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THE latest turmoil in the Middle East has sparked a rally in oil prices, introducing daily changes and overall volatility we haven’t seen since 2008. It’s only in the last few years that oil trading became readily available to retail traders, allowing us to benefit from changes in price, if we get it right.
Oil prices are driven by both technical and fundamental factors. The difference between oil production and consumption is around 1 per cent – that’s it. Therefore any potential change to supply or demand has an immediate effect on price, especially when a country like Saudi Arabia – producing around 10 per cent of the world’s oil – suffers from internal unrest.
We have two main oil contracts traded on world exchanges. West Texas Intermediate (WTI) oil, sourced in the US for domestic consumption, and Brent crude, sourced in the North Sea and serving as the global benchmark for the physical trading of oil.
As a result, one strategy that can be employed is called the “WTI-Brent arb”. When trading is in business-as-usual mode the difference between the two contracts tends to remain roughly constant. That means it is possible for a diligent trader to identify when this equilibrium is broken and accordingly trade the two contracts in different directions until equilibrium is restored and extract a profit.
Another way, which may bear more risk, is to challenge this equilibrium based on fundamental events. The current turmoil in the Middle East may affect production and therefore could cause the Brent price to rise, but why would WTI rise with it when the latter is produced and consumed in the US? WTI might be expected to go up, yet should it rise at the same rate as Brent?
If you want to learn more, join us this Wednesday at 2.30pm for an hour-long online seminar on oil. Register on our website at www.intertrader.com
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