Wednesday, January 23, 2013

Yeehaaa West Texas

  • The WTI-Brent spread will continue to narrow as the infrastructure weaknesses that caused the dislocation in the first place are being alleviated
  • One pipeline is already helping to alleviate the problem and more infrastructure projects to achieve this are in the pipeline
  • Over time the USA will achieve this as it does not want the WTI contract to lose its leadership benchmark status permanently
  • Buy WTI and sell Brent across the curve; we suggest areas like June 2013 
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Background: The oil market has a vast amount of different oils which are differentiated by their quality. Even within the USA there are a number of different oils with different specifications and names. All of the oils across the globe have a pricing relationship to each other based on quality differences and transport costs. Over the last years, however, one oil in particular has dislocated itself from the world oil prices: WTI (West Texas Intermediate);  by many considered to be the benchmark for US oils as it is the basis for the most traded futures contract in the world (recently overtaken by the Brent futures contract).

Opportunity: WTI had for decades been trading above Brent prices by about US$2 which were accounting for transportation costs. However, some years ago WTI began trading at a substantial discount to Brent by more than US$20. The main reason for this dislocation of WTI from the world oil markets was due to infrastructure difficulties in the Cushing area where the WTI oil is deliverable. The crux of the problem was that oil could not effectively get to the refineries that need the oil nor to the regions that transport the oil effectively and in the volumes required. This meant that stocks were rising in Cushing and each time a threat existed where futures holders threatened to deliver the oil into the WTI futures contract then the discount reached extremes.

This situation is however being cleared up through pipeline reversals which transport more than 400k b/d out of the region to regions that require the oil and therewith clearing up some of the dislocation that existed for so long. This has commenced already. Additionally, one has to bear in mind that this dislocation has cost WTI the leading benchmark status for crude oil and this the USA will not allow to become permanent. Hence we believe that future projects will eventually alleviate this infrastructure deficiency completely.

This should enable WTI to strengthen vis a vis the Brent futures contract. This trade has moved in the june area from -18$ to -12$ already but over the next few months we would expect this differential to move into single digits. Overall buying WTI while selling Brent across the curve seems reasonable.



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