Another day, and another widening in the WTI-Brent front-month future spread — this time to what looks to be approaching record wides.
The spread hit as much as -9.50 on Monday and according to Bloomberg data the record for the differential stands at -10.67, as struck on February 12, 2009:
The ever astute Olivier Jakob at Petromatrix, though, has a refreshing new take on the matter.
Whereas WTI did until recently have a very strong correlation with the S&P 500, this is no longer the case. Brent’s correlation with the index, however, is seemingly increasing by the day — tying in with the additional financial flows that have come into the contract since the beginning of the year.
As Jakob observes:
The WTI correlation to the S&P is now also broken but Brent has not
given up a strong correlation to the S&P. It does feel as if some of the correlation trading models have been switched from WTI to Brent at the start of 2011, which would make sense on the basis of the lower rolling costs in Brent versus WTI.
So could it all be down to correlation-based high frequency trading models finding their way into the Brent market?
If that is the case, it’s interesting to note the volatility they may be bringing with them.
As Jakob points out, the margin required to trade the Brent-WTI spread is usually a fraction of the margin required to trade ‘flat price’ (the pure oil price). Nevertheless, since the beginning of the year, the intraday changes on Brent-WTI have been approaching those of crude’s outright price.
That being the case, he says:
The problem now is that with the current volatility in the Brent- WTI spread the margins are not covering anymore the risk in the spread and that will increase the risk that exchanges are forced to initiate an increase in the Brent-WTI trading margins.
On a 50 day history-horizon we calculate a Value-At-Risk (VAR) on the Brent-WTI of 0.89 $/bbl versus 2.10 $/bbl on flat price WTI . On a history horizon starting on the first of January, the VAR on Brent-WTI moves up to 1.38 $/bbl compared to 1.85 $/bbl for flat price, ie about the same Value-At- Risk on a Brent-WTI position than on a WTI flat price position.
In our opinion we are clearly in the middle of a market disruption that can not be sustained due to the changes that it would bring in physical flows but also in the reshaping of the risk and functioning of the futures market (cracks).
In other words, if this continues, margin hikes should be expected soon.
Related links:
Brent’s got its problems too – FT Alphaville
‘WTI about as useful as a chocolate oven-glove’ – FT Alphaville
An unjustified WTI distortion? – FT Alphaville
Oil shock 2.0, or, the benchmark wars - FT Alphaville