Commodity Investing: The Ultimate Beginner’s Guide To Brent Oil? (USO, BNO, XOM)
Jared Cummans: Crude oil is one of the most vital commodities in the world. Whether we realize it or not, it has a presence in our everyday lives and is a fuel that our world simply cannot function without. But when it comes to crude investing, traders have long had two choice staring them in the face; Brent oil, and West Texas Intermediate (WTI) oil. The two have stumped many for quite some time, as they search for the intricacies that make these seemingly similar commodities inherently different. While most investors are familiar with WTI, brent leaves many scratching their heads. The best way to define brent crude is to simply distinguish what makes it different from its counterpart [see also 25 Ways To Invest In Crude Oil].
What’s The Difference?
The name “Brent” stems from a shared project between Exxon Mobil (NYSE:XOM) and Royal Dutch Shell who named all of their oil deposits after birds, including the Brent goose. Also note that Brent is an acronym for the differing layers of an oil field: Broom, Rannoch, Etieve, Ness, and Tarbat. Brent oil is considered a more sour commodity than WTI, though both crudes are considered sweet oils. This is generally based on the sulfur content of the underlying fuel with 0.5% being a key benchmark. When oil has a total sulfur level greater than half a percent, then it is considered sour, while a content less than 0.5% indicates that an oil is ‘sweet’. Brent has a sulfur level of around 0.37%.
Sour oil is more prevalent than its sweet counterpart and it comes from oil sands in Canada, the Gulf of Mexico, some South American nations as well as most of the Middle East. Sweet crude, on the other hand, is generally produced in the central U.S., the North Sea region of Europe, as well as much of Africa and the Asia Pacific region. While both types are useful, end users generally prefer sweet crude as it requires less processing in order to remove impurities than its sour counterpart. The majority of the world’s Brent is refined and found in the Northwest regions of Europe and is especially important to Scandinavian nations [see also Jim Rogers Says: Buy Commodities Now, Or You’ll Hate Yourself Later].
Because Brent is slightly more sour, the commodity often trades at a premium to WTI, though there is a fair amount of speculation as to how long this premium will last or if it will ever be erased. The premium comes from the fact that Brent requires more refining to be utilized in everyday machines and automobiles.
Brent’s Stellar Performance
It should also be noted that Brent has massively outperformed its WTI counterpart in recent years, giving investors yet another reason to look into this commodity. The chart below shows the difference in performance between the United States Oil Fund (NYSEARCA:USO) and United States Brent Oil Fund (NYSEARCA:BNO) for the trailing two years. The two ETFs track WTI and Brent futures respectively [see also Three Commodities Dividend Lovers Must Own].
Note that the two have near identical movements, but that Brent’s premium (which seemed to become exaggerated in early 2011) put it well ahead of the West Texas brand.
One of the most important things for investors to keep in mind is the individual price drivers of each underlying commodity. Below, we outline the most important factors playing into the everyday value of Brent oil.
- Global Economy: This is without a doubt the most important factor driving the price of Brent. If the global economy begins to sag, so too will this commodity as it will mean lower demand from consumers. Likewise, when the economy is booming, Brent prices are likely to charge higher based off of higher consumption of the fossil fuel. In recent years the global economy has been anything but stable, so giving a prediction for how Brent will turn out in the future is relatively impossible; keep a watchful eye on economic developments to stay ahead of the curve [see also Warning: Ignore Bill Gross’ Hard Money Prediction At Your Own Risk].
- Geopolitical Tensions: This has always been a major issue as far as oil is concerned as the suppliers and consumers of this commodity do not always get along. With sanctions of foreign oil as well as a fair amount of political unrest in the Middle East, crude prices hinge on the every development of these nations. We have seen even the threats of war cause a massive premium in oil prices and it will more than likely happen again at some point in the future. Until we (and other nations) can reduce their dependence on foreign imports, geopolitical tensions will remain a major point of contention for Brent prices (and WTI as well).
- Emerging Market Demand: One factor that many overlook is the demand from the world’s most dominant countries, like China and India. Though none match the consumption of U.S. oil, their demand for the commodity still has a lasting impact on its prices. In recent years, many have accused these nations of being faced with a slowdown after years of rapid expansion, should that ever occur, demand for oil will likely drop and put a dent in Brent prices [see also Doomsday Special: 7 Hard Asset Investments You Can Hold in Your Hand].
- Substitutes: For many years, people have been rallying around the concept of green energy and displacing the foothold that fossil fuels have in our everyday lives. While many argue that this is a long ways off (and others claim it is flat out impossible), substitute products are always in the works and it only takes one breakthrough to permanently damage Brent’s price.
Written By Jared Cummans From CommodityHQ Disclosure: No Positions.
CommodityHQ offers educational content, analysis, and commentary on global commodity markets. Whether you’re looking to speculate on a short-term jump in crude or establish a long-term allocation to natural resources, CommodityHQ has the information you need.