The Light Sweet Dire Divergence: Just Another Paper vs. Physical Disruption?

Tyler Durden's picture

Over the past few weeks we have dedicated quite a few articles to the WTI-Crude spread which today once again hit an all time record wide (here and here). Yet no matter the reason for the divergence, what is certainly lacking are explanations for why arbitrageurs have not stepped in to take advantage of this mispricing. While there has been much speculation, nobody has provided a comprehensive answer. Until today. Below we present the Weekly Tanker Opinion from Posen & Partners, "Light Sweet Dire Divergence" which gives what we believe could be the most credible explanation. Bottom line: just like in gold, there appears to be a dramatic divergence being created between the paper and physical markets in WTI. "The Brent crude oil benchmark currently represents the pricing benchmark for over 65% of the world’s traded physical crude oil. The WTI contract represents a pricing benchmark for about 30% of the world’s traded physical crude oil, while physical supplies of WTI are quite scarce. It should be noted, most of the crude oil being priced off the WTI contract is already trading at a significant premium to the contract itself implying that the market has already compensated for WTI’s lack of physical relevance. This could explain why shipping rates have remained depressed in the face of such a dramatic price discrepancy between the two contracts. It would also support the growing chorus of analysts, traders, and pundits calling for the Brent contract to be more indicative of fundamental demand for physical  crude oil (versus speculative demand for paper WTI contracts)." Much more in the full note...

Light Sweet Dire Divergence (pdf), from Posen and Partners


Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
goldenboy's picture

"maybe in the paper markets- but don't count on delivery" ....pretty much encapsulates the essence of the situation

egdeh orez's picture

Ehhh?  I thought we're flooded with crude.  Aren't there hundreds of tankers out there in the ocean storing crude for speculators?

Flakmeister's picture

  Well, lets call it 60 million bbl (I best estimate I can get)... lot of oil, almost 18 hrs worth at current world demand...

  Yeah, its a cheesy way to make money, but it doesn't change the pricing structure.

Get used to it....

Crisismode's picture

" just like in gold, there appears to be a dramatic divergence being created between the paper and physical markets


These are the cogent, optimum words.

The Gamers have learned well (young Skywalker) from Darth Vader (the JP Morgue)

and now know how to divert attention from the Physical by Three-Card-Montying the Paper.


They learned this from the first bankers (Goldsmiths) in ca. 1500 AD


And it still works today after 500+ years.


You'd think we'd have learned after half a millenium

but noooooooooooooooooo . .. . .. .. not us


gwar5's picture

I love my tanker,

My tanker loves me,

We are so happy, my tanker and me!

Cdad's picture

Step up the delivery schedule on the futures market, raise capital requirements on futures traders, and actively regulate positions size limits.  These are not shares of Netflix.  This is the nation's energy supply.  Make the paper a slave to the physical.  Were it the case, oil prices in the US would be a lot lower right now.

Cue the Peak Oil responses....

MyKillK's picture

"Make the paper a slave to the physical.  Were it the case, oil prices in the US would be a lot lower right now."


I think you missed the point, which was the opposite. Paper oil is trading lower than the physical value.

Cdad's picture


No, I understand the point just fine.  My point is not made for this minute, today, Egypt, etc.  My point is meant to address the embedded problem...including prior months of front running the resource ahead of absolutely slack bring us to this moment now.  I am talking about volatility caused by speculation.  Considering the importance of oil to our economy, I think it is past time to improve the system.

I am not trying to argue the current spread. 

Cue more Peak Oil responses....

h3m1ngw4y's picture

so you misinterpret the evil speculators hand with cost push inflation? the futures come as close to beeing the real deal, as long as delivery requests are met. if not all bets are off. volatility is not caused by the evil speculator it is caused by imbalances. but i think the slow brains need a scapegoat as ever.

That Peak Oil Guy's picture

Ok, I'll bite.

Higher production costs >> higher prices >> demand destruction >> lower prices >> decreased investment >> lower supply >> higher prices

Eventually it all leads to higher prices and lower supply as the norm and lower prices are now the exception.


CrashisOptimistic's picture

Oh, Jesus Christ.  This is not rocket science.

Texas only produces 3.5 mbpd now.  That's down 50% from 1980.  50%!

There Just Isn't Much Of It Left, and the pipelines that were originally supposed to distribute it now are filled with Canadian oil headed south or imported Mexican or Nigerian oil headed north.  It's Hard To Get To.  This makes it less valuable.  

Period.  Full stop.  Behold what happens as you run out of a product you cannot make any more of.

Devout Republican's picture

Please do not use the Lords name in vain.  God makes oil for us to use. We are never going to run out. Peak Oil my butt. 

Palin 2012!

10kby2k's picture


but god thot we going to use it only for cooking---so he thot he created plenty. his bad

Flakmeister's picture

 Looks like we caught a live one....

Thomas's picture

Why did God put our oil over in the Middle East?

if's picture

For the same reason he put your dirt in Boss Keane's ditch.

mannfm11's picture

Texas never produced 7 MBPD.  More like 3.2 million or so back in the 1970's.  They are around 2 million now. There wasn't any drilling for 20 years to speak of.  

As far as the story, the difference in price might have to do with the location of the oil.  They don't sell Brent in the US and the European markets just might be rigged better than the US markets are.  There probably isn't much use for oil in Bartlesville, OK, unless you are Phillips Petroleum.  There is a hell of a lot more to these contracts than merely the substance.  Also, there doesn't appear to be any shortage of oil, just a surplus of war machines in the oil markets.  

10kby2k's picture

goldman prob already handed the arbs their collective heads funding the other side of the trade

MyKillK's picture

I work for a very small California oil producer. We've been wondering about this curious divergence in the benchmark prices for a couple weeks now. Great article.

We sell to refineries who index their prices to a benchmark that closely matches the NYMEX futures / WTI benchmark. It is not heartening to know we're getting $10 a barrel less for our oil than what it's really worth. Anything we can do about it except hope the divergence narrows?

CrashisOptimistic's picture


Anything we can do about it except hope the divergence narrows?


Yes, there is.  Tell your customer your price.  Do not refer to any other price than the price you want and that you are confident your competition won't undercut you on.

If they (your competition) will sell at WTI price, then you have to.  If they don't swear fealty to the WTI price, then why are you?  If WTI price was below your cost of production, you would not be selling at that price, would you?  If not then, you need not do so now.


Tell your customer your price.  If he can get it elsewhere, he will.  If he can't, and MUST have your oil, he'll pay.  Done.

10kby2k's picture

i was kinda thinkin' uncle ben wanted to keep WTI down so the american consumer wouldn't throw a fit. the newspapers now report WTI to the sheeple and they are clueless that the larger brent market is nearing the magical 100 number. when we near that 100 number, sentiment turns against the current regime.  ben may have his hands in everything. check out pics of ben as a kid. whata dork. kinda scary he has so much power.  maybe he has voo doo dolls????

trav7777's picture

there's substantially more paper oil than real oil.

10kbpd on the futes?  Easy.

Locking up an actual 10kbpd supply of the real shit?  much much harder.  For that you have to talk to an actual producer, possibly get governments involved, and the price gets fixed by negotiation.  This ain't like buyin at fuckin walmart

RobotTrader's picture

Crude tankers went ballistic today:

5x normal volume:

3x normal volume

slewie the pi-rat's picture


oklahoma, hmmm...what's it worth not to have to take yer tanker and the few peeps aboard into the gulf?

but, that prob. isn't the whole, delicious enchilada, i would opine, RT.

front contracts.  one or two big buyers of N.Sea Black Gold.  "Stockpiling". 

i can't help thinking that this is probably part of a "spread" where jp morgue shorts PM's or now, even copper, and loads up the tankers for somebody BIG.

the WTI volume capacity seems to be in dispute here, also, but whoever da playa(z) be, they are buying NSea Crude ONLY and almost certainly hauling it outa there.

if only it were the mogambo!




chinaboy's picture

I am a little slow here. It appears that someone is trying to take away crude pricing power away from the U.S..  You agree?

If so, are we going to see domino effect?

Thanks for your opinion.


CrashisOptimistic's picture

Nobody is taking any pricing power away.  WTI is produced in a quantity of less than 3.5 million barrels per day.  Total global production is about 76 mbpd of just crude oil.  Why would the 3.5 mbpd type be definitive?

This is all just part of the process of it getting scarce.  Be patient.  It's all going to get much, much worse.

Oh regional Indian's picture

CIO, it definitely is a part of the plan to make it seem a lot more scarce than it is.

Such an easy excuse to take down JIT delivery systems, food, essential services, the like.

For the west, really bad news all around.

I'd be watching the signs around me very very carefully.


mannfm11's picture

Crash, WTI has nothing to do with where the oil is produced.  It is gravity measure, better known as light sweet crude.  There are heavy oils that come out of the mid east tahat sell for a highly discounted price.  US refineries used to be set up to process light crude, I believe because you could produce more gasoline out of it and it was easier to frac.  I would imagine if they sold oil for delivery at the terminal in Iran, it would be much cheaper.  Having oil in Rotterdam or where ever Brent is delivered is probably worth a premium.  

CPL's picture

Doesn't matter.  One week and the fires burn closer to home.  Tunsia and Egypt are drills the requests for help are in a well armed Ireland.


The next "wish you were government" drills filled with signs and chanting will be replaced with old school Black Irish.  No more friendly horseshit.  The fists were thrown first.  $5 a blue blood head collected.


Engineers online.  We are no longer bound by iron ring.  Pick a side, if unable use percentages, if the heavy side of percentages averages on those is on the poor side of the fence then guess what.


You're on my side.


If not.  I intend to sell organs as long as the body is fresh.  You are a working machine and salvage.

Snidley Whipsnae's picture

Paper markets = playing the game of monopoly

Physical markets = purchasing and taking delivery of a tangible commodity

We all, well most of us, knew that divergence of the paper vs real would arrive.

What did Eric Sprott experience when he recently purchased 15,000,000 oz of silver?

“We had to go into the market and buy about 15 million net ounces from third parties and it took us about ten weeks.  It was a very, very long process and the one thing we can read out of it is obviously there weren’t 15 million ounces sitting around somewhere.”

Sprott also said that a recent order for another 5 million oz of silver will take 2 months to deliver.

His prediction on silver this year? "$50 per oz, and gold to $2,150"$50_Silver,_Gold_Possibly_$2,150_by_Spring.html


Downtoolong's picture

by MyKillK on Fri, 01/28/2011 - 20:30 #915161

We sell to refineries who index their prices to a benchmark that closely matches the NYMEX futures / WTI benchmark.


This is the real crux of it. The banks have done an excellent job over the last 25 years of convincing the oil industry to index price every drop of crude oil and refined oil products relative to the futures market. After sucking everyone into the scheme, guess who now controls and manipulates the futures market and thus the price of physical oil everywhere in the world? Think about it, when was the last time you ever saw anything but futures market oil prices reported in the mainstream media? Who would know without reading something like this letter from Poten & Partners that physical oil price spreads are much  different and that the huge price spread we are all talking about is really much more localized between Cushing and the USG.


The Wall Street analysts are now all preaching that the sustaining spread between Brent and WTI is the result of some radical dislocation of major oil consuming regions in the world. They claim this is something new and suggest that that any smart investor should jump on the trend and buy into it while they still have a chance. I say bullshit, they’re not telling, they’re selling you right down a path that ends with them having more of your money. I guess we’re all supposed to just overlook the fact that the worlds physical oil supply and transportation system is among the most efficient and liquid (literally) of any that ever existed, where supplies can be shifted from Singapore to Rotterdam or Houston within weeks at a cost of $1-3/bbl max.


Admittedly, there is a real problem with storage and logistics at Cushing, which limit the flow of oil into and out of the facility. This bottleneck does cause the price of physical supplies there to diverge substantially from world markets at times. Ultimately, this translates into a fault in the design of the WTI futures contract, which is supposed to be a benchmark representing all physical oil in the North American Region. Rather than try to fix this problem (perhaps with a better futures contract design) the biggest Wall Street traders have simply chosen to exploit the situation, at times leasing large amounts of storage at Cushing to further limit and control it to make the problem even worse. The more squeezes and volatility they can cause in the futures markets the more money they make everywhere, and that’s all that matters to them.


Here’s something else I copied on this subject from Wikileaks:


On April 13, 2007, the now-defunct Lehman Brothers released a study which claimed that WTI Crude at Cushing is no longer an accurate gauge of world oil prices. A large stockpile of oil at the facility (mainly due to a Valero refinery shutdown has caused prices to be artificially depressed at the Cushing pricing point. This gap relative to world markets increased in early 2009 to nearly $12 per barrel at times, causing Saudi Arabia, a leading oil exporter and OPEC member, to announce an end to benchmarking its own oil prices to WTI.


So, here’s my question for all you investors in the USO ETF, what is you that you think you are really buying into?


Beatscape's picture

Fascinating. One way to interpret this situation puts the supply/demand Adam Smith view of looking at markets on its head.  In that traditional supply/demand analysis, you would predict that less supply of WTI oil would cause the prices of it to rise--but yet the opposite is happening. What is causing this?

Why, it's all an illusion controlled by the bankster behind the curtain. If the price of front month WTI on the board is not even the price at which you can buy the actual physical commodity, than what good is the WTI benchmark?

Oh, it serves its purpose very well in CPI & PPI calculations, the import/export component of GDP calculations, its use in various paper derivative contracts and other "official" bankster means of benchmarking crude oil prices.

It has become a very useful tool of the banking elite to use as a means of misrepresenting the oil market.  And, if you are skeptical of this conspiracy way of thinking, then please take a close look at the USO ETF.  Set up  by Wall St. banksters to reflect the price of WTI in the form of a convenient instrument to trade as a stock on the NYSE, it closed Friday at $37.58.  Yet WTI (even at it's artificially depressed price) settled at $86.10 on Friday, which places the USO fund at about 44% of the price of crude oil.  So if you bought the USO a couple years ago as a way to own oil in a paper form, you have been thoroughly fleeced by Wall St. 

The Count's picture

Next in line: Artificially low agri futures! Like with PM and oil, we will be fooled into believing that there is plenty of cheap wheat and corn, only the actual loaf of bread will cost you $10 at the supermarket. 

Babalooee's picture

Warning: Shameless Stock Promotion

Want sweet light crude at a discount price? Check out a tiny little company in Mississippi ...KFG. Positive cash flow, long time oil people, drilling inexpensive wells in the Wilcox sands. Will do a deep test in the Tuscaloosa late this spring. Step right up.

steve from virginia's picture

The question here is which market is leading, that is, which is a 'real' futures market and which is a kinda-sorta cash market?

The reasoning is that + $90 is too high to support most economic activity so gravity will emerge at some point. This would mean WTI is forward and Brent is cash. Sell Brent front month and buy longer- dated WTI contracts might be a good trade.

Maybe not, predicting petroleum prices is like predicting weather a month out.

The major indexes give us a choice. Drillers who ship to Cushing have the ability to hold crude off the market and let inventories drop and WTI prices firm. They aren't doing so for all sorts of reasons. These are probably the reasons why spare capacity has vanished along with tanker storage.

Physical arb is not an issue. The possibility of closing Suez canal means anything that floats will be in demand: the trip around Africa is another 5000 miles which adds/subtracts from Brent's appeal.

The solution to $100 oil is $100 oil -- and demand destruction. This is ongoing but how it all plays out is going to be the surprise.


Flakmeister's picture

  Well there are contracts and the need for ongoing cash flow. Short of the a force majeure, "The spice must flow", but I agree there is an element of logic to your argument.

I wonder how much of the disconnect between paper and physical commodities is due to the direct manipulation of markets, i.e. the Fed through its partners deperately trying to keep a lid on things. Try to make the demand destruction occur elsewhere before it has to happen here?