After hearing a manager last week talk about their trade of shorting the negative roll yield WTI Crude futures (West Texas Intermediate grade Crude Oil – aka Crude Oil as we know it here in the US) and going long the less negative to positive roll yield Brent Crude futures, our curiosity got the better of us and we mapped out what the long Brent/Short WTI trade has looked liked over the past 5 years, plotting the single contract rolling gain/loss assuming going shot 1 WTI Crude and long 1 Brent Crude contract.
The chart makes it quite clear why they have been interested in this trade of late – although the contrarian in us doesn’t think it looks too appealing to be getting involved right now.
Why has it been working so well? Just take a look at the curves of the Brent Crude market versus the WTI Crude market below. You can clearly see that the WTI is in contango (further out months more expensive than the nearer months/spot price), and the Brent is in backwardation (the opposite of contango, where further out months are less expensive than the nearer month prices/spot price).
That means that rolling over long WTI crude futures month to month causes you to pay a premium to go further out (and receive a premium if short), while rolling over long Brent futures results in receiving a premium. Traders love to find anomalies, and this qualifies, as the two products are essentially the same, yet you get paid to hold one, and do the paying to hold the other. Why not own the one you get paid to hold, and sell the one you have to pay to own – creating a situation where you get paid to hold both while minimizing the price risk.
Now, this is a simplistic view of what is going on here, and there are many risks involved, chief of which is that the movement in price can more than offset the roll yield, but you get the point.
What’s the difference, anyway? Crude oil is crude oil, right? Aside from the obvious geographic spread (Brent Crude comes from the Brent Sea area, WTI comes from the Texas area) and the locations where the contracts are traded (Brent is traded on ICE and settles in London, WTI is traded on the CME with settlement in Oklahoma), WTI is considered a “lighter” and “sweeter” oil (don’t ask us why they call it sweet- we don’t want to know who tasted it), which results in a more easily refined product and up until now, a more expensive product.
Over the years, WTI has become a proxy for supply/demand in the Americas – as all things being equal, Oil consumers in the Americas will choose to get their oil from the closest source (in America), while Brent has become a proxy for supply/demand in the rest of the world (especially Europe). With the problems in Egypt, Libya, and Opec – the supply picture for Brent has been muddled of late, while there has been a supply glut in Cushing, Oklahoma where the WTI futures are settled, resulting in Brent not only being in backwardation, but also trading at a premium to WTI Crude.