Arbitrage: WTI Crude Oil Vs. Brent Crude Oil

Includes: CRUD
by: Katchum

If you hadn't noticed, Brent and WTI crude oil were pretty correlated historically, but since 2011, something weird happened.

Brent crude oil started to move up, while WTI crude oil was flat (Chart 1). This is mainly caused by the increased oil supply in North Dakota due to the applied technique called "fracking." This increased oil supply drove down the WTI crude oil price, while Brent crude oil (tied to the Gulf Coast) has increased.

Chart 1: Brent VS. Crude

There are companies who are benefiting from this divergence due to cost advantages. This is especially true for those refiners located in the Midwest, for example, Marathon Petroleum Corp (NYSE:MPC). As this divergence continues, you could buy these refiners, as they use cheap WTI crude oil to refine it to high end products. With no major pipelines in sight, I expect this divergence to continue.

Chart 2: Marathon Petroleum Corp

Today, that divergence has gone to the stratosphere again, and I think it's an opportunity for investors to benefit from this divergence. Brent crude oil now costs $119/barrel, and WTI crude oil costs $96/barrel. That's a difference of $23/barrel, or $0.55 per gallon. That's possibly a 20% divergence you can bet on, based on today's oil prices. I expect that in time, several pipeline projects will start up to increase export capacity of this WTI crude oil. This will normalize the WTI crude oil price back to the Brent crude oil price. As we all know, the Brent crude oil price is tied globally, so I expect the WTI crude oil price to go higher rather than the Brent crude oil price to drop.

If you know that this divergence will normalize eventually, you can either buy WTI crude oil or sell Brent crude oil. This is the technique of arbitrage. As I'm positive WTI crude oil will go up in the future, I suggest buying WTI crude oil (NYSEARCA:CRUD).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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