West Texas Intermediate (WTI), also known as Texas Light Sweet, is a type of crude oil used as a benchmark in oil pricing. It’s also the underlying commodity of the New York Mercantile Exchange’s oil futures contracts.
“Although oil prices have risen in recent months, end market demand for distillates (diesel, jet fuel, heating oil, etc.) remains weak,” say Morgan Stanley & Co. Inc. freight transportation analysts William Greene and Adam Longson. “As a result, there is a large disconnect between the price of WTI and diesel. Historically, the relationship between diesel and WTI has stayed within a narrow range, but the price differential is now near an all-time low, which could have unforeseen consequences for a number of freight carriers. While there is precedent for very wide crack spreads (hurricane Katrina, sudden declines in crude prices in fourth-quarter 2008, etc.), this is the first time we have seen such a narrow crack spread.”
As for the effect on railroads, “CSX and Norfolk Southern are most likely to benefit from narrow crack spreads,” say Greene and Longson. “NS and CSX, in particular, still have a number of customers operating under fuel surcharge clauses that are indexed to WTI rather than on-highway diesel. When crack spreads narrow, the effectiveness of these fuel surcharge clauses improves. As long as crack spreads stay below historic norms, both carriers should benefit.”
BNSF, say Greene and Longson, “could post a narrower fuel hedging loss. BNSF has used WTI swaps and collars as part of its fuel hedging strategy. Higher WTI prices will reduce the negative impact from underwater hedges, but BNSF can also incur accounting gains and losses based on the effectiveness of the hedge—the tracking error between WTI and diesel. Remember that BNSF reported a $15 million gain from the ineffectiveness of WTI swaps in second-quarter 2009.”
The narrow crack spread is less positive for intermodal. “Though higher oil prices are generally bullish for intermodal volume and pricing, in reality customers are only concerned about the price of diesel,” say Greene and Longson. “As long as the price of diesel fails to rise, intermodal’s cost advantage vs. truck will be limited. A narrow crack spread could weigh on railroad domestic intermodal volumes and pricing as well as J.B. Hunt’s trucking intermodal volumes, although we'd argue this is mostly in the price.”