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The physical market and the WTI/Brent price spread
Author(s) -
Liu Pan,
Stevens Reid B.,
Vedenov Dmitry
Publication year - 2018
Publication title -
opec energy review
Language(s) - English
Resource type - Journals
eISSN - 1753-0237
pISSN - 1753-0229
DOI - 10.1111/opec.12117
Subject(s) - west texas intermediate , brent crude , cointegration , economics , econometrics , structural break , oil price , crude oil , statistical arbitrage , vector autoregression , mean reversion , financial economics , monetary economics , capital asset pricing model , arbitrage pricing theory , engineering , petroleum engineering , risk arbitrage
West Texas Intermediate ( WTI ) and Brent Crude are primary benchmarks in oil pricing. Although produced in different locations, WTI and Brent are of similar quality and are used for similar purposes. Under the oil market globalisation assumption (Weiner, 1991), prices of crude oils with the same quality should move closely together at all times. However, empirical evidence shows that notable variations exist in the WTI /Brent spread, particularly after 2010, creating risks as well as potential arbitrage opportunities for oil market participants. The paper analyses the dynamics of WTI /Brent price spread for the period between January 1994 and December 2016. A test for structural breaks in the WTI /Brent price spread indicates a change from a stationary to a non‐stationary time series in December 2010, which is also confirmed by the unit root and cointegration tests. The impact of physical market fundamentals on the dynamics of WTI /Brent price spread is then analysed using the Structural Vector Autoregression Model for each sub‐sample period separated by the structural break. Impulse response functions show that the WTI /Brent spread is mainly driven by US production shocks.