Focus on Opec

Crude markets finished last week on a soft note with February 2009 WTI trading in a relatively tight $2 band before ending the day at just over $42.00. While weak consumer demand, directly related to the continuing global economic downturn, dominates the derivatives markets, traders and analysts will be closely watching physical crude leaving Opec ports over the next few months. The pressure is on the cartel to deliver on its promised cuts; any lack of adherence to its own mandates will result in a prolonged recovery period for energy futures.

Consumer hedgers can look to the recent drop in implied volatility to secure cheap upside protection for the upcoming calendar year. The Cal09 WTI $60/$80 call spread strip is trading around $3,500 per 1000 barrels per month or it can be purchased for Zero Cost by selling the $41 put in the same tenor. The Cal09 underlying swap strip is currently trading above $51.00.

Singapore, 11:00

Crude Markets Volatile after Opec Cut

Light-sweet crude oil prices drifted lower yet again yesterday, with February 2009 WTI currently offered just above $42. While Opec's supply cuts were answered by the market with a sharp move lower, it was the heavy sour crudes that may have reached at least a temporary bottom. It is the production of this type of crude that will be most affected by the cartel's recent severe production cuts. Lower quality Dubai crude actually rose slightly yesterday.

With the global economic slowdown expected to continue to weigh heavily on consumer demand for much of 2009, downside producer protection strategies remain the focus of many traders. Implied volatilities have also recently relaxed, allowing for relatively cheaper option premiums. Using Asian-style options, the 1H09 WTI $30 puts are currently trading around $1,100 per 1000 barrels per month. By selling the $70 call in the same tenor, the puts can be made Costless (the resulting position would be the 1H09 $30/$70 Costless Collar). With the 1H09 swap trading under $48, this hedge would not produce losses at expiration without front-month prices moving up more than $22.

Singapore, 08:30

Volatility Reigns Ahead of Opec Meeting

Energy markets yesterday experienced a continuation of the recent high volatility as front-month WTI crude oil broke through the psychological $50 level only to end the day lower ($6 range). Wednesday's upcoming Opec meeting has put a temporary floor under prices as traders await news on the producer group's latest cuts. The question of whether or not to announce further cuts has already been answered; what remains is just how much will be announced and then followed-through on in subsequent months. Adding pressure to Opec is the increasing floating storage among physical traders and oil companies. The strategy of buying cheap surplus oil and selling back-dated futures along the contango curve has allowed some to lock in returns for 2009.

Implied volatility continues to hold strong, resulting in sharp P/L's for those hedging with swaps and relatively inflated premiums for those using options. The most basic and safest strategies for locking in protection at year-end often involve vertical spread strips. An example of short-term producer protection would be the WTI 1H09 $30/40 put spread strip using Asian-style options, currently offered at $2,000 per 1000 barrels per month. The strip can be made zero-cost by selling the $65 call in the same tenor.

Singapore, 09:00

Energy Prices Drop on Auto Sector Bail-Out Failure

Crude oil prices backed off recent highs after the US Senate caught many traders off-guard by rejecting the proposed $14 billion bail-out plan. Opec's upcoming meeting as well as the expected production cuts of approximately 2-2.5M had been priced into the market when news of the auto bail-out failure broke. With global oil demand expected to continue falling through much of 2009, the pressure is on the cartel as well as non-Opec producers such as Russia to remove excess production from the market. Producer nations are facing the continuing pressure of a double revenue hit, from both falling demand and plummeting prices.

Short and medium-term vertical put spreads using WTI options allow for easy entry and exit (deep liquidity) as well as no counterparty risk (NYMEX clearing). The 1H09 $20/30 put spread is trading at only $700 per 1000 barrels per month. This producer hedge allows for total protection of $9,300 per month with only $700 at risk.

Singapore, 21:00

Opec Expectations Push Crude Higher & Implied Vols Lower

Energy prices surged yesterday as a series of bullish announcements, although none too surprising, served to cast doubt on recent 4-year lows in the crude oil market. The International Energy Agency contributed to traders expectations of a large production cut from Opec, by stating world oil demand would drop in 2008 and then again in 2009. Adding to the bullish pressure was the news that Russia would collaborate with Opec at the cartel's upcoming meeting in Algeria. Many traders are expecting the producer nation to contribute a cut of approximately 500,000 barrels per day on top of the 1.5 - 2.5M cut many expect to see from Opec.

The resurgent underlying WTI price served to decrease implied volatility, resulting in relatively cheaper option premiums. Producer bargain hunters looking to protect against further price drops in the first half of 2009 are looking at the 1H09 $30/45 put spread strip, currently trading around $3,300 per 1000 barrels per month using Asian-style options. This put spread strip can be purchased for zero premium by selling the $68 call in the same tenor. With the 1H09 underlying calendar strip trading around $54, this zero cost strategy contains no risk below $68 (a buffer of $14).

Singapore, 07:00

Calendar Strip Verticals Offer Cheap Protection

Expectations of continued demand destruction put an end to Monday's brief rally in crude prices. January 2009 WTI traded back down below $42 while the extreme contango seen lately along the future's curve relaxed somewhat. The one-year contango (Jan09-Jan10) has dropped to approximately -$13 while December 2012 and 2013 each fell more than $4.00 (compared to front-month crude only dropping about $1.50). This may be a reflection of physical buyers entering the market to hedge long-term storage. Also of note is a report from the World Bank predicting a prolonged global economic downturn which will depress commodity markets for the next several years.

As implied volatility persists at elevated levels, vertical spreads remain the cheapest protection available. Producers looking for protection against further downside moves can take advantage of the liquidity of WTI options (making trade entry and exit relatively easy) and look at calendar strip spreads such as the 1H09 $25/40 put spread strip, currently offered at $3,000 per 1000 barrels ($3,000 of total risk with $12,000 of downside protection per month). The put spread strip can be made costless by selling the $66 call in the same tenor.

Singapore, 08:00

Contango flattens in the back

Long term consumer hedgers have been drastically affected by the steep contango crude market. The prompt futures have been as much as $14 lower than same year December contracts. Call options appear dear looking forward at these levels. Today, however, we have seen a turn in the market with back months futures falling as much as $3 (December 13) versus Jan 2009. This may indicate that the carry market is fully valued with storage filling and long physical players starting to capture their buy and store strategy.

Consumers with long hedge strategies should have an opportunity to buy lower strike calls soon.

Please call or email if there is a particular level you are waiting for.

Bounce off $40 Highlights Upside Risks

Commodity and equity markets rallied yesterday on the back of a new stimulus announcement from China and fresh Obama infrastructure hopes in the U.S. Opec also ratcheted up the tough-talk with an announcement of a possible surprise cut in production of 2 million barrels at the cartel's upcoming meeting. Crude traders had called for a strong push lower to $40 in WTI and last week's move may have been it. With many analysts still looking for $30-35, the current level beckons consumer hedgers to lock in 4-year lows across the futures curve.

Using Asian-style options, the WTI 2Q09 $65/85 call spread strip is currently trading around $3,000 per 1000 barrels of exposure per month. With very limited risk, this consumer hedge has $51,000 of upside protection and can be combined with the sale of the $40 put in the same tenor to make the entire structure costless. With the 2Q09 swap currently trading around $52, the zero-cost strategy has about $12 of downside space.

Singapore, 08:00

Calendar Strategies Highlighted

Front-month WTI pushed below the key $45 level yesterday leaving traders to ponder the next level of resistance for the benchmark contract. Implied volatility increased as a result of the lack of any bounce yesterday. As uncertainty as to where the market will bottom-out continues to rise, option strategies become more popular, thus increasing the implied vol. Also of note is the contango spread between January 2009 and January 2010 which has now widened close to -$14.00 (Jan10 is trading about $14 over Jan09) which may be a direct result of the inability of physical traders, because of a lack of credit, to buy spot physical for storage and hedge by selling back-dated futures in the derivatives market. Similarly, many traders expect crude prices to rebound in late 2009- early 2010; this is also reflected in the wide time spread.

With no bottom in sight for near-dated crude futures, cheap put strategies continue to be a winning play. Using Asian-style options, the WTI 1H09 $30 put strip is still offered at a relatively cheap $1,300 per 1000 barrels. This strategy can be made costless by selling the $87 call strip in the same tenor. An excellent long-term view on the market would be to partner the above strategy with the purchase of the WTI 2H09 $90 call strip for about $2,000 per 1000 barrels. This strategy can also be made costless by selling the $38 put strip in the same tenor.

With the 2H09 calendar swap trading above $56, there is currently about $18 buffer room on the downside. Similarly, with the 1H09 calendar swap trading below $50, there is a buffer of more than $37 on the upside.

Singapore, 08:00

Crude Pushes Lower

WTI crude oil fell below $47 in volatile trading yesterday, marking a drop of more than $100 in less than five months. Short-term producer hedgers have benefited from cheap put purchases over this period, as rising inventories and refining capacity combine with relentless consumer demand declines and a global deleveraging of risk. Despite the steep drop of recent months, many traders see no reason for a near-term reversal of the trend.

Many hedgers have been taking advantage of short-term downside bargains combined with a longer-term bullish perspective. Using WTI Asian options, the Q109 $30 put strip can be owned for only about $1,000 of total risk per month per 1000 barrels. This position can be combined with the purchase of the 2H09 $90 call strip for about $1,500 of total risk per month per 1000 barrels. This "calendar strangle strip" position effectively captures downside risk in the near-term while providing potential upside consumer protection for the remainder of 2009.

Singapore, 09:00

WTI Below $50 as a Result of Opec's Failure to Cut

Front-month WTI crude pushed below $50 yesterday, giving back much of the gains from late last week. The drop in prices was seen by many as a reaction to Opec's lack of further production cuts at the sideline meeting in Cairo over the weekend. Approximately $5 of premium had been built-in to the market as a precaution by traders against a surprise cut by the cartel; it was this premium that began bleeding out during Asian trading and accelerated as the western markets opened.

Implied volatility increased yesterday as uncertainty returned to the market. Traders are now focused on how low crude can push in the next three to six months. Strong buying has been seen in both the $30 and $40 put range through the first half of 2009. Using Asian-style options, the WTI 1H09 $30 put strip is currently offered at a very cheap $0.70. That's $700 of total premium at risk per month- crude need not trade below $30 for these options to return protection/profits- any sharp drop towards the $40 level in the next few months should result in an increase in value for these puts.

Singapore, 08:00