NEW YORK, June 6 Traders who have bet on a narrowing of the spread between Brent and West Texas Intermediate crude oil futures are nearing a moment of truth.
Stocks of crude oil in the U.S. Midwest are at an all-time high. Ditto for inventories at Cushing, Oklahoma, the delivery point for WTI futures.
Unless inland crude stocks decisively break with the current upward trend, and do so very soon, a fresh blowout in the Brent-WTI spread looks increasingly likely.
Already the fast-convergence thesis is looking in trouble. The startup of the 150,000-barrels-per-day Seaway pipeline in late May has so far made no impact on crude stocks at Cushing.
Lags in data and the likelihood that Seaway may have taken some time to reach full capacity mean the jury may be out on this question for another week or two.
But refinery problems, notably the unplanned shutdown of a crude unit at BP's Whiting, Indiana refinery last week, could well offset any gains from Seaway's running at capacity.
Without the catalyst of a sustained drop in Cushing crude stocks, the risk rises that traders who are long the spread may capitulate.
Add the likelihood of fresh wagers on a widening of the Brent-WTI spread and the playing field starts to look tilted against convergence bets, at least in the short term.
The same may well go for WTI timespreads. The contango in WTI has flattened considerably as traders anticipate an end to the oversupply at Cushing.
But such bets too may well be targeted for unwinding, at least at the front of the curve.
MAYBE NEXT YEAR
A further risk to the short-term Brent-WTI convergence thesis looms in planned refinery maintenance in the second half of 2012 and early 2013.
Major shutdowns are planned at BP's Whiting refinery and Marathon's Detroit facility in that period as the two companies complete upgrades.
Those shutdowns, combined with increased oil production from shale plays, are likely to pressure overall inland balances, and the Brent-WTI spread.
Routine autumn maintenance will only add to the pressure.
Similarly, the rise in shale oil output is chipping away at the anticipated impact of some projects on the situation at Cushing.
Take Magellan Midstream Partners' Longhorn pipeline. This project, due for startup in 2013, was expected to relieve pressure on Cushing by diverting crude from West Texas to the Gulf Coast.
The current discount on crude at Midland, Texas, where WTI-deliverable barrels each fetch some $4-$5 less than they might at Cushing due to pipeline bottlenecks, speaks volumes.
The "mini-Cushing" situation at Midland means the risk is now that Longhorn, and similar projects, only relieve partially the oversupply at Midland, leaving flows to Cushing unaltered.
Fresh pipeline projects should boost takeaway capacity from Cushing, starting in early 2013 with the upgrade of Seaway to around 400,000 bpd.
But these must be balanced with fresh inbound supplies, including planned lines from new Oklahoma shale plays, North Dakota, and other areas.
A decisive factor could well turn out to be the price of WTI. The recent selloff has likely affected drillers, but for the moment the psychology of most operators is likely colored by average prices, which have not been hit hard.
That may change, however, if WTI stays in the $80 range for longer. Bear in mind that most inland crude oil fetches less than the WTI price and some production will start to look vulnerable to weaker pricing.
Talk has emerged, probably prematurely, that Canadian oil sands growth is under pressure.
While this may prove to be true for smaller projects, most of the large ventures are difficult to slow down, especially as huge commitments to pipe oil are unlikely to go away.
Companies active in shale plays, however, are starting to push suppliers for discounts on field services. That's an important early indicator of firms' willingness to curb growth as a way of preserving profitability.
If North American oil production growth slows, it would give pipeline firms time to catch up with the glut.
But that puts a lot of variables into place. Traders trying to front-run the narrowing of the Brent-WTI spread have already been badly burned.
Another blowout could make the futures market reluctant to embrace convergence without more evidence next time around.