02 February 2018, New York/Houston/Singapore – Surging shale oil production in Texas and North Dakota is being felt on trading desks in Chicago, Houston and New York, where a brisk business in West Texas Intermediate crude futures is far outpacing contracts for London-based Brent crude.
As the United States approaches a record 10.04 million barrels of daily production, trading volumes of so-called “WTI” futures exceeded volumes of Brent crude in 2017 by the largest margin in at least seven years.
A decade ago, falling domestic production and a U.S. ban on exports meant that WTI served mostly as a proxy for U.S. inventory levels.
“There was a time when the U.S. was disconnected from the global market,” said Greg Sharenow, portfolio manager at PIMCO, who co-manages more than $15 billion in commodity assets.
Two changes drove the resurgence of the U.S. benchmark. One was the boom in shale production, which spawned a multitude of small producers that sought to hedge profits by trading futures contracts. Then two years ago, the United States ended its 40-year ban on crude exports, making WTI more useful to global traders and shippers.
U.S. exports averaged 1.1 million barrels a day through November 2017, rising to an average 1.6 million bpd in the final three months. That compares to just 590,000 bpd in 2016.
As U.S. production and exports grow, global firms that increasingly buy U.S. oil are offsetting their exposure by trading in U.S. financial markets. That also gives U.S. shale producers more opportunity to lock in profits on their own production.
Rival Exchanges, Shifting Profits
The U.S. boom has reignited a competition over oil trading that began in the 1980s between two of the world’s biggest exchange operators – Intercontinental Exchange, and the New York Mercantile Exchange, or NYMEX, which was acquired by Chicago-based CME Group in 2008.
For ICE and CME, energy represents the second-biggest source of revenue, trailing only stocks and interest rate trading, respectively. ICE is based in Atlanta but is known for its European contracts after it bought London’s International Petroleum Exchange and its Brent futures contract in 2001.
About 310 million U.S. crude futures contracts – worth about $16 trillion in oil – changed hands on CME’s New York Mercantile Exchange (NYMEX) in 2017, far more than the about 242 million contracts in Intercontinental Exchange’s Brent crude futures.
Energy products including WTI brought in $790 million in revenue for CME in 2016, the latest annual data available. Brent crude futures and options alone contributed nearly $300 million to ICE’s revenues in 2016.
Since 2011, trading volumes in WTI futures have risen by about 135 million contracts, compared to an increase of about 109 million in Brent, according to exchange data.
CME has said there is a “clear trend” that the U.S. benchmark is being used more globally, in part because of growing production there and relatively stagnant output of the North Sea crude grades that underpin Brent trading.
That makes investors more likely to trade in WTI than Brent, said Owain Johnson, managing director of energy research and product development at CME.
“You know more about what WTI will look like in the next five years,” he said.
Jeffrey Sprecher, chief executive at ICE, dismissed the notion that WTI’s global influence is rising versus Brent, calling it “a red herring.”
Export Surge Lures Buyers
The increasing liquidity in U.S. oil futures stems partly from the surge in hedging by domestic shale producers but also from growing overseas interest, which pushed outstanding contracts to new records in 2017.
Average daily volumes in WTI futures from outside the U.S. jumped nearly 40 percent in 2017 over 2016, according to CME Group data. Foreign participation in WTI now represents about 30 percent of CME’s average daily volume.
“The U.S. is reclaiming the title of being arguably the world’s most relevant crude oil benchmark” because of rising U.S. exports and production, said Michael Tran, director of energy strategy at RBC Capital Markets in New York.
Purchasers worldwide say the U.S. contract may have to change, however, to reflect the price at export hubs such as Houston. Currently, WTI contracts are tied to oil deliverable at the landlocked storage hub in Cushing, Oklahoma.
More supply is coming to Gulf Coast ports from Texas, where production is now near 4 million barrels a day.
“We need a new benchmark for pricing American crude oil for export to Asia and other areas,” said Chen Bo, president of Chinese state oil trader Unipec, at an industry event in Houston in November.
Unipec is the trading arm of refiner Sinopec and the largest buyer of U.S. oil in Asia; Chinese firms bought an average of 220,000 barrels a day of U.S. crude last year.
Sources with two major trading firms said CME has approached them to gauge demand for a benchmark futures contract that would have Houston as its delivery point.
In December 2017, the NYMEX introduced a new contract aimed at the growing market of Asian buyers importing U.S. crude, such as China, the second biggest importer in 2017. The contract prices the spread between WTI and Middle-East benchmark Dubai.
The contract allows Asian refiners to better evaluate the economics of U.S. crude compared to oil elsewhere, Chen said.
The dominance of Europe’s Brent and America’s WTI crude futures comes despite Asia’s growing share of global oil consumption, up from 27 percent in 2000 to almost 40 percent today. Europe’s and North America’s share of demand has declined.
A key reason for the Middle East’s and Asia’s failure to create an oil futures benchmark is that financial commodity trading is not well established in either region.
Middle Eastern producers are largely state-owned, and while the Dubai Mercantile Exchange (DME) was set up in 2007 to establish a new benchmark, it has so far not managed to attract enough liquidity to dominate the region.
In China, a long-delayed futures contract is expected to be launched by Shanghai’s INE exchange this year, with the stated goal of becoming Asia’s benchmark. But wrangling over details has undermined INE’s credibility, analysts say.
That’s left the United States, with its established commodity markets, operating as “the Wal-Mart of the oil market,” Tran said.
*Devika Krishna Kumar; Bryan Sims, Florence Tan & Henning Gloystein; editing: David Gaffen & Brian Thevenot – Reuters
