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

I evaluate the degree to which local supply/demand conditions and exchange rates affect the price for WTI and Brent and their price spread by estimating cointegrating vector autoregression (CVAR) models and using a saturation indicator technique to identify periods when these long- and short-run relations change. A bivariate CVAR model that includes the price of Brent and WTI changes during seven regimes. Two correspond to a boom and bust in prices associated a speculative bubble while the other regimes coincide with periods when the price spread between Brent and WTI rises and falls. These regimes are eliminated by adding exchange rates and variables that proxy local supply and demand. Of these variables, increased pipeline flows play the biggest role in reducing the price spread. Lifting the ban on U.S. exports of crude oil increases the price spread due to transportation costs and discounts needed to introduce refiners to a new crude. Conversely, there is no clear explanation for the sharp rise in the price difference. Instead, some of the increase may be associated with changes in the supply/demand balance for Brent that are not included in the model. Together, these results suggest that technical changes affect local supply and demand for crude oil and regionalize prices, but regionalization creates opportunities for arbitrage which are realized by investments in new transportation networks and legal changes, and they re-unify the world oil market. Lifting the U.S. ban on exports of crude oil in December 2015 increases the degree to which the global oil market is unified relative to 2011–2014, but does not imply a return to the previous equilibrium; the ongoing increase in the price spread between Brent and WTI could be reversed by investments in transportation infrastructure that allow PADD 3 exporters to load their cargoes on larger ships.