How to Spread Bet Light Crude: It’s Balls to the Wall with WTI and Brent Crude
If you’re looking for excitement, then trading on crude oil may be just the ticket. Light crude is one of the two main standards for oil, all other crude oil being priced in relation to one or other of the standards. It is more properly known as West Texas Intermediate (WTI) Light Sweet Oil, the Sweet referring to the fact that it has less sulphur than the other oil, Brent Crude. Experts in oil can actually taste and smell the difference.
On the futures market, oil is usually traded in lots of 1000 barrels, which corresponds to 42,000 US gallons, and prices are quoted in US dollars and cents, for example 10022 – 10026, which corresponds to an actual buying price of $100.26 per barrel. In this case, a point for spread betting purposes is the same as a cent change in price.
There are many influences on the price of crude oil, some of them are predictable or expected, and others come out of the blue. For example, every Wednesday the US issues details of inventory levels, that is how much crude oil is on hand, and this can move the market. Generally if the amount of oil is less than the previous week, it indicates a looming shortage in supply and you can expect the price to go up; the opposite is the case, in that if there’s a glut of oil you can reasonably assume the price should go down.
This does not always work. There are other influences on the price of oil, such as the stock of refined oil, or gasoline (petrol) that the US is carrying. There is a governmental emergency reserve of oil, and if the US decides to take action to release some, that too will impact the prices.
In addition to that information, about half of the world supply of oil comes from OPEC countries. The Organization of Petroleum Exporting Countries (OPEC) is a Middle East cartel that was formed to manipulate the supplies for price protection when the US imposed an embargo more than 50 years ago. To protect their income, there is open and declared manipulation that may happen at any time.
All this is to say nothing of natural hazards and causes of oil price fluctuations, such as hurricanes hitting the Gulf of Mexico where the US has many refineries; harsh winter conditions that increase oil consumption; hot summers that increase oil consumption for electricity production and summer driving; and the list goes on.
Oil pricing is very temperamental, and thus ideally suited as a basis for trading profits, provided that you keep ahead of the news and protect your capital. In the long run, you can be sure that the price of oil will rise, as, despite finding new reserves and ways of extracting oil, such as the oil sands, there is only a limited amount of oil in the world. However, crude oil can go down rapidly as well as up. If you are prepared to stay on top of the situation, then there are great possibilities for profit.
The oil price rapid descent since August 2014 would best be described as ‘dramatic’. To listen to some analysts you would think this is unheard of and that oil prices will remain low for ever. However, this line of thought goes against both history and logic. It is not if oil prices will ever recover but when they will.
Why is the oil price dropping?
Between the years 2011 and 2014, the global oil market remained stable. There was increased demand from China, the USA dollar was range trading versus the euro, and the Arab Spring ensured that there was an oil risk premium due to serious operational uncertainties in countries like Iran, Iraq Kurdistan, Libya, Sudan, Yemen and Syria. However around mid-2014, the light sweet crude oil glut (due to technological innovations in fracking/drilling leading to the USA shale oil inventory) started having its impact in global markets which led to a sharp decrease in the oil price.
When the oil price collapsed, Saudi Arabia didn’t reduce supply to support global prices. Meanwhile, the USA dollar rose by more than 20% against the eur since mid-2014 while there was lower than expected demand from China and a difficult market in emerging markets currencies, in particular the Russia rouble, the Brazilian real and the Turkish lira.
What does the USA shale oil revolution mean for oil prices? In the short to medium term, oil prices are likely to remain under pressure as hundreds of private producers in the USA and Canada are heavily indebted and will keep producing as long as oil prices remain above their marginal cost of production which can be as low as $20 a barrel in areas like North Dakota’s Bakken and Texas’s Permian Basin shale acreages. The low oil price will also mean that the inefficient producers will be squeezed out or forced into mergers. Only the biggest, lowest-cost shale producers with economies of scale will survive.
The big traditional oil companies Exxon, ENI, Chevron, Shell, BP, Total aren’t exposed to the shale story in any meaningful way and may decide to acquire the bigger, independent shale oil producers. At the same time high-cost drilling projects will be frozen worldwide. This means that projects in the Russian Arctic, offshore West Africa and offshore Brazil will all be brought to a halt in a low price oil environment. USA share oil supply is likely to slow down in 2015 as the sharp fall in USA rig count is already hinting, however global oil prices are likely to remain under pressure even if the USA only increased production by 0.5 million barrels a day. This together with the booming oil supply output in Iraq is likely to dominate the marketplace for the years 2015 to 2017.
So why is the oil price dropping?
There are actually several key factors at play behind the falling price of crude. Independently, they all have a negative impact on the price, but it’s their combined effect that’s so significant. Here are the four main reasons:
1.) The US Oil Boom
Exploding US oil production has transformed one of the world’s leading oil consumers into one of its leading producers as well. Innovative new drilling techniques (such as fracking) have unlocked huge deposits of oil and natural gas trapped in shale rock. US production now rivals oil giants Saudi Arabia and Russia. North Dakota alone produces a million barrels of oil per day.
2.) Reducing demand
Slow economic growth and currency depreciation has left demand for oil across Asia much weaker than expected. To make matters worse Governments are cutting fuel subsidies which is driving up the cost of gasoline (despite the drop in oil price) further reducing consumption. It’s not just Asia though. Austerity measures and slow growth in Europe have dampened demand too.
3.) Libya is back online
Civil unrest in Libya saw many of its oilfields blocked by rebel forces and, naturally, production fell. The situation has now improved, and many of these are
coming back on line. In fact, Libya seems to have sorted out the disruption much quicker than anticipated and its output is already beating analysts’ expectations.
4.) The strong Dollar
Commodity prices, including oil, are bought and sold in US Dollars. When the Dollar gets stronger it makes oil more expensive to buy in countries outside the US. That, in turn, weakens global demand and puts extra downward pressure on prices. The Dollar has been strengthening for the last six months, recently reaching five year highs, which certainly hasn’t helped the price of oil.
What challenges do the frackers face in the midst of a drop in oil prices? The drop in oil prices is highly problematic for oil frackers. Unlike conventional oil projects (those in Saudi Arabia and Iraq and all), shale wells lifespan is quite short. In the Bakken rock formation straddling parts of Montana, North Dakota, Saskatchewan and Manitoba, a well that might start out producing 1,000 barrels a day might fall to just 280 barrels by the start of the second year. By the start of the third year, the remaining reserves of that well would be less than half and annual production would be very marginal. As such fracking producers need to keep drilling many new wells to generate stable or rising revenues since existing wells’ reserves will runout rapidly. Because of this intense pressure to keep drilling, frackers are forced to keep raising new money by selling shares, taking out new bank loans and selling junk bonds. Many of these companies are already operating under heavy debts and its very uncertain whether banks and investors will keep injecting new money at present oil prices. The average ‘all-in’ breakeven cost for USA hydraulic shale is thought to be $65 per barrel so with the present price at $48 (and falling) the industry is under a lot of pressure.
How should you play the oil crash?
The main themes are:
- Saudi keeps pumping because it knows it will leave oil in the ground. Don’t think that is possible? Well the UK is leaving 200 years’ worth of coal resource in the ground. The Kingdom itself is starting to build out solar.
- Iran, Iraq will do the same, and their all in costs are not much more than Saudi Arabia.
- Hedges begin to run out in 2016, and unwind through 2017. This will reduce some marginal supplies.
- Expensive oil will be mothballed (Athabasca for example) and deep water developments will be curtailed.
- Cost will come down, but after a couple of years reverse up somewhat as capacity in the oil field services sector is retired or written off. On the other hand initiatives like Statoil’s, which questions the ethos of bespoke engineering solutions for each field could really make a difference.
- . China has finished its big build out and India shows insufficient sign of picking up the baton. Even if it does it would not build out as quickly as China.
I have no direct oil position at the moment as I think we rest here a moment. In the UK markets there have been plenty of casualties from the falling price of crude. As you might expect, the energy sector has been hit hardest. BP, Royal Dutch Shell and BG Group have all seen their shares tumble over the last six months. However, certain companies have struggled more than others.
Some investors may be out to grab themselves a bargain now that oil stocks are looking relatively cheap. However, to be successful with this approach they’d need to be confident that oil prices have finished falling. Trying to call the bottom of a downtrend is never easy. But when it comes to the oil, it’s especially difficult because there are so many global variables affecting the price.
The strong downwards momentum of oil doesn’t show any signs of slowing just yet. In fact, The International Energy Agency (IEA) predicts oil prices are likely to continue falling well into 2015. The IEA, a consultant to 29 major oil importing countries, has described this as, ‘a new chapter in the history of oil markets.’ It also said, ‘Barring any new supply problems, downward price pressures could build further in the first half of 2015.’
It appears that the fundamental factors pushing oil lower are unlikely to change anytime soon. Supply should remain high. Certainly the US and OPEC seem in no hurry to cut back on production. If tensions settle in the Middle East then even more oil could come onto the market. Demand is unlikely to suddenly jump either, given the uncertain economic outlook in both Asia and Europe.
Light Crude Spread Betting
The crude oil market can be profitable, because it has large price moves and great volatility. The current price for US Light Crude is 10,039.5 – 10,043.5. This is a price of a barrel of crude oil, in US cents, the standard for oil futures contracts. If you think the price of oil will be going up, you might place a buy bet for £5.50 per point.
Suppose that the price does increase, and it goes up to 10,112 – 10,116. This is a typical variation that you may see in one day. You close your bet and work out your profit.
- Your buy bet opened at 10,043.5
- Your bet closed at the selling price of 10,112
- The number of points you gained is 10,112-10,043.5
- So the number of points you won is 68.5
- Your stake was £5.50 per point
- Your total winnings are £376.75
The oil market is very volatile, so some of the time you will be figuring out your losses. Say the price went down to 10,024.2 – 10,028.2 on this bet, and you decided to close it to prevent further loss.
- Your buy bet opened at 10,043.5
- Your bet closed at the selling price of 10,024.2
- The number of points you lost is 10,043.5-10,024.2
- So the total number of points that you lost is 19.3
- Your stake was £5.50 per point
- Which means you lost £106.15
Now that price was for the rolling daily bet, on which interest is charged every day as the bet is rolled over. It is only a small charge, but if you’re taking the longer view on your bet, thinking that you will hold onto it for several weeks, it can work out cheaper taking a futures based bet. There will be a larger spread between the buying and selling prices, but no ongoing charge.
The current price for a bet two months away is 10,046.0 – 10,052.0. This has a larger spread of six points, and is also at a higher level than the daily rolling bet, which indicates that the general feeling is that the price will be going up.
Suppose over the next few weeks you think that the price of light crude will go down, and place a sell bet at £2.50 per point. In time, the price drops to 9807.0 – 9813.0, and you decide to close your bet while it is winning. Here’s how you figure out your profit.
- Your sell bet opened at the selling price of 10,046.0
- Your bet closed at the buying price of 9813.0
- The number of points you gained is 10,046.0-9813.0
- Total number of points you gained is 233
- Your stake was £2.50 per point
- So your winnings are £582.50
If you happened to choose the wrong direction this time, and the price of light crude went up to 10,068.5 – 10,074.5, you could work out your losses like this.
- Your bet opened at 10,046.0, and closed at 10,074.5
- The number of points you lost is 28.5
- At your given stake, this works out to £71.25
‘What the narrowing of the spread does tell us is that, finally, after years, WTI is perhaps moving closer to being aligned with the world market and with other US crude grades, a move that was long warranted, with all those perceptions surrounding Cushing ultimately proving to be a red herring.’
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