It was all the way back in June when we first touched on the unique opportunity being presented in the pricing differences between Brent Crude and WTI (West Texas Intermediate) Crude. With Brent in backwardation (meaning further out months are less expensive than the nearest months/spot price) and WTI in contango (meaning just the opposite, that further out months are more expensive than the nearest months/spot price), traders found themselves facing a unique opportunity. By shorting the negative roll yield in WTI Crude futures and going long the less negative to positive roll yield of Brent Crude futures, they were able to exploit price differences in economically similar products in an effort to turn a profit. Such is the nature of a spread trade.
As we showed in our last post concerning the Brent/WTI spread, this trade had been going gangbusters since about October of 2008. Well, as often happens, all good thing must come to and end, and here in October of 2011 – this trade has started to unwind as WTI has shifted back to backwardation rather aggressively.
Zerohedge commented on this not too long ago, stating:
It is the huge shift in the whole WTI crude complex that is perhaps more fascinating. For the first time since May 2011, Dec 11 WTI is more expensive than Dec 12 and in the last three trading days alone, the entire curve has shifted to backwardation very aggressively.
Here’s what the futures curve for both Brent and WTI looked like in June against what they look like today. You can see that Brent has steepened (more backwardation), while WTI has flipped, going from Contango to Backwardation.
What has this meant for the long Brent Oil/short WTI Oil trade? It has unwound some, but perhaps not as much as we would expect (probably because of the Brent seeing more backwardation – or perhaps because these positions haven’t rolled many times yet, where the roll cost/yield will be seen). The profitability of this trade since October 1st can be seen below:
Of course, when looked at over the last 5 years, this recent move is little more than a hiccup for this spread. Time will tell if the highs have been made and the spread starts the long retracement down, or whether this is a temporary pullback before the spread starts to widen again.
