WTI prices not keeping pace with fundamentals

Most interestingly, WTI has not only lagged behind Brent, but also behind Canadian crude oil prices, with Canadian Mixed Sweet crude oil at Hardisty having rallied more than $32/bbl from its June lows, and this has occurred despite the fact that crude oil inventories at Cushing have been drawing. We do not see the resulting widening of the WTI-Brent spread as sustainable.

WTI-Brent widening and WTI falling below Canadian grades even as Cushing inventories draw

Cushing crude oil inventories began to draw shortly after the reversed Seaway pipeline came online in late May, loosening a bottleneck that prevented rising crude oil production in the Bakken and Canada from reaching the US Gulf Coast. However, while the reversal of the Seaway has shifted the Cushing crude oil market back into deficit, allowing inventories to draw, the WTI-Brent spread has widened out to -$17.70/bbl rather than narrowing. We do not see this widening of the WTI-Brent spread as sustainable, and we continue to expect it to narrow going forward. In particular, with WTI now pricing near parity or below Canadian grades, we expect flows into Cushing will slow, accelerating the draw on Cushing inventories and putting greater upward pressure on WTI prices.

Repositioning our trade recommendations as risk-reward on the WTI-Brent narrowing looks better in 2013 after Seaway ramps up to its full capacity

With the conversion of BP’s Whiting refinery scheduled to begin in 4Q12 and the potential for a US SPR release rising with the tensions with Iran, we think the risk-reward to the WTI-Brent spread narrowing is better in 2013, after the Seaway ramps up to 400 thousand b/d, than in 2012. Consequently, we are changing our trading recommendation to be long September 2012 WTI futures as they approach expiry. We are maintaining our view that a tightening global crude oil market will force prices higher by rolling our long September 2012 WTI trade recommendation into a recommendation to be long the S&P GSCI Brent crude oil total return index, carrying forward the potential loss on the September 2012 WTI long futures position of 10.77%. In addition, we introduce a long June 2013 WTI-Brent spread trade recommendation, at an initial value of -$12.33/bbl.