Markets Wake Up to Predicament Between Russia and West

Crude oil pushed back above $120 yesterday on mounting tensions between Russia and the West. Diplomatic protests are a given at this point, but Russia also has at its disposal the ability to seriously curtail oil exports. The market appears to finally be waking up to a problem that began more than two weeks ago. The silver lining of the recent bump in prices is that less bullish rhetoric is likely by Opec nations ahead of the September 9th meeting. With prices remaining above $110, it was unlikely a decision would have been made to curtail output, but with a new range possible above $120, the focus is now on whether the market will continue to push to even further heights.

Consumers who locked in hedges while crude prices hovered around the $115 range certainly took advantage of cheap option premiums. Deals still abound however, as does a high level of uncertainty in the market. For short-term protection, the October through December 2008 $125 / 135 call spread can be purchased for Zero Cost by selling the $108.50 puts in the same tenour. This trade gives the consumer $10 of upside protection for the remainder of 2008 while putting no cash at risk above the $108.50 level.

Volatility pop

The early signs of hurricane risk were magnified when new information regarding Russian military movements hit the wires. Options volatility rapidly increased well over Wednesdays levels. Crude oil quickly was up more than $5.0/bbl and refined products over 14 cpg. As mentioned by previous posts, there is plenty of upside risk to consider. Product options expire Tuesday. Please IM, email or call for strategies prior to the weekend. Also note that Monday is a bank holiday in the UK and traders most likely will not go out short.

Tropical Storm Fay

NHC more bullish this AM - Crude up over $118 early NY time after London open had kicked off a small rally. Fay has a chance of making its way to the Gulf but reports are inconclusive currently. Traders are looking mostly to cover and remain neutral to long coming into this weekend. The bank long weekend in the UK may give more incentive for traders to go out long. In this case, short players can pick up long call spreads. Long players may be able to collect good premium for the 128 calls and perhaps add puts as a collar. The September Asian zero cost collar is now 110 put versus 128 call.

NY, 0850

U.S. Inventory Data Produces Increased Volatility

Energy prices showed marked volatility yesterday as a result of surprising U.S. inventory numbers. Crude stocks saw a build of 9.4m barrels last week, largely as a result of swelling imports. Converesly, petrol inventories provided an equal surprise on the downside, showing a draw of 6.2m barrels, marking the second week in a row of +6m draws. This can be blamed on both a weak refinery margin, where refiners will often choose to forego further production in favour of much-needed maintenance programmes, as well as disruptions caused by the previous tropical storm, Edouard.

Volatility often results in hedgers backing away from the market for fear of incurring added risks to their balance sheet. In fact, a volatile market is just the scenario for choosing options as a proper hedge over futures or swaps. Options provide cheaper protection as well as limited loss, allowing the prudent hedger to concentrate on their actual business and not worry about basis or downside hedging risk. Just such a consumer hedge would be buying the January through December 2009 $130 / 150 call spread for Zero Cost by selling the $105 / 93 put spread in the same tenour. This trade provides $20 of upside protection for every month in 2009 while having only limited risk, from the $105 level down to the $93 strike ($20 of free protection in exchange for $12 of max risk).

AP Story featuring HCEnergy

AP
Oil prices rise ahead of inventory report
Wednesday August 20, 9:41 am ET
By Pablo Gorondi, Associated Press Writer

Oil prices rise as investors look to inventory report for signals on US demand

Oil prices rose above $116 a barrel Wednesday as investors awaited a weekly crude inventory report which was predicted to show a drop in U.S. gasoline stocks.

By the afternoon in Europe, light, sweet crude for September delivery was up $1.55 to $116.08 a barrel in electronic trading on the New York Mercantile Exchange. Earlier in the session, it traded as low as $114.26 before rebounding. The contract rose $1.66 to settle at $114.53 a barrel on Tuesday.

Investors are waiting for a report later Wednesday by the U.S. Energy Department's Energy Information Administration on U.S. oil stocks for the week ended Aug. 15. The petroleum supply report was expected to show that gasoline inventories fell by 3 million barrels, according to the average of analysts' estimates in a survey by energy information provider Platts.

"People are going to be looking at the (gasoline) numbers," said Jonathan Kornafel, Asia director for brokerage Hudson Capital Energy in Singapore.

The Platts survey also showed that analysts projected oil stocks rose 1.7 million barrels and distillates went up 1.2 million barrels during last week.

Tropical Storm Fay -- which contributed to higher oil prices over the past few days -- moved inland in the United States on Tuesday, bypassing oil and gas platforms in the Gulf of Mexico.

Energy markets, however, were still nervous, as some computer models showed Fay possibly becoming a "boomerang storm" and moving back toward the Gulf, said Olivier Jakob of Petromatrix in Switzerland.

JBC Energy in Vienna, Austria, also mentioned "hurricane risk" as one of several factors supporting oil prices.

Tuesday's comments from Venezuelan Oil Minister Rafael Ramirez about a possible proposal at the September OPEC meeting to cut output if prices continue to fall lent support to prices.

Oil prices have rebounded after falling about $35, or nearly a 25 percent, from their trading record of $147.27 on July 11 on expectations that high gasoline prices and slowing economic growth in the U.S., Europe and Japan will undermine global energy demand.

"Just as the market overshot to the upside, it overshot the other way," Kornafel said. "It looks like we're consolidating between $112 and $118."

Weighing on oil prices was a slightly stronger dollar. The 15-nation euro traded was down to $1.4721, while the dollar rose near 110 Japanese yen. A rising dollar encourages investors who had been seeking commodities like oil as a hedge against inflation to sell their positions.

"I think credit markets need to improve in the U.S. before we see a sustained rally in the dollar," Kornafel said. "We may have hit a top for the dollar. I don't think this rally can last."

In other Nymex trading, heating oil futures rose 4.44 cents to $3.1681 a gallon, while gasoline prices added 4.11 cents to $2.9050 a gallon. Natural gas futures increased 16.1 cents to $8.137 per 1,000 cubic feet.

In London, October Brent crude gained 91 cents to US$114.96 a barrel on the ICE Futures exchange.

Associated Press writer Alex Kennedy in Singapore contributed to this report.

Market Consolidation Continues

Energy prices rallied ahead of Wednesday's U.S. oil inventory numbers. Gasoline stocks are expected to show a slight draw while crude supplies may register a modest build. Increasing tensions between Russia and Nato over continued military activity in Georgia, as well as resurgent fears over tropical storm Fay in the Gulf of Mexico served to pull oil off its recent lows. Consolidation between $112 and $118 continues.

As market participants become increasingly unsure as to crude oil's next move, option premiums continue to cheapen. Unlimited upside protection for the remainder of the 2008 calendar year can be had for Zero Cost by offsetting the purchase of the WTI September through December $120 calls by selling the $113 puts in the same tenour. Using Average Price Options, it is possible to gain protection above $120 for the remainder of 2008 with no premium at risk above $113.

Don't discount the risk before mid Sept.

Following Monday's easing of volatility in petroleum, the market has shown its fragility to potential weather event risk. We know that the seasonal peak is not for a few weeks so there is no discounting the potential for some activity affecting the Gulf of Mexico. Tropical storm Fay has not posed any threat as of now, but don't assume the risk is gone. If Fay fizzles, there could be something around the corner coming into September.

Given the easing volatility in the market (read less buyers than sellers of optionality), now is a good time to buy upside insurance. Asian style crude call options with a $125 strike for the September through December strip were offered today at $5/bbl. For lower premium trades, look to the $135 strike for $2.75.

NY, 530pm, Aug 19