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Crude Oil Trading

Crude oil trading can be a difficult market and is, at times, little understood even by oil traders or those involved in other instruments and markets. One reason is the complexity of the market in which the price of its main constituent – ie oil – is currently provided by a variety of global benchmarks.  For the purposes of crude oil trading the market tends to focus on either Europe’s Brent or the US based West Texas Intermediate (WTI).

Traders and investors usually track both and pour tens of millions in both Brent and WTI futures. However, they represent only a fraction of the hundreds of different types of crude which are traded on both the physical and financial crude oil trading markets. The International Crude Oil Market Handbook, the oil traders’ bible, lists almost 200 types of crude, from Kutubu of Papua New Guinea to Cano Limon of Colombia. However, for the purposes of this site all references to crude oil trading will generally refer either to the WTI or Brent contract because they are likely to remain the chief benchmarks for crude oil trading for some time to come, despite their relative problems.

These problems are linked to the demand and supply conditions of the areas where they are produced and stored which for WTI is Texas and Oklahoma in the US, and the North Sea for Brent.   An additional problem for WTI is that its source area is landlocked, making it more difficult to transport and distribute to global markets.

In crude oil trading WTI is the most popular oil future and is based on the light, sweet futures contract traded on the New York Mercantile Exchange (Nymex). However, from time to time the contract disconnects from the global market to the extent that even the US Energy Department has been forced to concede that WTI “does not always exactly follow the broader oil”, adding in a report published in June 2010 entitled “Keep and Eye on More than WTI”, that “temporary discontinuities in WTI relative to the prices of other crude oils occur occasionally”. These discontinuities often lead to prices showing smaller increases than those  of other benchmarks, or to prices falling faster, as happened in 2008.

Even the EIA has recently been moved to comment that: “Typically, different crude benchmark prices tend to move in the same direction, even during short-term price swings. But recently, WTI has exhibited larger swings than other crudes.”

Oil analysts and commentators have been attributing this disconnect to supply problems at the pipeline hub at Cushing, Oklahoma, which is the delivery point for the Nymex WTI contract and evev the EIA has admitted that “storage at Cushine is inaccessible by tanker or barge, and few outflowing pipelines exist. Hence, excess crude oil can be slow to dissipate once a glut develops”.

Recent erratic price movements in WTI due to storage challenges in Cushing resulted  in Saudi Arabia dropping the US benchmark last year as its reference for sales in the US for the first time since 1994, replacing it with a basket of crudes from the US Gulf of Mexico.

Meanwhile Brent, the second major oil price benchmark for crude oil trading, traditionally trades at a discount of at least $2 per barrel to WTI, but since 2007 has even traded at a premium of up to $10 per barrel because of the WTI storage problems.

However, Brent (which is in fact a North Sea blend of different crudes from fields other than Brent, namely Forties, Oseberg and Ekofisk) too has its own problems and can detach itself from the global oil market trend. This is important to know and appreciate as Brent forms the basis of the ICE (International Commodity Exchange) Brent futures contract.

The Brent price discontinuities usually occur during the summer months when the oil fields undertake their annual maintenance programmes which can reduce supply sharply, and result in the price of Brent tightening  even if oil market supplies are at a glut. When this combines with unexpected outages Brent prices will move well above comparable crude streams.   This was the case in July and August of this year, when Brent prices moved sharply higher while other crude oil benchmarks were showing signs of weakness.

In crude oil trading WTI and Brent their unique production and storage problems will always mean that insiders such as oil companies and big trading groups will always have a significant advantage over the majority of traders and investors as an oil company, for example, would have prior knowledge of any outage in the North Sea and any consequent supply problems.  In Cushing physical traders would know the level of stocks well ahead of other market participants allowing them to adapt their market positions accordingly

With almost 900k WTI crude oil contracts trading hands each day and volumes expected to grow, successful crude oil trading must also include an understanding of the underlying production and supply dynamics of these two global benchmarks.

Further information on crude oil trading can be found at the ICE.

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