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In oil markets, a U-turn for the hottest trade in years
October 26, 2011 / 5:06 AM / 6 years ago

In oil markets, a U-turn for the hottest trade in years

NEW YORK (Reuters) - At $93 a barrel, U.S. oil prices traded on Tuesday within a well-worn range. But that belies a radical move in energy markets this week -- the unraveling of one of the hottest and most volatile oil trades in years.

The trade-gone-haywire is known as the Brent-WTI spread bet, a wager on the relative value between the two most-traded oil futures in the world, London’s Brent and U.S.-traded West Texas Intermediate.

While the light, sweet crudes are equally prized by refiners, Brent’s premium to WTI grew steadily wider over the course of this year, moving from parity to a record $28 a barrel two weeks ago. The large divergence once seemed unthinkable, since barrels of oil are usually relatively cheap to transport between regions.

In recent days, the spread has been collapsing as WTI prices rise and Brent falls. Since Friday, Brent’s advantage has slipped from $22 a barrel to $18, and oil market insiders have been stunned by the recoil.

Since billions ride on the spread, its recent narrowing means that investors caught wrong-footed -- those betting long Brent and short WTI -- have likely been bleeding cash.

Traders and analysts speculated there could be a major money-loser among the hedge funds, investment banks and deep-pocketed trading houses, but none could be identified.

“I‘m sure a lot of the big energy funds got waylaid with this,” said money manager John Stephenson at First Asset Management in Toronto, with $2.7 billion under management.

“I have not heard of any specific funds having difficulty.”

Underscoring the move are tightening supplies of crude in the United States and the expectation of more oil shipments for Europe following the end of Libya’s civil war.

Few expect the gap between WTI and Brent to disappear completely until new U.S. pipelines -- such as TransCanada’s controversial $7 billion Keystone XL project to pipe oil sands crude from Canada to Texas -- enter operation in 2013 or later.

But the leading factor cited for the price distortion -- a surplus of crude at WTI’s landlocked delivery hub of Cushing, Oklahoma -- has been abating, despite few spare pipelines to carry oil away from Cushing.

A FUNDAMENTAL DIFFERENCE

Barclay’s warned earlier this year that WTI prices were becoming unhinged from fundamentals, and the financial services company cautioned against the spread trade.

But Citi analysts as recently as July forecast the spread could blow out to a whopping $40 sometime in the next year.

A torrent of recent energy news and data now point to shifting oil market fundamentals, many of which support a more narrow spread:

-- U.S. oil inventories have declined, and stood at 8 percent below levels from the same period of last year, according to the U.S. Energy Information Administration last week.

-- The draws come amid fewer U.S. crude imports, which fell to a 10-month low of 7.9 million barrels a day last week. On the East Coast, where several refineries have recently shut, imports are near 20-year lows.

-- A Midwest crude surplus is subsiding, at least temporarily, with stocks at Cushing, Oklahoma -- delivery point for WTI -- unexpectedly plunging by more than a quarter since hitting a 42 million barrel high this spring.

Earlier, a brimming Cushing hub helped to feed the Brent-WTI spread divergence, since record supply levels there depressed the value of prompt WTI relative to barrels for later delivery. That encouraged even more storage.

WTI’s big discount has called into question its usefulness as a benchmark grade. This month, Colombia and Brazil moved to price more of their oil exports off of Brent.

This week, however, the value of WTI for delivery in one month’s time has shot higher than WTI’s forward value for the first time in three years.

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