(Robert Campbell is a Reuters market analyst. The views
expressed are his own)
By Robert Campbell
NEW YORK, Nov 6 As 2012 winds down, traders'
thoughts turn to next year. For many, betting that the yawning
price gap between Brent and West Texas Intermediate crude oil
will narrow, a trade that went horribly wrong this year, looks
too tempting to pass up.
Even those badly burned by past spread trades are salivating
at the opportunity, as the prospect of outsized returns from a
narrowing some time in 2013 is hard to pass up.
A bet on WTI versus Brent, if successful, some buysiders
argue, offers a lot of "alpha," or returns over and above what
the broader market generates.
Alpha is the lifeblood of hedge funds, and the only real
justification for fat management and performance fees. Market
returns, or worse, give clients itchy feet.
So with commodity indexes widely expected to boost Brent
weightings at the expense of WTI next year (the S&P GSCI has
already said it will do so: [ID:nL1E8M60FG]), any outperformance
by WTI offers a chance to deliver a return that thumps the
But after getting fried this year by wrong-way bets on the
spread, there is a lot of nervousness on the buyside. No one
wants to be the muppet. Traders recognize there are plenty of
risks in this trade.
First up is refinery maintenance. Oil major BP (BP.L) began
a long-awaited shutdown of a large part of its 337,000 barrel
per calendar day Whiting, Indiana refinery for an upgrade that
is expected to slash demand for crude oil in inland North
America for three months or so by up to 250,000 bpd.
That should depress WTI prices and trigger increases in
stockpiles at Cushing, Oklahoma, the delivery point for WTI
Planned work elsewhere in the Midwest is expected to
exacerbate the impact of the Whiting shutdown by further cutting
into refinery buying of WTI and other crude oils that compete
with it for space in the market.
SPRING IS IN THE AIR
The heavy maintenance slate has convinced many traders to
hold fire on a bet on the spread. Brent's susceptibility to
quick upward moves in response to even minor problems with North
Sea production adds further risk.
With more refinery turnarounds expected to temporarily cut
into midcontinental crude oil demand in the spring of 2013,
hedge funds are looking to the later months of the second
quarter of next year as a potential entry point into the
narrowing Brent-WTI trade.
By then, with refinery maintenance turnarounds out of the
way, the fundamental picture ought to look more favorable, the
reasoning of these players goes.
Already the market has briefly shown episodes where Cushing
is no longer a market of last resort. The fact that the
Spearhead pipeline from Chicago to Cushing will not run full
this month is one sign.
Another is the periodic narrowing of the gap in pricing
between North Dakota's Bakken Blend crude BAK- and Light
Louisiana Sweet LLS- to levels that at times suggest rail
capacity is sufficient to clear the market. [ID:nL1E8KH7T8]
Other pipeline projects that will divert oil from the
Permian basin away from Cushing, such as Magellan Midstream
Partners' (MMP.N) Longhorn project, should offer further
Finally, the 250,000 bpd expansion of the Seaway pipeline
from Cushing to the Gulf Coast should offer the final piece of
the puzzle, draining huge amounts of cheap oil out of Cushing
towards the Gulf Coast.
TOO GOOD TO BE TRUE?
On paper, it looks like a solid trade. But not one without
risks of failure on a grand scale.
After taking a battering this year on the spread, traders
ought to be more aware of the risk that shale oil production
surprises to the upside.
The boom in North Dakota crude output this year has blown
away all but the most enthusiastic predictions. Might it not
surprise us again, especially as technology improves?
Many analysts understand that the big risk is not that North
Dakota surprises but that another area with no other market
outlets but Cushing does.
There are a lot of "pent up" barrels just waiting to flow
into the WTI hub from plays a lot less mature than the Bakken
shale in North Dakota.
The middle of next year will see the startup of a new
175,000 barrels per day capacity pipeline into Cushing from the
Mississippi Lime area in northern Oklahoma and southern Kansas,
backed by heavyweight Plains All American Pipeline LP. (PAA.N)
And there is plenty of other oil that wants to get into
Cushing. Look no further than the support given by producers in
Colorado's Denver Julesburg Basin for an expansion of the White
Cliffs pipeline, which is now expected to be completed in the
first half of 2014.
Similarly, the risk is that projects to divert supply from
the Permian basin away from Cushing only succeed in eliminating
bottlenecks at places like Midland, Texas.
In other words, Permian producers still ship the same amount
of crude to Cushing but earn a bit more as the downstream
bottleneck in East Texas has been relieved.
Ultimately the risk in the trade boils down to two things:
there is huge uncertainty about the speed of the increase in
Canadian and U.S. oil production and infrastructure seems
certain to lag output at least part of the year.
Until there is a surplus of shipping capacity in the North
American interior, Brent and WTI will remain fundamentally
disconnected commodities, that will ultimately obey the logic of
their own markets.
That disconnect makes it impossible to say what the "right"
number for a Brent-WTI spread is. That is the true danger of
(Editing by Sofina Mirza-Reid)
((Robert.Campbell@thomsonreuters.com)(+1 646 223 4950))
Keywords: COLUMN CAMPBELL/
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