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Trading in the USA - When Price Does Not Matter: Exchange Trading, Differentials, and the Cash Roll

As crude oil exports have become an integral part of US/Canadian trading, the market has evolved to accommodate this profound transformation. But the mechanisms used to price many of the most significant export grades are obscure and little understood outside a small cadre of professional traders and marketers. This is particularly true for the most liquid grades that employ a trading approach known as “exchange trading” or “spread trading,” in which volumes at regional hubs are valued in buy-sell transactions against domestic sweet crude at Cushing. In this context, “exchange trading” does not mean trading on a regulated exchange. Instead, it means trading via an exchange of barrels between buyer and seller. In today's RBN blog, we delve into some of the most complex aspects of this trading mechanism.

As we discussed in Part 1 of this blog series, our mission is to pull back the curtain on physical crude trading in North America, explain how it works, what sets the price, and who is doing the deals. In that blog post we discussed how most physical crude oil barrels in North America move under term contracts with formula prices tied to CME/NYMEX domestic sweet and hub prices from price reporting publications, and how those publications derive their numbers from transactions in the physical spot trading markets.  The convoluted aspect comes in the way the individual trades in those spot markets are structured.

A few things to note before we delve into the details. First, the exchange-traded grades at market hubs we are talking about are those most closely tied to exports. As shown in Figure 1, these include crude oils traded at Midland, Houston, Corpus Christi and Beaumont, as well as grades other than NYMEX DSW (Domestic Sweet) traded at Cushing and, to a lesser extent, LLS (Light Louisiana Sweet) and Louisiana offshore oils. (More on that Louisiana quirk in a minute.) Second, a number of other North America crude oil grades trade at differentials to NYMEX DSW but instead of using the exchange-trading mechanism, they settle against the NYMEX calendar month average (CMA), a topic that we last covered in Future(s) Games. (We’ll get back to that also in a moment.) Third, exchange-traded markets are primarily voice-brokered, meaning that the buyer and seller are matched by a human broker who facilitates the trade, helps structure the pricing mechanism and provides third-party documentation to the trading partners.

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