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Posts tagged with: "DCOILWTICO"

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WTI vs. Brent oil prices: When and why do they diverge?

West Texas Intermediate (WTI) and Brent crude oil prices generally track each other pretty closely,* although their levels can be different. In 2011, though, the two prices diverged. You can also read more here and here, but let’s talk about the details.

The FRED graph above shows the prices per barrel of WTI and Brent crude from 2010 to present. Before 2011, the average price of a barrel of WTI was $35.34 and the average price of a barrel of Brent was $34.00.

Price differences can reflect the ease of refining, the geography of where the oil is produced, costs of transportation to where the contracts are fulfilled, and political and economic conditions in the regions where the oil is sold. But the increasing price differential in 2011 is often attributed to the bottleneck in transportation of the product to Cushing, Oklahoma, where WTI oil futures contracts are settled. The gap began to narrow in 2014 when these bottlenecks eased, but it widened again in 2017.

With the onset of the COVID-19 pandemic, the WTI price fell precipitously; the Brent price also fell, but not as much. Our second FRED graph shows the current drop in prices since January 1, 2020. This difference in the behavior of the two oil prices may be caused by differences in the storage technologies at settlement. In Cushing, where WTI is settled, storage is fixed and the cost of transporting the crude to another storage facility is high. Brent, on the other hand, is produced in the North Sea and can be more easily transported to waterborne tankers for temporary storage.

*Correlation = 0.99 for May 20, 1987, to April 27, 2020.

How these graphs were created: Search for “Crude Oil Prices: West Texas Intermediate (WTI) Cushing, Oklahoma.” From the “Edit Graph” panel, use the “Add Line” feature to search for and select “Crude Oil Prices: Brent – Europe” and click “Add data series.” Adjust the date span by using the slider at the bottom of the graph or the date entry boxes at the top right of the graph.

Suggested by Michael Owyang.

View on FRED, series used in this post: DCOILBRENTEU, DCOILWTICO

Oil prices and expected inflation

Since the end of the Great Recession, market-based measures of long-run inflation expectations have seemed highly correlated with the spot price of oil. To see what we mean, consider the FRED graph above, where we plot the price of oil (West Texas Intermediate) against the 5-year, 5-year forward expected inflation rate. This measure of expected inflation is calculated using measured yield differentials between nominal and inflation-protected Treasury securities (TIPs) at 10- and 5-year maturities. (To further highlight the correlation, consider the scatter plot of the same data below.)

The 5-year, 5-year forward rate is meant to capture the bond market’s 5-year average forecast of inflation beginning 5 years from now. In this way, anything expected to affect the economy over the next 5 years should not factor prominently in a long-run forecast made 5 years from now. But then, why should the contemporaneous price of oil correlate so highly with the long-run inflation rate which is, or should be, anchored by monetary and fiscal policy?

One possibility is that because the stock of oil is an asset, its price is likely to include a forward-looking element. If the long-run outlook for global growth weakens, the value of this asset should decline. In the event of a long-run forecast of low growth, low interest rates, and low inflation, investors will move away from private sector securities into safe assets, such as U.S. Treasury securities. If so, the value of the stock of oil declines along with expected inflation.

How these graphs were created: Search for “5-year, 5-year Forward Expectation Rate.” From the “Edit Graph” panel, use the “Add Line” tab to search for and add the “Crude Oil Prices: West Texas Intermediate” series. With the “Format” tab, change the “Y-axis position” option to “Right” for “LINE 2.” For the second graph, use the “Format” tab to select plot type “Scatter.”

Suggested by David Andolfatto and Mahdi Ebsim.

View on FRED, series used in this post: DCOILWTICO, T5YIFR

Oil prices and breakeven inflation rates revisited

In an earlier FRED Blog post, we highlighted the simultaneous decline in the 5-year breakeven inflation rate and the price of oil in 2014. (The 5-year breakeven inflation rates are obtained from 5-year Treasury inflation-indexed constant maturity securities and are thought to represent the market’s expectation of CPI at a 5-year horizon.) At that time, we argued that markets might have believed that the drop in oil prices reflected a slowing in global demand that might result in a persistent decline in consumer prices. In this post, we make a longer comparison—from 2011 to 2019—between the same two series shown in the original graph.

The graph above shows that the correlation between the breakeven inflation rate and oil prices is not limited to the steep decline that occurred in 2014. Indeed, the correlation between the two series over the entire period shown (January 2011 through March 2019) is 0.65. Prior to 2015, the two series appear to occasionally move together. The comovement was particularly obvious when the two series exhibited large changes, rising together in early 2011, falling together in late 2011, etc. From January 2011 to January 2015, the correlation between the series was 0.49. From January 2015 to March 2019, the correlation between the two series became even more apparent, rising to 0.85.

A few academic papers have tried to analyze the cause of the comovement, but the high degree of correlation between the two series remains puzzling. Even if changes in oil prices pass through to consumer prices, one wouldn’t expect such a close correspondence between oil prices today and consumer prices at a 5-year horizon.

How this graph was made: Search for “crude oil prices,” select the series “Crude Oil Prices: West Texas Intermediate (WTI) – Cushing, Oklahoma” with a daily frequency,  and click “Add to Graph.” From the “Edit Graph” panel, select the “Add Line” option: Search for “5-year breakeven inflation,” select the first series shown (“5-Year Breakeven Inflation Rate, Daily, Percent, NSA”), and add the data series. In the “Format” tab, change the y-axis position from left to right for the breakeven inflation rate and set the start date to 2011-01-01.

Suggested by Michael Owyang and Hannah Shell.

View on FRED, series used in this post: DCOILWTICO, T5YIE


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