It is well documented that the United States is expected to become the world’s largest oil producer by 2020. That fact and the increased outflows from the storage hub at Cushing, Okla. have helped bring West Texas Intermediate crude (WTI) back near its traditional place as the world’s benchmark. WTI traded within a dollar of North Sea Brent in July, and many observers expect WTI to again trade at a premium to Brent in the near future.
This added strength to WTI has increased the preference for the contract among market participants. We’ve seen a flow of volume out of Brent to WTI as outflows at Cushing have picked up and the spread – which reached $23 a year ago – has narrowed. The near-term favorability toward WTI can also be seen in the 12-month forward curve for the WTI-Brent spread, which is moving to steep backwardation. In February, the front month of the spread was at .82, with the forward curve showing $11.38 backwardation within nine months. Put another way, the closer a WTI contract gets to expiring, the more valuable it becomes.
But if expanded oil production and outputs have been one of the stories of the year in markets, then the competitive pace of electronic trading might be one of the few things that have attracted even more interest. The electronification of markets has found its way to every futures market asset class. But some markets – like interest rates and equities – have traditionally attracted more electronic trading when it comes to trading options. With enhancements in trading technology now available to futures traders, more are now trading crude oil options electronically. In fact, electronic trading in WTI in August was more than 50 percent for the first time ever. Just 32 percent of WTI options were traded electronically in 2012.
The growth in trading WTI options electronically can be attributed to a few things. More trades that might previously have been executed on the trading floor or through a voice broker are now moving to the screen. One of the reasons for this is the increased activity in Request for Quotes (RFQ), the mechanism that allows market participants to execute spread trades on Globex, CME Group’s electronic trading platform. RFQs now account for 13 percent of WTI options volume on Globex.
By seeing the flexibility to make more complex trades electronically, market participants are also saving on transaction costs they might have previously paid to a broker. And, there is simply more liquidity in the WTI options market now. Some of those firms accustomed to trading interest rates and equities electronically have opened energy trading desks, and developed a business trading WTI options.
The technological capabilities of electronic markets have changed. More complex trades are available to more people at a lower cost. And the timing couldn’t be better for WTI crude oil. What we saw in August, and what we’re likely to continue to see, is the marriage between infrastructure changes that have made WTI a more valuable contract, and the adoption of trading strategies that take full advantage of the benefits of electronic markets.