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Will the benchmark West Texas Intermediate trade at a hefty discount to Brent for years to come? The oil market is split about the answer and some serious money is on the table with savvy traders taking opposite views about the direction of the price spread.
Until two years ago WTI traded most of the time at a premium of about $1-$2 a barrel above Brent, reflecting its higher quality, but over the past few months the relationship has reversed. On Thursday, Brent was $18.95 a barrel more expensive than WTI, after hitting an all-time high differential of $23.34 a barrel last week.
The wide spread is the result of multiple factors. The most important is a logistical bottleneck at the pipeline hub of Cushing, Oklahoma, which serves as delivery point for WTI. The bottleneck allows supplies to build up there as Cushing lacks, at the moment, pipeline capacity to evacuate the oil towards the refining centre of the US Gulf of Mexico. Besides, higher production in Canada and in the oil shale province of Bakken, in North Dakota, have exacerbated the flows towards Cushing. Brent has also its problems, as the lack of Libyan oil production pushes up demand for the North Sea’s benchmark just as its own production declines due to ageing oilfields and glitches at oil platforms.
The oil curve reflects the belief that the spread would continue for years to come, although it would narrow somewhat over time. The market sees a spread of around $15.50 a barrel by December 2011 and of $11 a barrel by December 2012. Five years from now, traders believe that the WTI-Brent would narrow to around $4 a barrel.
Is the oil curve right? Most traders believe it is wrong, but in both directions. So someone is going to lose some serious money over the next five years betting on WTI-Brent.
The argument of those who believe that the spread would narrow runs along the following lines. For one, Libyan crude production will resume sooner or later, lifting the pressure on Brent. Next, the companies planning pipelines out of Cushing will build them, removing the bottlenecking at the hub. There are two major pipeline projects in the works: the new TransCanada’s 700,000 barrels a day “Keystone XL”, which could be in operation by late 2013, and the reversion of the 450,000 b/d “Double E” pipeline of Enterprise Products Partners and Energy Transfer Partners. Betting that the spread would narrow – or taking a short position on it – is not without its risks, but Penin Remy, a commodities strategist at Société Générale, argues the risk, to materialise, “would mean that no pipeline is built and none are reversed”. Many traders agree with him and are shorting the spread.
But that is precisely the risk that those traders betting of a widening spread see in front of them. The camp is on the minority at the moment, but its voice is growing. The Keystone XL project is facing notable hurdles, not least the approval of the Environmental Protection Agency. And “Double E” has yet to get enough commitments from physical traders to justify the reversion. Moreover, some oil traders believe that the pipelines would not be enough as onshore oil shale production continues to boom, flooding Cushing with oil in spite of the de-bottlenecking of the new pipelines. Moreover, Brent output is likely to continue falling over the next few years, even if new graders are incorporated to the current blend of Brent, Forties Oseberg and Ekofisk.
There are so many factors influencing both the short- and the long-term prospects of the WTI-Brent spread that both sides only agree that the road would be bumpy. And that
