Analysis: "Widowmaker" oil trade lives up to its name

Traders work in the crude and heating oil futures pit on the floor of the New York Mercantile Exchange March 7, 2011.

NEW YORK (Reuters) - Big oil traders who bet on a rise in gasoline prices relative to heating oil ahead of the summer driving season may have thought they broke the curse of a "widowmaker" trade even as oil prices crashed.

They were dead wrong.

Some of the traders who shun the big, directional bets that hedge funds love have crowded into a common springtime trade: betting gasoline futures on the New York Mercantile Exchange (NYMEX) will hold at a premium to heating oil futures as consumption accelerates into the summer.

They have been counting their winnings since March, when the spread staged its biggest seasonal rise since 2007. The surge accelerated earlier this week as the Mississippi River swelled, threatening refinery operations in Louisiana and Tennessee.

But then came Wednesday, when gasoline futures collapsed in the biggest absolute drop in more than two years. The spread dropped by over 17 cents, the biggest one-day move since September 2009.

"There will be widows. Some people got pretty whipsawed. But that trade is not for the faint of heart," said Stephen Schork, editor of the Schork Report.

Indeed, lately it's been a stomach-churning ride. The spread has moved by more than 6 cents in either direction in four of the past eight trading sessions; prior to last week it moved by such a margin only nine times in two years. (Graphic: link.reuters.com/dac59r )

First, the U.S. Energy Information Administration came out with data showing an unexpected build in gasoline stocks as the threat level for refineries from the Mississippi river abated.

This, coupled with mounting concerns that gasoline pump prices near the critical $4 a gallon level will cause U.S. consumers to balk, pushed many bulls to the exit.

RBOB gasoline at one point slumped by over 30 cents or 8.95 percent. The price drop was so big it triggered a five-minute trading halt in all three oil major contracts for the first time since September 22, 2008.

VICTIMS

The "widowmaker" trade tends to be popular among trading houses and hedge funds which house some of the biggest speculative traders in the market.

One victim is said to have lost $500 million on a single bet in the summer of 2008 when gasoline failed to reach a premium to heating oil, contrary to the usual pattern.

On Wednesday, traders said a big Europe-based oil trading company was forced to stop out, or reverse its long position on gasoline to prevent further losses. Volumes spiked to the highest level in history as dealers rushed to place orders.

"If you were long you were happy this time yesterday and you're probably not so happy now," said an oil trader with a European bank. "The flood story freaked everyone out. The market attracted tourists and then we overshot."

U.S. refineries, which ramped up their gasoline production by 111,000 barrels-per-day last week, according to the EIA, are also set to take a hit if the slump in the futures market is carried to spot markets over the coming few days.

The price crash in theory wiped off more than $5 in profits for every barrel of crude processed into gasoline.

Traders who sensed that the price may have been reaching a peak were relieved on Wednesday to have sold near the top.

The signs were already there. Gasoline demand has been on a continuous slump since the second week of April according to EIA's 4-week average gasoline supply data.

"Luckily, I sold this morning. I'm too scared to watch it," said a gasoline trader with a bank.

Before Wednesday's crash, gasoline was trading at a record premium to heating oil, according to Reuters data going back to 2008.

Others saw the plunge as symptomatic of a new oil trading environment, characterized by huge price swings following last week's record drop in oil prices, for no obvious reason.

In percentage terms gasoline price fell by less than crude in last week's price crash, but on Wednesday they led the whole complex lower, analysts said.

"Last week's steep slide has increased volatility in the market, and we are still responding skittishly to that. Often in the period after a crash like that things become a little more volatile," said Gene McGillian, analyst at Tradition Energy.

Flagship commodity fund Astenbeck II run by top Phibro trader Andrew Hall was one name that suffered a double-digit loss last week as oil prices tumbled.

"If Andy Hall is calling the oil market wrong, then all hell is freezing over," said Schork. (Additional reporting by Edward McAllister and Janet McGurty; Editing by Jonathan Leff and David Gregorio)