Schork Oil Outlook: Brent/WTI Arb Still Wide Open
WTI lagged behind the rest of the complex last week but made up for it with gusto yesterday. October contract prices surged to their highest point in almost two weeks to settle 2.23% higher at 87.27. The front month spread tightened for the third consecutive session, as did the inter-market WTI – Brent spread. If the API reports a draw at the Cushing, Okla. hub, we will look for this spread to tighten further in WTI’s favor (the API’s are usually in agreement with the DOE when it comes to Cushing).
As illustrated in today’s issue of The Schork Report, the front-end of the curve for Nymex WTI crude oil futures has been in contango for the better part of the last five years. The discount on the spot market to the deferred contract six months out is clustered around 0.970 (1stm/6thm).
When the contango moves below 0.950, the market is encouraged to carry inventory forward. Conversely, when the market moves to backwardation, as was the case in the first half of 2007, the market ‘pays’ to pull barrels out of inventory.
Since the second half of 2008, not only has the market remained in contango, but we have seen a number of severe dips (<0.900) in the discount on spot barrels. Each one of these dips was accompanied by a sharp increase in supply at the Nymex delivery hub in Cushing. (PADD 2).
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The latest such sharp dip in the contango occurred in February and coincided with the start of the Keystone pipe flow into Cushing. For example, WTI for March 2011 hit a low of 0.880 (-$11.60/b) against the contract for August 2011 delivery. Inventory at Cushing peaked one month later at a record 41.9 MMbbls.
Oil stocks at Cushing have been falling ever since, i.e. ever since the relationship between Nymex WTI and ICE Brent disconnected.
Last night, spot WTI settled at a 0.780 ratio (-$24.61/b) against the corresponding Brent contract.
This has led to the second event we have been witnessing since the winter. In today’s Chart of the Day, we can see that as Canadian producers have switched focus away from natural gas, and towards crude oil, oil shipments to the U.S. Midwest (PADD 2) have increased, as have transfers from PADD 2 to the Gulf Coast (PADD 3).
Of course, with Midwest crude oil trading at less than 80- cents on the dollar compared with Brent (and similar Gulf Coast streams), this transfer of barrels has accelerated this year.
Here’s the rub, the DOE’s data is inclusive of tanker, barge and pipeline movements, BUT, excludes unconventional methods such as rail and truck shipments.
Our analysis suggests there is a considerable amount of oil being transferred via these unconventional methods. Yet, what is really interesting is that despite good demand for NYMEX quality oil, the front-end of the curve has not budged.
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Stephen Schork is the Editor of The Schork Reportand has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.