, and therefore it usually sells at a higher price.

WTI futures are also cheaper than prices charged by the Organization of Petroleum Exporting Countries, whose oil tends to be lower in quality and thus typically fetches a lower price.

This recent reversal in prices has prompted at least one prominent energy agency and some market analysts and investors to suggest Nymex oil is losing its influence as a global benchmark.
"Volatile WTI is sending mixed and misleading price signals not only to the market but to economic forecasters, government officials and policy makers," the International Energy Agency wrote in a report released last week.

"Further deterioration in the fragile WTI pricing mechanism would only serve to reinforce the view that the crude has become an irrevocably broken benchmark," added the Paris-based energy advisor to developed countries.

WTI's pricing anomalies have upended the crude's value as a basis for setting physical prices, the IEA noted in its report.

On Tuesday, front-month Brent futures closed at $41.03 a barrel on the IntercontinentalExchange, while front-month WTI ended at $34.93 on the Nymex.

The weakness in WTI futures has stemmed from excessive inventories at Cushing, Okla., the delivery point for Nymex futures. WTI has traded lower than Brent before, but this time the gap is particularly wide: It hit more than $10 last month, the most since Brent and WTI began trading in the futures market.

The artificially low WTI prices mean
1) oil users could pay a much higher price than WTI when they trade physical oil with producers.
2) It also means investors putting money in Nymex futures or oil exchange-traded funds linked with Nymex could see prices rally when Cushing inventories wane, as the Nymex contract rises back above levels of Brent and other global contracts.


Broken benchmark
WTI is a type of light, sweet crude with lower gravity and less sulfur than almost all the rest of the 100-plus varieties of oil.

The world currently only produces about 300,000 barrels a day of WTI, a fraction of the total production of about 85 million barrels a day. But since Nymex picked it as the basis for futures trading in late 1983, WTI became the most important pricing benchmark in global oil markets.
asr: so WTI is oil grade name, it can be produced by oil country , it is grade name for quality , low sulfer etc. so 300k out of 85 millions that is 0.5% of total oil/day

That's partly because of the transparency and frequency of data releases and high-volume trading on the Nymex. The U.S.' role as the world's biggest oil consumer and importer also has helped put Nymex's WTI oil contract in the lead.

Producers follow Nymex prices to price their oil, normally at a discount to a front-month WTI futures contract. OPEC members, who control about one third of the world's oil production, also price their oil at a discount to WTI that sometimes widens to more than $10, as their oil tends to be heavier and contain more sulfur.

But the relation has been reversed recently. The OPEC basket price, an index of 12 types of crude produced by the cartel's 12 members, stood at $41.49 dollar a barrel Monday -- more than $6 higher than the Nymex's front-month contract price.

WTI futures have also been trading lower than Brent, which historically tends to be cheaper than WTI. That's because WTI is of higher quality, and the cost of shipping oil across the Atlantic is priced in if the U.S. imports Brent from Europe.

The WTI-Brent price spread, typically positive between $1.50 to $2.50 a barrel, reversed to negative in December. The discount deepened to a historical trough of more than $10 on January 15

The Nymex has Cushing to blame for anomalies in its futures prices.
Covering more than nine square miles, Cushing is the largest oil transportation hub in the U.S. The pipelines transport crude from the Gulf of Mexico in the south and from Canada in the north.

As the Nymex delivery point, Cushing also serves as a key storage place for oil refineries in states such as Oklahoma, Texas and Kansas. As energy demand fell amid the economic downturn, refineries nation-wide sharply cut their petroleum production, leaving more oil sitting in storage.

Demand issues at Cushing "can sometimes influence WTI to the degree that WTI no longer represents world oil market conditions," wrote Mikka Pineda, an energy analyst, at RGE Monitor.

"Though oil demand is indeed collapsing all over the world, it's not necessarily collapsing to the same extent as WTI," he added.

Lacking an outflow pipeline to move oil to the Gulf Coast, Cushing inventories started to consistently increase from late 2008. They have risen for six straight weeks to reach a record high of 34.9 million barrels in the week ended Feb. 6, approaching Cushing's operational capacity of about 36 million barrels.
Excessive stockpiles pressured regional prices and eventually weighed on Nymex crude futures.


"WTI is an international benchmark, but it's based on a local, inland market," said James Williams, an economist at energy research firm WTRG Economics. "Anything happens at Cushing will impact Nymex prices."

Adding more inventories to Cushing, speculators, seeing arbitrage opportunities in a futures trading curve called contango, also piled oil into Cushing.
Contango is a condition whereby prices for nearby delivery are lower than prices for future-month delivery. Under a contango curve, speculators can buy nearby-month oil, store it, and sell it in a certain future month at a higher price.

Contango between a front-month contract and its successive contract increased to the biggest level of $8.49 in December.

Ways to revive the benchmark
To revive Nymex futures' importance as a valid international benchmark, the Nymex needs to pick a second delivery point along the Gulf Coast, analysts said. Building more pipelines linking Cushing to the coast could also alleviate storage pressures.
But both probably will take years. For now, "record stock levels at Cushing, anemic oil demand and plans by refiners to sharply cut throughput rates" will continue adding downward pressure on WTI prices, the IEA said in the report.
The disconnect between WTI and the international oil market could slowly disappear once oil demand rebounds and Cushing inventories starts falling, analysts said.
For the time being, investors probably should look at Brent as a more valid benchmark for the world market, said WTRG's Williams. Unlike WTI, the delivery point for Brent futures sits near the North Sea, a much flexible place for oil shipping. End of Story