Crude Oil Price Differentials : An empirical analysis on the factors behind the price divergence between WTI and Brent

Abstract

The main purpose of our thesis is to examine the long - run relationship be tween WTI and Bren t . Historically, the prices fluctuated around a constant differential, where WTI traded above Brent due to its slightly higher quality. Recently, the differential has been reversed as B rent has traded at a premium to WTI since 2010. We analyze the unusual behavior in the price relationship with the use of an Engle - Granger two - step test for cointegration to assess if the relationship has ended , and whether a new has been formed. We also d ecompose the WTI - Brent spread to examine if the deviation can be accrued to supply or demand conditions . Finally, we build an empirical model to determine what factors have had a significant impact on the spread’s divergence. We find that the long - run rel ationship between WTI and Brent ended in January 2010, and that a new relationship was established early 2014. However, the new relationship is different from its predecessor as Brent is now being traded at a premium to WTI. From our empirical findings we infer that insufficient pipeline infrastructure at Cushing is significant in explaining the spread’s divergence. We also conclude that shipping costs significantly affected the spread and have prolong ed the divergence between WTI and Brent .