The relative pricing of WTI and Brent crude oil futures: Expectations or risk premia?

This paper studies the spread of Brent-WTI futures prices using a no-arbitrage term structure model with one common and two latent idiosyncratic risk factors. We document more negative risk premia for WTI than for Brent, and the differences are more pronounced at longer maturities. The expectation of future spot price dominates the risk premium in determining the term structure of Brent-WTI futures spread, especially at short maturities. The common risk premia in both markets are negative and similar, while their corresponding idiosyncratic risk premia have opposite signs. The common risk prices of WTI and Brent are generally related to the US crude commercial stock, inflation, economic uncertainty, and hedging pressure; however, idiosyncratic risk prices are more related to their corresponding local production, short rate, and the term structure factors. The variance decomposition indicates that the idiosyncratic factors account for a considerable part at longer forecast horizons in both markets.