Opec Follow-through Seen in Brent/Dubai EFS

Crude prices ended last week in negative territory with WTI looking set to test the $40 level in early Asian trading Monday morning. Meanwhile, Brent, the North Sea benchmark also traded lower on the week but the WTI/Brent spread has now widened to almost $4 with Brent premium. Similarly, the Brent/Dubai spread has moved into negative territory. These atypical contract moves are a result of follow-through on the part of the Opec producers; the cartel has reduced the supply of their heavy, sour crude oil to the market, while the light, sweet contracts (WTI in particular) are suffering from a supply glut.

The above situation may take several months to play itself out, but the pattern is clear: less oil is coming to the market and those contracts directly concerned are rallying. Hedgers are beginning to take advantage of this phenomenon by buying upside protection for the 2nd half of 2009. Often the protection is cheap enough that it can be made Zero-Cost by selling a put significantly lower than the current market. For instance, the 2H09 WTI $75/90 call spread strip is trading around $2,800 per 1000 barrels per month. For a Zero-Cost strategy, sell the $40 put in the same tenor. With the 2H09 calendar strip trading above $57.50, this consumer hedge provides an average of more than $17.50 of room on the downside.

Singapore, 05:00

RBOB crack shows signs of strength

Following a tumultuous week of market action, RBOB closed the week stronger due to refinery turnaround news and macro index fund rebalancing. Data shows that most petroleum product contracts including crude had to be reduced to rebalance indexes while RB was increased. Distillate cracks had been stronger as NG markets rallied in Europe due to Russian supply concerns. Demand remains weak across the board, which muted the early week rally despite Gaza conflicts. Furthermore, unemployment data in the US reported today was slightly worse than expected, pressuring most markets lower.

Continued RB strengthening may be hedged with calls here, or puts hedging long physical. We are now finally in positive RB crack in the futures market. In general, crude does not look like a great hedge against refined products now as crack volatility remains high.

New York 15h00.

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.

Please call or email if there is a particular level you are looking to refresh.

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).

Please call or email for current information or stratgies.

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