Location Basis Differentials in Crude Oil Prices

We examine the long-run pricing relationship among crude oil prices at the North Sea (Brent), Cushing (WTI) and Louisiana Gulf (LLS) delivery points. The Brent-WTI location basis differential is stable until January 2010, but it widens to record levels in the next two years. Brent and WTI prices are cointegrated prior to this structural break, but not after. We show that the recent Brent-WTI basis differential is Granger-caused by Chinese demand. U.S. retail gas prices respond to Brent and WTI before January 2010 and then only to Brent afterwards. We report on recent changes in the supply chain designed to profit from the Brent-WTI spread. Crude oil, once it reaches the Gulf of Mexico, is still cointegrated with the Brent benchmark. Refining capacity constraints in the Gulf region and export restrictions prevent U.S. suppliers from re-integrating WTI prices with Brent.