Friday, 6 October 2017: 5:05 PM
West Texas Intermediate (WTI) and Brent are crude oil price indexes for sweet, light oil, meaning they are low density and low sulfur content and thus ideal for gasoline production. Brent is used to price roughly two thirds of internationally traded crude. WTI is an index of oil produced in Texas and southern Oklahoma, and is used to price other U.S. crude. If the world oil market is efficient, arbitrage should lead the West Texas Intermediate (WTI) and Brent crude oil price indexes to converge whenever they stray apart, or to be more statistically precise they should be cointegrated with a well behaved error correction model (ECM) describing how quickly the prices converge following a shock. From the beginning of our sample on May 20, 1987 until December 1, 2010 when U.S. oil production began to accelerate due to hydraulic fracturing (fracking), we find the two series are cointergrated. However, at this point the decades old U.S. ban on crude oil exports appears to have become a binding constraint on the efficient functioning of the world oil market long adapted to the U.S. being a large oil importer. From this date until the ban was lifted on December 18, 2015, the two prices are not cointegrated. From the lifting of the ban through to October 31, 2016, the end of our sample, the two prices are again cointegrated, indicating the transatlantic market for crude oil is operating more efficiently. We also find evidence the convergence in the two series is now occurring more quickly in this last period than in the first period, suggesting another source of efficiency gains.