Tag Archives: crude

Trading Ukraine Uncertainty

Removing the politics of the Russia-Ukraine issue and focusing on the economic implications of Russia’s bloodless annexation of the Crimean peninsula puts some trading opportunities on the table as global risk premiums jump. In order to do this, a couple of suppositions must be declared. First and most importantly, the United States will not actively engage Russian troops. In many ways, this is a replay of the Georgian conflict in 2008. Georgia was in revolt against Russia and wanted closer ties to the European Union and the US. Their cause was quickly championed by Western leaders until it became obvious that neither the European Union, The United States nor, NATO would take any military action to defend Georgia against Russia. This episode set the precedent for the current situation.

Continue reading Trading Ukraine Uncertainty

Global Glut Going Nowhere

The drop in gas prices over the last month has been a relief to us all. The economic sanctions placed by the European Union, Canada and the U.S. on Iran has simply shifted the flow of Iranian crude oil from west to east. The net result has been more oil on the global market with China, India and Russia picking up cheaper oil from Iran due to the lack of competition from western buyers. One would think that cheaper oil to the BRIC countries would be just the catalyst needed to help them develop their own internal demand for goods and services through the creation and evolution of their own middle class. Unfortunately, we are in an economic phase of global deleveraging and even the stimulus of low fuel prices will not keep their engines turning fast enough to save us from a second half slowdown here in the U.S.

The thesis of those who run our economy has been: If we can just provide enough economic grease to keep our own wheels turning the development of BRIC economies will, eventually, create demand for our goods and services. This is still probably true in the long run and the forward demand projection can be used to our advantage through tracking commercial trader purchases via the commitment of traders report. What a different world it has become when our economic horse has become hitched to someone else’s wagon.

China has been trying to engineer a soft landing for their economy through government expenditures on infrastructure and the attraction of foreign direct investment. The struggle can be seen in their manufacturing output, which has declined for seven straight months. They’ve also lowered their lending reserve requirement to stimulate financing which has dropped by 19% year over year and is at its slowest pace since Q1 of 2007. This may simply add further capacity to an already slack market in the wake of China’s 15-year building boom. This is also a futile attempt to increase home ownership, as home ownership is one of the few ways Chinese people have been allowed to invest their newfound prosperity and therefore, already represents an outsized portion of their personal portfolios. The Chinese result will sacrifice its citizens as the high water mark buyers and lead to further class separation between the builders who profited and the people who got stuck with the bill. This will leave them with little disposable income to buy our Apple computers and Fords.

The Chinese situation looks hopeful compared to India. The trouble in India is as much political as it is structural. Indian politics are confusing even to the Indian newspapers. It’s easy to go from the Times of India to India Press or any one of their nearly 2,000 daily publications and find contradictory information. Foreign businesses find it nearly impossible to find the right agencies for the right permits. Even if one does, it is quite possible that the rules will not only change but, be made retroactive thus, invalidating the entire business plan of the entity that just put the whole package together. This is exactly what happened to Wal-Mart between December of 2011 and February of this year. Permits were voided and taxes created by the new policy were made retroactive. Foreign direct investment is drying up rather than fighting its way through the bureaucratic red tape.

This still leaves Brazil and Russia to save us. Brazil just passed England to become the sixth largest global economy. However, Brazil’s balance of trade slipped into negative territory early this year for the first time since the economic crisis and once again ten years prior to that. Furthermore, their latest GDP readings were just positive enough, 0.34% to escape the technicality of recession. They are battling the decline by cutting interest rates for the seventh time in a row. This easing cycle has seen their rates decline by more than 400 basis points, including May’s cut.

Finally, Russia’s economy is shepherded by the fluctuations of natural resource prices on one hand and Vladimir Putin’s political inclinations on the other. The Russian shadow economy remains one of the largest physical cash exchanges in the world. The government recently limited official cash transactions to approximately $20,000 U.S.  Dollars. The political confusion has led to a flight of foreign capital out of the country. Putin’s sincerest desire seems to be the development of a quasi socialist Russia in which the natural resources are shipped abroad by governmentally monitored, semi state controlled companies. Putin then wants access to these revenues to fund his own programs and basically, become the Arab peninsula of natural resources while triangulating politically with Iran and China.

It doesn’t matter whose horse we hitch our wagons to if we’re all headed down the same path. The global balance sheet expansion experiment that hasn’t worked worth a darn in Japan is now being replicated in Europe just as it has been put to work here in the U.S. The world will pull through it and those countries that have been willing to make the tough choices, either through an enlightened electorate body or, the tight fisted hand of an autocratic leader will be the first ones to rebound. Our future, I’m afraid, looks more like the path of Japan’s lost generation than ever.

Over Priced Crude – Not Our Problem

The fall of dictators in North Africa and the refusal of others to leave has created a political mess throughout the oil producing regions. Tunisia, Egypt, Libya, Iran and others are all facing internal military conflicts. Some may turn into civil wars while others may squelch civil unrest through political concessions or direct government aid to their people. However, when it comes to the world’s supply of oil, the method of reconciliation isn’t nearly as noteworthy on the open markets as the fact that there are issues to reconcile in the first place. The era of instant press and relatively equal opportunity to generate information has created millions of on site reporters in the form of the common man producing cell phone videos, Tweets and Facebook networks.

The news has created an oil spike. The manic pursuit to grab the headlines has brought speculation in oil futures trading to new heights. Libya is responsible for 2% of global oil output. Egypt and Tunisia are irrelevant and Iran produces a sour crude of such low quality that they don’t have the domestic capabilities to refine it themselves and have to import 40% of their gasoline. Saudi Arabia has already broken ranks with OPEC and volunteered to increase output to appease the market and I wouldn’t be surprised if Obama tapped the strategic reserves.

There is a fundamental disconnect between the price of oil on the open markets and the fundamentals that move prices over the long term. The crude oil traded in the U.S. is typically referred to as West Texas Intermediate (WTI) while the oil that is produced and traded in the North Sea, Iran and Russia is Brent Crude. Brent crude is a lower quality crude that is both produced and consumed throughout Europe and Asia. WTI is easily refined and produced in the Gulf of Mexico, Alaska and the Black Tar Fields of Canada.

WTI crude oil is stored in Cushing, Oklahoma and the storage tanks are nearly full. Commercial traders of WTI strongly believe the market will not support these prices. In fact, they have accumulated a record short position. They have never sold so much of their future production at market prices as they are doing now. This is exactly opposite the of the Commodity Index Traders (CIT’s) and small speculators who have jumped on board the news events. History has shown that no one knows their market like the people who make their living in it. Therefore, it is not wise to bet against commercial traders for very long.

It is comforting to believe that the commercial traders may be right and that oil won’t stay at these levels for very long. However, Middle Eastern politics is a wild card game at best. The Schork Report states that we could have $4 gasoline with WTI crude trading at $115 per barrel. This is due to the refining and crack spread issues we discussed two weeks ago. Gas didn’t hit $4 in 2008 until oil traded over $145. This would have a serious effect on our economy. Ball State released a paper on January 21st, stating that GDP will decline by 2% if oil climbs to $110. Furthermore, 10 of the last 11 recessions accompanied rapidly rising oil prices.

It’s already been speculated that Obama may tap the strategic reserves to prevent higher energy prices from dragging down our struggling economy. Saudi Arabia isn’t the only oil exporter aware of the bearish fundamentals of the oil market and I suspect that other oil producing countries will sell all the forward production they can at these prices. I don’t expect energy inflation to dictate monetary policy. Ben Bernanke co-authored a paper in 1997 stating that the correlation between high energy prices and recessions had more to do with the over tightening of fiscal policy to clamp down on inflation than did the actual price of energy. Therefore, I don’t expect to see knee jerk rate hikes in response to the howls of inflation hawks.

Currently, the primary beneficiary overseas is Russia. They have the reserves, refining capacity and infrastructure to supply old world Europe and Asia. These are the areas most greatly affected. They are fully industrialized and their economies are heavily reliant on oil imports. The question we should be asking ourselves is why we spend between $50 and $100 billion a year to protect roughly $35 billion dollars worth of the oil we import. This amounts to the 15% of our total U.S. imports that come from the Golden Crescent. Two separate pools of academic research, nearly 10 years apart, 1997 and 2006, have addressed this issue and gone nearly unnoticed. Why is it that we pay the bill to keep the oil flowing overseas to other countries?

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Crude Oil vs. Natural Gas Ratio Spread

This week’s trade has been all about the spread between natural gas and crude oil. Using inter-market analysis allows us to compare the value of substitute goods. In this case, we can compare the price of crude oil to the price of natural gas to determine what price levels it becomes cost efficient for the markets’ participants to shift their energy needs from crude oil to natural gas and vice versa. The key to this type of analysis is using the proper pricing methodology. The calculation of the crude oil vs. natural gas spread is done using a ratio spread. Dividing the price of natural gas, currently around $4 per million metric BTU’s into the price of a barrel of crude oil at $77 gives us a ratio of 19.25. This ratio peaked at an all time high of 22.7 in April of this year.  A spread ratio closer to 12 would represent an average relationship over the last few years.

 

The trick to trading this ratio is to try and create equal dollar movement in both contracts. We want the trade’s profit or loss to be accurately reflected by the ratio’s movement. If we were to simply do a one to one spread, buying natural gas and selling crude oil, we would end up with an imbalance on the side of the trade that has the largest daily dollar movement.

 

This problem is solved by using the average daily range multiplied by the market’s point value to provide us with the average daily dollar fluctuation of the individual markets. Crude oil’s nine day average range is exactly $2 per barrel. There are two sizes of crude oil contracts, the full size and the half size. The full size is $1 per point, which means an average daily range of $2,000. The half size obviously yields an average daily cash fluctuation of $1,000. The natural gas market has an nine day average range of .1563. This market also has two contract sizes. The full size contract which, has a daily cash fluctuation of $1,563 and a quarter size mini contract which, fluctuates about $390 per day.

 

Now, we have the pieces to construct a trade that is dollar value neutral and will accurately reflect our natural gas to crude oil ratio spread. Ideally, we would sell one full size crude oil contract with a daily fluctuation of $2,000 and buy one full size natural gas contract with a fluctuation of $1,563 plus an additional purchase of one mini natural gas with a daily fluctuation of $390. This gives us an average of $2,000 daily movement in the crude oil and $1,953 daily fluctuation in the natural gas.

More information on crude oil and natural gas can be found at NY Energy Futures.com

 

This type of ratio spread can also be used in grain markets when trying to spread corn or wheat against beans or even the corn to cattle spread. Please call with any questions regarding this trade or, spread trading in general.

 

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk in investing in futures.

Natural Gas Bottoming?

November natural gas may very well be forming a tradable bottom at these levels. There are several reasons for this.

1) Seasonal patterns in November natural gas tend from the last week of August through the first week of September.

November Natural Gas Seasonal Chart

2)The commitment of traders commercial category continues to add to their positions, adding 11,000+ contracts last week which places them within shouting distance of their all time record long position. Perhaps, more importantly, commercial traders are becoming increasingly bearish on crude while building net long positions in natural gas.

3) The crude oil spread versus natural gas is bumping up against solid resistance at crude oil priced at 20 times the natural gas price. This is reflective of the commercial traders price action.

4) The COT Signals triggered a buy signal for Monday’s trade which corresponded with a technical breakout to the high side.

There are two natural gas futures contract sizes. The full size carries a margin of $5,400 and recent average day range of $1,600. The mini contract is 25% of the full size contract. The margin requirement is $1350 and its daily range is around $400.

Please call with any questions.866-990-0777

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk in investing in futures.

Who’s Right?

 

This blog is published by AndyWaldock. Andy Waldock is a trader, analyst, broker and asset manager.Therefore, Andy Waldock may have positions for himself, his family, or, hisclients in any market discussed. The blog is meant for educational purposes andto develop a dialogue among those with an interest in the commodity markets.The commodity markets employ a high degree of leverage and may not be suitablefor all investors. There is substantial risk in investing in futures.

This morning, (11/9/09) the U.S. Dollar is significantly lower and testing the ’08 lows. Gold is making new highs and holding over $1000 per ounce and crude is up $1.60. This is as it should be in a Dollar devaluing world, global assets priced in Dollars should climb in response to its decline. Economics 101 tells us that there is a negative correlation between global asset price and the price of the Dollar.

So far so good, right? Not so much. Every weekend, I download the Commitment of Traders Reports to see what the different categories of traders are doing. The three main categories  I track are the commercial traders, the small speculators and the funds. As many of you know, a big portion of my trading is based on the momentum of the commercial traders actions. There are three main reasons for this. First, they understand the fundamentals of the markets they trade – their markets are their business. Second, as the fundamental players in the business of their markets, they have a vested bottom line interest in pricing their products profitably. Finally, when they act collectively, based on their fundamental knowledge of their markets, they have the resources to move markets. Therefore, when they move, I want to be on their side.

Typically, the commercial positions rise and fall with the ebb and flow of the markets. They may act within the channel boundaries of a trending market or, they may be trading against support and resistance in sideways markets but, typically, they use their fundamental knowledge to pick the right side for the coming period of time.

Occasionally, we see these relationships pushed to the extreme and this is one of those times. I’ve selected three markets to illustrate this point – Gold, Crude Oil and the U.S. Dollar. As the Dollar has declined over this past year, we’ve witnessed a steady building of commercial long positions with a net accumulation of approximately 20, 000 contracts. Crude oil has seen commercial net short positions increase by more than 100,000 contracts since July. This also places Crude at a new net short record, eclipsing the August of 2007 mark. Finally, we have the Gold market. It’s been in the news everyday. Beginning in September, we can see that once the market started to breakout above the $990 level, commercial traders began to increase the pace of their selling. They have increased their net short positions by more than 30%. The final point to make is that people on the other sides of these trades are just that, people. Remember that it takes both a buyer and a seller to create a trade. The commercial entities need someone to take the other side of their trades. Those someones are the small speculators and the commodity funds. The commodity funds will always maintain a certain percentage of their assets in a given market. They adjust their asset base according to price, adding to their positions as prices rise and paring back their positions as the markets fall. Most importantly, they position themselves from the LONG SIDE ONLY. The small speculators can and do, trade both sides of the market and they are typically long at the top and short at the bottom. So, if the commercials have accumulated large, in some cases historical, positions that are opposite the markets’ current direction, who do you think is on the other side of their trades with historically sized positions betting on the trend to continue?

These are interesting times with the elastic band of the markets stretched to historical proportions. As a trader, I’m never one to bet my money against a trend’s continuation as my bottom line is only effected by the last traded price. Markets can remain irrational far longer than I can hold a bet against them. However, it would behoove those participants on the side of the small speculators to tighten up their protective stops as a reversal of fortune could send a record number of players heading for the exits.

 

A Quick Memory Test

Q:Last week, crude oil fell $20 per barrel. According to the Department of Energy’s “First Purchase Price,” when was the last time crude traded at $20 per barrel??????

A:March of 2002! I certainly thought it was pre-911.

Click on the link for the full DOE price series.

8-3 doe.asp.xls

 

 

Rare Occurrence in Crude

The fundamentals in crude oil have continued to erode since February of this year. The highs, over the last $40, can be viewed as a “bubble.” This bubble has been fueled neither by Commodity Index Traders and large speculators, nor Hedge funds and carry trades. I think a strong case can be made that the last leg of this rally should be attributed to large producers unwinding their forward hedges. Producers and forward short hedgers are subject to human error just as individual traders are. Hedge transactions manifest themselves in the Commitment of Traders data as commercial purchases when the market makes new lows and as commercial sales when the market rallies. Just as most economic decisions are made, “at the margin,” so too are the hedger’s trading decisions. Their traders use their understanding of the fundamentals in their market to create oversold and overbought zones within the market’s natural movement and attempt to trade accordingly.

This strategy works for them the vast majority of the time.  However, when a market unhinges from fundamental factors and begins trading on sentiment, the commercials find themselves at the mercy of the public at large. Using the chart below, the white line represents the commercial index of positions on a scale of 0 to 100. Zero equals totally short and can be seen at the following points, (5/06, 7/07, 8/07). One hundred equals totally long and can be seen at, 6/05 and 10/05. Currently, the index is at 78, the highest since a 79 reading in February of ’07.

The yellow line represents total open interest. Technically, speaking, in a healthy trend, open interest should increase as the market moves out to new territory, either higher or, lower. This has not been the case with crude oil. Open interest peaked in July of ’07 and has continued to decline ever since. Open interest now stands at 1.3 million contracts, the lowest since March of ’07.

Furthermore, I have discussed, at length, the negative spread we’ve seen between the front month prices and the later expirations. In real terms, this backwardation in prices is evidence that producers don’t believe that we will be near these prices as the deferred contracts come due for delivery. Producers continued to sell the deferred contracts in order to lock in profits at levels they don’t believe will hold into the future.

Lastly, over the last previous weeks, we have seen the total commercial position shift from net short, to net long, with the market at all time highs. Therefore, I would suggest that the rally from the January highs, under $100 per barrel through the current highs, over $145 has been driven by commercial capitulation and a speculative blow off, rather than fundamental supply and demand issues. Ultimately, it proves the old adage true for everyone, even the big guys, “The market can remain irrational longer than one can remain solvent.”

Historically, there have only been three times when commercial positions have shifted from net short, to net long while the market was at all time highs.  The market declined, twice, by an average of 22.5% and once, the market rallied by 5.8%. Clearly, we are on the cusp of a top. Given the magnitude of a possible decline, one may be advised to purchase put options. Those wishing to sell futures may wish to wait for a close under $140 to initiate a short position.

Crude Fundamentals Remain Negative

The underpinnings of the Crude Oil market do not justify the current market prices.

1) Crude made new all time highs Friday….on declining open interest, which peaked last July.2) Distant delivery for Crude isn’t charging the storage and insurance premiums it should in a healthy bull market.3) Using NYSE prices, oil stocks are pricing it at $75 per barrel. 4) According to Business Week, the major players have done little to increase capital spending….even at these prices.