$100 Oil: Brent Crude Versus WTI Crude Spread Issues (USO, BNO)

Oil is really trading above $100.00 now.  Brent Sea Crude April11 Futures on ICE were at $102.97 Thursday, while WTI Crude March11 futures went out at $86.45.  What is interesting is that there is a rather common spread here that investors have used for years.  This is the Nymex WTI Cushing to ICE Brent crude oil spread and it has only just started to come back in after widening out to what are historically unprecedented levels.   What is funny here is that there are now exchange traded products which follow each WTI Crude and Brent Sea Crude via United States Oil (NYSE: USO) and United States Brent Oil (NYSE: BNO).  Some may be considering these as a way to make a spread bet.  There are some serious caveats to consider before this.

First, you better understand why this is move is happening and why the old historic $1 to $3 nominal spread has widened out to as much as over $16 before coming in to -$13.56 as of Thursday evening as you can see on the Bloomberg chart screen-grab here.

The reasons are more than ‘just because of trading preferences’ and this may very well be very much of a permanent situation with historically wider spreads.  Will it remain a whopping $13 or $16?  Unlikely.  First off, there is a difference in the months as the Front-month ICE crude futures CO1 expire before Nymex CL1 so the same month contracts must be used in this calculation.  Here are just some of the larger issues you have to consider that could be secular trends:

• Global investors and international markets are seeking to get out of just being tied to the U.S. Dollar
• The Greenback is being printed into a lower-valued currency
• A dual policy of QE2 and tax cuts is not viewed positively by outsiders
• Brent Sea and Dubai oil markets are becoming the norm for where Middle Eastern producers want to sell
• The IMF has called on a “one-world reserve currency” to be ‘considered’ rather than just the U.S. Dollar
• Cushing, Oklahoma has severe supply surplus in oil
• Refineries have more supply than demand
• Egypt’s recent clashes and unrest in Africa and the Middle East are closer to the Brent and Dubai markets
• Saudi Arabia dropped WTI as its benchmark for pricing oil to U.S. customers long before this spread changed
• There is a common belief that Wall Street speculation is driving WTO too much
• International producers want more control of their products

The relative performance really broke apart in January as the BigCharts.com chart shows:

The Nymex WTI Cushing to ICE Brent crude oil spread is calculated by subtracting the Brent price from the WTI price. The contracts used are based on the current ICE Brent contract. In order to display the most recent prices available, Bloomberg includes pit prices, overnight trading, as well as trading after settlement.  The price fluctuations of the USO versus BNO exchange-traded products can be seen here in the chart starting in January.

The Brent exchange-traded product is run by United States Commodity Funds LLC and defined as follows: “The investment seeks to replicate, net of expenses, the daily changes in percentage terms of the spot price of Brent crude oil as measured by the changes in the price of the futures contract on Brent crude oil as traded on the ICE Futures Exchange that is the near month contract to expire. The portfolio will consist primarily of investments in futures contracts for crude oil, heating oil, gasoline, natural gas and other petroleum-based fuels that are traded on the ICE Futures Exchange, the NYMEX and other U.S. and foreign exchanges.”

The USO Oil exchange-traded product is run by United States Commodity Funds LLC and assets are nearly $2 billion on last look.  Its is defined as follows: “The investment seeks to reflect the performance, less expenses, of the spot price of West Texas Intermediate (WTI) light, sweet crude oil. The fund will invest in futures contracts for WTI light, sweet crude oil, other types of crude oil, heating oil, gasoline, natural gas and other petroleum based-fuels that are traded on exchanges. It may also invest in other oil interests such as cash-settled options on oil futures contracts, forward contracts for oil, and OTC transactions that are based on the price of oil.”

Here is something more that you must know.  The “BNO” holdings are listed as a mere $13.8 million in ICE Brent Crude Future CO APRIL-2011 and lists $13.53 million in cash.  This is a tiny exchange-traded product and it has a tiny average daily volume and has never hit even 100,000 shares in a day. There is also a share price differential.  The USO trades around $36.06 and the BNO trades at $68.61.

So, now you know that if you count an ETF as a derivative you are technically looking at a derivative of a derivative AND you are assuming the ‘thru time’ tracking risks associated with exchange traded products.  As we have always said about ETFs: KNOW WHAT YOU ARE INVESTING IN!!!! The descriptions and titles are never enough.

As you would expect… There’s an ETF for that!

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JON C. OGG