CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75.00% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
Oil is one of the most traded commodities in the financial markets. If you plan to expand your portfolio and include energy instruments, understanding the difference between the two crude oil benchmarks, the West Texas Intermediate (WTI) and Brent Crude, is crucial.
Here’s a criteria-wise distinction between the two benchmark oil varieties:
WTI Crude is extracted from mines across Louisiana, North Dakota and Texas in the US, while Brent Crude is extracted from European regions around the North Sea. These include Oseberg, the Forties, Ekofis and Brent, of course.
The density of oil determines the ease of conversion into fuel. Low-density oils are easier to convert and more valuable in the oil trading industry. WTI is “very light,” with an API gravity of 39.6°. It is the lightest oil. Brent, on the other hand, has an API gravity of 38° and is considered a “light” oil.
The sulphur content determines the oil’s sweetness. The lower the sulphur content, the higher the crude’s usability for petroleum products. Oil traders must note that a variety of oils are called “sweet” when the sulphur content is low. With a sulphur content of 0.24%, WTI is a “very sweet” oil. The Brent is a little less sweet with 0.40% of sulphur, although it is also considered “very sweet.”
Oil has been the lifeblood of the global economy since the first industrial revolution. The ease of transportation makes it more valuable. Brent, being extracted from the sea, is easier to ship across the world via waterways. WTI, on the other hand, is mined from landlocked areas. With longer distances to cover from the oil field to the refinery and then to the markets, the transportation costs are higher for WTI.
All these factors, combined with the delivery logistics, global demand and growth outlook, play a key role in determining oil prices. Therefore, oil traders have a little more to consider than the fundamentals.
The oil produced across the world varies in quality, viscosity, odour and amount of impurities present (which translate into cleansing and refining requirements). Benchmarking the crude simplifies pricing for the wide variety of oils produced globally. It is a way to bring harmony to the distributed oil market.
Did you know there is also a third benchmark? It is the Dubai/Oman Crude and Saudi Arabian oil falls under this category. It is exported primarily to Asia from the Middle East. However, due to a steady decline in production since the 2010s, it has lost the status it used to enjoy. This is because benchmark crude must possess certain qualities, such as:
Based on the benchmark, other types of crude oils are valued according to an agreed-upon differential. The differential includes the additional transportation costs to a marketing hub, the amount of sulphur and API density of the oil (which determines the purification effort), refinery capacity utilisation and global supply-demand dynamics. You must also keep an eye on news updates and economic data to gather insights while trading oil.
The two benchmarks are correlated, with their prices moving as a function of the supply and demand fundamentals of the global markets. As a result, they move together. As of July 23, 2024, Brent Crude was trading at $79.41 per barrel, up 4.64% YTD, while WTI was trading at $77.64, up 8.85% YTD. The difference between the two prices is widely known as the Brent-WTI differential. Geopolitical tensions and supply-chain disruption are among the major factors that affect these prices in opposing ways, giving rise to a wider or narrower differential.
For instance, in 2020, oil prices were severely affected by the worldwide lockdowns to prevent the spread of the COVID-19 pandemic. The reduced demand weighed heavily on oil prices. The slump in WTI prices was caused by fears of the US supply over-running its storage capacity amid demand pullbacks across the world. WTI prices plummeted to -$37 a barrel. Due to access to the European markets, Brent was affected considerably less and settled at $18 per barrel. Hence, the differential rose to $55. The production war between Russia and Saudi Arabia contributed to the free-fall of prices.
Similarly, in 2022, when Russia attacked Ukraine, the differential increased once again, as European nations had to import oil from outside the continent. The differential was over $12 per barrel within one month of the invasion and spiked to $14.37 per barrel after the sanctions on Russian oil were imposed.
Understanding the factors that affect the differential is critical while trading oil with arbitrage and for high-frequency trading styles. While the differential creates disturbances in the oil market, it generates immense opportunities for traders.
Popularly, traders use contracts for difference (CFDs) to trade this commodity since CFDs eliminate the need to own and store the underlying commodity. This means no transportation costs or storage concerns. CFDs also enable you to take advantage of both uptrends and downtrends in the highly volatile oil market. Additionally, CFDs are traded on margin. This amplifies traders’ purchasing power. However, beginners must remember that margin trading magnifies both profit and loss potential. This necessitates robust risk management, such as stop loss, take profit and trailing stop loss, while trading oil via CFDs.
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