Energy Markets Pulled in Opposite Directions

Aside from February WTI, energy prices consolidated and in many cases pushed higher last week amid further evidence of follow-through on supply cuts from Opec producer nations. Consumer demand looks set to continue dropping through 2009 as the International Energy Agency fell into line with Opec and the US Department of Energy in predicting back-to-back years of falling oil demand. The combination of drastic supply cuts with continuing global economic turmoil leading to receding consumer demand will certainly inject uncertainty and thus volatility into the energy markets for some time to come.

For the moment, implied volatility has decreased due to last week’s underlying price action. Consolidation has resulted in cheaper option premiums, temporarily allowing hedgers to lock in long-term hedges at relative bargain prices. Using Asian options, the WTI Feb through December 2009 $65/85 call spread strip can be purchased for an average price of about $2,750 per 1000 barrels per month. By selling the $44 put in the same tenor, the call spread strip can be owned for Zero Cost thus providing the full $20,000 of consumer protection per month. The Feb-Dec underlying calendar swap is currently trading above $53.00, thus allowing for an average downside buffer of more than $9.00 paired with maximum upside protection of $220,000 per contract.

Singapore, 09:00