End of Q1 2013 trade @ CBOT & hot air on shale

As trading came to a close for Q1 2013 at the Chicago Board of Trade (CBOT) on Thursday afternoon, the Oilholic saw crude oil futures rise during the last session of the first quarter aided undoubtedly by a weaker dollar supporting the prices. However, yours truly also saw something particularly telling – fidgeting with the nearest available data terminal would tell you that Brent crude futures slipped nearly 1 percent over Q1 2013. This extended a near-1 percent dip seen in Q4 2012. Overall, Brent averaged just around the US$112 per barrel level for much of 2012 and the Brent-WTI premium narrowed to its lowest level in eight months on March 28. That said, it must be acknowledged that US$112 is still the highest ever average annual price for the benchmark as far as the Oilholic can remember.

In its quarter ending oil market report, the CME/CBOT said improved sentiment towards Cyprus was seen as a supportive force helping to lift risk taking sentiment in the final few days before Easter. On the other hand, concerns over ample near term supply weighed on nearby calendar spreads, in particular the Brent May contract.

In fact, the May versus June Brent crude oil spread narrowed to its slimmest margin since July 2012. Some traders here indicated that an unwinding of the spread was in part due to an active North Sea loading schedule for April and prospects for further declines in Cushing, Oaklahoma supply.

Away from price issues, news arrived here that ratings agency Moody’s reckons an escalation in the cost of complying with US federal renewable fuel requirements poses a headwind for the American refining and marketing industry over the next two years (and potentially beyond if yours truly read the small print right).

Moody’s said prices were spiking for renewable identification numbers (RIN) which the US Environmental Protection Agency (EPA) uses to track whether fuel refiners, blenders and importers are meeting their renewable-fuel volume obligations.

Senior analyst Saulat Sultan said, "US refining companies either amass RINs through their blending efforts or buy them on the secondary market in order to meet their annual renewable-fuel obligations. It isn't yet clear whether recent price increases reflect a potential shortfall in RIN availability in 2014, or more structural and permanent changes for the refining industry."

The impact of higher RIN prices will depend on a company's ability to meet its RIN requirements internally, as well as the amount of RINs it can carry over to 2014 and gasoline export opportunities, Sultan says. Refiners carried over about 2.6 billion excess RINs to 2013 from 2012, but the EPA expects a lower quantity to be carried over to 2014.

"RIN purchasing costs can be sizable, even while refiners are generally enjoying a period of strong profitability, such as they are now. Integrated refining and marketing companies including Phillips 66, Marathon Petroleum and Northern Tier Energy LLC are likely to be better positioned than sellers that do not blend most of their gasoline, such as Valero Energy, CVR Refining LLC and PBF Energy, or refiners with limited export capabilities, such as HollyFrontier," Sultan added.

Concurrently, increasing ethanol blending, which is used to generate enough RINs to comply with federal regulations, raises potential legal issues for refiners. This is because gasoline demand is flat or declining and exceeding the 10% threshold (the "blend wall") could attract lawsuits from consumers whose vehicle warranties prohibit using fuel with a higher percentage. However, Moody's does not believe that companies will raise the ethanol content without some protection from the federal government. 

Meanwhile, all the hot air about the ‘domestic dangers’ and ‘negative implications’ of the US exporting gas is getting hotter. A group – America’s Energy Advantage – has hit the airwaves, newspapers and wires here claiming that "exporting LNG carries with it the potential threat of damaging jobs and investment in the US manufacturing sector as rising exports will drive up the price of gas to the detriment of domestic industries."

So who are these guys? Well the group is backed by several prominent US industrial brands including Alcoa, Huntsman chemicals and Dow Chemical. Continuing with the subject, even though only one US terminal – Sabine Pass – has been permitted to export the fruits of the shale revolution, chatter in forex circles is already turning to shale oil and gas improving the fortunes of the US Dollar!

For instance, Ashok Shah, investment director at London & Capital, feels this seismic shift could improve growth prospects, reduce inflation and diminish the US current account deficit, with significant ramifications for long-term investors.

"For the past decade we have seen the US Dollar in decline, on a trade weighted basis. I believe the emergence of shale oil as a viable energy source looks set to have a considerable impact on the US dollar, and on the global economy as a whole," Shah said.

"Furthermore, a lower oil price will drive lower global headline inflation benefiting the US in particular - and a lower relative inflation rate will be a positive USD driver, improving the long-term purchasing power of the currency," he added.

The Russians are stirring up too. Last week, Gazprom and CNPC signed a 30-year memorandum to supply 38 billion cubic meters (bcm) to 60 bcm of natural gas from Eastern Siberian fields to China from 2018. The negotiations haven’t concluded yet. A legally binding agreement must be signed by June and final documents by the end of the year, covering pricing and prepayment terms. Let us see the small print before making a call on this one. On a related note, ratings agency Fitch says Gazprom is unlikely to offer any meaningful gas price concessions to another one of its customers – Naftogaz of Ukraine – in the short term owing to high spot prices for natural gas in Europe, currently being driven by the continued cold weather.

Sticking with the Russian front, Rosneft, which recently completed the acquisition of TNK-BP, has negotiated an increase in its oil shipments to China from the current 15mtpa to as much as 31mtpa in exchange for a pre-payment, and has agreed on a number of joint projects in exploration, refining and chemicals production with CNPC and Sinopec.

This is it for this post; it is time to bid goodbye to Chicago and Lake Michigan’s shoreline and hop 436 miles across the Great Lakes to say hello to Lake Ontario’s shoreline and Toronto. The Oilholic leaves you with a view of the waterfront and the city’s iconic buildings; the Willis Tower (once Sears Tower is on the left of the frame above).

It’s been a memorable adventure to Illinois, not least getting to visit  CBOT – the world’s oldest options and futures exchange. Leaving is always hard, but to quote Robert Frost – “I have promises to keep, and miles before I go to sleep.” That’s all from the Windy City folks! Keep reading, keep it ‘crude’!

To follow The Oilholic on Twitter click here.

To email: gaurav.sharma@oilholicssynonymous.com

© Gaurav Sharma 2013. Photo 1: Exterior of the Chicago Board of Trade. Photo 2: Chicago's Skyline and Lake Michigan, Illinois, USA © Gaurav Sharma.

Crude thoughts from 141 West Jackson Blvd

A visit to Chicago would not be complete without setting foot inside 141 West Jackson Boulevard – the Chicago Board of Trade’s (CBOT) iconic abode – and gathering the pulse of the market straight from the world's oldest futures and options exchange. Over 50 different options and futures contracts are traded here, including ‘cruder’ ones, via close to 4000 member traders both electronically and through open outcrys; so plenty to observe and discuss.

There was only one man though whom the Oilholic had in mind – the inimitable Phil Flynn of Price Futures Group, veteran market analyst and the doyen of the business news broadcasters. The man from the “South Side” of Chicago has never been one to sit on the fence in all the years that yours truly has been mapping his market commentary. And he wasted no time in declaring that the WTI could reassert itself in the Battle of the Benchmarks pretty soon.

“First, let’s take the Brent-WTI differential into perspective. It narrowed to US$13 at one point today [March 28] and it will continue to narrow, albeit in fits and starts. We’ll come back to this point. WTI’s claw-back in terms of market stature could be down to simple nuts and bolts stuff! The US could – and I think will – become a treble impact jurisdiction – i.e. one of the world’s largest consumer, producer and exporters of crude oil somewhere between 2015-2018; if you believe the current market projections. So what could be a better way to get a sense of the global energy market than to have all of that rolled into one contract?”

Flynn reckons people were behind the curve in awarding Brent a victory in the Battle of the Benchmarks. “Everyone says these days that Brent is more reflective of global conditions. My take is that they should have reached this conclusion five years ago and it’d have been fine! Yet now when the clamour for Brent being the leading benchmark is growing, market supply and demand dynamics are changing for the better here in the US and for the worse in the North Sea.”

The veteran market commentator says the period of Brent being a global benchmark will be akin to the "rise and fall of the Roman Empire" through no fault of its champions but rather that of "late adopters" who missed the pulse of the market which was ticking differently back in 2007-08 with the rise of Asian crude oil consumption.

“There is a lot of politics in anointing the ‘favoured’ benchmark. As a trader I don’t care about the politics, I go with my gut instinct which tells me the problems associated with the WTI – for instance the Oklahoma glut – are being tackled while Brent’s are just beginning. WTI is liquid, has broad participation and also has the backdrop giving an indication of what supply and demand is. Therein, for me, lies the answer.”

Flynn also feels the technicals tell their own story. In December, he called a WTI low of US$85 and the top at US$97 and was vindicated. “It is flattering to look like some kind of a genius but it was pure technical analysis. I think there was a realisation that oil was undervalued at the end of 2012 (fiscal cliff, dollar-cross). When that went away, WTI had a nice seasonal bounce (add cold weather, improving US economy). It’s all about playing the technicals to a tee!”

Flynn sees the current WTI price as being close to a short-term top. “Now that’s a scary thing to say because we’re going into the refining season. It is so easy to say pop the WTI above US$100. But the more likely scenario is that there would a much greater resistance at about the price level where we are now.”

Were this to happen, both the Oilholic and Flynn were in agreement that there could be a further narrowing between Brent and WTI - a sort of “a meeting in the middle” with WTI price going up and Brent falling.

“The WTI charts look bullish but I still maintain that we are closer to the top. What drives the price up at this time of the year is the summer driving season. Usually, WTI climbs in March/April because the refiners are seen switching to summer time blends and are willing to pay-up for the higher quality crudes so that they can get the switchover done and make money on the margins,” he says.

His team at Price Futures (see right) feels the US seasonal factors are currently all out of whack. “We’ve recently had hurricanes, refinery fires, the Midwest glut, a temporary gas price spike – which means the run-up of gasoline prices that we see before Memorial Day has already happened! Additionally, upward pressure on the WTI contracts that we see in March/April may have already been alleviated because we had part of the refinery maintenance done early. So barring any major disasters we ‘may not’ get above US$100,” he adds.

As for the risk premium both here and across the pond, the CBOT man reckons we can consider it to be broadly neutral on the premise that a US$10 premium has already been priced in and has been for some time now.

“The Iran issue has been around for so long that it’s become a near permanent feature. The price of oil, as far as the risk premium goes, reflects the type of world that we live in; so we have an in-built risk premium every day.”

“Market wizards could, in theory, conjure up a new futures gimmick solely on the “risk premium in oil” – which could range between US$3 to US$20 were we to have a one! Right now we have a US$7 to US$10 premium “near” permanently locked in. So unless we see a major disruption to supply, that risk premium is now closer to 7 rather than 10. That’s not because the risks aren’t there, but because there is more supply back-up in case of an emergency,” he adds.

“Remember, Libya came into the risk picture only because of the perceived short supply of the (light sweet) quality of its crude. That was the last big risk driven volatility that we had. The other was when we were getting ready for the European embargo on Iranian crude exports,” he adds.

With the discussion done, Flynn, with his customary aplomb, remarked, “Let’s show you how trading is done the Chicago way.” That meant a visit down to the trading pit, something which alas has largely disappeared from London, excluding the London Metals Exchange.

While the CBOT was established in 1848, it has been at its 141 West Jackson Boulevard building since 1930 and so has the trading pit. “Just before the Easter break, volumes today [March 28] are predictably lower. I think the exchange record is 454 million contracts set 10 years ago,” says Flynn.

As we stepped into the pit, the din and energy on the floor was infectious. Then there was pin drop silence 10 seconds before the pit traders awaited a report due at 11:00 am sharp...followed by a loud groan.

“No need to look at the monitors – that was bearish all right; a groan would tell you that. With every futures contract, crude including, there would be someone who’s happy and someone who’s not. The next day the roles would be reversed and so it goes. You can take all your computers and all your tablets and all your Blackberries – this is trading as it should be,” says Flynn (standing here on the right with the Oilholic).

In July 2007, the CBOT merged with the Chicago Mercantile Exchange (CME) to form the CME Group, a CME/Chicago Board of Trade Company, making it a bigger market beast than it was. Having last visited a rather docile trading pit in Asia, the Oilholic was truly privileged to have visited this iconic trading pit – the one where many feel it all began in earnest.

They say the Czar’s Russia first realised the value of refining Petroleum from crude oil, the British went about finding oil and making a business of it; but it is the United States of America that created a whole new industry model as we know it today! The inhabitants of this building in Chicago for better parts of 80 years can rightly claim “We’re the money” for that industry.

That’s all from the 141 West Jackson Boulevard folks! It was great being here and this blogger cannot thank Phil Flynn and Price Futures Group enough, not only for their time and hospitality, but for also granting access to observe both their trading room and the CBOT pit. More from Chicago coming up! Keep reading, keep it ‘crude’!

To follow The Oilholic on Twitter click here.

To email: gaurav.sharma@oilholicssynonymous.com

© Gaurav Sharma 2013. Photo 1: The Chicago Board of Trade at West Jackson Boulevard (left) with the Federal Reserve Bank of Chicago (right), Chicago, USA. Photo 2: Phil Flynn (standing in the centre) with his colleagues at Price Futures Group. Photo 3: Phil Flynn (right) with the Oilholic (left) at the CBOT trading floor © Gaurav Sharma 2013.