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Wednesday, January 26, 2011

Games Traders Play with Oil, Part Deux

Following up on yesterday's post,  'Speculators now DEPRESSING the Price of Oil ? ', one should check out Julian Murdoch's piece in SEEKING ALPHA, "How to Play the High Brent-WTI Spread".

Until 2008, WTI--West Texas Intermediate crude--commanded a premium over Brent--North Sea crude-- because, as Murdoch explains, "WTI is a sweeter, lighter crude, and all things being equal, gasoline refiners prefer to work with WTI over Brent."  Since then, Brent has been trading at a premium to WTI.

What gives ?

Partly, Murdoch continues, it's because while WTI is prey to contango (see yesterday's post below), Brent has become increasingly vulnerable to price-manipulation because of declining production--about 26% since 2006--further constrained by recent North Sea offshore oil-rig mishaps/problems.

"So with tight supply and trading games pushing Brent prices up, and oil surpluses keeping WTI prices low, it only makes sense that the Brent-WTI spread should be as high as it is today.

"But will the trend continue? No way to tell for sure. No matter—U.S. ETF investors can easily invest in either side of the spread.

" Since USCF's introduction of the United States Brent Oil Fund (BNO), the fund is up 24 percent compared with the comparable WTI fund, the United States Oil Fund (USO):

"The two funds are similar in that they both own a single, front-month contract and roll it two weeks prior to expiration. The only difference is USO owns WTI, while BNO owns Brent.

"Although there's no guarantee that Brent will continue to outperform WTI, the future curves imply that maybe, it just might:
Immediately obvious is that WTI is in fairly strong contango through the next year—a function of the aforementioned ample inventories. Brent's curve, on the other hand, remains comparatively flat, although technically in contango. If these conditions persist, then BNO will likely continue to outperform USO simply because of the roll cost—although all it takes is a drop in U.S. inventories to quickly flatten the WTI futures curve and change the picture completely."

So, what's an oil-focused investor to do ?

"In the end, when it comes to crude, it pays to remember that more options exist than just plain old WTI."