Many traders and hedge funds are nursing losses after a whiplash reversal in one of the biggest commodity trading trends of the year – a bet on a widening spread between different types of crude oil.
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IEA Oil Reserves
Traders say the unexpected release of the Western countries’ petroleum strategic stocks last week left many in the oil market wrong-footed, particularly those that had traded on the relative price differential of Brent crude and Dubai crude.
The price difference has narrowed sharply between the lower quality, heavy sour Dubai crude, the benchmark for Middle East supplies, and the premium quality, light sweet Brent, the North Sea’s benchmark.
The spread has plunged to a six-month low, dropping nearly 50 per cent in just four days, traders said.
So far companies have not disclosed any losses but given how widespread the bet on widening spreads had been, the move would have hit many traders hard.
“When you see markets break like this you know there is going to be a lot of pain on the street,” Michael Guido, associate director of hedge fund sales at Macquarie in New York, said, echoing a widely held view within the industry.
The loss of production from Libya pushed up spreads between Brent and Dubai crude to a six-year high earlier this month as refiners bid up the North Sea benchmark crude, which is of a quality similar to the output from the North African nation. Traders also sold off Dubai because Saudi Arabia has announced it would boost its production.
The spread touched a session high of $9.20 a barrel on June 15, the highest since October 2004.
But the IEA’s release suddenly altered the supply and demand balance of the market. Instead of a flood of heavy, sour oil from Saudi Arabia, the market is now braced for the release of light, sweet oil from the emergency reserves. As a result, the spread plunged to $3.30 on Monday, down nearly 65 per cent from a fortnight ago.
The release has also hit the time-spreads, or the difference between the cost of crude oil for immediate delivery and its forward price. Betting on time-spreads are a popular trade among hedge funds.
A week ago, the premium of spot Brent over the two-year forward was of nearly $4.5 a barrel. But by Tuesday, it had flipped upside down to a 11 cents discount.
The collapse of the differential indicates that the release of the strategic reserves is not only lowering the headline cost of oil, but also the premiums that refineries were until a week ago paying to secure scarce supplies of high quality, light sweet oil.
Additional reporting by Gregory Meyer in New York and Jack Farchy in London