Distillate cracks stonger despite market selloff

A New Year rally has not followed through at this point with a near $6 sell off. This week, however, the news regarding natural gas availability in Europe (Russia) has had an important and significant affect on Gasoil prices (US Heat and Jet). The "crack" (difference of distillate prices such as Jet compared to crude) has expanded by over $3 per barrel due in part to the fact that Europeans pay for natural gas and heating oil (gasoil) with interrelated pricing schemes. The prices are interrelated due to switching ability in the heating market.

Additionally, we are seeing strong indications for a cold winter in Europe, which will support this "crack" expansion.

This situation could persist. With this in mind, using some near term gasoil or heating oil call options strategies would be more effective than crude oil. Longer term, we continue to recommend crude oil call spreads.

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New York 16h13

Implied Vol Relaxes

Evidence of Opec production cuts continues to mount with the Brent/Dubai EFS trading at parity. Typically, the lower quality, sour crude of the Dubai benchmark would trade at a discount to Brent or WTI. The narrowing of the spread is a strong indicator of follow-through on the part of regional producers. Meanwhile, geopolitical risks continue to increase as there appears no peaceful end in sight to the Israeli/Gaza conflict and the Russia/Ukraine spat has now spread into the EU, with Russia cutting back gas it claims Ukraine is siphoning off for itself.

Despite the current market uncertainties, implied volatility has dropped off markedly in WTI and Brent options. The cheaper premiums have encouraged hedgers to re-enter the market during the current period of flux. Producer hedgers have looked again to medium-term downside protection in the form of the WTI Cal09 $35/45 put spread strip, currently trading around $2,300 per 1000 barrels per month. This put spread strip can be made Costless by selling the $90 call in the same tenor. The Cal09 swap strip is currently trading around $58.50.
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Singapore, 09:00

Geopolitical Tensions Back in Focus

Geopolitical tensions continue to put upward pressure on energy markets as Feb09 WTI and Brent crude both rallied closer to the $50 level. Renewed militant attacks in Nigeria on Eni operated pipelines come as the Israeli/Gaza conflict looks set to worsen. Meanwhile, Russian and Ukraine have yet to settle their Natural Gas spat as the EU looks into possible siphoning off of gas by the latter country. Further evidence of Opec supply cuts are evident in the tightening of the Brent/Dubai EFS, now at its narrowest level in eight years. The heavy, sour crude of the Dubai Middle East contract is a superior indicator than that of Western benchmarks such as WTI or Brent in the short-term regarding any production cuts by regional producers.

Cheap, near-term upside protection still remains in the Q109 WTI $60/75 call spread strip. Trading around only $2,000 per 1000 barrels per month, this consumer strategy offers total protection of $39,000 with only $6000 at risk. The strip can even be made Costless by selling the $46 put in the same tenor. With the Q109 calendar strip trading above $52.50, the Zero-Cost strategy provides an average downside buffer of about $6.50.

Singapore, 09:00

New Year Rally keeps volatility high

Following late 2008 inventory reduction strategies and a general bearish sentiment, it is not hard to believe a correction or bounce was due. The Israeli confrontations with Hamas in Gaza were more than enough news to help the market sustain a rally. Now we are seeing plenty of upside hedges coming in, taking advantage of put skew (calls cheaper in comparison, and selling puts to finance appears a good tradeoff).

Volatility remains high by historic standards in the low 90s (%). The high level of volatility still provides a good opportunity to those who can use a 3 way strategy (selling 1 option net) to achieve low cost hedges. One such idea is to buy a call spread and sell a put such as the WTI Q1 62-72 call spread versus the $40 put for zero cost. The current swap reference for Q1 is $52. This is more of an insurance trade but accepts a $40 floor, which is near the marginal cost for many producers outside the Middle East (such as Canada).

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New York 415pm

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