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Physical Markets, Paper Markets and the WTI-Brent Spread

We document that, starting in the Fall of 2008, the benchmark West Texas Intermediate (WTI) crude oil has periodically traded at unheard-of discounts to the corresponding Brent benchmark. We further document that this discount is not reflected in spreads between Brent and other benchmarks that are directly comparable to WTI. Drawing on extant models linking oil inventory conditions to the futures term structure, we test empirically several conjectures about how calendar and commodity spreads (nearby vs. first-deferred WTI; nearby Brent vs. WTI) should move over time and be related to storage conditions at Cushing. We then investigate whether, after controlling for macroeconomic and physical market fundamentals, spread behavior is partly predicted by the aggregate oil futures positions of commodity index traders.

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Energy Specializations: Petroleum – Markets and Prices for Crude Oil and Products; Petroleum – Policy and Regulation; Energy Investment and Finance – Public and Private Risks, Risk Management; Energy Investment and Finance – Trading Strategies and Financial Instruments; Energy Modeling – Energy Data, Modeling, and Policy Analysis

JEL Codes:
L13 - Oligopoly and Other Imperfect Markets
E60 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook: General
D81 - Criteria for Decision-Making under Risk and Uncertainty
G13 - Contingent Pricing; Futures Pricing; option pricing
E61 - Policy Objectives; Policy Designs and Consistency; Policy Coordination

Keywords: Crude oil, Brent, WTI, LLS, Spread, Fundamentals, Inventories, Cushing, Paper Markets, Commodity Index Trading (CIT)

DOI: 10.5547/01956574.34.3.7

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Published in Volume 34, Number 3 of The Quarterly Journal of the IAEE's Energy Economics Education Foundation.