Opec Decision and Sing FO Hedging

Energy markets showed strength in late-day trading on Monday, recouping much of the losses from early Asian trading. WTI in particular surprised many traders by pushing higher on the day. This was after being offered more than one full standard deviation lower than unchanged, a volatile move which initially was a kneejerk reaction to Opec’s announcement of no more immediate cuts. Instead, the cartel took the much more shrewd step of stating it would focus on the remaining 800,000bbls/day it had previously announced it would remove from the market. By not announcing further production cuts, Opec took a gamble on not talking the market up with rhetoric that would see them have to remove more oil than necessary from the market to retain their hard-won credibility. Instead, by simply pushing to enforce greater accountability to recently announced cuts, the group’s compliance level should rise towards the 90% level; thus giving them greater pricing power in the long-term than simply taking the bait from the market and announcing more cuts than are necessary. Once digested, the market responded appropriately.

Consumer hedgers if not before, should now be on high-alert for futures prices to trend higher. Further cuts in Middle Eastern crude, especially of the heavy, sour variety will lead to increased upward pressure on Fuel Oil prices. Ali Naimi, the Saudi Oil Minister, has specifically stated that a WTI price of between $60-75 is crucial to allowing marginal producers to continue producing heavy oil. Bunker hedgers looking to protect against a near-term rise in Fuel Oil prices can look to owning a 2Q09 $255 price cap in Sing FO 180 for zero cost by accepting a price floor of $240 in the same tenor. This hedge provides for unlimited upside protection (just as with a swap) with the added benefit of less painful margin calls should the market trend lower (vs a swap hedge).

Consumer hedgers looking for immediate protection without risk accumulating immediately on the downside can own an option structure from April09 through Dec09 which pays out $800,000 per 10,000MT per month in Sing FO 180 if the underlying swap settles at the end of each month above the current price of approximately $255. If the underlying was to move lower, the hedge continues to pay out upon monthly expiration so long as the underlying settlement is not below $207. Below this level, losses begin to accumulate. Settlement at or above the current swap price of $255 results in payout each month of $800,000 per 10,000MT, equating to $80 of upside protection regardless of whether the underlying expires at the current price of $255 or $80 higher or anywhere in-between.

Singapore, 09:00

Refinery Action and Fuel Oil Hedging Strategies

Crude oil experienced significant price weakness yesterday on the back of profit-taking and a larger than expected inventory build. This occurred while Cushing WTI inventories indicated a slight draw due to turnaround season refinery demand. This is not to indicate refinery demand is relatively strong; in fact refinery runs are quite soft and the Singapore Fuel Oil market continues to witness a similar reduction in supply as refinery action continues to mitigate. The Fuel Oil market has felt an even more direct impact from Opec production cuts which have substantially removed medium and heavy sour crude from the market. While bunker fuel demand remains under pressure, the supply losses remain the foremost driver of market sentiment.

Sing Fuel Oil implied volatility remained unchanged yesterday after weakening significantly on Tuesday. The considerable drop in front-month FO enables consumer hedgers to lock in price caps or sell price floors at a level close to the bottom of the current near-term price range. An April Sing FO 180 $250 price cap (call) can now be owned for Zero Cost by accepting a price floor (put) at $231. Taking a different route, 10,000 MT of the $220 price floor (put) can be sold at $15.00 which indicates total premium received of $150,000 IF April Fuel Oil expires at or above $220. Below $220 the seller of the price floor still receives premium upon expiration so long as the underlying contract does not expire below $205 ($220 - $15 of premium received), below this point the hedge incurs losses equal to being long the underlying swap from $205. Similarly, if the underlying Fuel Oil swap moves higher the hedger will receive $150,000 of protection after expiration, basically mimicking a long swap position from $240 which is sold out at $255.

For a consumer hedger worried about a short-term rise in prices, the above strategy provides $15.00 of upside protection while not experiencing losses until the market moves below $205. With the tight trading ranges as of late, consumers with actual physical risk may opt for this strategy to reduce daily mark-to-market volatility seen with using only swaps for protection.

Singapore, 09:00

Sing Jetkero Consumer Hedges

Energy markets stumbled again yesterday as doubts surfaced as to whether increased refinery runs will continue to draw down excess crude stocks. Valero’s McKee refinery may be taken offline imminently as opposed to later in the year; this puts downward pressure on WTI as this would be one less major refinery processing feedstock into gasoline ahead of the summer driving season. Despite the Valero rumors, crude stocks are expected to have experienced a slight draw last week on the back of relatively strong unleaded gas margins.

Implied volatility in Products weakened yesterday due to the lack of follow-through on the recent bullish momentum. In the NY market, Jet fuel prices pushed lower after replacement costs via the Gulf Coast weakened. On the back of a similarly weaker crude market, sentiment can be expected to be negative heading into Asian trading for Sing Jetkero. This leads to further opportunities to lock-in price caps for 2010 before a much-anticipated trend higher begins in the second half of 2009. With the Sing Jetkero Cal10 underlying swap currently trading around $71, an $80 price cap can be locked-in for zero cost by accepting a price floor of $65 in the same tenor. For consumer hedgers looking for a limited price floor, the Cal10 $50/60 put spread can be sold to partially offset the price of a $75 price cap. By selling this put spread, the hedger has limited downside risk (only $10) while maintaining unlimited upside price protection above $75. The short put spread strategy enables the hedger to own a Cal10 $75 price ceiling at a deep 35% discount.

Singapore, 09:00

Heating oil crack now attractive for fuel hedging

Today we saw a significant early rally in WTI crude, ending up $1.61/bbl, which we believe was largely due to front month short covering. This follows the anticipated fund crude "roll", where front month contracts are sold in order to buy following month contracts. Interestingly, the Brent contract did not see much of a rally and ended down 68 cents on the day.

The futures curve continues to flatten with December only $3 over May futures (WTI). Looking into the second half of 2009, here are some hedge strategies and prices:

1) Crude swap 5185:
a. $55 Asian WTI call ($6.60/bbl)
b. 55-75 @$4.70/bbl
c. Zero cost collar using the $60 call sells the $45 put

2) Heating Oil swap $1.39/gallon (second half).
a. $1.50 call @ 18 cents/gal OR $7.55 per bbl
b. $1.50 - $2.00 call spread is 12 cents/gal OR $5.00/bbl
c. Zero cost collar using the $1.60/gal call sells the $1.28 put

Keep in mind that the heating oil crack to crude is fairly depressed versus recent history. (See graphic above)

The reason for distillate price weakness this is largely due to:
Overcapacity in refining due to delayed turnarounds now nearing completion (supply higher) and new large capacity in India (Reliant)
Reduced demand in diesel specifically (15% lower in US)
Forced production of distillates when making gasoline into summer season. Higher inventories versus seasonal norm (see graphic #2 below)

Please call or email if there is a particular strategy you would like to review or price.

Two shares of Citi will get you a one-way subway ticket off of Wall Street.

Two shares of Citi will get you a one-way subway ticket off of Wall Street. Another sharp downturn in equities meant another devastating turn for energy yesterday. All eyes on front crude today with non-farm payrolls and the ubiquitous ETF roll underway.


NATURAL GAS

A 102bcf draw was relatively in line with consensus and brings storage to 1,793bcf, roughly 218bcf over the 5-year average and about 300bcf more year over year. The draw did not seem to get in the way of producer hedging which reportedly came through in the backs - evident in the big futures trading for the day (140,627 futures contracts)
There is a sea of mild weather coming up in the next week which will result in a very bearish EIA report on March 19th; however, a cold wave is expected to hit the Northeast just in time for the all the St. Patty’s day revelers. Consequently, end of March storage has the strong potential to come in under 1700bcf lending support to NG before the next leg down


CRUDE & PRODUCTS

Diesel Side Note: food processing companies are increasingly anxious about hedging CAL10. Although there does not seem to be significant concern about price risk for the balance of 2009 we caution that there could be some price increase. For example, parts of South America are having a lackluster hydro year and will need to keep diesel on-hand for electric power generation. Yesterday PDVSA announced that spot market distillate exports will drop in Mar/Apr amid simultaneous outages at the Cardon and El Palito refineries. Jet fuel exports will be limited to 7 cargoes, 2 less than in Feb; no high-sulfur diesel cargoes will be available, from the typical 2. Exports of low-sulfur diesel from the Puerto La Cruz refinery are seen at the usual 4 cargoes. PDVSA closed a jet fuel tender in late-Feb for 4 spot market cargoes in March. Jet fuel and diesel cargoes go mostly to the US and European markets. Venezuela normally exports 2 spot market cargoes of high-sulfur sulfur diesel and 6 more through government agreements. PDVSA said the refinery maintenance had "no impact" on exports (Source: Energy News Today)

Consensus seems to be building among end users that 2010 will experience some economic turnaround. And, more importantly, the current low prices out the curve is an opportunity to lock in hedges for international truck fleets


ROLL INFORMATION

The schedules for major Index rolling of spot Crude Futures: (“days” refer to business days)

Rogers Index (RICI):2nd to last day of month prior; last day of month; first day of expiring month

DeutscheBank (DBC): 2nd thru 6th days of expiring month

US OIL Fund (USO): lasts 4 consecutive days, for monthly start dates click on http://www.unitedstatesoilfund.com/uso_rolldates.html (starts today for April09)

DJ-AIG (AIGCI): 5th thru 9th days of expiring month

Goldman Sachs (GSCI): 5th thru 9th days of expiring month

Ranie Hotis, CFA
HCEnergy

Sing FO Caps and Floors

Crude markets pushed higher yesterday on positive news surrounding stimulus packages as well as newly released inventory and demand figures. China is expected to announce fresh stimulus measures today, news that will surely result in a sustained rally across refined products and crude feedstock. The world’s second largest oil consumer has quietly been adding to strategic reserves and recently ordered several refiners to increase production of gasoline after a marked rise in demand. Meanwhile, in the US gasoline demand continues to recover slowly and refiners have begun to step-up production as a result of the higher margins. Paired with a distinct decrease in imports, the 700,000+ draw in crude for last week was no real surprise.

Yesterday’s abrupt move higher resulted in a decrease in implied volatility, and thus cheaper option premiums. Expect the Singapore refined product markets to push higher today, particularly Fuel Oil as this market has recently been plumbing lows not seen since mid-Feb. Prior to the lows of several weeks ago, traders can mark out support levels back to late-December 2008 at around $200. As the current push higher can be traced to decreased supply, lower inventories and increased product demand, this may be the beginning of a sustained (albeit slow) move higher. As uncertainty has been removed from the market, option volatility has already begun to decrease noticeably. The Sing Fuel Oil 180 Q209 $300 call is currently offered at an average price of only $16.00 per MT and this upside price cap can be owned for zero premium by accepting a $210 floor in the same tenor. With the Q209 swap trading just over $240, this hedge offer substantial breathing room on the downside with unlimited consumer protection above $300.

Singapore, 09:00

Sing Jetkero Consumer Strategy

Energy markets vacillated yesterday following the sharp pull-back from last week’s recent highs. Unfortunately, the commodity markets appear to be taking their lead from equity markets, which while also plumbing new depths on Monday, took a short breather yesterday. With so much volatility and uncertainty having been introduced to markets in the last seven months, traders are having difficulty focusing on any longer-term trends, instead trading more off of at-the-minute information. Particularly harmful to sentiment was news that the US, Europe and Japan have experienced a drop in oil demand of almost 10% in only the past 3 years.

Despite the lack of movement, refined products showed a slight increase in implied volatility yesterday. Using April Sing Jetkero as an example, most observers would expect yesterday’s lack of movement to result in relatively lower implied vols and thus cheaper option premiums. However, the recent break below $50 has introduced renewed uncertainty to the market. This along with the broader energy market questions of how much lower can it go and when will it bounce (and how hard) continue to inject fresh ambiguity to the market. Sing Jetkero consumers can protect their future fuel purchases against exactly this type of market sentiment using simple option strategies. For example, 250,000 barrels of Sing Jetkero can be locked-in at a max price of $65 per barrel for the next 12 months (April09-March10) by accepting a price floor of $51 in the same tenor. This with an underlying calendar swap price of just over $56. Moving the price cap higher will similarly result in a lower price floor (and lower margin requirement with less mark-to-market volatility).

Singapore, 09:00