We were a little busy yesterday proposing ways to save the industry, but that doesn’t mean we weren’t paying attention to the markets- particularly to movements in Crude. As Europe toyed with investor confidence for the umpteenth day in a row, and supply routes expanded stateside, Crude began to make some pretty interesting moves.
For starters, WTI Crude, whose prices are the ones people most frequently watch in the U.S., surged higher, strengthening the divergence between Crude prices and stock market performance that we’ve seen in November. In October, correlation between WTI and the S&P 500 was at an astounding .94. While November’s correlation at .49 is still fairly substantial, the sharp drop has us at least moderately hopeful that the risk on/risk off trading may be unwinding- at least to some extent. If today’s performance is any indication, with stocks down 1.66% and Crude up 2.38%, that could be a good sign.
However, perhaps more interesting has been the developments in the previously profitable spread opportunity between WTI and Europe’s Brent Crude. Bloomberg summarized it nicely:
The spread between January contracts for WTI on the New York Mercantile Exchange and Brent on ICE Futures Europe tightened as much as 35 percent to $8.32 a barrel before settling at $9.28, the smallest since March 8. The gap for the contracts nearest to expiration has narrowed by 67 percent since reaching a record of $27.88 a barrel Oct. 14.
We had already posted on the collapse of that spread trade’s profitability earlier this month, and this move seems to be another nail in that coffin. There are two parts to this. First, there is the shift from contango into backwardation by WTI Crude that we referenced in our most recent analysis of this trade. Yes, further out WTI Crude Oil is now at a discount to the near month contract prices (and/or spot prices). The second is that Brent Crude has gone even further into backwardation, with its front month prices getting even more expensive than its further out prices. The further negative in our table below, the further in backwardation the commodity is.
The catalyst for yesterday’s action was news that a Canadian company plans to reverse the flow of a pipeline current running from the US Gulf Coast to Oklahoma. Part of the problem with Crude Oil being in contango over the past year or so was too much supply in Cushing Oklahoma where the WTI crude contract settles, thanks to the booming success of the Canadian Oil sands and Balken field in North Dakota. With this production in the middle of North America a rather new development, there is very little means to get the oil out of the middle of the country.
Now, in one of life’s little twists, a plan to increase supply to the rest of the world (by piping it down to the Gulf of Mexico and shipping it from there) has actually meant a spike in WTI Oil prices. So much for that supply up/prices down lesson you learned about in Econ 101… at least, on face. The reasoning is that while overall prices may come down with access to this supply, it will make the WTI Crude Oil more attractive to those paying those high Brent Crude prices, resulting in more demand for the WTI Crude (so yes, your Econ professors are still right).
We’ll see how this all plays out in the near future, with initial moves in both WTI and Crude this morning being down, but for now we’re left wondering….. (and by full disclosure we’re not pipeline engineers) did it really take this long for someone to come up with the idea to pump the oil the other way down a pipe?