It’s been quite a week or so for asset prices everywhere. And that includes oil. As fears have mounted that the global economy is heading for its second big double dip, the Brent Crude price has slipped and even flirted with the $100 per barrel level. Currently it trades around $107. And sure, a spread better could opt to play a further fall (with a short trade) or an extended bounce (via a long trade). However right now there is a more interesting option.
Brent Crude is not the only type of oil out there. Far from it in fact. Over in the US, there’s another type, known as West Texas Intermediate (WTI). This trades at a lower price per barrel currently around $85. So what?
Well, as Reuters points out, the gap between the two is “flirting with an all-time record” (that record is $23). The key question is why. As Joshua Schneyer notes, “since 2009 falling Midwest inventories have usually resulted in a narrowing of the Brent-WTI spread”. And at the moment, commercial crude oil stocks in the Midwest and Cushing are at their lowest reported levels this year (which ought to boost the WTI price and narrow the gap, or spread, between it and Brent Crude).
Sure, a majority of analysts and oil traders expect the spread to widen further. But that very fact creates an opportunity for a contrarian. The fact WTI stocks are under pressure suggests the price should rise whilst some commentators suspect Brent is being driven up by speculators as much as tight North Sea supply.
Indeed, a few serious observers such as Dominik Chirichella of the Energy Management Institute note, “WTI/Brent is so out of whack it’s unbelievable”. He expects the gap to narrow back down to more like $10-12. The fact there is so much disagreement over where the spread will go next creates plenty of price volatility and equally, opportunities for adventurous commodities traders.
If the bears are right, then a spread better should look at a pairs trade – short Brent and long WTI. Such a trade does not depend on the overall direction of the oil market to make money but rather on the gap between the two prices narrowing. Of course, should the gap set new records you will lose out (and would need the reverse trade – long Brent, short WTI to make money), so check out stop losses with your broker before trading and keep bet sizes modest.