(Bloomberg) -- It’s oil’s version of Godzilla versus Mothra.
The widest gap in three years between U.S. and global oil prices is shaping up as a battle between trading giants who see an opportunity to export millions of barrels at great profit and financial players betting pipeline bottlenecks will make Texas crude even cheaper.
West Texas Intermediate crude in Cushing, Oklahoma, the U.S. benchmark, sank to more than $11 a barrel below international marker Brent on Thursday, the biggest discount since March 2015. Further illustrating the congestion, WTI delivered in Midland, Texas, the heart of the prolific Permian Basin, is $20.50 a barrel cheaper than the same oil in Houston.
Hedge funds and other primarily financial traders are betting that pipeline shortages in the Permian will lead to an inland glut as soon as August, while oil majors and large trading houses are counting on record U.S. exports to narrow the gap, according to traders and brokers who asked not to be identified. The disconnect in sentiment is more stark than usual, and reflects the massive growth in U.S. crude supply, which has outpaced the development of pipelines to Gulf Coast refineries and export docks.
"Generally, there should be a fairly linear relationship between U.S. exports and the arbitrage," said Michael Tran, global energy strategist at RBC Capital Markets LLC. "But that relationship breaks down as the WTI discount widens to the point where the U.S. can export as much as needed by the broader market."
For now, price moves have favored the financial players. Even as U.S. exports touched a record 2.57 million barrels per day earlier this month and are averaging over 2 million barrels a day in the past six weeks, the spread between Texas and the world keeps widening.
With no major pipeline capacity set to come online until the second half of 2019, more bets are being placed to profit from a wider gap. On Thursday, 1,000 contracts of WTI-Brent put spreads traded for September. The buyer of the spread stands to profit if the gap widens past minus $12 a barrel, with the maximum gain at minus $16. Each contract is for 1,000 barrels.
"The widening appears to be driven by a combination of micro, macro and flow factors," Ed Morse, head of commodities research at Citigroup in New York said in a note to clients, in particular noting "thematic trades" in which investors bet that crudes outside the U.S. would outperform American crudes.
"The arbitrage will likely remain choppy and wide, but at current levels the global market is pulling as many barrels as it currently needs, suggesting that there is no shortage of physical crude at this point in time," RBC’s Tran said.
Contributing to the WTI-Brent selloff is the copious amounts of oil flowing from wells across the Permian, putting pressure on prices. Oil supply from the region is set to grow by 78,000 barrels a day in June to 3.3 million, according to the EIA. American output has already whizzed past OPEC-heavyweight Saudi Arabia and is closing in on Russia.
"You can expect U.S. output to rise," said Sandy Fielden, director of research and commodities for Morningstar Inc. in Austin, Texas. "And the more it rises, the more it would discount WTI."
In 2015, the last time the spread was this wide due to pipeline congestion, it held beyond $10 for almost a month before snapping back. A further increase in U.S. crude exports, which some analysts see hitting 3 million barrels a day, may offer relief. Further out, nearly 2 million barrels a day of new pipeline capacity will be added in West Texas starting in the second half of 2019, alleviating most of the bottlenecks.
Permian oil pipeline congestion could affect output as early as the start of 2019, according to the Federal Reserve Bank of Dallas. Long-dated oil would need to trade below $45 a barrel, about $9 below current levels, to slow production dramatically, according to Bloomberg New Energy Finance analyst Tai Liu.
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