Brent-WTI crude spread could provide a trading opportunity

With the spread between Brent crude and WTI widening to three-year highs, could we be set for a reversion to mean?

Oil rig
Source: Bloomberg

Crude prices have been diverging over recent months as the shift in the dynamic of oil supply alters the price of one type of product over the next. With both Brent and WTI hitting three-year highs in recent months, there is an understandable difference in price between the two forms of oil, owing to the changing dynamic behind regional supply. The overabundance of WTI under the growing shale output within the US has ensured a lower rate of ascent compared with Brent, which is based on a light, sweet crude coming from North Sea oil fields. To a large extent there is little reason to believe the US is about to reverse the trend of growing output. However, with the US having lifted the ban on exporting crude abroad, there is reason to believe that the US will become the go-to source of oil in Asia, due to its more competitive price. With that in mind, it makes sense that this historically significant gap between these two main forms of crude will soon start to close once more.

Looking at the chart below, the rise in crude prices has certainly been more pronounced for Brent (grey) than WTI (green) in recent weeks. The spread (lower panel) between the two is now approaching $11; levels not seen in over three years. On that occasion, the gap between the two forms of crude provided a mere flash in the pan, with the spread only remaining above $10 for less than a week.

This makes for a potential reversal to mean situation, where we could see selling more heavily focused on Brent crude, while gains become more geared towards WTI. Perhaps this is the beginning of a new norm, yet if we see that spread fall back below $10, there is a strong chance we will start to see a shift back to norms of $2 to $3. With that in mind, if the spread between WTI and Brent falls back below $10, it would make sense to buy WTI and sell Brent.

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