adam robinson oct 12 2009

8/3/2019 Adam Robinson Oct 12 2009

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Oil and the Great Recession: Physical Realityor Investor Fantasy?

Adam RobinsonRBS Sempra CommoditiesOctober 2009


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Topics

The Great Recession and oil fundamentals

Oil and stagflation

Momentum trading and oil speculation


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The Great Recession has created substantial spare capacity in the

oil market, for now


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But supply does matter if theres a possibility of a storage max-out

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$30

$40

$50

$60

$70

$80

$90

$100$110

$120

Cushing Crude Oil Inventories (Left Axis) WTI Prices, Weekly Avg (Right Axis)

WTI falls as Cushing

nears max storage

Mn bbls of

Inventory

WTI Prices,

weekly avg

Lower inventories let

"other factors" dominate

WTI

Inve

ntorie

s


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Since February, the glut has shifted from crude to distillate, with some

fearing that a distillate storage max-out this fall would weigh on crude

Distillate Stocks (mmb)

Source: EIA

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J F M A M J J A S O N D

Prior 5 Year Range Prior 5 Year Average 2008 2009


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Moreover, distillate spreads have been lower than gasoline spreads for

so long that if possible, storage operators have put heating oil in tank

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2M-3M Heating Oil Spread 2M-3M Gasoline Spreadcents/gallon


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However, the market has been able to find an outlet on the water

for distillate, so refiners have been able to continue to produce

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2M-3M Heating Oil Spreadcents/gallon

Storing oil products on the water is economic


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But where then to put the gasoline?

Gasoline Stocks (mmb)

Source: EIA

Feb-08

236Sep-09

213

180

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J F M A M J J A S O N DPrior 5 Year Range Prior 5 Year Average 2008 2009


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Conclusion: Storage economics link the present to the future

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Heating Oil Gasoline Crude Oil$/bbl


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So what then are investors thinking about?

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OECD Oil Demand Non-OECD Oil DemandMn B/D


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Will cyclical factors in the economy finally start to create more oil

demand in the US? Some banks believe so

Source: Bloomberg, Morgan Stanley Commodity Research


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But even if fiscal stimulus turns to drag and the economy does the

W, will investors sell commodities?

August 2009 Update


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US fiscal deficit could be the stagflation trigger

Continued Unprecedented Rise in the US Fiscal Deficit

Interest Rates Rise

Fed does nothing

Federal borrowingcosts balloon;

interest rate rise

Higher interest ratesand fear of higher

taxes push economyback into recession

Recession hurts taxrevenues further,

pushing up deficits andinterest rates, starting

the negative cycleagain

Fed loosens policy

Monetary policy rulesin time indicate

tightening needed

If Fed maintains looserpolicy, fears of inflationare stoked, pushing upnominal interest rates

Inflation Loop: Themore loose policycreates inflation

fears, the more itsneeded to push down

nominal yields

Recession Double Dip


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Why the Fed wont take the punch bowl away for a while

Rolling 12-month volatility of US CPI


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So far, what have we concluded?

The physical market is sloppy But we have the capacity to store the glut

Curves are reshaping to make that storage economic

Investors can drive the price of oil

As long as the Fed doesnt take the punch bowl away,commodities should do well in a recovery or stagflationscenario


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All this analysis presumes that investors are buying or selling oil

based on their view of some aspect of the forward fundamentals

CTAs trade solely on price.Why? Because it works

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Technical Bullish Indicator Technical Bearish Indicator Price

$/bbl


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Where does momentum come from in commodities?

Inelasticity of supply and demand

Inventory trends tend to persist

Autocorrelation of inventories is above 90% for

the vast majority of commodities

Inventories also relate to pricesPrice trends, therefore, tend to persist as well


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Inventories predict prices, but prices predict prices better

Long-short portfolio of commodities sorted byinventories and sorted by prior spot returns

(1) The Fundamentals of Commodity Futures Returns. Gorton, Hayashi, and Rouwenhorst. NBER Working Paper No. 13249. Published July 2007.

13.4%

8.8%

16.0%

12.8%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

Inventories 12-mth Spot Returns

Avg Annual Return Std Dev


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But prices predict prices even better

Inventories are difficult to observe

Past prices are more informative of futureprices than observable inventories

Inventory problems: publication delays, revisions, anddata limits in non-OECD

Which inventories should be counted? Inventories that cannot be immediately delivered?

Inventories held in raw form below ground?


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In addition to the momentum traders, banks are also positioned to

push prices toward $60 in the short run

When banks buy calls, they have to sell ina rising market

When banks sell puts, they have to sell oil

in a falling market

Currently producers have bought $60 putsand sold $80 calls to banks


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On the long side are pension investors, China and retail players

China willing to buy in size at $55 for strategicstocks

For retail players, peak oil and China provide aplausible enough long-term fundamental bull story

without any clear price target

Young/immature asset class + career risk in

bucking a trend = upward pressure on oil prices bysome index investors


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So what have we concluded, and where are prices going?

To forecast prices with any accuracy, the physicalglut is relevant but not paramount

Ultimately, either way the economy goes,commodities should outperform other risk markets

Momentum traders turned bearish in Septemberand that indeed could be the short term trend as aknee-jerk reaction to recent economic dataworsening

Banks may also have to sell the market down to$60 to hedge positions


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Ultimately, however, the bull case is intact, and if the economy

rebounds before 2015, prices could spike

Brazilian deepwater = at least a North Sea of oil

The rig market has finally responded, but first output 5 years away

Alternative energy and conservation also will play a part

Another price spike is likely before 2015 if the economy rebounds

Global Deepwater Rig Deliveries

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0 1

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30 29

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510

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2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

# rigs

Source: ODS-Petrodata


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Intro to RBS Sempra Commodities


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RBS Sempra Commodities Overview

Overview

On 1 April 2008, RBS and Sempra Energy formed RBS Sempra Commodities LLP (RBS SempraCommodities).

RBS Sempra Commodities is a top tier global commodities trader whose primary activitiesinclude

Physical commodities merchant (buyer from producers, seller to consumers)

Commodity derivatives (financial trading)

Creation of risk management products and solutions (combination of financial and physical)

RBS Sempra Commodities principal commodity lines include the following Energy natural gas, power, coal, crude oil and products

Metals base metals, precious metals, plastics and steel

Other green credits, bio fuels, agricultural commodities

RBS Sempra Commodities profile Geographically diverse trading in Western Europe, CEEMEA, Asia Pacific, and the Americas

Prudent strong risk management controls have been tested during the last several commodity cycles

Sizable employs approximately 1,100 FTEs worldwide and transacts with over 2600 customers


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Global Commodities Presence

Calgary

Houston

Stamford

London

Geneva

Singapore


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Trading Capabilities


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Natural Gas

Business Overview

Worldwide natural gas RBS Sempra Commodities is an international natural gas marketer with a primary focus on the NorthAmerican (ranked #1 non-producing gas marketer in North America in Q1 2009 by Platts) and European wholesale markets as wellas the international Liquefied Natural Gas (LNG) market. RBS Sempra Commodities Natural Gas franchise offers physical trading,market making, and risk management solutions to its global customer network.

RBS Sempra Commodities natural gas services include

North American natural gas

Continental United States

Canada (western and eastern border points)

European natural gas

United Kingdom

Germany

Netherlands

Belgium

LNG trading

Gas storage Derivative and Structured Products (financial and physical)

Management of physical assets and options

Customer Types

Exploration & production

Utilities

Independent powerproducers

Industrials

Commercial

Residential (energyaggregator supply)

Municipalities andgovernment entities

Pipelines and storage

Trading companies

Financial institutions

Hedge funds


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RBS Sempra Commodities is the #1 Physical Trader amongst

bank platforms

We are not a producer affiliate.

As such, we are not limited to marketing gas from our ownaffiliated assets.

This reduces the likelihood of conflict of interest and enables usto offer more competitive pricing.

RBS Sempra is uniquely positioned to provide

extensive expertise in the physical marketcombined with a strong presence in thefinancial market.


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Oil and Oil Products

Business Overview

Worldwide crude oil and oil products RBS Sempra Commodities is a worldwide trader of oil and oil products, specializing inphysical delivery of crude oil and crude related product, storage and transportation, as well as on-shore and off-shore blendingcapabilities. RBS Sempra Commodities oil desk offers physical trading, market making, and risk management solutions to itsextensive customer network.

Worldwide oil and oil products services include

Crude (WTI, Brent and Dubai benchmark crudes)

Heavy products (high and low sulfur fuel oil, and bunker fuel)

Light products (jet, naphtha, kerosene, gasoline, distillates)

Natural Gas Liquids (NGLs)

Physical storage

Physical and OTC products for a majority of crude oil and oil products

Derivative and structured products (financial and physical)

Customer Types


Utilities

Industrials

Commercial

Pipeline and storagecompanies

Integrated oil companies

Refiners

Financial institutions Hedge funds

Traders and marketers


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Power

Business Overview

Worldwide power RBS Sempra Commodities is an industry leading power marketer with a primary focus on the North Americanand the European wholesale markets. RBS Sempra Commodities Global Power team offers physical trading, market making and riskmanagement solutions to its extensive customer network

RBS Sempra Commodities power services include

North American power (physical trading and otc)

United States (East, West, ERCOT)

Canada

European power (physical trading and otc)

United Kingdom

Nordic Area

Continental Europe Germany, Austria, France, Netherlands, Belgium and Spain

Emerging power markets Poland, Czech Republic, Slovakia, Hungary, Croatia, Serbia, Romania,Bulgaria, Greece, Italy, Portugal

Await deregulation of markets in Asia, Latin America, CEEMEA

Structured products (financial and physical), management of physical assets and options

Customer Types

Utilities


Commercial

Industrial

Trading and marketingcompanies


Hedge funds


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Metals

Business Overview

Worldwide Metals RBS Sempra Commodities is a leading metals trading group, specialising in base metals, precious metals, steeland plastics. RBS Sempra Commodities offers market making and execution, risk management solutions, physical trading andwarehousing to its extensive customer network.

Worldwide metals services include

Physical trading

Provide liquidity and a reliable partnership to some of the industrys largest producers and consumers globally

Base Metals, Plastics & Steel - focused on trading LME-deliverable material both on-warrant and physicaland concentrates across all major world locations

Warehousing

Approved by the London Metal Exchange, the London International Financial Futures and Options Exchangeand the New York Board of Trade to store and issue exchange-traded warrants for commodities including aluminium,aluminium alloy, copper, zinc, lead, nickel, tin, plastics, steel, cocoa and coffee

Futures and structured products

The Royal Bank of Scotland plc is a ring-dealing member of the London Metal Exchange (LME)

The Royal Bank of Scotland plc is a member of the London Bullion Market Association (LBMA),

a member of the London Platinum and Palladium Market (LPPM)

Our range of hedging products includes:

Structured swaps and options

Averaging

Two asset arbitrage options

Cross commodity indexation

Customer Types

Producers

Smelters

Industrials Commercial


Hedge funds



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Coal & Dry Bulk Freight

Business overview

Worldwide coal RBS Sempra Commodities is a major participant in the international physical and financial wholesalecoal and dry freight markets. RBS Sempra Commodities coal franchise offers physical trading, market making, andrisk management solutions to its extensive customer network.

RBS Sempra Commodities worldwide coal services include

Steam/thermal coal trading physical and financial Structured products (physical and financial), management of physical assets and options Producer financing

Core competencies:

Structured transactions Hedging structures Marketing Producer optimization (continental arbitrage) Directional and relative value trading

Customer Types

Coal aggregators andproducers

Utilities

Independent power

producers

Industrials

Steel producers

Trading and marketingcompanies


Hedge funds


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Agricultural Products

Business overview

Agricultural products RBS Sempra Commodities agricultural products trading group has a growing business in ethanol and bio-fuels primarily focused on North America. Through its Henry Bath Warehousing division, RBS Sempra Commodities providesstorage for coffee and cocoa for London International Financial Futures and Options Exchange (LIFFE) and New York Board ofTrade. The agricultural products trading group is committed to growing its grain and oilseeds business to include financial

markets worldwide as well as physical markets.

Agricultural products services include

Ethanol Physical and financial

Risk management solutions

North American listed grain markets Corn

Wheat

Soybean

Coffee

Cocoa

Customer types

Suppliers

Industrials Commercial

Bio fuels project



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This report reflects the current views of RBS Sempra Commodities and is intended for informational purposes only. RBSSempra Commodities may make investment, hedging and trading decisions inconsistent with the views expressed in thisreport and/or based on information not reflected in this report. RBS Sempra Commodities assumes no obligation to

advise of any changes in its views and assumes no responsibility or liability for the accuracy or completeness of theinformation provided or any loss suffered. RBS Sempra Commodities does not act as a fiduciary or financial, investmentor commodity trading advisor for its customers, each of which is responsible for its own investment, hedging and tradingdecisions.

The Royal Bank of Scotland plc. Registered in Scotland No. 90312. Registered Office: 36 St. Andrew Square,Edinburgh EH2 2YB. The daisy device logo, Make it happen and RBS are trade marks of The Royal Bank of ScotlandGroup plc. Sempra is a trade mark of Sempra Energy.

Sempra Energy Trading LLC and Sempra Energy Solutions LLC, each a subsidiary of RBS Sempra Commodities LLP,are not the same company as the utility, SDG&E or SoCalGas, and Sempra Energy Trading LLC, Sempra EnergySolutions LLC and RBS Sempra Commodities LLP are not regulated by the California Public Utilities Commission.

Disclaimer

adam robinson oct 12 2009

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