Citi Sees WTI-Brent Spread Blowing Out To $40

Citigroup C released a report last week that suggested that the already massive premium in Brent crude versus West-Texas Intermediate (WTI) crude oil could blow out to as much as $40 or more. During Monday's trading session, the spread between the two crude benchmarks is trading at an all-time record of $22.14, with the spread nearly doubling in just the last two weeks. Should the price discrepancy between Brent and WTI continue to rise, it will likely cause tremendous volatility in the commodities markets as big players betting against a convergence in the spread would likely get wiped out and may have to raise cash by liquidating positions in other commodities. The one thing that is for sure right now is that traders putting on bullish or bearish positions in the Brent-WTI spread are playing a dangerous game given the volatility inherent in the trade. Readers may recall that just last month the spread collapsed from $20 to $14 in a couple of days. Prior to that, the spread collapsed overnight back in January - undoubtedly blowing up some large trading desks in the process. The reason that Brent crude is trading at a record premium to WTI is because of the continued explosion of crude production in landlocked portions of Western Canada and the U.S. Midcontinent. Even though market participants have been doing everything they can to ship the oil out of these producing areas, it hasn't been enough. As a result, there has been a glut of crude oil in large parts of the United States. Alternatively, across the ocean, the Brent crude market has been consistently tight. This is the result of declining North Sea production and disruptions emanating from Libya, which is embroiled in civil war. According to Citigroup, "At some point between now and summer 2012, market dynamics are being set up for perhaps a doubling of the recent spread to $40/bbl or even wider, combined with a shutting in of production both in Western Canada and the US midcontinent due to the continued explosion of production of crude oil in these regions and the inadequacy of physical evacuation to other markets whether by pipeline, truck, rail or barge." The bank does not see the Brent premium as being a permanent phenomenon, however, which is in opposition to the current conventional wisdom that suggests Brent will continue to trade at a healthy premium (although not $40). The Citi report suggests that Brent-WTI spreads will remain volatile before blowing out to +$40, followed by "eventual convergence of WTI and Brent, perhaps by 2013, at which point WTI should regain some of its lost status as an appropriate global benchmark of crude oil price, at which point Brent should lose considerable luster as a reliable benchmark." ACTION ITEMS:

Bullish:
Traders who believe that the current record Brent-WTI spread will continue to widen might want to consider going long Brent futures which trade on ICE, while at the same time shorting NYMEX WTI Crude futures. Be aware, however, that this is a ridiculously risky trade. Be prepared to make, or lose, a lot of money.

Bearish:
Traders who believe that this spread is going to collapse just like it has on multiple occasions in the past when it got this wide, should short Brent futures while going long NYMEX WTI futures. Neither Benzinga nor its staff recommend that you buy, sell, or hold any security. We do not offer investment advice, personalized or otherwise. Benzinga recommends that you conduct your own due diligence and consult a certified financial professional for personalized advice about your financial situation.