Oil markets brace for turbulence of index shift
NEW YORK (Reuters) - Amid the drama of Iran, the meltdown of refiner Petroplus and a wave of upbeat economic data, it was all too easy to overlook one of the most important short-term factors shaping oil markets this week: the reweighting of the world's biggest commodity indexes.
The S&P GSCI Index .SPGSCI and the DJ-UBS Index .DJUBS, the world's no. 1 and no. 2 commodity indexes, announced two months ago plans to rejig their component weights to reflect growing trade in European benchmark Brent crude, at the expense of U.S. WTI, which some traders say had become detached from global prices.
The transition is now nigh: over the course of five days next week, pension funds and investors who have an estimated $180 billion (116 billion pounds) tracking those indexes will transfer their holdings from prompt futures contracts into later months. This month's "roll", as it's called, is particularly important because it will also adjust for the new target weights, hiking the indexes' exposure to Brent and cutting their WTI holdings.
In one of the biggest such re-weightings in years, funds will need to sell off more than $6 billion worth of U.S. crude futures and buy up more than $5.4 billion of Brent crude, analysts estimates, likely creating short-term tremors in the market.
Anticipation of the roll is already affecting prices, with the closely watched Brent/WTI spread expanding nearly $3 a barrel to near its widest point since mid-November, reflecting a bigger premium for European oil over landlocked U.S. crude.
"We think reweighting has an impact on pricing and widening the spread," said Sarah Emerson, president, Energy Security Analysis Inc. in Boston. "I don't think it will be a dramatic one, but the reweighting is a factor."
The index roll is just the latest factor to roil the Brent/WTI spread, which gapped to a record $28 a last year as a surge in U.S. onshore "tight oil" production and a reduction in both Libyan and North Sea supplies in Europe created an unprecedented distortion between the world's most-traded contracts.
After narrowing from record highs over $28 in October on expectations new pipelines would ease a crude glut in the U.S. Midwest, the spread widened this week from below $8 a barrel on Monday to $11 on Friday amid growing concerns about the threat of a cut off of Iranian supplies to Europe due to new sanctions against Tehran.
The reweighting toward Brent also marks another boost for the InterContinental Exchange, the primary exchange for trading the contract, in its ongoing competition with the New York Mercantile Exchange -- home to most of the trade of U.S. crude oil futures -- to be the premiere oil exchange in the world.
Graphics on the impact of the index shifts on oil markets:
BY THE NUMBERS
While the increased Brent weights were announced months ago, giving traders plenty of time to anticipate the switch, the shift of billions of dollars from one market to another is still likely to felt in the market, traders say.
The S&P GSCI Index, which said in November that about $100 billion in investments tracked it, will cut its holdings in WTI from 32.6 percent of its weighting to 30.25 percent, and beef up its Brent holdings from 15.9 percent to 17.35 percent.
The DJ-UBS Index, with around $80 billion in tracking funds as of mid-2011, said in October it would introduce Brent into its index for the first time, putting it at around 5 percent of its weighting, cutting WTI from 15 to 9.7 percent.
Based on current oil prices and estimates of the holdings of the S&P GSCI and the DJ-UBS indexes in 2010, the impending roll five-day period for the contacts could see 6.27 million barrels of WTI sold off -- valued at $6.37 billion at Friday's prices -- in addition to whatever would have been sold without the rebalancing. For Brent, 48.4 million barrels worth $5.45 billion will be purchased to achieve the target weightings.
That would mean selling nearly 12.6 million barrels of WTI and buying nearly 9.7 million barrels of Brent each day to reweight the indexes, a relatively small proportion of daily trade that came to an average of about 700 million barrels a day on the NYMEX and nearly 500 million barrels a day of ICE Brent.
In terms of open interest, the impact of the indexes is more dramatic.
Roughly 4.5 percent of the total 1.387 million contracts of NYMEX WTI held in open interest will be sold by the indexes next week to achieve the reweighting. The indexes will purchase about 5 percent of Brent open interest of 931,000 lots -- a sizeable shift over the course of a week.
The shifts will take effect during the traditional roll periods of the indexes, falling on January 9 to 13 this month. The indexes move 20 percent of their positions daily during that period.
For more details on the DJ-UBS Index and the roll period, see: r.reuters.com/mup85s
For more details on the S&P GCSI Index and the roll period, see: r.reuters.com/sup85s
Indexes such as the S&P GSCI Index and the DJ-UBS Index are popular with non-traditional commodity investors seeking access to the asset class. The indexes typically hold near-month contracts in a commodity, and then sell them off for later month contracts between the fifth and ninth business days of a month.
Brent's allure for these simple, long-only indexes lies in the structure of its forward curve. The contract's backwardated structure, where months further out are cheaper than the front month and point toward a near-term supply threat, offer profits during the roll period.
WTI, locked in the opposite structure -- known as contango and indicating ample supplies -- offers losses during the roll.
In addition, analysts point out that Brent -- considered to be the international benchmark for crude -- is a far more representative of global market conditions than WTI, which is heavily impacted by inventory levels in the U.S. Midwest.
"The obvious thing is that investors don't want to be in WTI unless they feel that the big $10 gap is going to close," said Adam Sieminski, chief energy economist at Deutsche Bank in Washington DC.
"The feeling in oil markets is that there are fewer problems associated with Brent, which is more responsive to geopolitical events and what's going on in the global markets."
Rising inventories at the delivery point of the New York Mercantile Exchange's oil futures contract in Cushing, Oklahoma, helped weaken WTI last year, while Brent was bolstered by the loss Libyan exports to Europe.
Those factors helped send Brent to a record premium of over $28 a barrel to WTI last year, but the spread has since weakened after companies announced pipeline plans to alleviate the glut of crude in the Midwest and as Libyan exports rebound.
The impending shifts in the index weightings are not the only factor fueling Brent's rise against WTI this week. In addition to Iranian threats to cut supplies due to new sanctions by the West, analysts noted support came from disruptions in flows from Nigeria, another important exporter to Europe.
Shutdowns in three European refineries owned by Petroplus due to a credit squeeze could, however, damp demand for crude feedstock in the region, analysts noted.
"There has been a knee-jerk reaction in Europe to Iran. These concerns about Iranian crude supply do not much affect U.S. crude supply," said Matt Smith of Summit Energy, in Louisville, Kentucky.
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