An oil market stuck in a range of $70 to $80 a barrel might seem to limit trading opportunities, but spread traders are as busy as ever, betting on time and quality differentials. US data show the number of outright speculative positions in excess of those required to offset commercial hedges in the oil markets is now around half what it was in August 2008 and at the lowest since October 2007.
Analysts attribute the withdrawal of much of the capital by banks, funds and other multi-asset investors to the failure of crude oil to break out of the $10 range between $70 and $80 that has dominated for almost a year. But the relative stability of outright oil prices masks a fluid movement in the differentials between futures months, crude oil grades and other derivatives that dominate the books of the world's big commodity trading houses. Spread trading is booming, dealers say.
"There is so little flat price trading, people don't make money out of prices going up or down," said Christopher Bellew, a broker at Bache Commodities in London. "They make money on differentials, spreads, that type of thing."
In contrast to 2008, when US benchmark crude hit a record above $147 per barrel in July and fell below $35 by December, this year oil has averaged around $76 and two-thirds of front-month closing prices have been between $70 and $80.
"That's not where the trade is," said an oil dealer with a large American-owned trading house. "The volume is in spreads." Oil futures prices, in the view of many analysts, have been driven in the past year by correlations with equities and the dollar, rather than fundamentals of supply and demand.
This may have encouraged a shift to more spread trading from the flat price by industry participants, known as commercials. "Those players that are closer to the fundamentals, the commercial traders, I think they have been expressing their views on the market much more on the spreads than on the flat price," said Olivier Jakob, analyst at Petromatrix.
"It has been much more difficult, the fact that the flat price has been highly correlated to the dollar and the S&P, to trade the flat price based on the fundamentals."
One of the most popular spreads is the differential between the two front futures contracts for North Sea Brent, now October and November, a trade favoured by the dealer with the American-owned trading house. He cited the closure on July 26 of the Enbridge Inc oil pipeline between Ontario and Indiana, which has reduced Canadian consumption of US crude and encouraged Canadian purchases of North Sea Forties crude.
"We have been doing a bit of flat price trading but not much," the trader said. "It is a bit scary to do too much because it is driven by different forces."
Other spreads, such as the difference between the two main global crude benchmarks, US crude - also known as WTI - and Brent, are active.
"The real opportunity has been in trading Brent/WTI, which has been a lot more volatile," said a US-based futures trader. While US crude has in the past typically traded at a premium to the North Sea grade, this relationship has changed in recent years and Brent is now above the US marker because of reduced supply from the North Sea and Nigeria, and record high US oil inventories.
"I don't know how much further the Brent-WTI spread has to go. I would be expecting it to go the other way fairly soon," said Mike Wittner, analyst at Societe Generale.
Another popular spread is between the first two December futures contracts, now December 2010 and December 2011, known as "Dec-Dec Red" or just "Dec Red" - a trade dominated by the view of the economic outlook, forward demand, supply and stocks.
"Your view of the forward spreads depends on your view of stocks," said Wittner. "Analysts had forecast that there would already have been a seasonal drop in US inventories by this time but it hasn't happened." The Dec Red Brent spread hit its widest for 20 months this week at over $5.50 per barrel and last week the December 2011 contract saw its highest trading volume ever with the equivalent of over 16 million barrels of crude oil traded in one day.
"In terms of spread trading, we are having one of our busiest periods," said a crude trader with a European refiner.