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Crude on the Wide - Why?
We set another record yesterday. This one has me scratching my head. The Brent WTI spread widened to $27.22. That’s never been seen before.
There are some partial explanations for this phenomenon. Brent is lighter in grade and justifies a somewhat higher price. But not $25.
Another consideration is the increasing flow of crude from the Bakken field in North Dakota. This crude often heads to Cushing, Oklahoma, and therefore creates a supply glut. The WTI price should be lower than Brent based on this. But, one again, $25 seems out of whack. The smart guys up in NDAK are also sending crude by trains to the Gulf area where prices are higher.
Another consideration is that WTI is a hedging mechanism for algo computers. When there is announced evidence of a slowing economy the markets all react. If economic activity is in decline it makes “sense” that crude should trade lower. Computers that are trying to move risk around buy bonds and sell crude. The WTI contract is the place for this type of market force to be settled.
So which price is right for crude? Is it Brent or is it WTI? The answer, to me, is that Brent is the benchmark to look at. WTI (and the futures pricing behind it) has little to do with the cost of petroleum in the US. Consider this chart of LLS crude. This is the pricing for ‘sweet’ crude for cash delivery at the Gulf of Mexico.
What is very clear is that the cost of crude used by US refiners to produce gasoline has nothing to do with the WTI price. LLS pricing has been running a $3-4 premium over Brent for some time now. That, to me, makes perfect sense.
A shipment of Nigerian crude (sweet) has two destinations. One is Rotterdam, the other is the GOM (Louisiana offshore delivery). The shipping cost for GOM delivery of a VLCC (1mm barrels of crude) is about $4/Brl higher than for European delivery (4-6 extra days of transit). Therefore a pricing matrix where LLS is equal to Brent +$4 is consistent.
The price of gasoline for much of the country is driven by crude pricing in the Gulf; not Cushing, Oklahoma. At yesterdays closing price for LLS the price of gas is going higher in the USA. So another big drag on the economy is in front of us.
Some thoughts on this.
A few months back the smart folks at the Department of Energy tried to influence the LLS pricing by releasing crude from the SPR. That worked, for about a week. The LLS/WTI spread was about $15 at the time. Given that it is much higher today I think it is possible that D.C. will again choose to sell some more of the strategic holdings of crude in an effort to create a cheaper cost for gasoline. If the DOE was in for a penny in June then they should be in for a pound (or two) right now. One can be sure that the interventionists in Washington are teeing this up as I write.
I can’t come up with a logical explanation for the huge WTI/LLS pricing differential. With a spread of $27 one could fill up a few hundred-car trains in Oklahoma and ship the excess crude to the Gulf. With the spread as wide as it is, a train full of crude could drive back and forth across the continent a few times before getting to the final destination and still end up cheaper that $27. So what gives?
I smell manipulation in this. What it comes down to is that the price of crude that we actually use to make gas has little to do with the price of crude that is traded on the exchanges. Why?
We know the US economy is broadly in decline. We know that $4 gas is a factor that will accelerate the downward economic forces. We know that $115 crude (lls/Brent) will translate to $4 gas at the pump. We know that the “deciders” love to intervene to “fix” things that are broken.
My conclusion? The DOE will be doing Round II of SPR sales. This will happen in the near future. When that happens some fat cat oil companies will make a bundle (they did last time). But like the SPR sales in June there will be no lasting effect on market prices. Gas is going up in price, and it’s going to stay high. Just another gloomy factor in an already gloomy economy.
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Here is a chart of Cushing inventories:
http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=W_EPC0_SAX_YCUOK_MBBL&f=W
Notice the effect of the turn-on of the Keystone pipeline. Also note that the local oversupply is falling.
Refiners that have storage at Cushing have no incentive to arb out the price as refined goods are tracking Brent.
I have also heard noises that lower quality oil is being blended with NGL to satisfy WTI contracts. Remember a WTI contract is based on API and sulphur content, not point of origin.
handy chart, when did Keystone come online?
June of 2010... but I don't know how the rate was ramped up.... nominal capacity is 430,000 bpd
There is also some seasonality, stocks tend to rise in the first part of the year....
What, youre expecting actual market forces here? As if buyers and sellers are just out there freely trading? Lulz.
I have aslo heard there are resons in teh trading systems, positions limites, regulations on exchanges they trade, i.e. what would be called manipulation for wti is OK in other markets. Not sure if this data can be looked up, and really I don't recall the source material for my thoughts
#This one has me scratching my head.
there is no need in scratching head.. futures oil trading is not what it used to be.
#1
ITS PAPER TRADING THAT HAS NOTHING TO DO W/ SUPPLY/DEMAND,,
WHY? it's easy.. lets look at daily results from CME
http://www.cmegroup.com/trading/energy/crude-oil/light-sweet-crude_quote...
only yesterday overall trading volume was over 500,000 contracts ( 1 contract == 1.000 barrerls)..
whole energy import is less 400,000,000 bs permonth... so any given sunday there's more paper trading then per 1 month import..
(http://www.census.gov/foreign-trade/statistics/press-release/index.html )
HOW MANY CONTRACTS ARE SETTLED physical? i heard its less 10% overall..
#2
this spread is not real otherwise big operators would be buying futures, taking delivery in Cushing,
sell futures Brent in london, and rent big tankers to deliver oil .. its arbitrage at the purest...
cost of tankers should rise over moon .. i dont hear about someone making a bundle
because nobody is able to take physical delivery.. its like paper trading in gold/silver..
so why????????
i guess THERE'S AGREEMENT BETWEEN FED/ECB abd buggest brokers/banks about trading in commd/ bonds/stocks.
big banks are not allowed to drive down price of bonds /stocks ( unless of course its terminal like in Greeece/Spain),
in return speculation is allowed in commodities
alx
enough of how many contracts are physically settled that has nothing to do with it. Those with tin foil heads need to move to the rear of the bus.
soryy, all places are taken by lovers of investing in paper oil..
alx
There is no "arbitrage opportunity" at Cushing. You can't just get "train cars" and start shipping crude to the Gulf. It's all controlled by local forces and monopolists. Google it for detail, baby.
yes you can, hurry to the back of the bus the seats are filling up.
exactly ..
alx
I was just thinking about this issue yesterday. My idea was the big boys were keeping it down so they could buy cheap physical and ship it for a great profit. I have had the conclusion this spread should not exist at this extent for a while, and it bothers me. so, I too have come to the conclusion something is going on as well.
I'm only certain of one thing. The .gov would like us to focus on the WTI price, because then we will feel that the price of oil is "low." Because, to the .gov, we are dumb and dumber.
WTI falling !
In the meanwhile gasoline will continue to track Brent upwards.
Maybe answering how much WTI priced oil goes to China and from where will bring us 1000 light-years closer to reality ? Just sayin' .
Nice work Bruce. Personally, since I know several people using oil as an inflation hedge, much like PMs, think the spread does reflect a disconnect between CPI numbers and reality. Just my two cents.
sorry bruce.. you didnt do your homework
#There are some partial explanations for this phenomenon. Brent is lighter in grade and justifies a somewhat higher price
WTI is a light crude oil, with an API gravity of around 39.6 and specific gravity of about 0.827, which is lighter than Brent crude. It contains about 0.24% sulfur and is thus rated as a sweet crude oil (having less than 0.5% sulfur), sweeter than Brent which has 0.37% sulfur.
http://en.wikipedia.org/wiki/West_Texas_Intermediate
alx
unless the refining costs for some reason suddenly jump, the spread should remian fairly constant, not increasing width. don't forget shipping cost of the product to the united states as well that has to add into cost. hate to tell you, your facts may be correct, but the amount of the price difference can't be expalined by your logic in my view.
i was talking about ' lightness'.. WTI is better quility..
alx
There are a number of other reasons as well, Brent is delivered to Gulf offshore pipes for refineries on the coast, while WTI is mired in pipeline bottlenecks. Brent is listed on the SPX in euro which has magnified the difference in prices. But, rumor has it the North Sea production is declining faster than expected, as well as some closures for maintenence and a leaky Shell pipe. Brent also competes with Libyan oil for delivery where WTI does not, so with Libya offline Brent was impacted and Texas was not, remember small moves in marginal production can make big moves in speculation.
north sea is almost dry.
those 'closures' and 'leaks' have much to do with the current situtation in lybia.
boy, thatcher sure had a long-term vision...too bad that horizon was a mirage.
http://www.youtube.com/watch?v=IlkXQm7tSCY
lend an ear/
lend an ear,
janus
My guess. WTI is what the USA uses for inflation. WTI is a paper price and crude is the real price. We should likely soon see the same disconnect between COMEX and PAGE, as soon as the latter opens.
Excellent Bruce, thanks.
Thanks Bruce. Love reading your opinion on matters. You've got some great insight.
what i don't understand is: why is this not the mother of all arbitrage opportunities? why aren't hedge funds absorbing this Nile sized delta? Are there simply no vehicles to ride to absord the juice from this?
There is and they are, there are just so many means to move the massive amount of oversupply out of the mid con
I think WTI as a trading vehicle may be as big as the turd USO has been.
Options on that USO bitch did not represent the same oil ramp in 08. Not even close.
Cushing has added about 33% to capacity lately, pipelines are a bottleneck, but when new pipe capacity has added to the flows it turns out refiners at this time cannot absorb the extra oil, so the bottleneck is just shifting from transport to refining. What will be needed is a major push to get refining capacity in the Texas to North Dakota corridor. Also, Valero might be a good play since it has the ability to refine heavier and more sour crude than it's competition.
I'm sure smarter folks than you and me are profitting handsomely.
My understanding is that Cushing is overstocked due to insufficient pipeline to get oil from the new fields to the refineries. Since it has the traditional index for stock positions and has become disconnected from reality due to the pipeline issues the WTI price is more volatile (my guess, I've never checked the reality of this assumption). In order to have a good arbitrage you have to be able to move the asset from one column to the next and that's pretty hard to do with when your talking about millions of barrels of oil and not enough pipeline or trains.
If the pipline limitation is really at work, Kinder Morgan should see some opportunity there. Long KMI or KMP.
You might want to google Keystone XL.... the company to go long is TRP
Look at Enbridge if you are shopping.
http://www.northerngateway.ca/project-info/route-map
Flak, you were raising the same spread question about a month ago. What is your take on this? My instinct is that nothing is legit and soon, something known as a "market" in this stuff will cease to exist.
As you know, I have been "baffled" by this spread and have been following it for a while:
A few things we do know
1) Capacity at Cushing has risen over the past few years
e.g. see http://www.eia.gov/todayinenergy/detail.cfm?id=1930
2) The Keystone pipeline increased the flow to Cushing since June 2010
3) PADD 2 production has risen (i.e. Bakken), most of this oil heads to Cushing AFAIK.
4) Stocks at Cushing have risen since 2007 while refining capacity with direct access to Cushing has not.
So we have a land-locked delivery point where "local" refiners can store oil and maximize their profits vis a vis the crack spread....
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Here are things that we do not know but "make sense"
1) I have heard through the grapevine that lower grades of crude are being blended with NGL to satisfy WTI contract requirements. NGL are the liquids that arise from shale gas plays and are primarily feed stock for petrochemicals. This cannot explain all of it, but it may be contributing.
2) With the release of the 60 million barrels from the SPR (to help overcome the Libyan shortfall), the IBs shorted the hell of WTI, knowing full well that their shorts would be covered by the SPR release. (JPM getting a lions share of the oil is well documented). The ploy was to drive down the price in the hope that by the time the market priced things in that Libya would be resolved.... Two reasons why they would do it this way
a) a short term stimulus via cheaper energy (increased consumer confidence, yadda, yadda, yadda)
b) a short term supression of the oil price so as to give some head room for whatever form QE3 would be
I don't think that realized that Brent and WTI would completely decouple, thereby negating a). It has taken a while but the sheeple are starting to notic the WTI-pump relation is FUBAR.
So the situation is complicated (since when was the oil market not?) The spread is a result of many unrelated factors pushing in the same direction....
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Another tell is that my recommended oil play, PBT, is trading off of Brent pricing (on a historical basis) even though it is real WTI (the very definition). This tells me the smart money is anticipating the spread to narrow over time...
in my line of work, we deal with the "crack spread" too but for now, prisons are less profitable than pipelines
thanks
I don't think I would call the insiders 'smarter', I rather call them criminal banksters myself
amen brother
Is there anything that the governments DON'T intervene in now?
The short answer is "NO". Even now my company has several SBIR and STTR grants for technology development.
Bruce, does the price of WTI play any role in the calculation of inflation? Could the WTI price be used to keep it low?
Thanks for the detailed answer
thanks very informative
i think the cost to bring the excess oil not being used in middle america refineries to the coast cost more than $15 a barrel. Its not light sweet crude meaning it has more sulfur and is thicker with more gunk around the globe there are not many refineries that use the lower grade crude. so i think thats why the arbitageurs can't arbitrage away the spread
i guess im wrong about the quality of wti
Au contraire, WTI is one of the finest oils around....
Really, WTI is not only lighter and sweeter than Brent (lower specific gravity and less sulfur) but it has a lower viscosity, flows better and believe it or not that makes a big difference when it has to be sent through pipelines.
We get that argument a lot where I live, gasoline is 40 cents more because it has to be trucked 270 miles from the refinery. Gak, cak, ugh! Forty cents a gallon for a truck ride? Averaging 8,000 gallons of gas per truck from the refinery to storage tanks locally? A five hour drive with road destruction and traffic? And worse than that on the coast where I am from originally tack on another 40 cents per. Eighty cents higher than the I-5 corridor, half a buck higher than 19 miles away over the state line in Oregon where gas taxes are 6 cents higher and all fuel is full serve, you are not allowed to pump your own gas in Oregon. Just another reason to live in this gorgeous state, no sales taxes and no handling gas pumps.
So the costs of the trucking must be equal to 8000 gallons times 40 cents per load. They are claiming that it costs $3,200 to drive a load of gas from the refinery to here? All I can say is I have got to get into the business of driving gas from the refinery to here.
Greed on their part, lack of redress on our part, let the fuckers take it all, payback will be a bitch for the rich.