In oil markets, a U-turn for the hottest trade in years

At USD 93 a barrel, US oil prices traded on Tuesday within a well-worn range. But that belies a radical move in energy markets this week the unravelling of one of the hottest and most volatile oil trades in years.

The trade-gone-haywire is known as the Brent-WTI spread bet, a wager on the relative value between the two most-traded oil futures in the world, London's Brent and US -traded West Texas Intermediate. While the light, sweet crudes are equally prized by refiners, Brent's premium to WTI grew steadily wider over the course of this year, moving from parity to a record USD 28 a barrel two weeks ago. The large divergence once seemed unthinkable, since barrels of oil are usually relatively cheap to transport between regions. In recent days, the spread has been collapsing as WTI prices rise and Brent falls. Since Friday, Brent's advantage has slipped from USD 22 a barrel to USD 18, and oil market insiders have been stunned by the recoil. Since billions ride on the spread, its recent narrowing means that investors caught wrong-footed -- those betting long Brent and short WTI -- have likely been bleeding cash. Traders and analysts speculated there could be a major money-loser among the hedge funds, investment banks and deep-pocketed trading houses, but none could be identified. "I'm sure a lot of the big energy funds got waylaid with this," said money manager John Stephenson at First Asset Management in Toronto, with USD 2.7 billion under management. "I have not heard of any specific funds having difficulty." Underscoring the move are tightening supplies of crude in the United States and the expectation of more oil shipments for Europe following the end of Libya's civil war. Few expect the gap between WTI and Brent to disappear completely until new U.S. pipelines -- such as TransCanada's controversial $7 billion Keystone XL project to pipe oil sands crude from Canada to Texas -- enter operation in 2013 or later. But the leading factor cited for the price distortion – a surplus of crude at WTI's landlocked delivery hub of Cushing, Oklahoma -- has been abating, despite few spare pipelines to carry oil away from Cushing. A fundamental difference Barclay's warned earlier this year that WTI prices were becoming unhinged from fundamentals, and the financial services company cautioned against the spread trade. But Citi analysts as recently as July forecast the spread could blow out to a whopping USD 40 sometime in the next year. A torrent of recent energy news and data now point to shifting oil market fundamentals, many of which support a more narrow spread: -- U.S. oil inventories have declined, and stood at 8 percent below levels from the same period of last year, according to the U.S. Energy Information Administration last week. -- The draws come amid fewer U.S. crude imports, which fell to a 10-month low of 7.9 million barrels a day last week. On the East Coast, where several refineries have recently shut, imports are near 20-year lows. -- A Midwest crude surplus is subsiding, at least temporarily, with stocks at Cushing, Oklahoma -- delivery point for WTI -- unexpectedly plunging by more than a quarter since hitting a 42 million barrel high this spring. Earlier, a brimming Cushing hub helped to feed the Brent-WTI spread divergence, since record supply levels there depressed the value of prompt WTI relative to barrels for later delivery. That encouraged even more storage. WTI's big discount has called into question its usefulness as a benchmark grade. This month, Colombia and Brazil moved to price more of their oil exports off of Brent. This week, however, the value of WTI for delivery in one month's time has shot higher than WTI's forward value for the first time in three years. Getting creative

Over recent months, US oil producers and traders have wised up to the trend. Since oil's value has eroded at Cushing and risen in relative terms elsewhere, a growing number of shippers are finding ways to circumvent the hub, using railroads, barges or trucks to ship elsewhere. Between 60,000 and 100,000 barrels a day are moving by rail between PADD 2, the Midwest, and PADD 3, the Gulf Coast, according to estimates from six logistics industry sources consulted by Reuters who requested anonymity. Lario Logistics is preparing to ship its first unit train -- filled with up to 70,000 barrels of oil -- from North Dakota to the Gulf Coast in the first week of November, a spokesman told Reuters. In St. James, Louisiana, logistics firm U.S. Development is expanding its crude-by-rail terminal to receive up to two unit trains a day as of December, said spokesman Bill Swann. The facility already takes up to one train a day, and will likely undergo another expansion after December, Swann said. A logistics expert who monitors U.S. crude storage levels and pipeline flows estimated that between 150,000 and 200,000 barrels per day of oil that would typically flow through pipelines to Cushing have recently been diverted elsewhere, including along Enbridge's massive Canada-to-U.S. pipe network. The expert asked not to be named, and Enbridge declined to discuss if any volumes were diverted from Cushing. Marathon has said it has been sending some Canadian crude on river barges from Illinois to Louisiana, where it owns a refinery. Oil traders say they have also been tracking additional volumes of crude moving by barge or, more rarely, in tanker trucks to avoid the Midwestern glut. The Midwest bottleneck is also abating as the region's refineries - benefiting from cheap Midwestern crude – run their plants at higher-than-typical rates. Analysts at Goldman Sachs, a hugely influential bank in commodity markets, have for weeks been predicting a tighter U.S. oil market. Since early October, they have been calling for the Brent-WTI spread to narrow to USD 16 a barrel within three months, and to USD 6.50 within a year, as rail and pipeline flows out of the Midwest, or PADD 2, continue to rise. Brent prices fell after the death of Libyan strongman Muammar Gaddafi last week, on expectations Libya will gradually restore prewar output -- near 1.6 million barrels a day -- which ground to a halt this year. Temporary outages at North Sea oilfields have subsided, including the UK's 200,000 Buzzard field. Those factors prompted speculators, such as hedge funds, to pile funds into WTI futures and options last week, increasing their net long positions by 9 percent. Out further on the horizon, a major new oil discovery by Norway's Statoil, announced this week, improves production volume prospects for the North Sea in the coming years. Statoil said the field -- which could contain between 1.7 billion and 3.3 billion barrels -- may eventually produce 800,000 bpd.