The globalisation‐regionalisation debate in international crude oil markets: old wine in new bottles

• Date: 01 September 2018
• DOI: http://doi.org/10.1111/opec.12136
• Published date: 01 September 2018
• Author: Arif Billah Dar

The globalisation-regionalisation debate in

international crude oil markets: old wine in

new bottles

Arif Billah Dar

Assistant Professor, School of Economics, Shri Mata Vaishno Devi University, Katra Jammu and

Kashmir182320, India. Emails: a.billah@smvdu.ac.in, arifbillahpcu@gmail.com

Abstract

In this paper, a new perspective of testing the globalisation–regionalisation hypothesis in the two

international crude oil benchmarks, the European Brent and the American WTI, is proposed. Existing

studies have failed to take into account the time horizons in studying the globalisation–regionalisation

of two benchmark crude oil markets. This study overcomes the given limitation by testing the

correlation and cross-correlation at different time horizons. The results are suggestive that the two

benchmark crude oil markets are more globalised at longer time horizons compared to the shorter time

horizons. Furthermore, in the recent years, it is found that the two markets have regionalised.

1. Introduction

There are more than 150 different varieties of crude oil bought and sold in the global

crude oil markets. The consensus among the section of economists and crude oil market

experts is that the global crude oil markets behave like a ‘one great pool.’(Adelman,

1984). In technical jargon, this phenomenon is known as the globalisation of the crude

oil markets. Advocates of the globalisation hypothesis argue that the active arbitrage

takes place in the global crude oil markets so that the trade in the physical and paper oil

market balances the price differential among the major crude oil benchmarks. Contrary

to this stream of thought, Weiner (1991) advocates that the global crude oil markets are

regionalised as the global crude oil markets do not have a tendency to move together.

Significant transportation costs in shipping crude oil discourage the arbitrage opportu-

nities in the crude oil markets. The argument gathers strength under the consideration

that differences in crude oil quality and the specification of refineries to refine a

particular kind of crude oil, do not allow active arbitrage in the crude oil markets.

Adelman (1992) counter reacts to the regionalisation debate and opines that substantial

price differentials make the shipping costs hence arbitrage unviable. The debate is still

JEL classification: F21, F41, Q43, N53, N73, O33.

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244

thriving and has generated more heat than light. The studies of Kaufmann and Banerjee

(2014); Liao et al. (2014); Chen et al. (2015) are few recent papers that shed light on the

globalisation–regionalisation debate within the crude oil markets.

What makes this discussion interesting and contemporary, however, is the apparently

growing price divergence in two major crude oil benchmarks of the world in recent

years; namely the West Texas Intermediate (WTI) and Brent. The WTI serves as the

benchmark for the crude oil consumed in the United States. The crude is extracted from

the wells in the United States and transferred to Cushing, Oklahoma via pipelines. With

an API gravity of 39.6 degrees and sulphur content of 0.24 per cent, the WTI crude

remains suitable for gasoline production and stands out as one of the lightest and

sweetest crudes of the world. The Brent, on the other hand, is a composition of crude

extracted from four different fields in the North Sea and comprises of Brent Blend,

Forties Blend, Oseberg and Ekofisk crude. The API gravity of this crude stands

approximately around 38.06 degrees with sulphur content of 0.37 per cent. This crude

variety is slightly heavier and sourer than the WTI. Being relatively lighter and sweeter

crude, WTI historically has mostly been (not always) traded at a $1 or $2 premium. The

difference or the spread between the WTI and the Brent reflects the quality differential.

Historically, this spread has exhibited a stable trend; suggesting the comovement of the

two markets and a phenomenon supportive of the globalisation of the crude oil markets

hypothesis. In the recent years, however, specifically post-2010, the two markets have

been witnessing growing divergence. Before 2010, the WTI, e.g. was trading at a $1 to

$2 premium and in subsequent years the Brent starting trading at a substantial premium.

This observation is indicative of the growing regionalisation of crude oil markets in

recent years as envisaged by Weiner in 1991. Some experts believed this divergence as

ephemeral and reasoned out its root to the civil war in Libya. However, the prolonged

civil war in Libya did not allow the two benchmarks to converge, proving short-lived

deviation in the crude oil markets as an unfit proposition. The second reason that the oil

experts believe is that there has been too much accumulation of crude oil in the refinery

city of Oklahoma following the excessive supply from oil sand fields in Canada and

Bakken oil. The Oklahoma City being the delivery point of WTI crude oil for various

crude oil demanding areas lacks storage facilities and outflow infrastructure. The

inventory pile up has thus induced the lowering of WTI prices. All these factors taken

together with the slow economic recovery of the North American States have contributed

significantly to the price divergence in the WTI and Brent crude benchmarks.

A voluminous body of literature debates on the globalisation–regionalisation

hypothesis in the crude oil markets. Empirical studies have supported both the globalisation

as well as regionalisation hypothesis. Studies like Gulen (1996, 1999) using cointegration

technique on both weekly and monthly data have shown that the similar quality crude oils

are cointegrated particularly during the rising prices of crude oil. Ewing and Harter (2000)

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