Views from Wall Street on oil market volatility

The Oilholic finds himself 3,460 miles away from London in New York, with Wall Street giving the crude market yet another reality check. In the last few months, money managers of all description, not just our friends in the hedge fund business, are scratching their heads having first seen a technical bear market in July, only for it to turn in favour of a technical bull market in August!

But now, with all that phoney talk of producers coming together to freeze oil production having fallen by the wayside, both Brent and WTI have started slipping again. 

Not one Wall Streeter the Oilholic has spoken to since arriving in the Big Apple seems to discount the theory that oil may be no higher than $50 per barrel come Christmas, and even that might be a stretch. 

In a desperate bid to keep the market interested in the production freeze nonsense, the Saudis and Russians pledged cooperation ensuring "oil market stability" at no less august a venue than the G20 summit in China earlier this month. Of course, as no clear direction was provided on how that "stability" might actually be achieved and nothing revealed by way of production alterations or caps, not many are quite literally buying it – not on Wall Street, not in the City of London.

Forget the shorts, even the longs brigade have realised that unless both the Saudis and Russians, who between them are pumping over 20 million barrels per day (bpd) of oil, announce a highly unlikely real terms cut of somewhere in the region of 1 to 1.5 million bpd at the producers’ informal shindig on the sidelines of International Energy Forum (due 26-28 September) in Algiers, price support would be thin on the ground.

In fact, even a real terms cut would only provide short-lived support of somewhere in the region of $5-10 per barrel. As a side effect, this temporary reprieve would boost fringe non-OPEC production that is currently struggling with a sub $50 oil price. Furthermore, North American shale production, which is proving quite resilient with price fluctuations in the $40-50 range, is going to go up a level and supply scenarios would revert to the norm within a matter of months.

A number of oil producers would substitute the hypothetical 1-1.5 million bpd Riyadh and Moscow could potentially sacrifice. That’s precisely why Wall Street is betting on the fact that neither countries would relent, for among other things – both are also competing against each other for market.

Another added complication is the uncertainty over oil demand growth, which remains shaky and is not quite what it used to be. Morgan Stanley and Barclays are among a rising number of players who think 2016 might well end-up with demand growth in the region of 625,000 to 850,000 bpd, well shy of market think-tank projections of 1.3 million bpd.

Trading bets are mirroring those market concerns. Money managers sharply decreased their overall bullish bets in WTI futures for the week to September 6th, and also reduced their net position for a second straight week, according to Commodity Futures Trading Commission (CFTC) data.

In numeric terms - "Non-commercial contracts" of crude oil futures, to be mostly read as those traded by paper speculators, totalled a net position of +285,795 contracts. That’s a change of -55,493 contracts from the previous week’s total of +341,288; the net contracts for the data reported through August 30th.

The speculative oil bets decline also dragged the net position below the +300,000 level for the first time in nearly a month. That’s all for the moment from New York folks, as the Oilholic leaves you with a view of Times Square! Keep reading, keep it ‘crude’! 

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© Gaurav Sharma 2016. Photo 1: Wall Street & New York Stock Exchange, USA. Photo 2: Times Square, New York, USA © Gaurav Sharma, September 2016

Fuel hedging as oil stays ‘lower for longer’

The last decade has seen extreme volatility with unprecedented price swings. Having been at $115 per barrel in June 2014, oil slipped below $30 at one point in less than two years, driven lower by overproduction, harking back to the kind of volatility we saw during the global financial crisis of 2008-09. 

While the latter was down to a dip in demand, and the former is being caused by oversupply sentiment, volatility makes hedging crucial for fuel consuming companies. Two experts from financial consulting firm Volguard – Simo Mohamed Dafir and Vishu N. Gajjala – have made a brilliant attempt to tackle subject via their book Fuel Hedging and Risk Management published under the current batch of the Wiley Finance series.

Acknowledging the turbulent times faced by fuel derivative providers, Dafir and Gajjala, set about offering their own hedging solutions to those hoping to manage fuel price volatility, by putting forward strategies from origination to execution of a hedge within confines of a holistic risk management structure.

This book, of just under 300 pages split by 10 detailed chapters, begins with a basic overview of inherent market risks and the strategic nature of the oil and gas business, before moving on to tackling fuel derivative instruments.

Subsequent strategic dialogue moves on to scenario analysis, derivative term sheets and market curves for those starting out on their careers. Concurrently, advanced practitioners in the fuel derivatives market will appreciate Dafir and Gajjala’s treatment of price, volatility and exposure optimisation models, as well as credit risk and associated Company Voluntary Arrangement [or “CVA”] cost examinations.

Key bits of the text are accompanied by detailed case studies and examples treating real-life trading scenarios. The Oilholic feels such a format helps readers appreciate the tone and complexity of risk management of derivatives far better than a bland linear treatment of the subject. One find’s the narrative is just as useful for established players, as well as newcomers to the fuel hedging world.

However, this blogger would attach a caveat – for those contemplating a career in the fuel hedging business – Dafir and Gajjala’s work is not a starter kit, rather a very solid, splendid second title that serves as a constructive follow-up to an initial baptism to the derivatives world. 

The Oilholic would be happy to recommend this book to commodity traders seeking a refresher course, quantitative professionals in the fuels space, risk managers and corporate treasurers at transportation firms, including airlines and shipping businesses whose needs and concerns it directly addresses. It could also be of immense help to those looking to develop a corporate framework for financial risk analysis.

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© Gaurav Sharma 2016. Photo: Front Cover – Fuel Hedging and Risk Management © Wiley Publishers, 2016

Threat of the other & US energy security

The intertwining of US foreign policy with the country’s energy security has been a matter of public discourse for decades. The connection only witnessed a dilution of sorts roughly six years ago when the US shale bonanza started easing the economy’s reliance on oil imports in meaningful volumes. 

In an era of ‘lower for longer’ oil prices and shale’s contribution to US energy security being hot topics, author Sebastian Herbstreuth refreshingly reframes the country’s ‘energy dependency’ as a cultural discourse via his latest book – Oil and American Identity published by I.B. Tauris. 

In a book of 270 pages, split by six detailed chapters, Herbstreuth attempts to draw and examine a connection between the US energy business and American views on independence, freedom, consumption, abundance, progress and exceptionalism.

Stateside, foreign oil is selectively depicted as a serious threat to US national security. However, that selective depiction is contingent upon the ‘foreignness of foreign oil’ to quote the author. Herbstreuth shows how even reliable imports from the Middle East are portrayed as dangerous and undesirable because the region is particularly 'foreign' from an American point of view, while oil from friendly countries like neighbouring Canada is cast as a benign form of energy trade.

The author has somewhat controversially, and rather brilliantly, recast the history of US foreign oil dependence as a cultural history of the world’s largest energy consumer in the 20th Century.

That age-old concern about there being an existential threat to the US, as a society built on the internal combustion engine and mobility, is in part born out of the very cultural fears flagged by the author in some detail.

The striking thing is that the fear still lurks around despite the rising contribution of US shale oil and gas to US energy security. Reading Herbstreuth’s work you feel that in many ways the said fear slant is never going to go away, for it is as much a cultural issue as a geopolitical or economic one, neatly packaged by the political classes for the ultimate ‘Hydrocarbon Society’.

The Oilholic would be happy to recommend Oil and American Identity to fellow analysts, those interested in the oil and gas business and cultural studies students. Furthermore, a whole host of readers looking to ditch archaic theories and seeking a fresh perspective on the crude state of US energy politics would find Herbstreuth’s arguments to be pretty powerful.

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© Gaurav Sharma 2016. © Photo: Front Cover – Oil and American Identity © I.B. Tauris, 2016.

On crude producers’ talks, analysts & academics

As the second month of the third oil trading quarter of 2016, comes to a close both Brent and WTI futures remain in technical bull territory despite a recent cooling down of oil prices. 

The Oilholic is struggling to find any market analysts – including those at UBS, Commerzbank, Morgan Stanley or Barclays to name a few – keeping their faith in (a) the oil producers’ talks pencilled in for end-September producing anything tangible, and (b) whether an output freeze would actually work with oil production in Russia and Saudi Arabia at record highs. 

A real terms cut in production could provide a short-term boost to prices but it does not appear to be even a remote possibility at this point. Yet, the long callers continue to bet on an uptick if the latest US CFTC data is anything to go by. As the Oilholic pointed out in July, demand projections continue to head lower, so yours truly did ask the question in a recent Forbes piece – are the talks as much about stabilising oil supply, or a likely post-Sept dip in China’s demand.

As for viewing the oil price via the prism of demand permutations, Fitch Ratings’ latest assumption for ratings purposes just about sums it up. The rating agency assumes Brent and WTI will average $42 per barrel in 2016, up from its $35 base case in February.

“However, we do not believe that the rapid price recovery seen in the first half of 2016 will continue. The sub-$30 prices at the start of the year approached cash costs for many producers and were unsustainable in all but the very short term. Prices in the $40-$50 range allow most producers to break even on a cash basis, if not to cover sunk costs,” it added. 

Furthermore, market expectations that US shale production will begin to rebound at prices above $50, will keep prices below that level until a supply deficit has eroded some of the inventory overhang.

Away from market shenanigans, another one of those research papers predicting there are no viable alternatives to oil and gas for meeting global energy needs arrived in the Oilholic’s mailbox. This one is from the Head of Petroleum Geoscience and Basin Studies research and Chair of Petroleum Geoscience at University of Manchester Dr Jonathan Redfern and energy recruiters Petroplan; overall an interesting read. 

Sticking with ‘crude’ academic papers, another interesting one was published this month by Luisa Palacios of Columbia University’s Center on Global Energy Policy charting Venezuela’s growing risk to the global oil market.

The country’s problems are well documented, but Palacios claims glaring losses in oil production have "yet to translate into a commensurate fall in oil exports", due to the heavy toll taken by the economic collapse on domestic demand. (PDF download link)

Furthermore, the stability of exports reflected in the data in first half of the year "masks a deteriorating trend with June exports already more than 300,000 barrels per day lower than last year’s average."

Despite all the headline noise about Venezuela, the most severe risks to oil markets thus still lie ahead. Certainly food for thought, but that’s all for the moment folks! Keep reading, keep it crude! 

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© Gaurav Sharma 2016. Photo: Oil platform © Cairn Energy Plc. 

Pump more, even if oil price slumps more mantra

As oil remained in a technical bear market for much of July, we saw well timed quips by major oil producing nations, within OPEC and beyond, fanning chatter of another round of talks aimed at freezing production. And well, its done the trick – both Brent and WTI futures have bounced back from the their low point of August 2, to an above 20% rise as the Oilholic writes this post, i.e. a technical bull run!

Yours truly cannot consciously recommend buying into this phoney rally, because any talks between OPEC and non-OPEC producers face the same impediments as last time, with Iran and Iraq remaining non-committal, and those calling for a freeze (Saudi Arabia and Russia) only willing to do so at record high levels of production. For the Oilholic’s detailed thoughts on the issue, via a Forbes post, click here. 

However, it’s not just National Oil Companies who are in full on production mode. It seems the largest independent US and Canadian oil exploration and production (E&P) companies are still paying their executives more to focus on boosting production and replacing reserves, rather than conserving capital and reducing debt, according to Moody's.

Only four companies of the 15 companies, the ratings agency sampled in July, even included debt-reduction goals as part of their broader financials, or balance-sheet performance goals. For example, Pioneer Natural Resources (rated by Moody’s Baa3 stable) included a ratio of net debt-to-EBITDAX to account for 15% of its executives' target bonus allocation.

Fourteen of the sampled companies use performance award plans linked to relative total shareholder return. Christian Plath, Senior Credit Officer at Moody's, opined that the strong and direct focus on share prices raises certain credit risks by rewarding aggressive share repurchases and the maintenance of dividends even when cutbacks would be prudent.

“The focus on shareholder returns also reflects the E&P companies' high-growth mindset, and may motivate boards and managers to focus on growth over preserving value. Nearly all of the awards are in some way linked to share-price appreciation. While large companies generally try to tie long-term pay closely to share-price performance, the link appears stronger in the E&P sector,” he said. 

Furthermore, Moody’s found that despite the slump in oil prices that has dented E&P company returns, production and reserves growth targets still comprised almost a quarter of named senior executives' target bonuses in 2015.

“This makes it the most prevalent metric in annual incentive plans ahead of expense management and strategy. Given our pessimistic industry outlook, this system of compensation is negative for credit investors and suggests that many E&P companies are finding it difficult to shed their high-growth strategies," Plath added.

Drawing a direct connection between what Moody’s says from a sample of 15 North American E&P companies and the gradually rising US and Canadian rig counts would be an oversimplification of the situation.

However, taken together, both do point to producers stateside either getting comfortable in the $40-50 per barrel price range or finding ways of carrying on regardless with the full backing of their paymasters. Any price boosting production freeze by global oil producers will be warmly welcomed by them. That’s all for the moment folks! Keep reading, keep it crude! 

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© Gaurav Sharma 2016. Photo: Pipeline warning sign, Fairfax, Virginia, USA © O. Louis Mazzatenta / National Geographic.