The WTI/Brent oil futures price differential and the globalisation-regionalisation hypothesis

Abstract

This study examines the globalisation-regionalisation hypothesis in the WTI/Brent crude oil futures price differential by considering a set of potential determinants at 1, 3 and 6 months to maturity contracts. To this end, we employ monthly data over the period 1993:1-2016:12 for a set of crude oil-market specific (convenience yield, consumption, production) and oil-futures market specific (open interest, trading volume) determinants. Our results can be outlined as follows. First, the WTI/Brent convenience yield spread can drive a wedge between the WTI and Brent oil futures prices for the nearby month and 3-month contracts. Second, the WTI/Brent oil production spread is a significant determinant for the 1-month, 3month and 6-month to maturity contracts, while the WTI/Brent oil consumption spread is significant for the 6-month contract. Third, the WTI/Brent open interest spread appears to influence the oil futures price variability between the WTI and Brent for the 3-month and 6month contracts, while the WTI/Brent trading volume spread lends predictive power for the 1-month and 3-month contracts. Fourth, the oil futures market does not appear to be globalised in every time period. We provide evidence of a regionalised oil futures market over the short-run. Fifth, our robustness analysis lends support to the above findings. The findings of this study provide valuable information to energy investors, traders and hedgers.

Evaluating robust determinants of the WTI/Brent oil price differential: A dynamic model averaging analysis

“…Prest (2018) also finds that the long-term government bond yields exercise predictable power to explain oil prices fluctuations and we thus argue that consequently it can influence the evolution of the price differential between WTI and Brent. The relationship between the BY spreads and oil prices has been also documented by Filippidis et al (2020). However, our finding is a further evidence in favor of a time-varying analysis, which allows one to identify the direction of the BY impact at the different economic conditions that prevail at each time period.…”

“…It would be instructive at this point to note that previous studies such as those by Milonas and Henker (2001), Filippidis et al (2019), and Geyer‐Klingeberg and Rathgeber (2021) have also shown the major importance of the convenience yield in explaining the behavior of the WTI/Brent oil price differential. More specifically, Milonas and Henker (2001), report that the convenience yield acts as a significant determinant of the price differential between WTI and Brent for near to maturity futures contracts.…”

“…More specifically, Milonas and Henker (2001), report that the convenience yield acts as a significant determinant of the price differential between WTI and Brent for near to maturity futures contracts. Similar findings have been documented by Filippidis et al (2019) who find that the convenience yield provides significant predictive power to explain the variability in the differential between WTI and Brent for near to maturity contracts, while this does not hold for longer to maturity contracts. Finally, Geyer-Klingeberg and Rathgeber (2021) report that the convenience yield is the most important determinant of the WTI/Brent price differential.…”

“…We argue that a positive change in the oil production differential, which indicates a higher WTI production, and hence a decrease in the price of WTI, is expected to cause the WTI/Brent oil price differential to decrease. Authors such as Büyükşahin et al (2013), Liu et al (2018), Prest (2018), Caporin et al (2019), Filippidis et al (2019), and Kaufmann (2020) have highlighted the importance of oil production to explain the behavior of the WTI/Brent oil price differential.…”

“…Indicatively, the literature suggests that the more linked the financial and oil markets become, the higher the use of the oil futures market by financial participants (see, e.g., Juvenal & Petrella, 2015; Tang & Xiong, 2012;Wimmer et al, 2021). The increased trading activity in the oil futures markets is expected to exercise an impact on oil prices and hence they could explain oil price differentials, as also suggested by Büyükşahin et al (2013), Filippidis et al (2019), and Geyer-Klingeberg and Rathgeber (2021). Typically, the futures market trading activity is captured by open interest (OI ) and trading volume (TV ), which are related but distinct concepts.…”