Historic OPEC+ Production Cut: WTI-BRENT Pair Trade Around The Corner?

On Sunday, OPEC and allies (known as OPEC+), announced that it has agreed to cut Oil production by 9.7 million barrels per day for May and June.

That said, it is expected that total global oil cuts will amount to more than 20 million barrel per day, equivalent to around 20% of global supply, effective May 1.

This production cut is by far the biggest ever, more than four times deeper than the previous record cut in 2008, and reductions in production will stay in place until April 2022.

But despite this record size production cut, oil prices didn't show any signs of a relief rally into the start of the week which is especially surprising after WTI ended Thursday nearly 10% lower for the day, while BRENT closed a little more than 4%.

The message sent by market participants seems clear: "This is not enough!" given the still difficult to estimate impact the Coronavirus and resulting economic shutdown around the globe will have and thus the demand for oil will not only naturally be lower in the time to come, but realizing the size of the oil oversupply there seems no real reason to see oil prices rising strongly from the region around 20 USD per Barrel.

"Buy the rumours, sell the facts"

In addition to this, we shouldn't forget the Tweet from US president Donald Trump on April 2, when he tweeted that he

"Just spoke to his friend MBS (Crown Prince) of Saudi Arabia, who spoke with President Putin of Russia, & I expect & hope that they will be cutting back approximately 10 Million Barrels, and maybe substantially more which, if it happens, will be GREAT for the oil & gas industry!"

While WTI shot higher that day within minutes and gained up to 35%, most of the above mentioned production was probably already priced in and thus the stabilisation in oil prices over the last week with the following drop on April 9 was a perfect example of "buy the rumours, sell the facts".

How to trade WTI Crude Oil and BRENT in this environment?

Besides a classic momentum trading approach which would place a Sell Stop Order below the current yearly lows around 19.00 and a stop at 29.00 USD, aiming for a drop mid-term to as low as 10 USD per Barrel and probably even lower, we'd like to present another trading idea here.

As presented in our Trading Spotlight webinar series in the webinar with the topic 'Market-neutral trading strategies explained', a potential pair trade setup is currently given in WTI and BRENT.

When looking at the current price development in Brent and WTI oil, we can spot a massive jump in the ratio of the two prices, going above 1.3.

The main reason for this development is certainly, roughly speaking, that BRENT oil is waterborne crude priced on an island in North Seas, 500 meters from water with access to ships while WTI is landlocked sitting behind thousands of miles of pipe.

Still, both assets are 'fungible' and we should usually expect the two prices to converge rather sooner than later with the ratio and a calculated EMA on the ratio (as discussed in the Trading Spotlight webinar) to cross back above its ratio.

Therefore, we would currently trade WTI Long and Short an equivalent amount of BRENT.

Nevertheless, current market conditions are not only very volatile but also very unfavorable for oil and especially WTI.

And since pair trades usually work without a Stop Loss and the divergence of the WTI and BRENT spread could continue to widen (resulting in a floating loss for a WTI Long – BRENT Short position), such a trading idea should be taken very cautiously and based on the individual risk appetite of each trader.

(Click on image to enlarge)

Source: Admiral Markets MT5 with MT5-SE Add-on WTI Daily chart (between January 7, 2019, to April 13, 2020). Accessed: 13 April 2020 at 10:15 AM GMT - Please note: Past performance is not a reliable indicator of future results, or future performance.

In 2015, the value of WTI fell by 31.1%, in 2016, it rose by 42.8%, in 2017, it increased by 11.5%, in 2018, it fell by 24.6%, in 2019, it increased by 33.3%, meaning that after five years, it was up by 13.6%.