Finance

Basic Strategies to Trade WTI and Brent Crude Oil

The two most actively traded crude oil benchmarks are Brent Crude oil and West Texas Intermediate crude oil. While both are considered global benchmarks for Atlantic basin crude oils, Brent crude oil is used to set the price of approximately 66% of the world’s internationally traded crude oil supplies. Brent Crude refers to the components of the Brent Complex, which is a physically traded oil market based around the North Sea of Northwest Europe. Brent originally received its name from the initial oil field from which it was produced. Brent is a light sweet oil, that is used to produce many different types of distillates including Gasoil and Kerosene.

West Texas Intermediate (WTI) is a light sweet crude oil that is delivered in Cushing Oklahoma. Unlike Brent oil, WTI is not named after a specific group of oils. In 1981, the US government allowed the oil market to float which marked the beginning of the physical WTI Crude Oil spot market. Before relinquishing control of oil prices the WTI traded under the US Emergency Petroleum Allocation Act of 1973.

Brent currently trades at a premium to WTI. During the past 2-decades, the premium has turned to a discount during a brief period in 2016. The premium has been as high at $26 per barrel. During the financial crisis of 2008, Brent took over as the global benchmark, as landlocked WTI in Cushing Oklahoma was difficult to extract. Before this period, WTI oil trading prices transacted at a premium to Brent, allowing the flow of oil to come into the United States which remains the world leader in crude oil consumption.

What Has Occurred Since the COVID-19 Pandemic Broke Out

As COVID-19 spread across the globe, crude oil prices began to tumble as demand started to ease. The first layer of demand destruction came as airlines were grounded. As quarantines were announced throughout the globe, ground transportation came to a halt. In the US, by April gasoline demand dropped 40%, but by May it rebounded to be down approximately 25% year over year.

To make matters worse, Saudi Arabia decided that Russia’s unwillingness to cut production further, in March required a different response. Saudi Arabia announced an oil price war, and reduced its contract price and increased production. Both Brent crude oil and WTI took a turn for the worse, eventually pushing the WTI futures contract into negative territory for the first time in history. On April 20, 2020, WTI crude oil futures closed at -37.63. This reflected the enormous price for crude oil storage which was unavailable in the United States as demand dropped and nobody wanted oil. To counter the drop in demand, OPEC announced a historic oil production cut of 9.7 million barrels a day.

Strategies to Trade Oil

The whipsaw in price action provided opportunities to trade the oil markets. Investors generally use fundamental analysis, evaluating supply and demand to determine the future price of Brent and WTI. Every week the Energy Information Administration reports oil supply, demand, and inventory levels. You can monitor the level of inventories on the EIA website, and determine if inventories are likely to rise or fall which will eventually impact the price of oil.

Another type of strategy is the use of technical analysis. This is the study of past price action to determine future price movements. This includes using trend analysis, momentum analysis, or mean reversion analysis. The bottom line is that you can use multiple strategies to trade oil, as long as you consider the overall macro environment to help you determine future price changes.

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