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WESTERN CANADIAN SELECT CRUDE OIL - TRADING STRATEGIES
Producer hedging the production of heavy crude oil
An oil producer sells its future production of heavy crude oil to a customer at an agreed-upon
price today. The producer seeks to lock-in this price to protect against an adverse price
movement between the time the price is agreed upon (today) and the time that the heavy crude
oil will be produced and delivered in three weeks. The price of one barrel of heavy crude oil
(specifically, Western Canadian Select “WCS”) is quoted in the market at a price of 10$US below
the price of West Texas Intermediate (WTI).
Since Canadian crude oil is priced at a differential to WTI the producer is exposed to the risk of
large fluctuations in the price differential between heavy crude oil and light crude oil. Specifically,
if the price differential widens the producer’s profitability and cash flow will be adversely impacted.
Hence, the producer is looking to lock-in the price differential between WCS heavy crude oil and
WTI light crude oil to hedge the production of heavy crude oil.
The producer has two alternatives to choose from to hedge the production of heavy crude oil:
1. Use WTI Light crude oil futures as a proxy to hedge the production of Canadian Heavy
crude oil, or
2. Use WTI Light crude oil futures and Canadian Heavy crude oil Differential Futures.
BACKDROP SCENARIO
Today in 3 weeks
WTI FUTURES 50$US 46$US
WCS WTI DIFFERENTIAL
PRICE
(NGX WCS WTI Index
represents the price
differential between WCS
and WTI)
-10$US
Note: WCS is priced at
10$US per barrel lower
relative to WTI.
-16$US
Note: WCS is priced at
16$US per barrel lower
relative to WTI.
WCS (implied price of one
barrel)
40$US 30$US
STRATEGY
The producer has two alternatives to hedge the production of WCS heavy crude oil :
ALTERNATIVE I
The producer sells WTI futures (“dirty hedge”) :
Action Today In 3 weeks Remarks
Producer sells NYMEX
WTI futures
Sell NYMEX WTI
futures @ 50$US
Buy NYMEX WTI
futures @ 46$US
Producer closes out the
position in WTI futures.

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Note: there is no delivery
of WTI crude oil as the
position is closed prior to
the expiration of the WTI
futures contract.
Profit = +4$US
Price of one barrel
of WCS
(producer’s inventory of
heavy crude oil)
60$US 50$US Loss as a result of the
price drop of one barrel of
WCS heavy crude oil.
Loss = -10$US
Net Profit / Loss Net Loss = -6$US per barrel
Producer hedging of WCS heavy crude oil using only WTI futures results in a loss of 6$US per barrel. The loss is
explained by the fact that WTI futures does not account for the basis risk between heavy crude oil (WCS) and light crude
oil (WTI). Therefore, the producer is faced with an additional risk that is not covered by using only WTI futures.
The basis (price differential between WTI and WCS) has widened from 10$US to 16$US. If the price differential
widens further and the producer does not hedge this risk, the producer will incur an even larger loss - adversely
impacting profitability.
Therefore, to hedge the basis risk (price differential), a producer must sell WCS DIFF futures as well.
ALTERNATIVE II
The producer sells WTI futures and sells WCS DIFF futures :
Action Today in 3 weeks Remarks
Producer sells NYMEX
WTI futures
Sell NYMEX WTI
futures @ 50$US
Buy NYMEX WTI
futures @ 46$US
Producer closes out the
position in WTI futures.
Note: there is no delivery
of WTI crude oil as the
position is closed prior to
the expiration of the WTI
futures contract.
Profit = +4$US
Price of one barrel
of WCS
(producer’s inventory of
heavy crude oil resulting
from future production)
60$US 50$US Loss as a result of the
price drop of one barrel of
WCS heavy crude oil.
Loss = -10$US
Producer sells WCS DIFF
futures @-10$US (price based
on the NGX WCS WTI Index)
Note: the NGX WCS WTI
Index is the underlying index
Sell WCH DIFF futures
@ -10$US
Buy WCH DIFF futures
@ -16$US
Producer closes out the
position in WCS DIFF
futures.
Note: The producer sells
WCS DIFF futures to
hedge the basis risk

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of the WCS DIFF futures
contract
between heavy crude oil
(WCS) and light crude oil
(WTI).
Profit = +6$US
Net Profit / Loss Net Profit / Loss = 0$
(resulting in a fully hedged
position)
Therefore, the producer’s strategy to sell WTI futures (to hedge the price of one barrel of WCS) combined with the
sale of WCS DIFF futures contract to hedge the basis risk (specifically, to hedge against a widening of the price
differential between one barrel of WTI and one barrel of WCS) results in a fully hedged position.
Had the producer not used the WCS DIFF futures contract, he would have suffered a loss of 6$US per barrel. The
producer can hedge the basis risk using WCS DIFF futures contracts.
In this scenario, regardless whether the price of WTI or WCS rises or drops, the producer’s motivation for initiating
the transaction is to hedge against the risk of a widening of the price differential between WTI and WCS.
Financial Impact of the price differential between Light and Heavy crude oil for producers and refiners
Source: Petro Canada
Note: In general, a widening of the price differential leads to poorer profitability for Canadian
heavy oil producers and a narrowing of the differential leads to poorer profitability for oil
refiners. Therefore, both producers and end users have a price risk to manage that would
be mitigated using the Canadian heavy crude oil differential futures contract.

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Refiner hedging a narrowing price differential between heavy crude oil and
light crude oil
A refiner’s processing margins are gradually being squeezed as a warm winter has sharply
reduced the demand for heating oil. The refiner expects margins to shrink further from current
levels as OPEC and Canadian producers cut output of heavy crude oil, as global demand slows -
tightening supply and narrowing the price discount of heavy crude oil relative to light crude oil.
Refiners buy crude oil as the raw material for their operations to produce and sell refined products
– typically, heating oil and gasoline. Hence, refiners make money from the differential between
different grades of crude oil (light and heavy) and prices of refined products, not the price of crude
oil and gasoline alone.
Since Canadian crude oil is priced at a differential to WTI the refiner is exposed to the risk of
large fluctuations in the price differential between heavy crude oil and light crude oil. Specifically,
a narrowing price differential between heavy crude oil and light crude oil implies that it costs the
refiner more to produce heating oil by refining heavy crude oil – thereby, cutting into profitability.
Consequently, the refiner seeks to lock-in the price differential between heavy crude oil and light
crude oil to hedge against the risk that the price differential will narrow between the time the price
is agreed upon with the producer and the time that the heavy crude oil will be delivered in four
weeks. To hedge the risk against further erosion in processing margins, the refiner decides to
adopt a strategy using Canadian Heavy crude oil Differential Futures (WCH DIFF futures listed on
the Montréal Exchange).
BACKDROP SCENARIO
Today in 4 weeks
WTI FUTURES 52$US 42$US
WCS WTI DIFFERENTIAL
PRICE
(NGX WCS WTI Index
represents the price
differential between WCS
and WTI)
-12$US
Note: WCS is priced at
12$US per barrel lower
relative to WTI.
-5$US
Note: WCS is priced at
5$US per barrel lower
relative to WTI.
WCS (implied price of one
barrel)
40$US 37$US
STRATEGY
The refiner buys WTI futures and buys WCS DIFF futures to hedge against the risk that
the price differential between heavy crude oil and light crude oil will narrow:
Action Today in 4 weeks Remarks
Refiner buys NYMEX WTI
futures
Buy NYMEX WTI
futures @ 52$US
Sell NYMEX WTI
futures @ 42$US
Refiner closes out the
position in WTI futures.
Note: there is no delivery

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of WTI crude oil as the
position is closed prior to
the expiration of the WTI
futures contract.
Loss = -10$US
Price of one barrel
of WCS
(change in the price of
heavy crude oil over the
time period)
40$US 37$US It costs the refiner 3$US
less (per barrel) to buy
WCS heavy crude oil.
Profit = +3$US
Refiner buys WCS DIFF
futures @-12$US (price based
on the NGX WCS WTI Index)
Note: the NGX WCS WTI
Index is the underlying index
of the WCH DIFF futures
contract
Buy WCH DIFF futures
@ -12$US
Sell WCH DIFF futures
@ -5$US
Refiner closes out the
position in WCH DIFF
futures.
Note: The refiner buys
WCH DIFF futures to
hedge the basis risk
between heavy crude oil
(WCS) and light crude oil
(WTI).
Profit = +7$US
Net Profit / Loss Net Profit / Loss = 0$
(resulting in a fully hedged
position)
Therefore, the refiner’s strategy to buy WTI futures (to hedge the price of one barrel of WCS) combined with a long
position in WCS DIFF futures contract to hedge the basis risk (specifically, to hedge against a narrowing of the price
differential between one barrel of WTI and one barrel of WCS) results in a fully hedged position.
Had the refiner not used the WCS DIFF futures contract, he would have suffered a loss of 7$US per barrel. The refiner
can hedge the basis risk using WCS DIFF futures contracts.
In this scenario, regardless whether the price of WTI or WCS rises or drops, the refiner’s motivation for initiating the
transaction is to hedge against the risk of a narrowing of the price differential between WTI and WCS.

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Investor expects the price differential between heavy crude oil and light
crude oil to widen
An investor believes that the price differential between heavy crude oil and light crude oil will
widen from the current level of -12.25$US per barrel (as measured by the level of the NGX WCS
WTI Index which represents the price of one barrel of Western Canadian Select Heavy Crude Oil
minus the price of one barrel of West Texas Intermediate Crude Oil). Supporting the outlook, is
the view that demand for asphalt and roofing tar – produced by refining heavy crude oil – will be
considerably lower in the foreseeable future on slower construction activity, and demand for
gasoline – produced mainly by refining light crude oil – will be higher ahead of the summer driving
season. Against this backdrop, the investor expects the price of heavy crude oil to underperform
relative to the price of light crude oil.
Strategy
The investor decides to use Canadian heavy crude oil differential futures to benefit from the
expectations of a widening of the price differential between heavy and light crude oil. Specifically,
the investor sells 5 Canadian heavy crude oil differential futures contracts (equivalent to 5,000
barrels of heavy crude oil).
In two months
In two months, the price of the WCS futures contract drops to -16.50$US per barrel (representing
the price differential between heavy crude oil and light crude oil), and the investor closes out the
position. Consequently, the price differential between heavy crude oil and light crude oil widened
from -12.25$US to -16.50$US per barrel. Thus, the investor realizes a profit of 4.25$US per barrel
for a profit of 4,250$US per futures contract excluding commissions – calculated by multiplying
4.25$US per barrel by the trading unit of 1,000 barrels for the futures contract.
The investor’s total profit on the position of 5 contracts is calculated as follows:
4.25$US per barrel * 1,000 barrels per contract * 5 contracts = 21,250$US
BUY SELL # of
contracts
WCS
Futures Level
PROFIT / LOSS
(for 1 contract)
PROFIT / LOSS
(for 5 contracts)
Today √ 5 -12.25
in 2 months √ 5 -16.50 +4,250$US
(profit per contract)
+21,250$US
(profit on the position
of 5 contracts)
Given available research or fundamental market information, investors must consider as well the
historical volatility and the price evolution of the differential price between heavy crude oil and
light crude oil prior to initiating a position in the WCS futures contract.
▪ Historically, the differential price between Canadian Heavy Crude Oil (WCS) and Light
Crude Oil (WTI) is very volatile. The Volatility - as measured by the standard deviation of
the differential prices over a 20-day period – since 2010 has ranged from a high of 310% to
a low of 32%.
▪ Moreover, the differential price since 2010 has ranged from a high of US$42 per barrel to a
low of US$7 per barrel.

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Differential Price and 20-day annualized Volatility (WTI Light minus WCS Heavy): Feb 2010 to Feb 2015
Source: Bloomberg L.P.