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VIDEOHow to Play the Spread in West Texas, Brent Oil
By
Roger Nachman Aug 26, 2010 11:30 am
West Texas Intermediate is currently trading below Brent, but that course will reverse sooner rather than later.
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Investors should pay attention to the spread in the two types of oil traded. It's very profitable if you know how to trade it.
There are two types of oil traded around the world. West Texas Intermediate (abbreviated WTI) and Brent North Sea (shortened to BNS) crude. West Texas Intermediate is the most commonly referred to oil here in the United States, as it's traded on the New York Mercantile Exchange, now a subsidiary of the Chicago Mercantile Exchange (CME). Brent is traded on the Intercontinental Exchange (ICE), and has been since 2005. Before that, it was traded on the open-outcry International Petroleum Exchange in London.
West Texas Intermediate is currently trading below Brent, with WTI at $73.05 per barrel and BNS trading at $74.78. In all my years of covering, analyzing, and watching the commodities markets (admittedly not as long as some of the grey beards), I've never seen West Texas Intermediate not eventually reverse course, and cost more than Brent.
Depending on the fluctuations in the currency markets, Brent may cost more than West Texas Intermediate for an extended period of time. But it always reverses course, with WTI costing more.
There are two ways to play this and I'm going to give the bull and bear case. Keep in mind I lean toward the bull case in this one.
If you believe domestic growth is going to fall off a cliff, then your hypothesis would also include West Texas Intermediate taking a nosedive. Investors could short United States Oil Fund LP ETF (USO) or Occidental Petroleum Corporation (OXY). Occidental is most closely linked to the price of oil, as indicated in this chart.
I don't believe this is the case, and that growth will remain moderate and investors are too worried about growth slowing. Once this thesis begins to play out, West Texas Intermediate should begin to outperform Brent. The way to profit off this is the reverse of the trade above. Go long USO and OXY. I'd expect West Texas Intermediate to climb over $75 per barrel, good for a gain of at least $2 per barrel.
Personally, I see oil at the end of the year somewhere in the low 80s, as growth isn't as bad as expected. Another catalyst for this thesis is additional stimulus provided by the US government on fears that growth is slowing.
West Texas Intermediate always comes back to trade at a higher price than Brent. It's not a matter of if, it's a matter of when. I'm inclined to believe it starts to happen sooner rather than later, and investors may want to take a look at those plays mentioned above to profit off this spread in the different types of black gold.
Below, find some more great ETF and market content from Benzinga:
Three Asian ETFs That Disappoint
India ETF Could be Poised to Breakout
ETFs to Watch August 26, 2010
No positions in stocks mentioned.
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