Short Brent/Long WTI: an "obvious" trade?

Tuesday, Feb 15 2011 by
17
Short BrentLong WTI an obvious trade

Emptyend recently mentioned an FT article which I had previously read, commenting on the disparity in the oil price for WTI crude and Brent.

The price difference between the world’s top oil benchmarks reached an intraday record of more than $16 a barrel, doubling in three weeks, as West Texas Intermediate oil disconnects from top global oil references Brent and Dubai. The spread fell back to just above $14...

Historically, Brent trades at a discount to WTI as the Brent blend is slightly lower "quality" than WTI (West Texas Intermediate).

It occurred to me that, surely, this pricing anomaly cannot persist forever? Eventually, physical traders must surely take advantage and buy cheap oil from Cushing and sell it at a substantial profit on the world market? This Bloomberg article comments on the anomaly further:

Oil Supplies Rise in Survey on Cushing Pipeline: Energy Markets

U.S. crude stockpiles rose for a fifth week as TransCanada Corp. completed an extension of a pipeline to Cushing, Oklahoma, adding to a glut at the country’s biggest oil-trading hub, a Bloomberg News survey showed.

U.S. Oil Glut May Be Eased by Seaway Pipeline Reversal, JBC Says

A reversal of the Seaway Crude Pipeline System may reduce the record discount U.S. benchmark West Texas Intermediate incurred versus North Sea Brent, according to Vienna-based researcher JBC Energy GmbH.

The latter headline illustrating the point that eventually, physical oil will be moved in the most profitable direction. This seems to me to open up an obvious and relatively low risk trade: to go long WTI and short Brent. I have duly done so (in very modest size to begin with) on the April contract. Should the anomaly not have corrected before expiry in late March, I intend to roll these contracts.

Here is a table of recent closing prices for these contracts.



Daily close

Brent WTI Spread




01-Feb 101.70 93.77 7.93
02-Feb 102.80 93.72 9.08
03-Feb 102.27 93.28 8.99
04-Feb 100.37 91.92 8.45
07-Feb 99.87 90.62 9.25
08-Feb 100.87 90.56 10.31
09-Feb 102.52 90.32 12.20
10-Feb 102.25 90.78 11.47
11-Feb 101.35 89.07 12.28
14-Feb 103.01 88.82 14.19

 

I have managed to open my trade today with a spread of $14.18. Let's see how it goes. :0)

Further Research and Data

The above represents my initial view, data and knowledge on opening this trade, for reference. And it may turn out to be naive... Below, I will maintain my table of spread data for the April WTI contract and the Brent May one , going forward. [see later for why I have switched the Brent contract to the May one].

 

    Daily close
  Brent (May) WTI (Apr) Spread
       
01-Feb 102.15 93.77 8.38
02-Feb 102.96 93.72 9.24
03-Feb 102.49 93.28 9.21
04-Feb 100.63 91.92 8.71
07-Feb 100.37 90.62 9.75
08-Feb 101.01 90.56 10.45
09-Feb 102.72 90.32 12.40
10-Feb 101.82 90.78 11.04
11-Feb 101.30 89.07 12.23
14-Feb 103.41 88.82 14.59
15-Feb 101.91 87.66 14.25
16-Feb 104.16 87.96 16.20
17-Feb 103.82 89.00 14.83
18-Feb 103.43 89.90 13.53
21-Feb 108.09 95.39 12.70
22-Feb 106.53 95.37 11.16
23-Feb 112.15 98.97 13.18
24-Feb 111.12 96.73 14.39
25-Feb 112.32 98.16 14.16
28-Feb 111.86 96.87 14.99
01-Mar 116.47 100.58 15.89
02-Mar 116.23 102.43 13.80
03-Mar 114.66 101.91 12.75

Many thanks to the readers that have pointed out possible flaws in my thesis, helping to steer me in the right direction for further research.

Physical Arbitrage

As mentioned above, the thesis behind this trade is that the spread cannot widen forever and that eventually, physical oil traders will take over and arbitrage the spread away. What does that mean, in practice? Considering the April WTI contract that I am buying, it means that they will also buy those contracts, take delivery of the oil at the contract price and arrange for shipment to Europe or Asia. Simultaneously, they would sell, say, the Brent May (or later) contracts, so that they know what prices they will receive for the oil when it arrives. It is possible that the oil has to be blended before delivery, but I doubt it because Brent is slightly lower quality than WTI, so WTI oil should meet the Brent spec. I find it hard to imagine that shipping costs would be anything like $10/bbl, so buying oil for $87/bbl, shipping it, and selling it a month or two later for a guaranteed $101/bbl would be a highly profitable and negligible risk trade. That process will eventually reduce the spread.

Considering this subtelty (i.e. the delay between buying and selling), it actually makes more sense to short the May Brent contract and remain long the April WTI one. I have rolled my April Brent short at a cost of 18c into the May contract, taking advantage of the current small Brent contango.

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That's the theory, in outline. The question is, can it work in practice? I have heard a commentator say that there is no aribitrage between Brent and WTI, which is what has led to this "spread blowout". So, I thought I'd check that out, and quickly came across this (see post by "gekko21"):

The Brent-WTI (Atlantic Arb) is the most commonly traded oil arb in the world with traders being able to take North Sea Brent and ship it across the Atlantic depending on WTI prices and freight costs----the trade can also go the other way with WTI going to Europe.

Now of course, this is only from a post on a BB, so may or may not be true - but it appears authoritative to me and I tend to believe it unless anyone can provide better evidence to the contrary.

The WTI Contract

Next to check is whether there are any issues concerning settlement of the contracts I'm trading. Here, I can get definitive answers, from the horses mouth:

(A) Delivery shall be made F.O.B. at any pipeline or storage facility in Cushing, Oklahoma with pipeline access to TEPPCO, Cushing storage or Equilon Pipeline Company LLC Cushing storage. Delivery shall be made in accordance with all applicable Federal executive orders and all applicable Federal, State and local laws and regulations. For the purposes of this Rule, the term F.O.B. shall mean a delivery in which the seller:
  • provides light "sweet" crude oil to the point of connection between seller's incoming and buyer's outgoing pipeline or storage facility which is free of all liens, encumbrances, unpaid taxes, fees and other charges;
  • in the event of the buyer's election to take delivery by interfacility transfer ("pumpover") to either TEPPCO, Cushing or Equilon Pipeline Company LLC, Cushing, from seller's delivery facility, bears the lesser of the pumpover charge applicable for pumpover from seller's delivery facility to TEPPCO or Equilon Pipeline Company LLC;
  • retains title to and bears the risk of loss for the product to the point of connection between the buyer's outgoing and the seller's incoming pipeline or storage facility.
(B) At buyer's option, such delivery shall be made by any of the following methods:
  • By interfacility transfer ("pumpover") into a designated pipeline or storage facility with access to seller's incoming pipeline or storage facility.
  • By in-tank transfer of title to the buyer without physical movement of product; if the facility used by the seller allows such transfer, or by in-line transfer or book-out if the seller agrees to such transfer.

(C) All deliveries made in accordance with these rules shall be final and there shall be no appeal.

Clearly only physical oil traders can hold the contract to settlement and actually take delivery of the oil, as specified above. Rulebook Chapter 200 specifies the oil blend/purity that is acceptable for delivery - so oil containing "gunk" would not be acceptable!

Pipelines

So, now to the crux of the matter: how easy is it to get oil in and out of Cushing? Wikipedia proves a nice overview of Cushing:

Cushing is a major hub in oil supply connecting the Gulf Coast suppliers with northern consumers. Cushing is famous as a price settlement point for West Texas Intermediate on the New York Mercantile Exchange[4] and has been cited[7] as the most significant trading hub for crude oil in North America. As of 2007, Cushing holds 5 to 10 percent of the total U.S. crude inventory. Signs made of a pipe and valve on the major highways near town proclaim Cushing to be the "Pipeline Crossroads of the World", and the town is surrounded by several tank farms. Most storage tanks are owned by four entities: oil giant BP, and energy-transport and logistics firms Enbridge Energy Partners, Plains All American Pipeline, and SemGroup Energy Partners. On July 13, 2010, BP announced it will sell its assets in Cushing to Magellan Midstream Partners.[8]

Next, I thought I ought to get a better understanding of the US pipeline network and Cushing's location within it. Click on the thumbnail below to see it properly:

The "key" to the pipeline numbers is here: http://www.theodora.com/pipelines/united_states_pipelines.html

As can be seen from the map, Cushing is around 400miles due north of Houston and the GoM coast, where import/export pipelines converge.

Now, I note the article highlighted by nigelpm, which suggests that Cushing will remain oversupplied and WTI depressed for a very long time. I am sceptical of this, for two reasons. Firstly, the article itself illustrates that with such a large spread, producers will use any means they can to get oil to export terminals where they can achieve better prices. African4life makes the point that pipleines can be "turned around" but that this takes time. This brings me onto my second reason for scepticism: observing the data tabulated above, the WTI/Brent spread has built up awfully quickly. This seems to me more characteristic of a  temporary "bubble" in the spead than a long term shift. If the spread remains so large, surely Canadian producers in Alberta can get their oil out to a terminal on the pacific coast for shipment to Asia, rather than accepting way below market prices in the US? There are plenty of pipelines going to oil terminals on the coast but I suspect that some of them are flowing in the "wrong" direction and it takes time to turn them around - but that's a matter of weeks or a month or two, rather than years. [as the Wiki article mentions, the normal flow of oil is from Texas northwards]

I do not have the detailed information on the pipeline network to be truly confident of this hypothesis (or I'd enter this trade in size!). I will use market behaviour of the spread to guide me.

WTI Contango

Nigelpm made a very good point about the WTI contango being much steeper than the Brent one. ISTM that this is a direct consequence of the current Cushing oversupply anomaly: physical traders will want to buy longer dated contracts because they do not yet have the capacity to export sufficient oil that arrives at Cushing in the near future. This situation should change over time, if my hypothesis is right. If not the contango will eventually kill the potential profitability of this trade.

Mark


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172 Comments on this Article show/hide all

BobGe 10th Jul '11 153 of 172

O/T
Now that they seem to have successfully wrecked the comparative charting on the FutureSource website, what are people using to monitor futures please?

Tks.

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marben100 11th Jul '11 154 of 172
1

In reply to BobGe, post #153

I use detailed tick charts from my CFD platform, provided by IG Markets. The two hour chart now appears to be turning down, so I'm back in at a spread of $20.12 on the September contracts.

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bugsmunny 11th Jul '11 155 of 172
2

Hi Marben - is there a way on IG index to chart the difference - I have been doing it manually.

Went short on Brent and long on WTI this morning - at $21 something spread on September contracts.

200pips in profit since.

Still since we had a spread of $15 only a couple of weeks back - will hold on a bit longer.

B

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marben100 11th Jul '11 156 of 172
1

In reply to bugsmunny, post #155

I think MaxCashflow found a way to do it using "advanced charts". Unfortunately, due to a technical glitch, advanced charts don't work on my computer so, like you, I have to maintain my charts of the spread manually.

Mark

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marben100 11th Jul '11 157 of 172

...and out again: my stop's been beached, so spread narrowing not confirmed. Back to watching & waiting. Now at $21.22

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bugsmunny 11th Jul '11 158 of 172

Tried the advanced charts but some Java problem - sounds like it could be the same issue.

Will just have to manage the old-fashioned way.

Left my bets open - will see what happens - really can't see the spread much wider for reasons we discussed before.

Anyway will open more bets if it does move a bit further apart.

B.

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emptyend 26th Jul '11 159 of 172
3

Another important FT article for those with this trade on.....it considers scenarios which may lead to the spread widening to $40-50 ....or more!! 

In sum it seems there are plenty of predictions that a production surge is coming that will overwhelm the present capacity to move supplies away from Cushing.

ee

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marben100 11th Aug '11 160 of 172
1

The spread neary hit $24 early yesterday... but has been declining since then, so I'm back in @ $22.96

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nigelpm 11th Aug '11 161 of 172
2

Must admit with all the bargains about this trade doesn't interest me at all right now.

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emptyend 20th Aug '11 162 of 172
1

Another relevant article here in the WSJ for those with a position:

The race is on to build pipelines to relieve a glut of crude oil in the U.S. heartland, but not all of the four plans will make it to the finish line.

It is a competition that is being closely watched in oil markets. The amount of pipeline capacity that eventually comes on line and the pace at which it is built will determine how fast U.S. and European benchmark oil prices will come together again, analysts say.

On Thursday, crude futures on the New York Mercantile Exchange settled at a record $26.49-a-barrel discount to Brent crude, now widely seen as a more accurate indicator of world oil prices.

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marben100 20th Aug '11 163 of 172
1

In reply to emptyend, post #162

Hi ee,

Fortunately, as my trading strategy is based on following the chart trend - with the expectation that at some point this enormous spread will collapse - I exited the position that I mentioned some time back. I have tried to re-enter a few times, without success so far (should be more patient!), but am in profit (just!) overall for this trade.

I continue to monitor the spread closely, as I feel there is a big profit to made here at some point. I'll continue to be guided by what the "big boys" are doing, as reflected in the price action.

 

Probably more significant for most of us, however, is that commentators still frequently refer to the WTI price: now $82.37. Clearly this is irrelevant, except to US gas consumers, midwest refiners, and any oil companies who have no choice but to deliver into Cushing. Psychologically many may be breathing a sigh of relief and thinking: "oh that's OK, oil is well below $100/bbl"... but even Louisiana Light Sweet - not a million miles from Cushing - and more relevant to Aminex, I hope!, is currently at $105.71/bbl. This (false) thought that the oil price has "collapsed" may well be driving some selling of oil stocks.

Cheers,

Mark

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emptyend 20th Aug '11 164 of 172
1

In reply to marben100, post #163

This (false) thought that the oil price has "collapsed" may well be driving some selling of oil stocks.

No I don't think its that!

I just think that the market is making the same trades that worked for traders in 2008.......but this time round commodity prices are staying high because they are the only hedge against devaluation of paper currencies - and there must be a snap-back coming soon.

I don't think anyone apart from the arbs and the locals is paying much attention to Cushing prices currently.

ee

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mallwood 24th Aug '11 165 of 172
1

100,000 bopd currently being shipped by rail from Cushing to the gulf ports, could be expected to rise to 300,000 bopd if price differential persists.

http://www.investorvillage.com/smbd.asp?mb=4288&mn=77819&pt=msg&mid=10873890

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TheFurryOne 24th Aug '11 166 of 172
4

Good article on this posted by SIR COOP on investorvillage:

www.investorvillage.com/smbd.asp?mb=11837&mn=9694&pt=msg&mid=10862545

The take-home is this: The WTI-Brent price disparity will persist for the foreseeable future, as the only real solution to oversupply at Cushing – the Keystone XL expansion – is still sitting on Hilary Clinton’s desk awaiting approval. She, it turns out, is a bit busy these days, so we don’t expect progress on that front to come quickly. Until capacity develops to move crude from Cushing to the Gulf Coast, Brent will remain the crude price that best reflects supply, demand, and sentiment in the global oil market.

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emptyend 27th Oct '11 167 of 172
1

Another relevant development is reported by the FT today. The article concludes:

The Brent-WTI, which has already claimed several victims amid the hedge fund community, could be looking at new casualties.
It remains a gamble of timing.....
ee
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marben100 16th Nov '11 168 of 172

In reply to emptyend, post #167

It remains a gamble of timing.....

...and today the gamble paid off - a $4 collapse within a matter of minutes. :0)))  Pleased to say I was in with a double sized trade at the time (and remain in), having followed the chart down over the last few days: http://www.reuters.com/article/2011/11/16/column-oil-seaway-idUSN1E7AF0I220111116

NEW YORK, Nov 16 (Reuters) - Anyone betting the spread
between Brent and West Texas Intermediate crude oil futures
would widen again got flattened today by the announcement of
the Seaway pipeline reversal.
    The spread has a long way to fall after setting highs of
more than $25 a barrel seen this summer. With the prospect of a
large increase in capacity out of Cushing from 2012, a decline
to $5 a barrel or less looks likely.

I have moved my stop loss down to guarantee a decent profit on this trade. Right now, looks likely it will be hit as the spread is bouncing back a bit. The spread is already down to ~$10 today (hit $8.50 briefly) - the lowest it's been for several months.

On the bigger picture, this is bad news for Obama, as WTI prices (which, I presume, affect gasoline pump prices?) are now back above $100/bbl, after being below $90 for quite some time.

Cheers!

Mark

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nigelpm 16th Nov '11 169 of 172

Nice one mark. Back in to $9.

Was always on the cards.

My problem was much more interesting opportunities elsewhere so this was very much put to one side.

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nigelpm 6th Feb '12 170 of 172
1

The "Obvious trade" just got interesting once again!

Back out to $19

http://www.reuters.com/article/2012/02/06/us-brent-wti-redux-idUSTRE8151XA20120206

Just watching for now

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emptyend 9th Oct '12 171 of 172
2

In reply to emptyend, post #2

 

It occurred to me that, surely, this pricing anomaly cannot persist forever? Eventually, physical traders must surely take advantage and buy cheap oil from Cushing and sell it at a substantial profit on the world market?

It occurs to me that market anomalies can persist for longer than one can remain solvent.

This is a trite point but AFAIAA there is nothing to stop Cushing tanks continuing to fill from nearby fields (until/unless they build a new railroad to the coast) whereas the Brent market (along with Tapis, Mias etc) remains super-tight based on strong demand from refiners.

Whilst I doubt you will lose your shirt playing the spread, I think you may find the unwinding of the spread to be disappointingly slow.

ee

Just returning to this topic for a moment, I see that the Brent/WTI spread has widened out again.....

The “spread” or difference between Brent, which is seen as the global benchmark, and West Texas Intermediate, the US benchmark, widened to as much as $22.92 a barrel on Monday.

...which I think bears out my clear caution above when this topic first emerged 20 months ago! Well done to those who made a bob or two on the swings in the meantime - but it looks as if the spread is set to remain roundabout the $15-25 range for some while yet!

Mind you....I'd rather be proven right on certain other matters where I have a pecuniary interest! ;-)

ee

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loglorry 16th Dec '12 172 of 172

Thought I'd check back on this thread to see how it was working out.

II notice WTI is still 86 with Brent around 109 so sstill a $23 spread. Will this ever close?

Log

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About marben100

Marben100

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I am a full-time private investor... with a little trading on the side (generally small-scale arbitrage in specialist niches). Previously, I spent 24 years in the IT industry, 13 of those running my own IT services firm. I invested as a "hobby" for 20 years before turning it into a full-time occupation in 2004. I really enjoy the "research" side of investing, finding out about varied businesses and industries and learning what makes them tick. Since going "full-time" I have learnt an awful lot from some very erudite investors & professionals who are kind enough to share their expertise in electronc forums such as this. I can now count a number of them as my friends, having had the opportunity to meet them in the real world, as well as this virtual one! I try to pay back the debt I owe by sharing what I've learnt and I always value constructive criticism to correct my errors and misapprehensions! I am a Director of ShareSoc, the UK organisation for individual shareholders. See below for details.     more »


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