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Is It Time To Collapse The WTI-Crude Spread?
Recently there has been much speculation about the nature of the notable divergence between WTI and Brent. Explanations range from the now traditional Cushing syndrome, to Hess attempting to corner the BFOE, to correlation desks blowing up, to the ludicrous, which includes HFT (as much as it is trendy to blame parasitic HFT for everything, is not responsible for correlation trades, especially not in markets that do not have endogenous liquidity at least 1,000 times above that needed for HFT to actually add value). Probably the best explanation to date comes from JPM's Lawrence Eagles who in a just released note asks "Is Brent-WTI wide enough." His lede: "Brent and WTI have been trading increasingly as entirely separate commodities in recent weeks, driven by decidedly different fundamentals. Yet this is an important spread, which tells us a lot about regional Midwest and international crude economics and will, over time, drive investment that will ‘normalize’ price discrepancies." In other words, it is not the spread's wideness that is the outlier: it is the fact that it was overlapping for so long that is peculiar. In time, Eagles claims, speculation may drive the spread so wide that the economic incentive to close the gaping infrastructure holes will be large enough and the discounting of this act will bring the spreads back to parity. In the meantime, the spread will likely persist. Not only that, but he also believes that the 2012 calendar dated differential, currently trading at a far more reasonable $2.50, will likely also diverge, as two years is insufficient time for the required changes to transpire. Furthermore, the last straw that convinces us that it is likely early to bet on a convergence, is Goldman's just released commodities report which has a WTI target $2 above Brent. By now everyone should know what they say about trading Goldman recommendations...
The complete explanation from JPM:
Brent and WTI have been trading increasingly as entirely separate commodities in recent weeks, driven by decidedly different fundamentals. Yet this is an important spread, which tells us a lot about regional Midwest and international crude economics and will, over time, drive investment that will ‘normalize’ price discrepancies.
We continue to see Brent tightness as reflecting both the ongoing decline in North Sea crude supplies, along with increased pull of Middle Eastern, Russian and West African crudes by Asia. Concern that Brent has become overextended have been underscored by the wide differentials of Dated to Urals. Urals and Brent refining margins confirm this trend, but in relation to comparative crudes, Bonny Light and LLS the ‘overvaluation’ is less apparent. This signals to us that it is Urals that is cheap, rather than Brent that is overvalued—a factor we relate to the Belarus oil pricing dispute. If correct, this pricing gap should narrow in the coming weeks, amid signals the dispute has been resolved.
Unsurprisingly the main issue for the wide Brent –WTI spread seems to lie not with Brent but rather with WTI.
An examination of the monthly flows is revealing. Domestic crude flows into and out of the Midwest have collapsed in recent months, as rising production within the region and continued inflows from Canada squeeze out supplies from the Gulf Coast. Equally significantly, the wide price spread between WTI and Brent has led to a sharp increase in flows out Padd 2 to the Gulf. As we have said before, ‘price will always find a way’.
Latest available data indicate that net flows between Padd III and Padd II dipped below 800 kbd for the first time since 1986 (which is as far back as available data goes). Furthermore, data for imports from Canada into Padd II also indicate a decline in late 2010, but we see this as a dual function of increasing Bakken production, alongside pipeline restrictions.
Pricing differentials clearly economically price-out shipments of oil from the Gulf Coast to Cushing, Oklahoma. However while spot prices are clearly indicating a lack of ullage, or demand for incremental shipments, the solution to the problem revolves around reconfiguring pipeline flows to rebalance the system. Therefore we have to take not only average spot prices into account, but forward prices too.
With the Calendar 2012 Dated Brent-WTI differential at less than $2.5/bbl, it seems the market is already discounting a resolution to the issue by 2012. Relief will come when the TransCanada Keystone project is completed to Nederland, Texas, but this is some way off and will still result in WTI pricing below historical levels as Cushing changes from being a premium inland market, to a transit point for Canadian and locally produced grades as they head towards higher value markets.
But over time it is likely that further outlets will be needed. The market spreads do not currently appear to provide the financial incentive to undertake the contractually tortuous process of reversing pipelines or building more, which means that either incentives need to increase, or the process has to be driven by under-utilization. Most likely a combination of both.
The net result is that prompt WTI spreads have to remain wide for some time to come, and ‘supercontangos’ will remain a recurring feature on the landscape. Longer-term incentives however suggest that the Brent-WTI spread in 2012 needs to widen.
And there you have it: nothing more than a question of medium-term supply/demand imbalance, and one likely without an immediate catalyst that will bring the spreads to parity. Then again, the cliffhanger is, of course, that this is a JP Morgan report... about commodities. And there is hardly a firm that has perfected the art of manipulation in that particular space better than JPM: not even Goldman. Which is why at the end of the day we wouldn't be surprised if it were to come out that it was not Hess but rather the House of Dimon that was currently cornering the Brent market. Unfortunately, for the time being no incremental information is available. Suffice to say: those who believe that a compression trade between the spot curves is a slam dunk: be very careful.
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the oil market is larger lie, to scope and scale in multiples as compared to PM's..
where is all this light sweet crude @ $50bbl coming from? $90bbl...
not trying to be a dick, but this shit is getting pumped up from the sea floor off of $300m $400m rigs... shipped, processed, re-shipped and the refined???? that aint cheap.
as for being long oil at anything under $100bbl... grab it while you can!
For the record, I am just bitchin.. the article is great.. sorry to be some what.. or way off topic for a first post.
I don't think a rant about oil market manipulation is off-topic. I'd like to know how they get futures to go down overnight with the riots in Suez.
They already know the outcome, silly.
I hope you are right.
I posted this earlier today....maybe it is relevent.
PS: There are some charts in there I could not copy over. Here is the link:
http://seekingalpha.com/article/248502-how-to-play-the-high-brent-wti-sp...
By Julian Murdoch
We often talk about the difference between Brent and WTI crude oil on this site. But never has the difference seemed so stark as now.
Brent crude, you may remember, is drilled from the North Sea oil fields and serves as the benchmark for European crude oil, while WTI (aka West Texas Intermediate crude) serves as the benchmark for U.S. oil.
WTI is a sweeter, lighter crude, and all things being equal, gasoline refiners prefer to work with WTI over Brent. Thus, in a vacuum, WTI should trade at a premium to Brent. But we don't live in a world of blind equality.
Looking back over the past five years (except for 2008, that is), WTI tended to obey common wisdom and run at a premium to Brent by roughly $2. But in 2008, the latter half of 2009 and now over the past few months, the two switched, with Brent trading at a premium—sometimes a substantial one—to WTI:
On Monday, that premium was $8.74—the largest spread seen over the past five years. So what gives?
Brent Trading Games, WTI Surpluses
Oil expert Chris Cook, former compliance director for the International Petroleum Exchange, points out that futures aren't what set the price of Brent crude. Physical cargoes coming out of the North Sea do.
"That amount coming out of the North Sea is gradually declining," he told Hard Assets Investor in a phone interview Monday. "It's been in secular decline for some time."
According to the Energy Information Administration, production in the North Sea in 2006 was 4.343 million barrels per day, but by the end of 2010, it had dropped 23 percent to just 3.348 million bpd. What's more, the EIA predicts this trend will continue to the tune of 185,000 barrels per day in 2011 and 156,000 bpd in 2012 (EIA's recent Short-Term Energy Outlook - Jan 2011).
New exploration licenses continue to be issued for the North Sea, and new discoveries continue to be made, but overall, says Cook, nothing can come close to slowing—never mind stopping—the production decline.
It hasn't helped that existing rigs in the area have had a few mishaps. Statoil briefly closed two of its fields in the North Sea earlier this month after a gas leak was discovered. (Combined, the two fields—Snorre and Vigdis—produce around 157,000 bpd.) Then just last week, Royal Dutch Shell closed four interconnected rigs in the original Brent field, when large hunks began falling off one. That took about 20,000 bpd off line, and the complex will stay closed for several weeks to come.
"The fewer and fewer cargos there are knocking about," says Cook, "the easier it is for people to actually influence [the price]. That is exactly what is going on—trading games. Hetco, the trading arm of Hess Co. in the U.S., has bought up roughly a third of this month's cargo and some of the next."
These "trading games among consenting adults," as Cook terms them, have gone on for years. But as Brent became a more widely adopted global benchmark in the 1990s, these trading plays began to affect the volatility of the global price of crude—and the Brent-WTI spread.
"I think we're seeing some games which have temporarily pumped up the arbitrage between the two contracts," he says. "Brent is financially pumped up, whereas WTI is more rooted in the underlying market because it is deliverable."
Physical delivery of WTI crude, which occurs in Cushing, Okla., has a real effect on crude prices due to the storage/delivery bottleneck that sometimes accumulates there. That means short-term inventory surpluses and deficits can have a significant impact on prices.
"Inventories in the U.S. have been coming down in the last few months, but there is still a healthy amount of oil in storage in the U.S., which tends to push the market more into contango,," says John Hyland, portfolio manager and chief investment officer of United States Commodity Funds LLC.
Indeed, according to the EIA's weekly petroleum inventory reports, inventories are still well above five-year averages, although they are lower today than in previous months.
So with tight supply and trading games pushing Brent prices up, and oil surpluses keeping WTI prices low, it only makes sense that the Brent-WTI spread should be as high as it is today.
But will the trend continue? No way to tell for sure. No matter—U.S. ETF investors can easily invest in either side of the spread.
Investing In The Brent-WTI Spread
Since USCF's introduction of the United States Brent Oil Fund (BNO), the fund is up 24 percent compared with the comparable WTI fund, the United States Oil Fund (USO):
The two funds are similar in that they both own a single, front-month contract and roll it two weeks prior to expiration. The only difference is USO owns WTI, while BNO owns Brent.
Although there's no guarantee that Brent will continue to outperform WTI, the future curves imply that maybe, it just might:
On the left, we've plotted the futures curve for both oil contracts over the next year. On the right, we show the historical cost of rolling that front-month contract over the last year.
Immediately obvious is that WTI is in fairly strong contango through the next year—a function of the aforementioned ample inventories. Brent's curve, on the other hand, remains comparatively flat, although technically in contango. If these conditions persist, then BNO will likely continue to outperform USO simply because of the roll cost—although all it takes is a drop in U.S. inventories to quickly flatten the WTI futures curve and change the picture completely.
So what's an investor to do?
One option would be to buy one and sell the other, depending on which way you think the spread is going to go, and take advantage of the arbitrage between the underlying crudes. With Brent at such a tremendous premium, it's a tempting play, although a flattening of the WTI curve could work against you.
Another option is to pick the crude that aligns with your investment strategy, whether it's something U.S.-centric or a more global approach. Hyland sees real opportunities in the latter.
"If you're bullish on oil because you're bullish on India and China, you're already halfway there to being non-U.S. centric. You've already concluded that the price of oil is no longer solely dictated by how many people are going to drive to Disneyland this summer," he says. "So take the next logical step and think about what kind of oil exposure you want to buy."
In the end, when it comes to crude, it pays to remember that more options exist than just plain old WTI.
From - SeekingAlpha
Light crude Vs Heavy crude.
Has something to do with Diesel - Asia's Fuel of Choice.
Life moves in a direction - get educated or you will be run over.
I so annoy the capture questions by putting FU as an answer that it Capitulates and rolls over and ask's me 20 X 2 = ........
Answer = 40 unless your GS then the answer is FU
Yes light crude is mostly gasoline with bit of deisel and some oil and lubricants. Heavy crude is mostly deisel, oil, gear oil, grease compounds.
What pisses me off is when the answer is negative and I put in "-33" or whatever and then is says I've got three digits which is too many... then I just resubmit and it takes... wtf?
"That amount coming out of the North Sea is gradually declining," he told Hard Assets Investor in a phone interview Monday. "It's been in secular decline for some time."
That is the key...simple supply and demand. North sea extraction is already difficult..but with declining supplies this price will stay high (unless someone is quietly sitting on a massive field).
The link would have saved most a lot of scrolling past it.
Minor heads up for future impacts. Bakken production will rise. It won't be anything like the bizarre numbers the drillers want believed (to get drilling funded), but it will rise.
They don't have infrastructure. They do have roads and railways. Oil shipments by train from unpipelined sub arrays is credible as a tertiary growth vehicle.
Just don't get caught up in the hand waving. They'll get 500-600K bpd from the entire region someday, 6ish years from now, expensively, and by the time they do, Texas and Alaska will have seen their production decline by more than that.
many guys are not getting it (90% who are posting)... you are getting it and you are right on the bakken. WTI will continue to be at a discount due to local market supply / dmd fundamentals.... indeed bakken production (and horizontal drilling in oil, a new technique) is a MODEST game changer... this with oil sands (coupled with WEAK US DEMAND) means we will be well supplied and cushing crude will sell at a discount to other products (North Sea Brent)
Brent also has always been considered more of an "international market" proxy vs WTI being a local US product. We know where emerging demand growth is headed vs US...
finally, and people giggle at this schyt, but North Sea crude production has PEAKED several uyears ago... its TIGHT in Rotterdam and their precious crude pumped from the north sea is quite scarce... look @ this table of actual and forecasted UK production (one of the components of Brent)... the facts dont lie (ps I cant paste this sucka.. and if it doesnt appear google north sea crude production and you'll see for yourself)
Indeed there are a lot of other "paper market" issues that cloud the trading market fundamentals -- USD, Futures Action, Correlation trade... as I said yesterday, I guesstimate the "financalization" of the commodity can explain nearly half of the price moves. But I see this one clearly -- and the original JPM document says the same -- this is due to fundamentals of the local market....
Now I am going to resist 'splaining myself, shut up and trade to make some money...'nuff said my brothers...
Brent is a corner trade that will unwind, back to correlation.
We are deep into Asia. I can talk about my usd/jpy trade. I still am even on a nice pip profit LONG USD. Why? ACB getting rejected. Global slow down. Yen retards. All of the above. LONG USD!
Looks to me like the USD is ready to fall off the cliff against the yen.
Oh I just had sooo much fun. Reverse algebra.
Now that I'm done with funny business. Check out Brent Prices rolling into Europe. @ bucks?
2 dollars on the April contract? Brent. Not Light sweet.
BoJ and Kampo. I hedged after 50 pips. No greed.
It's not intervention. It is however a warning. Check out the swissy vs eur and usd.
Swithing cost bizhez!!!
Ahh look at that hammer swing on the h-1 usd/jpy chart.
I guess the swing in the Yen/Dollar comes from this news about Japan. http://t.co/BAhWkyM
Yen got downgraded because of debt, aging society and rising government debt in near term. Well, how come US dollar is not downgraded ? We are in much worse shape than the Japanese.
If we keep crushing our currency, will arabs agree to keep sending crude?....The british pound seems to be quite stable despite their fiscal woes while the buck gets battered....
I call bullshit on the entire article. It’s a clever assembly of facts and arguments designed to persuade investors into thinking that the current situation is a new normal and progressing. Therefore, you should buy into it now! So very JPM, so very Wall Street indeed. It’s what they don’t say that can hurt you. Such as the fact that the world physical crude oil supply and transportation system is among the most efficient and liquid (literally and financially) in the world. You can shift oil supplies from just about anywhere to anywhere in a few weeks and it doesn’t cost $10/bbl to do it. More like $1-$3 depending on the specific situation. Maybe this is JPM’s way of telling us that their traders need to make $7-$8/bbl on such arbs to make it worth their while, i.e. make their bonus this year. Maybe it's just part of their smoke screen to divert peoples attention from the fact that this huge spread is nothing more or less than the result of a futures market manipulative squeeze, which I'm now more inclined to believe JPM is a big part of already.
I say this report is just part of the pump in preparation for the coming short and dump of the Brent/WTI spread in the futures market and JPM plans to be among those leading that corrective charge in the bank controlled futures market. Keep one other thing in mind too: when a Wall Street banker talks about the long term, they mean anything over 90 days.
You do not understand the problems. Pipelines are not bidirectional without a great deal of administrative / regulatory gobbledygook. If pipelines flow imports from Houston northward, you can't flip a switch and flow WTI into them southward for export to magically close the spreads. IDWTW (it doesn't work that way)