The purpose of this report is to take a deep dive into the role of the Brent and West Texas Intermediate (WTI) crude oil benchmarks, their mutual relationship, and their interaction with the global oil market. The report looks at the dynamics that shape the characteristics of Brent and WTI, in particular their physical and financial drivers.

The report was prompted by the extraordinary oil market situation in early 2020 as a result of the Covid-19 pandemic, and prepared by Energy Intelligence for ICE Futures Europe. Virtually overnight, the world saw demand for refined products collapse as governments restricted trade and travel to stop the spread of the virus.

Refineries were forced to limit their runs and crude oil intake.

At the peak, the world faced a surplus of more than 10 million barrels per day of crude oil. Production was shut, and surplus oil went into storage. The rules of supply and demand pushed oil prices down sharply. Tremendous pressure was put on the benchmarks Brent and WTI, which are the key instruments to determine the value of crude oil.

On Apr. 20, for the first time in history, the oil price fell into negative territory when WTI collapsed to minus $40 per barrel. Although the subzero price was recorded for just one day, it sent shockwaves throughout the industry. With most oil production in the Americas linked to WTI, all that crude had to price negative as well. And if such pressures could buckle WTI, markets wondered if it could also happen to Brent, which informs global oil prices.

For WTI, which links its futures contract to the physical delivery of oil at the landlocked storage hub in Cushing, Oklahoma, too many futures contracts overwhelmed the physical system. The holders of these con- tracts had no intention of taking physical delivery. Their future positions, one day before expiration of the contract, represented more than 100 million barrels of oil for tanks that could accommodate only a few million barrels.

For Brent, which is a financially settled contract, the pricing complex absorbed the high volume of futures contracts and let surplus oil sail to the market. This allowed the Brent futures contract to still trade at $25/ bbl when WTI went negative. The spot price of physical Brent cargoes, known as dated Brent, traded $8/bbl below the futures contract, and this discount paid for storage of surplus oil. By mid-May, the Brent futures contract and physical price had nearly converged in a signal that the world had mopped up most of the surplus.

The intricate Brent pricing system handled this unprecedented supply disruption, applied discounts, and did not go negative. Two factors were key. The first is that Brent is a seaborne benchmark and that its physical discounts paid for storage. In fact, those discounts allowed for oil stored in tankers alone to grow by 120 million bbl in April and May — the equivalent of 60 very large crude carriers of 2 million bbl each. The second factor is that Brent futures financially settle at expiration without physical delivery. There is no pressure on physical tanks. A vast volume of contracts were trading very close to expiration and were cash settled.

The events of 2020 are unique. But the extreme price volatility of 2020 has shed a new light on the characteristics of global benchmarks as they have developed over the years. Notably, being water- borne in nature, Brent can arbitrage market anomalies away, which helps shave volatility peaks.

Both Brent and WTI have exchange-traded futures contracts that reflect the actual price of oil linked to the contract. In the case of Brent, the link is indirect; in the case of WTI, it is direct. As oil is a strategic commodity, market sentiment about the wider macroeconomic and political context also blends into the price.

Brent’s personality is that of a physical benchmark. It attracts more physical participants like producers and merchants and sets a global price of oil for all to see. Its pricing ecosystem allows for physical and derivative prices to diverge and dissipate shocks in times of dislocations. This trait also allows for surplus oil to sail to the market and for high volumes of contracts to trade without directly upsetting the physical market.

WTI’s personality is that of a financial benchmark. Its system attracts more financial participants like banks and hedge funds that are typically not looking for physical delivery. Yet, it’s a futures contract designed for physical delivery, which directly links the contract price on the exchange to physical prices in the market. The pricing and delivery point for the contract is landlocked in the US Midcontinent, in Cushing, which has a large, but ultimately limited, storage capacity. On Apr. 20, too many contracts ended up in the system ahead of expiration. With no capacity available to store the equivalent oil volumes of all the expiring contracts on 2019 that day, the price collapsed.

The negative WTI price was one such signal — a warning that risk capital can overwhelm the physical oil market. Oil prices have stabilized since. Producers have cut crude oil production and global oil demand has bounced back, creating a new equilibrium in the physical market. The shock absorbers in international oil trade, Brent futures and dated Brent, are again trading closely together.