INSIGHT: Crude trading patterns change on wide WTI-Brent price gap

21 February 2011 17:50  [Source: ICIS news]

By Giovanni Coiro

LONDON--The wide gap between the Brent and WTI forward curves is resulting in changing trading patterns, with the spread becoming a bet opportunity for traders while Brent attracts volumes away from its US counterpart.

In the middle of October last year WTI was trading at a premium to the Brent crude basket but the situation has reversed sharply, with the price gap between the two marker crudes widening to more than $10.00/bbl in Brent's favour.

While the April WTI futures contract was trading at around $94.45/bbl on Monday 21 February, April Brent was trading $10.52/bbl higher at around $104.97/bbl.

While prices have been driven up on Monday on the back of market nervousness over civil unrest in Libya, the gap has narrowed as WTI posted bigger gains than its counterpart due to short covering ahead of the expiry of the March NYMEX WTI contract on 22 February.

But changes in the gap between the two markets have attracted additional trading interest on the price spread and have led to traders shifting focus away from the US market.

There are more people than before trading the WTI/Brent spread, according to Rob Montefusco, a broker at Sucden Financial.

And if the trend continues and it is logistically and legally possible, then the market may see WTI physical crude being taken out of Cushing, Oklahoma - its delivery point - and transported outside the US, Montefusco says.

Some have believed that the price gap between the Brent and WTI crude front-month contracts could persist through 2011 and possibly into 2012.

Oversupply at Cushing, and the differences in supply-and-demand dynamics compared with the Brent market, have resulted not only in a drop in the WTI futures curve relative to Brent but a clear difference in the steepness of the contango structure between the two markets.

Reports have suggested moves to alleviate that oversupply may come sooner rather later, and possibly before 2013 when a pipeline is expected to link Cushing to the US Gulf.

But David Fyfe, head of the International Energy Agency's (IEA) Oil and Markets Division, at a conference at IP (International Petroleum) Week in London on Monday, said that the current weakness in the WTI contract compared with Brent could persist until 2013, when the pipeline that will take crude away from Cushing becomes operational.

Brent futures have also been attracting more trading volume away from WTI due to the negative roll yield on those trades. This is a cost investors incur in a contango market when selling the expiring front-month contract and buying the next month's contract.

If the contango is persistently less steep on the Brent forward curve there is a tendency for traders to shift to a market where they minimise the loss of rolling the contracts.

In the futures market, a contango structure exists when the price of a futures contract is progressively higher compared with the front-month contract.

Persistent oversupply at Cushing has resulted not only in a drop in the WTI futures curve relative to Brent, but a clear difference in the steepness of the contango structure between the two markets.

Because storage capacity at Cushing is constrained and because crude at the hub is landlocked, any surplus material translates into lower spot prices and a steeper contango on the futures curve.

And the situation has been exacerbated in the past couple of years by upgrades that have given US refineries a greater ability to process heavier crudes.

The Keystone pipeline which is bringing Canadian oil into Cushing has also helped fuel the situation. The ambitious four-stage pipeline project has some enthusiastic backers, particularly for the stage that is expected to link Cushing to Port Arthur, on the Texas Gulf Coast.

Analysts have noted that increased inventories at Cushing are resulting in a steeper contango in WTI and to traders moving more volume to the Brent market, thus widening the gap further.

The spread is becoming an independent bet, they say, and is likely to add to crude price volatility.

Crude stocks at Cushing approached record January highs last month, increasing by 300,000 barrels to 37.7m barrels, Energy Information Administration (EIA) data showed last week. The data suggest that the trend will continue.

Neha Popat contributed to this article

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By: Giovanni Coiro
+44 20 8652 3214



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