Petroleum is considered the largest source of energy worldwide. About 40% of the energy produced for electricity, transportation, heating, and cooling comes from oil, compared to 28% from coal and 24% from natural gas.
Despite the global movement to reduce emissions from petroleum transportation, the need for petroleum, such as crude oil, continues to be an essential product for global energy consumption.
Within the petroleum complex, production comes initially from crude oil. The most liquid benchmarks are West Texas Intermediate (WTI) crude oil, a North American crude oil, and Brent Crude oil, a global benchmark originating in the United Kingdom. Trading WTI crude oil relative to Brent crude oil has several pros and cons.
What is West Texas Intermediate Crude Oil
West Texas Intermediate (WTI) crude oil is a grade of crude oil used as a benchmark in oil pricing. WTI is focused around the Cushing Oklahoma area of the United States, a land-locked area where crude oil is delivered and stored.
The location is a light, sweet crude oil with low density and sulfur content. WTI is the underlying commodity of the New York Mercantile Exchange’s oil futures contracts. Refiners often use lighter, sweeter crudes to make products like gasoline and diesel.
What is Brent Crude Oil?
Brent crude oil is considered a global benchmark and a light-sweet crude oil. Several types of crude oil locations can be called Brent.
Four different types of crude oil include Forties, Oseberg, Ekofisk, and Brent. These four types of crude oil are all produced from the North Sea and are used to benchmark the price of referred too rent crude oil. WTI has a sulfur content between 0.24% and 0.34%, making it sweeter than Brent crude oil, which has a sulfur content of 0.35% to 0.40%.
How Can You Trade WTI Crude Oil
West Texas Intermediate is actively traded as a physical crude oil that can be stored in facilities. Most WTI produced in the United States comes from the Permian Basin. The Cushing Oklahoma delivery point is the location specified for delivery futures contracts listed by the Chicago Mercantile Exchange, which owns the New York Mercantile Exchange.
The delivery point is a complex system of 35 inbound and outbound pipelines and storage terminals. The storage volume accounts for 13% of the volume of crude oil in the United States.
Most days have volumes above one million futures contracts, equivalent to one billion barrels of crude oil. Approximately 12 million barrels of physical crude oil are produced daily, well short of the amount traded on the futures exchange.
How Can You Trade Brent Crude Oil
Like WTI, most Brent Crude Oil is traded via futures contracts listed on the Intercontinental Exchange. Brent volumes are closer to half a million per day, which is still substantial. Brent is also a global benchmark; therefore, other crude oils worldwide use Brent as a benchmark to measure other locations.
For example, African crude oil is often quoted as a spread to Brent Crude Oil. Brent oil production in the North Sea is about 2.5 million barrels daily, only a portion of the volume represented by the Brent Crude Oil futures contracts.
Oil production in the United States is about 12 million barrels a day, which is why Brent can trade at a premium to WTI since there is less Brent available.
What are the Benefits of Trading WTI Crude Oil?
There are several benefits to trading WTI crude oil. It is considered the most liquid futures contract, and therefore it provides an excellent gauge of crude oil prices and allows investors to enter and exit positions with little slippage.
There are also multiple different futures contracts and other derivatives that use WTI as a gauge of oil prices. The most liquid WTI futures contract has a deliverable specification. When a futures contract is delivered, the buyer must produce the cash to purchase oil and take delivery on the delivery date.
The seller must deliver crude oil with the expected specifications of the exchange. The problem with trading the delivered WTI futures contract is that if you do not intend to take physical delivery, you must exit or roll your position before the last trading date.
An alternative is a financial WTI futures contract. The CME offers an e-mini futures contract on WTI with a financial delivery and a contract size of 500 barrels instead of 1,000, which is used for the delivered contract.
The CME also offers an e-micro contract with financial delivery and a contract size of 100 thousand barrels. The flexiblity offered by the futures exchange allows traders who want to take delivery and those who do not to trade WTI crude oil.
The CME offers multiple-size contracts as well. The CME also offers options on futures contracts. An option is the right but not the obligation to purchase the futures contract at a specific price on or before a certain date.
Additionally, WTI crude oil is used by contract for different brokers and ETFs to track the movements of crude oil prices.
The Benefits of Trading Brent Oil
One of the benefits of trading Brent oil is that it is the global benchmark. Brent oil futures contracts are traded on the Intercontinental Exchange (ICE). The Brent futures contract provides a choice to buyers and sellers.
The contract can be a physically delivered contract or a financially settled contract. The exchange publishes a cash settlement price for the contract settlement if you take the futures contract through the settlement period and choose a financial settlement.
What is the Downside of Trading a Futures Contract?
There are some issues for traders looking to trade futures contracts. Futures contracts expire, and each futures contract has a monthly delivery, either physical or financial. For example, the ICE Brent futures contract has up to 96 consecutive months of futures contracts.
If you are trading the spot price of Brent Oil, you will need to roll your futures contract before expiration to maintain exposure to higher or lower futures contracts. When you sell one futures contract and buy another (or buy and sell), you pay away brokerage and the price difference, which can be costly.
Since the price of crude oil that is nearby can be different from the price of a futures contract that is a year from now, you cannot just buy or sell a one-year forward futures contract and expect to generate the same returns from your trade. The scenario is the same for WTI.
The difference in the price of a spot contract and one deferred is called the term structure of a futures contract. The term structure generally reflects whether there is higher expected demand currently or in the future relative to supply. For example, spot prices are usually lower during a recession than deferred prices.
What are the Downside of Trading an Option on a Futures Contract
The benefit of an option is that the most you can lose is the premium you pay for an option. If the option you purchase is in the money at expiration, you can purchase a futures contract at the strike price. You would still need to deal with the same issue of the term structure of the futures contract.
The Bottom Line
The upshot is that there are pros and cons of trading WTI crude oil and trading Brent crude oil. Both WTI and Brent Crude oil are liquid benchmarks for North America and the world, respectively.
The WTI futures contract is the most liquid and is traded on the Chicago Mercantile Exchange. The Brent futures contract is traded on the Intercontinental Exchange.
WTI is a land-locked area in the United States. While WTI is the North American Benchmark, it does not reflect the oil price at the coast. A different price is created when transportation is added via pipeline or truck.
The WTI futures contract, while not perfect, is a gauge of the price of crude in Cushing, Oklahoma. About 13% of the crude oil storage in the United States is located in this area. The futures contracts are flexible. There are delivered futures contracts as well as financial settlements.
There are also several sizes, including a full-size, a mini, which is half the size of the full-size contract, and a micro contract which is 10% the size. Brent futures contracts are also flexible. You can choose either a delivered contract or a financial settlement agreement. Brent is a global benchmark and crude oil in areas throughout the global trade as a premium or discount to Brent crude oil prices.