A trading company has a term supply deal of one Aframax cargo per month of WTI Midland FOB Corpus Christi at a floating Argus WTI Houston-related (MEH) price. In April, the balance-of-the-year forward curves for WTI versus Brent and Dubai imply that the best netback value for the cargo is provided by the European market, into which he will eventually place the cargos on a dated-related basis. The trader decides to lock in the arb economics with a paper hedge for the next six months. For cargos loading June – December, he will:

The trading company is now long the WTI Midland strip at a $3.85 discount to the target European dated Brent market, which the trader believes will more than cover freight and loading costs. The futures will price out along with his supply deal and subsequent physical sales into the dated market.

The arb is open to deliver cargos of WTI Midland into Northwest Europe. With Gulf Coast refiners coming out of turnaround, a trader believes that the U.S. will not have sufficient supply to export at a high rate. He wants to express the point of view that the arb for July loading must close by using liquid paper instruments, and executes 100 contracts of the following instruments at the per barrel prices below:

On May 19, the trader sees the forward market has shifted, with WTI Houston differentials and WTI time spreads strengthening to close the arb. He wants to cover his position and lock in $.45 in profit.

A European refiner is looking to buy a 700K barrel cargo of WTI Midland at a WTI-related price for delivery into Europe. The WTI/Brent (CL/BZ) spread is trading at -$4.20

The refiner wishes to buy insurance against the crude oil purchase being too expensive relative to Brent-related product sales (WTI-Brent narrowing). 

Refiner buys 700 WTI-Brent Crude Oil Spread (BV) option calls with a strike of -$4.10, paying $.20 as insurance against the WTI/Brent spread narrowing.

At BV expiration:

• Scenario A: The WTI/Brent spread (CL/BZ)  is -$5.00 per barrel
  • The call option expires worthless since the spread is lower than the strike price
  • The refiner is able to lock in the price of his crude oil at $5.00 below Brent
  • The net purchase expense for crude oil is -$4.80 under Brent (-$5.00 net the $.20 call premium)
• Scenario B: The WTI/Brent spread (CL/BZ) is -$3.50 per barrel
  • Since the spread is .60 above the call strike price, the option pays out $.60 or $420,000
  • The refiner is able to buy a cargo of WTI-based crude at -$3.50 below Brent
  • The net purchase expense for crude oil is -$3.90 under Brent (-$3.50 CL/BZ less $.60 option payout plus $.20 option premium paid)

In this example, the refiner pays a premium to insure against the narrowing in the WTI-Brent spread. If the spread widens, the refiner buys the WTI-based crude oil at a wider discount to Brent, with the profit offsetting some of the premium. If the spread narrows, the option pays out, helping to offset the higher relative cost of crude oil.

The WTI-Brent Crude Oil cross month spread option (Exchange Code: BVX) provides a tool for managing the unique cross-month spread risk that arises from cargo transit time: loading or pricing a cargo in one month and selling it in a different month.    

In this example, a trader has a term purchase of a 700K barrel U.S. Gulf Coast cargo, paying a WTI-based price for the month of loading. Based on his assessment of freight and quality for the January cargo, he believes he will earn a higher return by selling the cargo into Europe off a February Brent price if the January WTI/February Brent spread is -$4.00 or wider. If the spread is narrower than -$4.00 he will resell the cargo locally off of a WTI price.    

To take advantage of his physical optionality on the cargo delivery, he decides to sell 700 January BVX puts with a -$4.00 strike . The trader collects the premium of $.75 or $525,000.   

At BVX expiration:  

• Scenario A:  January WTI/February Brent spread is -$5.00 per barrel
  • Since the spread is wider than -$4.00, the trader will sell the cargo into Europe and can lock in $1.00 of paper profit on the cargo or $700,000
  • Since the spread is $1.00 below the put strike price, the trader owes $1.00 or $700,000 on the option  
  • The trader keeps the $.75 or $525,000 in option premium
• Scenario B:  January WTI/February Brent spread  is -$3.75 per barrel
  • The option expires worthless
  • The trader sells the cargo into the domestic market
  • The trader keeps the $.75 or $525,000 in option premium  

The trader monetizes the optionality in the cargo by collecting a premium on the sale of the put. If the spread narrows beyond -$4.00, the option expires worthless and the trader keeps the premium. If the spread widens, the trader will owe money on his option but will offset the loss by physically buying crude off January WTI and delivering it to Europe for a February Brent-related sale

The hedging and trading opportunities for transatlantic crude oil trade are numerous. For more information about the products used above or other transatlantic arb products, please refer to the list below, or contact energy@cmegroup.com.