LONDON After several years of neglect, oil investors are again betting heavily on the price difference between two global benchmarks - Brent and U.S. crude futures - due to a push in Washington to impose a controversial import tax.
At the start of this decade, the play on the spread between North Sea Brent and U.S. West Texas Intermediate (WTI) contracts futures earned traders and banks hundreds of millions of dollars, provided they played the high-stakes game right.
This trade, nicknamed the "widowmaker" for its high level of risk, fell out of favour about four years ago when the two contracts resumed moving in tandem, sharply reducing the spread volatility on which it depended.
Then OPEC's decision in November to cut crude output, hoping to reverse more than a year of steep price declines, revived investors' interest in oil generally.
Now the WTI/Brent trade is back in fashion on expectations that the spread will again become highly changeable due to the possibility that under President Donald Trump the United States will slap an effective 20 percent tax on imports, including oil.
Commodity traders and investors are betting that WTI will strongly outperform Brent, at least initially, provided the U.S. corporate tax reform includes the border adjustment tax.
The renewed interest in crude spread trading is visible in record open interest for both Brent and WTI, which describes the number of open positions for each derivative, with WTI challenging the dominance of Brent for the first time since 2015.
Many Republicans in Congress want a border tax to help revive domestic industry, though whether it ever sees the light of day remains uncertain.
House Speaker Paul Ryan backs the measure although some fellow Republicans have suggested it might struggle to get through the Senate. Trump has sent mixed signals but criticised the plan as too complicated, while opposition is growing among industries likely to be affected.
On top of this, lawyers say it would almost certainly break World Trade Organization rules.
Still, the uncertainty has had an electric effect on oil markets. Exchange data shows money managers have racked up a record of nearly 900 million barrels' worth of combined WTI and Brent futures and options, almost doubling their holdings in the last two months alone.
This build-up has been far more aggressive in the WTI market, where investors have doubled their holdings by nearly 225 million barrels, while in Brent, they have raised them by around 45 percent, or 137 million barrels.
Fund managers are putting their money on an initial rally in WTI versus Brent if the tax comes into force. The argument is that U.S. buyers would turn away from imported oil such as Brent in favour of domestic crudes exempt from the tax. Goldman Sachs, for instance, forecasts WTI would immediately appreciate by a quarter relative to Brent.
This would mark a contrast to the last few years, when swelling U.S. oil production from shale deposits has kept U.S. futures at a discount to the North Sea benchmark. WTI could even trade at a substantial premium over Brent.
Uncertainty over U.S. tax policy poses problems for the oil industry itself. Analysts at Goldman Sachs - one of the most active banks in physical commodity trading - advised crude producers last month to manage their price risk by selling long-dated Brent futures and consumers to buy WTI futures.
"We recommend shifting hedges to Brent as the basis risk is smaller than the policy risks ... In turn, consumers and refiners should consider hedging through WTI instead of Brent until the policy uncertainty is lifted," the bank said.
"Should the (tax) be implemented, we recommend that US producers aggressively take advantage of the 25-percent relative appreciation of WTI prices."
The analysts assigned only a 20 percent probability to the tax being implemented, noting that at the time of their Jan. 24 report futures prices implied only a 9 percent chance.
They also expected a rally in outright WTI prices would be short lived, as the initial jump would encourage U.S. producers to raise their output. Combined with the likelihood that OPEC members would resume their production growth, this would create a large oil surplus in 2018, they predicted.
MAKING WTI GREAT AGAIN?
Futures prices already show the expectations that Brent's premium over WTI will dwindle.
Front-month Brent futures LCOc1 are currently trading around $55.50 a barrel, about $3.00 above WTI CLc1. However, this premium all but disappears further along the futures curve for dates when the effects of any import tax might be felt.
The December 2018 WTI contract is at a discount of just 45 cents to Brent - compared with around $2 in early January - while the December 2019 contract CLZ9 is only 10 cents below its Brent counterpart LCOZ9.
Hedge fund manager Pierre Andurand believes a much bigger change of relative fortunes is possible. "If the tax is adopted, WTI could move to a $10-premium to Brent, providing a substantial economic advantage to U.S. producers," he told investors in a monthly newsletter.
He expects OPEC, which let prices dive in 2014-15 in the hope of putting higher-cost U.S. shale producers out of business, to show greater discipline having agreed the output cuts. "While we believe there is a 30 percent chance for the tax adjustment to go through, it also reinforces our belief that OPEC will do anything that is necessary to push oil prices higher as soon as possible," Andurand said.
The U.S. shale oil producers themselves aren't yet buying into the idea of an initial tax-driven WTI surge.
Stuart Staley, head of commodities trading at Citi, said last week that he had yet to see interest materialise among industrial clients for playing the WTI/Brent game.
A senior executive at a major trading house added that shale producers have been conspicuous by their absence from the hedging market in the past few weeks, precisely because of their reservations over the border tax.
"Basically shale firms don't know what to do. You would look stupid if you hedge and the WTI price rallies afterwards," he said.
(Additional reporting by Catherine Ngai in NEW YORK, Liz Hampton in HOUSTON, and Henning Gloystein in SINGAPORE; Editing by David Stamp)