A Regionalized or Unified Oil Market: The Price Spread Between Brent and WTI

Over the last several years, I have published papers that show arbitrage opportunities largely unify the world oil market and that they can account for much of the price differences among crude oils. Exceptions include crude oils that are especially heavy or originate in nations with poor governance. But my confidence in these results was limited by the sudden appearance of a large spread in the prices for Brent and WTI, which are two of the world’s most important benchmark crude oils. As stated by the Morpheus character in the film The Matrix, “You don’t know what it is, but it’s there, like a splinter in your mind, driving you mad.” My splinter, I had to understand why to crude oils from nations with relatively transparent governments and similar physical characteristics (both light and sweet), suddenly seemed to be priced by regionalized markets. This sudden separation in price also perplexed other researchers. They posited several possible explanations; the shale oil boom, imports from Canada, building inventories, the lifting of the US ban on crude oil exports, changes in transportation infrastructure, declining production of crude oils that make-up Brent, the collapse of Libyan production, and even exchange rates. But these efforts did not satisfy my curiosity. Often, authors examined only a subset of possible explanations, which raised the specter of omitted variable bias. In others, authors ignored the nonstationary nature of the data, which raised the possibility that the statistical results were spurious. Finally, many analyses implicitly assumed that the spread was caused by a sudden change in an explanatory variable and so looked for a change-point in the price spread, rather than focusing on the factors that influenced the price of Brent and WTI.