The Gaping Gap Between The Price of Nymex and Brent. Which is Right?

(Dow Jones Newswires), Jan. 28, 2011

More than ever, the price of oil depends on where you look. Oil prices have sunk to a two-month low around $85 a barrel on the New York Mercantile Exchange, but ICE's Brent oil futures are soaring toward $100 a barrel.

The gap between the two prices--more than $12 as of Friday morning--is the biggest ever. Nymex March futures were recently trading up 0.3% at $85.85 a barrel, while ICE March Brent trades up 0.6% at $97.97 a barrel.

The yawning chasm between the two most widely quoted prices proves the power of a small Midwestern town on the global oil market. Nymex futures are reflecting steadily rising inventories in Cushing, Oklahoma, the oil storage hub where anyone holding a contract when it expires must either purchase or deliver real barrels of crude each month.

The trouble starts when too much Canadian oil heads into Cushing's web of pipelines, crowding out tank space theoretically set aside for Nymex-related deliveries. In the next couple months, a new TransCanada pipeline promises to bring yet more Canadian oil to Cushing.

Brent represents oil produced in the North Sea, a long way from the glut developing in Oklahoma. It's also cash settled, meaning no oil needs to change hands. The two contracts usually trade within $2 of one another.

So which contract reflects the "real" cost of oil?

For now, the market's going with Brent. On the U.S. Gulf Coast, home to some of the country's biggest oil refineries, Light Louisiana Sweet, a locally produced oil, also trades at $12 a barrel above Nymex--not a coincidence.

The same adjustments are being made throughout North America, where Nymex is the main pricing benchmark. Joe Gorder, an executive at Valero Energy Corp., a major U.S. refiner, declared Nymex oil futures "irrelevant" for gauging prices earlier this week.

"The storage issue is not an issue," says Joe Raia, CME Group Inc.'s director for energy products, including Nymex oil futures.

A quick look at the eye-popping gaps between Nymex and Brent verifies that the storage issue is an issue.

But the Nymex oil contract can't be counted out yet. The benchmark was supposedly "broken" in February 2009, when it traded at a then-record discount to Brent of more than $10. The gap was down to 63 cents two weeks later.

And while the new pipeline may fill Cushing's tanks, oil companies are constantly building more. TransCanada is also planning another pipeline to take oil from Cushing to the Gulf Coast, potentially as soon as 2013.

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