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Risks and Drivers in Brent-WTI Spread Trades

Article Quant Q&A · Author: bill_080
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Summary

The document examines a proposed mean-reversion trade based on the price difference between Brent and West Texas Intermediate crude. It cautions that a wide spread need not close quickly, and that futures contract expiration and rolling can prevent a trader from capturing convergence. One response recommends considering liquid contracts farther along the curve. It also questions whether daily-price cointegration is enough to support a statistical arbitrage, since the mean-reverting process may be slow.

Other responses explain why the benchmark oils can differ in value: regional supply conditions can leave some refineries oversupplied, while crude quality and refining losses affect equilibrium prices. Supply concerns can also shift demand for one benchmark. The discussion therefore challenges the assumption that the spread must return to zero and emphasizes contract selection, roll effects, and underlying fundamentals. It offers qualitative cautions rather than a tested trading rule, quantified risk limits, or a demonstrated profitable strategy.

Key ideas

  • A Brent-WTI price gap may persist, so convergence timing is uncertain.
  • Futures expiry and rolling can erode a spread trade even if prices later converge.
  • Daily-price cointegration does not by itself establish a timely or tradable mean-reversion signal.
  • Regional supply imbalances and crude quality differences can support persistent price differences.
  • Contract maturity and liquidity are important considerations when structuring a spread position.

Tags

CommoditiesFuturesMean reversionRisk management
Full text
# Price of Brent versus West Texas Intermediate


# Price of Brent versus West Texas Intermediate












As of right now, the price of Brent Crude is $\$$111.59/bbl and the price of WTI Crude is $\$$98.36/bbl. I'm well aware that futures markets don't set the spot price for oil, but actual supply/demand does. And, that I don't have access to enough refinery/supplier data to figure out the supply/demand balance for WTI, or the supply/demand balance for Brent. However, common sense says this mismatch in price will eventually close.

Is anyone making any kind of bet on this situation? If so, could you share a general description of how you're controlling risk?

Edit (03/01/2011): For future reference, below is a graph of the spread:

## Answer by RockScience (score 5, accepted)

https://quant.stackexchange.com/a/621

If I were you I would be very cautious when playing this mean reversion. For several reasons.

1/ You never know when this spread is going to close, and the contracts on which you enter the trade may have expired. Then you would have rolled. In fact the arbitrage can close without any opportunity to capture it because of the roll yield. I advise you to play directly on the backend of the curve if you can find contracts that are liquid enough.

2/ The cointegration between daily close prices of WTI and Brent is strong but the mean reverting process may be very slow to move. I would not play this "statistical" arbitrage. High frequency ok, but with daily prices... is it really statistically meaningful?

This is the price of a basket which is long WTI and short brent for the same maturity. Do you see any mean reversion?

## Answer by Tangurena (score 2)

https://quant.stackexchange.com/a/642

There is a surplus of production between the Mexican Gulf and Canadian sources of crude. This makes refineries in the Midwestern US oversupplied driving the price of WIT down.

## Answer by glyphard (score 1)

https://quant.stackexchange.com/a/595

A significant portion of the price difference between different types of oil futures has to do with whether their sulfur content(heavy, light, sweet).

If supply and demand for each are in equilibrium they should not have the same price.

However, both brent and wti are light, but brent is not as light as wti (brent has more sulfur). More sulfur, means more loss in refining, which means that the equilibrium price of the heavier, brent, is higher than wti.

The fact that the prices are contango-ed suggests a demand imbalance in brent... perhaps produced by the fact that there are supply concerns(opec basket) stemming from the political crisis in libya. Libyan oil(opec basket) is not technically brent, but lack of supply there can contribute to a demand surge in brent.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.