February 6, 2012 / 8:03 PM / 7 years ago

Analysis: Brent premium to U.S. oil set for another blowout?

NEW YORK (Reuters) - Brent crude’s premium to U.S. oil could be poised for another record run after jumping 50 percent over the past week, as an expected build in Midwest inventories again exerts pressure on the U.S. benchmark.

The Brent-WTI spread, which measures the difference between London-based Brent and the U.S. benchmark West Texas Intermediate (WTI), has jumped past $19, up sharply from near $12 at the start of last week.

With U.S. refiners starting seasonal maintenance just as a major pipeline starts carrying more crude, traders said the oil glut in the U.S. Midwest that helped drive last year’s record spread was back on their radar. That should widen the discount between what refiners pay for oil around the WTI delivery point of Cushing, Oklahoma, compared with the price paid by refiners on both U.S. coasts and in the rest of the world.

Some said the Brent-WTI spread could jump past $20 a barrel and possibly top last year’s record-breaking surge past $28, providing a boost to Midwest refiners but cutting profits for producers in the North Dakotan shale fields, which have created much of the glut.

Crude oil stockpiles in the Midwest hit a record high over 107 million barrels in the second quarter of 2011, before falling back to just over 91 million barrels in November, according to data from the U.S. Energy Information Administration. Over the past three week, Midwest crude stockpiles have been climbing again, topping 94 million barrels in the week to January 27, the highest level since September, according to the EIA.

Stockpiles at Cushing have also grown over the two weeks to January 27 to top 30 million barrels for the first time since December, the EIA data showed, snapping five straight weeks of declines.

Historically, Brent and WTI had traded within a dollar or two of each other. But in 2011, the loss of Libyan crude from global markets due to turmoil in that country lent support to international benchmark Brent, while growing supplies at Cushing pressured U.S. crude prices.

Philip Verleger, oil economist and consultant with PKVerleger LLC in Colorado, said one reason the spread has surged again after three months of relative stability was down to refinery closures on the U.S. East Coast and in Europe, which has driven a wedge between the price of gasoline and diesel there and in the U.S. Midwest.

“We’ve lost 1.4 million barrels per day (bpd) of refining capacity on the East Coast and in Europe, so product markets are tighter there, but that’s not the case in the Midwest,” Verleger said.

“Product prices in Chicago and the Midwest are around $6-$8 a barrel lower than they are on the East Coast or Gulf. That’s set to continue.”

Verleger said low product prices would cut demand for crude from refiners in the Midwest, pushing the spread out further.

While gasoline in New York Harbor has traded around $2.90-$2.95 a gallon over the past week, in Chicago prices have been about 20 cents a gallon cheaper. That’s the equivalent of $8.40 a barrel, a near record price difference according to Reuters data.

When the spread exploded in 2011, it became one of the most popular oil trades in years, attracting the attention of hedge funds and other investors and at times trading on technical factors as key levels were broached. It eventually collapsed over two dramatic weeks in late October and early November to around $10.

The collapse came amid expectations the planned reversal of the 150,000 barrel per day (bpd) Seaway pipeline would eventually help drain the glut from the Midwest to the refining centers on the Gulf Coast and reconnect WTI to global markets.


While the Seaway pipeline should start draining supplies from the Midwest in the second half of this year, traders may first move to fill the storage tanks at Cushing in anticipation.

Shipments down the 190,000 bpd Spearhead pipeline from near Chicago to Cushing are set to operate at full capacity for the first time in months in February, as traders scramble to gain preferential shipping rights for later in the year once Seaway is reversed. Operator Enbridge (ENB.TO) said last week capacity on the line was massively oversubscribed.

Once Seaway is reversed, traders will use Spearhead to bring relatively cheap oil from North Dakota and Canada into Cushing before sending it the giant Gulf Coast refinery hub, where it fetches a hefty premium.

Hedge funds and other large investors are betting that’s one reason the spread could widen further, with the Brent-WTI trade becoming more attractive as the flat price of crude has been relatively stable, torn between offsetting fears of supply disruptions from Iran or further problems in the euro zone that have sparked demand concerns.

Mike Guido, director of hedge fund sales at Macquarie Bank in New York, said there was the potential for the spread to go much wider in the short-term, and could remain at elevated levels for the whole year.

“Brent is not an attractive short for hedge funds. It’s clearly the default benefactor from event risk (like Iran), but it also holds a residual bid from the Asian buyer and is subject to Nigeria risk as well,” said Guido.

“The reality of a stateside glut of oil is also now setting in, and recent news of continued refinery shut-ins and reduced demand are strong fundamental drivers of what could be a much wider spread in the short term,” he said, adding he thought funds might look for the spread to narrow slightly before going long Brent and short WTI again, targeting a spread near $20 a barrel.

Others said there is little reason the spread couldn’t blow out even further, arguing that while it is underpinned on the downside around $10 a barrel by the cost of moving crude out of the Midwest by rail and other more expensive alternatives to pipelines, the top end of the range faces no such restriction.

“I’m looking for it to run to $20 while the Midwest refineries are still in maintenance, before fading slightly as WTI and gasoline start to follow their seasonal pattern in the spring,” said Richard Ilczyszyn, founder and chief strategist at iitrader.com in Chicago.

“But there’s no reason it couldn’t go further, to $30 or more. No one wants to take the short side of the trade yet.

Oil economist Verleger argued that, in theory, heightened oil supply in the Midwest could create a situation similar to that in the U.S. natural gas market, where prices have plummeted to 10-year lows as a result of the rapid rise in shale gas production.

“There’s no reason WTI in the Midwest couldn’t go the same way as natural gas. There’s every reason for the spread to go wider.”

Editing by David Gregorio

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