The price difference between West Texas Intermediate and Brent crude reached a record high of more than $28 a barrel earlier this month. But, almost unnoticed, the market has started to price a return to the parity between the two benchmarks in five years.
The direction of the five-year forward WTI-Brent spread has captured quite a lot of attention among hedge funds, with savvy traders taking opposite long and short positions. The recent abrupt price swings suggest that someone has lost some serious money.
Only three months ago, the Nymex Dec 2016 WTI contract was about $5 below the ICE Dec 2016 Brent contract. On Thursday, the WTI contract traded 90 cents above Brent. Over the past month, the WTI-Brent Dec 2016 spread has moved a whopping 161 per cent. The Dec 2015 WTI-Brent price spread has followed a similar pattern, collapsing from $6.86 a barrel in early September to just $1.83 a barrel on Thursday.
The bet on a return to WTI-Brent parity appears based on progress to build several new pipelines that promise to de-bottleneck Cushing, the key delivery point for the WTI benchmark, and the return of Libyan crude.
Even taking into account the potential for delays, most traders believe that in five years, TransCanada's 700,000 b/d "Keystone XL" pipeline would be in operation. Indeed, the company says it could be moving oil by late 2013 or early 2014. The U.S. State Department gave a provisional green light to the $7-billlion project, although final approval is several months away. Another project is in the offing with Enbridge developing the Monarch pipeline to bring crude from Chicago to Houston via Cushing. Enbridge says it could start shipping by late 2013, moving up to 300,000 b/d from Cushing to Houston.
But the price difference between WTI and Brent is also coming under pressure for contracts for delivery in 2012 and 2013, suggesting that traders are not only betting on pipelines. The return of Libya to its pre-ward output level of 1.6 millon b/d, expected by late next year, would play a large role on the five-year forward spread, putting pressure on Brent prices.
At the same time, Goldman Sachs believes that railway shipments within the U.S. would alleviate the constraints of the Cushing storage centre. The Wall Street bank on Thursday told clients that the WTI-Brent price spread would narrow from more than $22 a barrel to $16, $13 and $6.50 on a 3, 6 and 12-month outlook.
Yet, there are so many factors influencing the long-term prospects of the WTI-Brent margin - in particular, North Sea oil production, pipelines in the U.S. and the geopolitics of north Africa - that the spread is likely to become a widow-maker for hedge funds betting on its movements.