Determinants of the WTI-Brent Price Spread Revisited

Abstract

We apply autoregressive distributed lag regression (ARDL) and several methods of structural break analysis on a daily data set between 1995 and 2014 to explore various supply and demand factors as drivers of the price differential between WTI and Brent crude oil. In line with previous literature, we identify a major break in the WTI-Brent spread in December 2010. The ARDL regression reveals that the convenience yield, as a proxy for crude oil inventories, is the most important spread determinant. Moreover, also the trading activity in crude oil paper markets, shipping costs, as well as the stock market development in the US and Europe affect the size of the spread. Unlike other papers, we find that the impact of the spread determinants changed after the break in 2010. Especially, the impact of local WTI inventories as well as the influence of paper markets activity on physical trading in crude oil spot markets have gained in importance. In summary, the rising variability in the spread time series after 2010, which reflects a decoupling process of WTI and Brent, can be explained by an absolute increase in several economic determinants.

Keywords: Crude Oil, West Texas Intermediate, Brent, Convenience Yield, Structural Break