London, 3 March 2011

Since December 2010, the front-month WTI/Brent spread has widened significantly. The spread hit a record of -$19.54/ bbl on 21 February 2011 when TransCanada announced that the second phase of the Keystone project had started to operate. The term structure for WTI has also weakened dramatically. The M1/M6 time spread also reached a recent record, of -$10.48/bbl, on 10 February 2011 (Figure 1).

James Zhang, Commodity Analyst with Standard Bank, believes the widening of both spreads have been driven by concerns over the containment risks at Cushing, the Nymex WTI futures contract delivery point. Since April 2010, the crude inventories at Cushing have been hitting seasonal highs. The latest DOE reports put the Cushing inventories at an all-time high of 38.6MB by 25 February. This is in contrast to the 46MB of storage capacity at Cushing as of September 2010, according to the DOE.

"While WTI continues to trade at a significant discount to Brent, the term structure of WTI has shifted significantly during the past two weeks. What is more important is that, given the current term structure, it no longs pays to store oil at Cushing. The structure has flattened to a level that is below the breakeven level of our storage model (Figure 2).

"With the shift in the term structure, the incentives to accumulate WTI inventories at Cushing for a contango play has disappeared. Consequently, we expect the pressure on Cushing storage to ease, which in turn is likely to lead to narrowing of the WTI/Brent spread. The main risk remains whether the strengthening of the WTI term structure was a temporary move driven by MENA turmoil or a structural shift driven by underlying changes in physical oil flows around Cushing," says Zhang.

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Commodities Now.