Barclays' notes tied to Brent appear well priced; risk lies with volatility, WTI-Brent spread

By Emma Trincal

New York, Nov. 14 - Barclays Bank plc's 0% leveraged contingent barrier enhanced notes due Nov. 27, 2013 linked to Brent crude futures contract appeared well priced for investors seeking energy and oil exposure, but the volatility associated with oil prices and with Brent futures in particular should be carefully examined, sources said.

Among one of the risks is the spread of Brent crude oil futures over the West Texas Intermediate (WTI), also known as Texas light sweet, another well-known crude oil benchmark, sources said.

The payout at maturity will be par plus triple any gain in the price of Brent crude oil, up to a maximum return of at least 28.5%, according to a 424B2 filing with the Securities and Exchange Commission.

The exact cap will be set at pricing.

Investors will receive par if the price falls by up to 20% and will be fully exposed to losses if the price falls below the 80% barrier level.

Volatility eyed

"If it were S&P-linked, these would be extremely attractive terms. But this is on Brent, which is a different story, a non-equity asset that's much more volatile," a market participant said.

Tom May, partner at Catley Lakeman Securities, said that the structure was straightforward.

"This is just another way of going long oil. It doesn't strike me as massively innovative," he said.

Pricing, he added, was based on the one-year forward.

"Not sure where the forward is right now, so I can't say if it's a good trade. But if oil is high, it's a bad investment, isn't it?"

Brent oil prices rose more than 1% on Wednesday, nearing $110 a barrel after an Israeli strike killed a Hamas leader in the Middle-East.

"If I had the choice I would go for more protection and a lower return," May said.

Brent, WTI spreads a factor

Another important risk factor to consider is the difference between the front month Brent and WTI futures contracts, the market participant said.

"You would have to carefully look at the premium of Brent crude over other benchmarks, in particular the WTI, because this spread is going to have an impact," the market participant said.

"I'm sure the spread is another source of volatility for the Brent benchmark.

"An 80% barrier, European monitoring and a 28.5% cap, on the surface it looks good. But this trade is not just based on Brent. If you see the Brent WTI spread narrowing, it wouldn't take much to breach the downside significantly. Obviously, the economics are there for a reason," he said.

As of Wednesday, the Brent WTI spread is at approximately 20%.

WTI contacts for December trade at $86.30.

"Wow, I didn't know there was such a big spread. I may buy WTI and sell Brent," a commodities trader said.

The spread between Brent and WTI futures is at one of its highest level so far this year, according to the U.S. Energy Information Administration.

Possible arbitrages between the two benchmarks may create downward pressures on Brent, said Matthew Bradbard, vice-president of managed futures and alternatives at RCM Asset Management.

Bradbard said that he is long WTI, targeting a $90 to $92 price before moving out of his position.

"Brent is trading at a big premium over WTI, and it's been like that for years," he said.

The spread between Brent and WTI prices is indicative of the significant transportation costs of moving additional barrels of crude oil from Cushing, Okla., to the U.S. Gulf coast and recent lower supply from Brent crude oil streams, according to the U.S. Energy Information Administration.

"The spread could narrow if people began to think that Brent is too expensive. In that case, Brent could be coming lower," said Bradbard.

"If the spread narrowed to the point of disappearing and if it was mostly due to a drop in Brent futures prices, a 20% decrease in Brent would just come close to the 20% downside threshold.

"Do I think it's feasible for Brent to move 20%? Yes. You could get a good decline from a narrowing of the spread. But I can also see that all across the board, commodities and equities. A lot of it has to do with the fiscal cliff because we don't have a solution. Look at stocks today," he said.

U.S. stock prices dropped Wednesday, with the S&P 500 down 1.4% for the day to 1,355.50, its lowest level in five months.

"My bottom line is that I wouldn't trade on a one-year term. You may have a 28.5% cap, but you are exposed to full losses on the downside while your upside is limited. I usually don't like that type of payoff," said Bradbard.

Barclays is the agent. JPMorgan Chase Bank, NA and J.P. Morgan Securities LLC are placement agents.

The notes will price on Nov. 16 and settle on Nov. 21.

The Cusip number is 06741TKP1.

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