Quality is Driving Dollars, Which Drives Industry Change

The value of WTI at Cushing, Oklahoma is the benchmark for crude prices in North America. It is also the primary input into CME Group’s NYMEX Light Sweet Crude Oil contract, often referred to as WTI. Although it’s often called the WTI contract, WTI is just one of many grades that could be delivered against the contract. NYMEX also includes other crudes and blends that meet the quality parameters, referred to as Domestic Sweet Crude Oil (DSW).

If the above sounds confusing that’s because it is, and buyers felt the same way. When using the NYMEX contract, they were uncertain whether they would get the quality they actually wanted. The rise in US production compounded the problem as several new light streams were also sent to Cushing for delivery against the NYMEX contract. This buyer concern had real consequences. Observable differences between the physical market and NYMEX specification began to appear. Buyers were willing to pay more for physical WTI, which implied a market premium for reduced quality uncertainty. This is a surprising occurrence in an efficient market where both purchase options should have the same quality. It became clear that if parties were willing to pay more for the “same” crude, then it was likely that measurement requirements were not accurately representing physical realities, and needed to be revised.

In response to the uncertainty, the CME group has added new quality requirements for crude deliveries as of the January 2019 contract month. They added five additional measurement requirements while keeping the previous requirements unchanged. NYMEX futures have been updated with these new tests in the hope that the contracts now better account for the quality concerns that were showing up in the cash market. The biggest issue for any futures contract is that it no longer mirrors the underlying cash market. If this ever occurs, it means that the instrument is no longer an effective hedge, which reduces liquidity and makes the contract less viable. The goal of the contract revision is to create a more liquid market by ensuring all volumes represent a consistent quality. A deeper WTI pool is expected to promote efficiency, transparency, and increased activity. All of this is achieved by simply changing how quality is approached.

Upcoming Webinar: Validere’s CTO Ian Burgess will be hosting a webinar on understanding the new NYMEX quality rules around distillation, vanadium, and TAN on Thursday,  February 7th at 10 AM MT (11 AM CT).


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Mark Le Dain