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.
Special Offer: Invest like Buffett, Slater and Greenblatt. Click here for details »
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:(B) At buyer's option, such delivery shall be made by any of the following methods:
- 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.
- 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
About the Author's Website
ShareSoc is a not-for-profit campaigning organisation, promoting individual share ownership, fighting for shareholder rights and providing educational resources to investors. ...read more or visit website »
Disclaimer:
The author may hold shares in this company, all opinions are his own and you should check any statements that appear factual and not rely on them before making an investment decision. The author is NOT a qualified analyst nor authorised to give investment advice. Whilst the author is a director of ShareSoc, all views expressed are entirely his own and not necessarily those of ShareSoc.
172 Comments on this Article show/hide all
In reply to nigelpm, post #111
Hi Nigel,
The real players in this market are the physical arbs and the refiners/pipeline owners. The main losers are Canadian upgraders, who AIUI are having to sell the bulk of their production at WTI prices and deliver to Cushing.
My trading strategy is based on two premises:
NB the July WTI contract expires in 7 days whereas July Brent expires tomorrow. IME the August WTI contract is likely to receive a boost in the last few days before expiry, as traders long the July contract have to roll into August. August Brent may be artificially boosted right now, as July contracts are closed out, leading to a temporary widening of the spread. August Brent could take a tumble once all the July contracts have been rolled (unless a preponderance of financial traders are short, which could have the reverse effect).
So, there may be a very good entry point to short the spread coming up very soon! I am watching carefully for my re-entry.
Cheers,
Mark
Back in again as it looks like a bit of a sudden collapse in the spread to well below it's recent low. My stop remains above the recent (record) high, so somewhat broader this time. Hopefully, the fortnight long recent uptrend in the spread is now well and truly over.
Yeah, was $22.5 at one point today, now $21.
Per Goldman:
http://www.bloomberg.com/news/2011-06-14/goldman-says-cushing-supplies-not-driving-wti-brent-spread.html
The record discount of West Texas Intermediate crude to North Sea Brent is widening because of flows of light, sweet crude to Europe and Asia instead of the U.S. Gulf Coast, Goldman Sachs said in a note
In reply to African4Life, post #93
This is the sort of sloppy language that was drummed right out of those who have taken finance degrees in the last 25 years!
This situation ISN'T an "arbitrage". An "arbitrage" involves the simulaneous buying and selling of an identical item in two locations. We don't have that here. We have a contract that specifies delivery at Cushing - and one that specifies delivery elsewhere. The ONLY way that this gap will ultimately close is if the physical supplies to Cushing can be diverted to other markets and reduce the present oversupply at Cushing. There is no doubt at all that this will happen eventually, given the large price differences and plans for infrastructure - but there is plenty of doubt as to exactly when (and you can be sure that the profits on the difference will mostly be taken at some point by those who are investing in the physical infrastructure).
ee
ps.....bargepole fully deployed on this trade, for the reasons outlined several times above. This is a "big boys game".....and the retail punter is playing poker with a market in which some of the other players have a number of cards up their sleeves.
ps.....bargepole fully deployed on this trade, for the reasons outlined several times above. This is a "big boys game".....and the retail punter is playing poker with a market in which some of the other players have a number of cards up their sleeves.
It's strange isn't it. I completely agree with your comments here but still think I'll make money on it - perhaps deluded - we'll see.
P.S. Good to see you back posting! ;-)
In reply to emptyend, post #117
Evening ee,
In defense, with all due respect, and much is due indeed, but physical trades like these is my bread and butter, and hence it is a real arbitrage for me.
(I understand the reasons for your comments though)
Situations like these keep me in the office till late, pity we don't have a big enough coach in the office (yet)! But it is also the reason for me not being involved in these BB's as I would have wanted to be. Many thanks to you and various others for very insightful comments!
best regards,
A4L
It's easy to construct any old reason for this spread. It's likely to be multi-factorial
In part it is speculative in my opinion and the spread will fluctuate by significant amounts due to random effects.
It's so far from it's normal that it will have a tendency to revert which offers some underlying protection.
And sorry, I don't believe "big boys" can predict the future any better than the next - so I'll play the probabilities thanks.
B.
In reply to African4Life, post #119
Just to be clear on that, I wasn't criticising the idea that there is money to be made from playing the spread between the two contracts - I was criticising the misuse of the word "arbitrage". True arbitrage is extremely low risk, because one is long and short of an identical deliverable - that isn't the case here......though I completely understand the temptations of taking a position. The difference between the contracts is historically huge (used to be $2-5 max IIRC).....but there are good reasons that the historical relationship can be binned until the physical demand/distribution barriers come down substantially. Good luck anyway, A4L.
Neither do I. However, the information they have available to them on the actual facts of the situation on the ground and the plans for future developments is light years ahead of that available to the private punter. Accordingly, they will be well ahead of the average punter.
ee
Hellenic Shipping News
Wednesday, 15 June 2011 11:00
The record discount of West Texas Intermediate crude to North Sea Brent is widening because of flows of light, sweet crude to Europe and Asia instead of the U.S. Gulf Coast,Goldman Sachs said in a note.
The growing price gap “has been primarily driven by the weakening of U.S. Gulf Coast light-sweet crude oil prices relative to Brent crude, not a Cushing bottleneck,” Goldman analysts including David Greely said today, referring to the delivery point for the WTI contract in Cushing, Oklahoma.
“The arbitrage between the U.S. Gulf Coast and Europe has flipped, and the market is now directing light-sweet crude oil away from the U.S. Gulf Coast and toward Europe and Asia,” Goldman said.
That caused Brent’s premium to widen in June and reach a record close of $21.80 a barrel yesterday, the bank said. Downside risk for the WTI-Brent spread is “limited” in the near term, Goldman said. The analysts expect the difference to narrow and said they would not make a trading recommendation on it because “the risk associated with the fundamental uncertainty is too high.”
The reversal of the arbitrage was caused by lower prices for Louisiana Light Sweet grade relative to Brent crude, which makes it more attractive for traders to ship top-quality oils to Europe and Asia than the U.S.
WTI crude moved into discount versus North Sea Brent in August amid a glut of stockpiles at Cushing.
Source: Bloomberg
And from PVM, David Hufton, yesterday:
Brent and WTI went their separate ways again yesterday with WTI losing $2 bbl and Brent gaining 7 cts/bbl, taking the arb at the close to -$21.20. The reasons for the huge differential are well rehearsed. Three factors have coincided to create a perfect storm. Firstly, huge and ever increasing volumes of WTI are trapped in the US mid-west where crude from Canada and oil shale production pours in. Secondly, the North Sea loading programme is particularly tight this month because of production problems at the Buzzard field which feeds into Forties. Thirdly, Europe has been deprived of 1.5 mbpd of crude from Libya all of the sweet variety. A change in any one of these elements will impact the WTI/Brent arb. Yesterday we had the added factor of a force majeure declaration by Shell on Bonny Light loadings due to a series of leaks and fires in the Trans-Niger pipeline. Production has been resumed but loading schedules have been disrupted. A corollary of the shortfall in sweet crude and its actual and planned replacement with sour has been a dramatic widening in the Brent/Dubai EFS which we marked at +$8.38 bbl for July and +$7.45 bbl for August at 16.30 London time yesterday(13June).
(If I am in breach of any confidentiality/circulation law, do delete post)
In reply to African4Life, post #122
Re copyright, you'd do best to provide a link and then a short quote (typically no more than 20-25% I believe is generally-accepted). (you can go back in to edit for one hour after posting)
Re
........that is it in a nutshell.
ee
Well, riding on the big boys coat-tails ;0), the downtrend seems to be established now (with a lower low and lower high formed on the chart), so adding to my position, resetting stop to just above most recent, lower, high. If that high is breached, then the downtrend will appear to be over... but judging by previous trends, it is likely to persist for a few days now. The uptrend lasted a fortnight previously, but the down phases have tended to be sharper and shorter than the up ones (generally 2-4 days).
Why I disagree with ee about the value of this trade in that my losses are limited to ~$1/bbl by the stops but the potential reward (with a good chance of a decline to below $15) is much better. However, trading in this way only works if you spend quite a bit of time watching screens.
Goldman's analysis makes no sense to me, and I suspect they're talking their own book (which, IMO, they usually do - with their pronouncements to the "hoi polloi"). If oil is being exported from the US, that will tighten suppies there, causing the Louisiana price to rise, which eventually will feed back to WTI.
Moreover, as I type, their statement is being contradicted by the market, and the spread is falling quite rapidly (with August Brent off sharply following the contract roll yesterday). It's now more than $2 off the high.
http://ftalphaville.ft.com/blog/2011/06/15/594576/wgo-whats-going-on-in-brent-wti/
WGO – Whats Going On in Brent-WTI?
Posted by Izabella Kaminska on Jun 15 10:10.
First there was Cushing syndrome. Then there were Brent market antics. Now, nobody knows what’s going on in the Brent-WTI spread...
In reply to African4Life, post #125
Don't know why the analysts are surprised that oil is being shipped out of the US. The reason for LLS now trading at a small discount to Brent seems obvious to me (vs it's usual premium): it's the time-lagged effect of physical artibrtage which I suggested would occur much earlier in this thread. Physical arbs, who bought June WTI contracts a couple of months ago, which are now being delivered, and went short Brent - have found a mechanism to get their oil to the coast, from where it's being shipped out of the US to cover their short Brent contracts. Wouldn't be surprised if Goldman were involved in that trade . ;0)
The LLS discount doesn't explain at all why we've just had a bubble in the forward Brent/WTI spead... which I'm pleased to say, continues to collapse nicely. :0) I suspect the bubble has a lot to do with the "big boys" (i.e. the physical arbs) taking advantage of Brent shorts forced to roll their contracts (which explains the Brent backwardation I observed). The arbs will make a packet having sold July Brent contracts for physcial delivery at inflated prices, which they can then fill using WTI purchased on cheap contracts a month or two ago. This works very well for the physical arbs, as long as they can convince the hoi polloi that there's a bottleneck at Cushing and they can't get the oil out. The shrinking inventories there, as mentioned in the article, however, tell a different story.
That's why I always use front month +1 for this trade. Given that I don't expect to hold my position in August contracts for more than a couple of weeks at the most, I won't have to roll. Next time I open a position I will probably use September contracts which are now available for me to trade. For now, the downtrend continues and I'm holding my current position. :0)
Mark
In reply to marben100, post #126
The shrinking inventories there, as mentioned in the article, however, tell a different story.
Indeed. This was my point higher up the thread that seems to be ignored by most reports - it was however VERY clear to me that speculation has been driving it since $15 rather than a pure "too much oil" situation at cushing.
Comes back to my earlierl point - the market is far too complex to make any accurate predictions - just have to play the probabilities that the spread is too wide to be sustainable.
So far so good - nicely in the money on the August contracts.
Wild day.
Was $19 at one point. Back out to $22 again now.
In reply to nigelpm, post #129
You gave me a scare there nigelpm, as I left my screen around 7:30pm BST, after which it is rare for there to be significant price swings. However, the August-August contracts are currently showing a spread of ~$17.90, having peaked at just over $21.35 yesterday, so my profit remains intact. ;0)
Position size increased over the course of the day and stops reset above recent intraday high, to lock in profits.
Brent has tumbled by about $5 today, as well as the spread, contrary to Goldman's suggestion.
Let's see what tomorrow brings.
In reply to marben100, post #130
The hazard of discussing a commodity that is traded in many different instruments of course - yesterday this was following the July- July spread.
However, I am somewhat bemused by the cash pricing right now on CMC - they have Brent at 118 and WTI at 95 indicating a spread of 23!
For those out there who like this kind of thing could be worth shorting that Brent on CMC and longing the IG august at 114!
Profit taken and fully out, for now. Spread appears to be heading back up, short term. Now at over $18.80. Back to watching & waiting.