volatility analysis - platts · inventories in the us were as high as 532.34 million barrels which...

APRIL 2017

VOLATILITY ANALYSIS / EMEA

OIL

APRIL 2017VOLATILITY ANALYSIS EMEA

2© 2017 S&P Global Platts, a division of S&P Global. All rights reserved.

CRUDE OIL

�� Dated Brent prices soared in the first half of April on two key fac-tors: geopolitical tensions between the US and North Korea and disruptions in Libya�� The second half of April saw poor buying interest in the North Sea caused by weakness in Asian demand�� A large volume of floating tankers are waiting to be sold around Singapore and China’s ports�� Many refineries in the Far East are slowly getting back online after their maintenance period�� OPEC production was at 31.85 million b/d in April according to S&P Global Platts survey�� The large differential between Dated Brent’s and ICE Brent futures’ monthly volatility indicates that some changes in the fun-damentals might be on the horizon�� Some market turbulence should be expected but overall the mar-ket should stabilize in the run up to May 25

The first half of April saw Dated Brent prices soaring because of two main factors: geopolitical tensions between the United States and North Korea and disruptions to important oil terminals in Libya due to the civil war and rebel militias. Nevertheless, the buying pressure did not manage to drive prices above the $55-$56/b range because the North Sea complex began deteriorating from mid-April onwards.

Specifically, the market trend started to tremble around April 18 when BFOE grades began to drop as a consequence of uncertainty in Asian demand. The Dubai/Brent EFS was favorably cheap in mid-April which supported the physical arbitrage of BFOE grades towards the Far East but, surprisingly, many Brent, Forties and Ekofisk cargoes couldn’t find buyers despite the fact they were being offered at competitive prices. The reason for such weak buying interest in the North Sea, despite advantageous arbitrage economics, is clearly a weakness in Asian demand. It is worth noting that the Asian market does not really need additional oil from the North Sea because, around Singapore and China’s ports, a large volume on floating tankers is waiting to be sold. The competitive Dubai/Brent EFS structure encouraged market participants to load BFOE grades in the North Sea and send them to the Far East even if the cargoes were unsold and that is precisely why there are so many floating barrels in that area.The month of April was characterized, as far as the physical market is concerned, by a weak Asian appetite due to the fact that refineries in the Far East are slowly getting back online after their maintenance period. The largest market participants involved in trading North Sea grades, during the month of April, have been consistently offering BFOE crudes at lower prices because, given what happened in March and April, it is very likely that they will tend to play conservatively. In fact, internal European demand, should Asian demand not pick up anytime soon, will be the only way to clear North Sea tankers and no trader wants to end up with an unsold cargo.Internationally, the balance between US supply and OPEC overall production, which was at 31.85 million b/d in April according to the S&P Global Platts survey, was once again in the spotlight of many market participants. The International Energy Agency, on April 13, released its report according to which:

1. The 2017 global oil demand growth forecast had been cut to 1.3 million b/d (it was 1.4 million b/d)

2. Global crude oil supply fell to 95.98 million b/d3. OPEC overall production in March dropped to 31.68 million b/d4. The global crude oil market has almost reached balance

between demand and supplyClearly, it is difficult to talk about balance with the ever-increasing

crude oil production in the United States and the general “feeling” in the market is that OPEC members will have to extend the cuts at least until the end of the 2017. On April 19, the Energy Information Administration released a forecast on the American crude oil market stating that the total US crude output will reach the record figure of 9.9 million b/d while the yearly average production throughout the entire 2017 should be around 9.22 million b/d. Furthermore, the Saudi minister Khalid Al-Falih stated that OPEC and non-OPEC members (read Russia) are likely to extend the production cuts if the level of global inventories does not fall below a certain level. He also added that the cuts could be extended, if necessary, to nine or 12 months “because our target is the level of inventories and this will be the indicator of the success of our initiative."

The battle between the Saudis and American crude producers will hardly see any winner in 2017, in fact, at the end of April crude inventories in the US were as high as 532.34 million barrels which implies that the current level is more than 30% higher than its five-year average. Overall, the global oil market expects OPEC members to keep producing less than 32 million b/d for the rest of 2017 but, on the other hand, if the American production keeps rising and US rig counts

DATED BRENT

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DATED BRENT � ICE FUTURES

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continue to grow, the Saudis will just end up losing market share which is exactly what they have been trying to avoid since June 2014. In other words, they are stuck between the proverbial rock and a hard place.Overall, the Dated Brent market lost 3.24% in April, from $52.07/b to $50.39/b, while its monthly volatility dropped by 8.86% going from 26.82% to 24.45% in 18 trading days.

Dated Brent’s volatility curves are all moving very close to one another but it seems the fluctuation rate might have found a new short-term equilibrium point. Clearly, the threat of a contraction process is always there and the month of May will possibly prove to be a particularly difficult trading month because on May 25 OPEC will officially meet again and will have to decide whether to keep the production cuts or not. Speculators and commercials are definitely taking positions to profit and hedge from and against all market movements that will generated by their decision and the “physical vs paper analysis” can help in detecting such differences.

Dated Brent’s April average price equaled $52.53/b while ICE Brent futures averaged $53.73/b during the same period implying an average price differential of $1.19 in favor of futures over physical. This figure is slightly higher than the year-to-date average of $1 while the 2 year

average settles around $1.19 with Brent futures prices consistently higher than Dated Brent’s. Nevertheless, the most interesting divergence comes from volatility.

The fluctuation rate of the Brent physical market closed the month of April at a 16.44% premium over ICE Brent futures, however, the overall monthly differential was 11.56% which is substantially far from the long term one (1.04%). The large volatility differential is due to Dated Brent’s monthly volatility being constantly higher than that of Brent futures implying that some changes in the fundamentals might be on the horizon. Nevertheless, Dated Brent’s volatility curves are showing that a potential new equilibrium level might be in formation (possibly only in the short term) while the “physical vs paper” analysis shows that both physical and futures volatilities are now fluctuating around it. Consequently, it is likely that both Dated Brent’s and ICE Brent futures’ volatilities will tend to increase in the very short term but will stabilize in the coming weeks implying that some market turbulence should be expected but overall the market should also gain a few dollars in the run up to May 25. Nonetheless, it is highly unlikely that the $54-$55/b range will be breached.

REFINED PRODUCTS

�� The outlook on Eurobob gasoline prices is positive but the uptrend will tend to be slow and far from aggressive�� The volatility curves of the diesel ARA market indicates that they will tend to move slightly higher in the very short term but, on a monthly basis, they will just continue to move sideways support-ing prices�� May is a very delicate month for the jet market because of the OPEC meeting on May 25 but also because many market partici-pants are expecting the summer flying season to increase demand�� The outlook on the fuel oil 3.5% Rotterdam market is positive and prices could potentially, although very slowly, uptrend in the short term

The Eurobob market has been pulled in two different directions by sup-ply/demand dynamics. In fact, very healthy West African demand has been keeping the European gasoline market up with around 16 million barrels exported to the region. Clearly, the aggressive buying pres-sure coming from Africa has contributed to tighten the local market. On the other hand, though, the US EIA reported a build of 1.5 million barrels in mid-April with total gasoline stocks reaching more than 237 million barrels. High gasoline inventories are actually normal in April because many refineries produce more gasoline to counterbalance the usually overwhelming summer demand. Clearly, the inventory build has slowed down a bit the European gasoline market because the trans-Atlantic arbitrage from Northwest Europe heavily relies on this arbitrage. Nevertheless, the Eurobob market did not drop because the strong demand in North Africa (Morocco above all), the Persian Gulf and Latin America kept the buying interest alive.The favorable arbi-trage in the first half of the month encouraged market participants to ship more gasoline from Europe to US but a very good crack spread, which averaged $12.52/b in April, incentivized refiners to produce more Eurobob and that is precisely why European gasoline ARA stocks remained fairly stable at around 1.1 million barrels. Overall, Eurobob

gasoline prices in April lost 5.93% (from $547.75/mt to $515.25/mt) because of the build in US inventories and an increase in production favored by good crack prices.

Eurobob’s monthly volatility dropped by 52.95% in 18 trading days, going from 62.81% to 29.55%, because the start of the summer driving season moved gasoline prices quite a lot pushing the fluctuation rate all the way up to 60%. The bimonthly and quarterly volatility curves remain fairly high but it is unlikely that they will continue to move up and, given what seems to be a more stable fundamental picture in the month of May for gasoline demand, it is reasonable to state that a slight increase in volatility should be expected but it should not last long and the market shouldn’t be destabilized by it too much. Overall, the outlook on Eurobob gasoline prices is positive but the uptrend will tend to be slow and far from aggressive.

The European diesel market was a bit tight in April because good demand for middle distillates was registered in Germany, France, Italy and also Turkey. Furthermore, the start of the agricultural season has

EUROBOB GASOLINE FOB AR BARGE

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Jet CIF NWE monthly volatility decreased by 10.79% in the month of April but, as happened in the diesel ARA market, the fluctuation rate dropped all the way down to 13.97% on April 13 pushed by the uptrend and then bounced back up in the second half of the month because of the price retracement. The monthly, bimonthly and quarterly volatility curves are almost overlapping but it looks like they are now trading around a new equilibrium level, at least in the short term, and it is likely that they will continue to oscillate sideways or even sensibly drop in

revived the diesel market in Poland, northern Germany and the whole Baltic region keeping the European diesel market well bid. It is also important to point out that many European diesel end-users are preparing to fight more aggressively for diesel coming from the US Gulf Coast because both Nigeria and Ghana will move to 50 ppm sulfur gasoil, whose production is usually very limited, from July 2017 onwards implying that a large part of the West African demand will have to be satisfied by 10 ppm diesel. Overall, the European diesel market was well bid because healthy demand in the Mediterranean and some refineries still undergoing maintenance in Russia (they have to do it now because Q1 and Q4 are too cold for that) contributed to keep market prices up. The healthy demand in France, Italy and Germany has significantly dried up gasoil ARA stocks which dropped by 5.4% (from 3.26 million barrels on April 6 to 3.08 million on April 24) and the fact that the European diesel crack, throughout the whole month of April, averaged $10.1/b implies that buying pressure remained fairly stable and constant. Diesel ARA prices moved up from $470/mt on April 3 to $497.5/mt on April 13 pushed by steady demand and good crack prices but the drop in the crude oil market, the fact that the European diesel market remains fairly well supplied, the fact that summer grade diesel is cheaper than its winter spec and a seasonally weak demand are all contributing factors that pushed prices back to $452.25/mt on April 28.

Diesel ARA’s monthly volatility dropped by 3.17%, going from 21.80% to 21.11%, over the course of April but it is important to note that the fluctuation rate touched 12.67% on April 13 and recovered since then. The volatility curves of the diesel market are very close to one another implying that they will probably tend to move slightly higher in the very short term, however, although the risk of a contraction process remains justified, it is likely that, on a monthly basis, they will just continue to move sideways in coming weeks supporting prices and market trend. Overall, the outlook on the diesel ARA market is positive and a slow price uptrend is likely to happen in the short term, everything else being equal.

The demand for jet within Europe remained stable but far from aggressive during the month of April. The European jet market is on the brink of experiencing a large increase in buying pressure as the summer season approaches, however, things are still moving slowly. The majority of market participants, however, seem to prefer a buy-and-store type of strategy as jet inventories keep going up in the hope that summer demand will kick in from the second half of May onwards. The amount of jet fuel produced and the actual level of inventories will hopefully clear in coming weeks because the market could experience severe drops in price, should that not be the case. Furthermore, the crack economics were incredibly advantageous in April because jet crack prices were $10.84/b on April 3, fluctuated within the $11/b-$11.24/b range between April 11 and April 24 and overall averaged $10.89/b for the whole month. Clearly, high crack prices pushed a lot of refineries to produce more jet fuel than normal and the expected seasonal peak in demand encouraged many market participants to buy more than usual. In fact, the buy-and-store strategy, adopted by many European traders, translated into a 15.77% increase in jet ARA stocks (from 685,000 mt on April 6 to 793,000 mt on April 28). European jet prices dropped by 3.57% in April, from $503.75/mt to $485.75/mt, but they touched $530/mt on April 13 before being dragged down by overproduction, demand still not being strong and the retracement on the crude oil market.

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FUEL OIL 3.5% ROTTERDAM

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coming weeks supporting prices.Nevertheless, some small level of turbulence in the very short term should be expected. May is a very delicate month for the jet market not just because of the OPEC meeting on May 25 but because many market participants are expecting the summer flying season to increase demand. Overall, the steady fluctuation of the volatility curves should keep jet CIF prices sustained so the general outlook for this market is positive.

The fuel oil 3.5% Rotterdam market was very quiet during the month of April with only a few transactions taking place and mostly on a term contract basis. Particularly, the demand for both high and low sulfur fuel oil was rather weak both in Northwest Europe and the Mediterranean throughout the whole month of April. It is important to point out that in April the IEA stated that many countries, including China, are moving away from fuel oil towards cleaner products and that Chinese demand for residual fuel oil will soon halve from levels seen in 2015. These factors surely already contributed and will continue to contribute to diminishing overall demand for fuel oil. Fuel oil ARA

stocks increased by 1.65% in April (from 1.54 million barrels on April 6 to 1.17 million barrels on April 24) confirming the slow buying pressure registered both in north and south Europe. Fuel oil 3.5% Rotterdam prices moved from $280.50/mt on April 3 to $299/mt on April 13 but the drop in crude prices and a weak demand dragged them back down to $274/mt.

Rotterdam fuel oil’s monthly volatility increased by 5.84% in 18 trading days, in fact, it went from 28.45% to 30.11% following a healthy leverage effect (asymmetric movement between price and volatility). However, all volatility curves did not move much and fluctuated sideways for the whole of April on what appears to be a short term equilibrium level. While there is the risk of a contraction process under formation, the fuel oil market should continue to experience low volatility in coming weeks which should help to stabilize prices. However, small and short-lived volatility bursts should be expected. Overall, the outlook on the fuel oil 3.5% Rotterdam market is positive and prices could potentially, although very slowly, uptrend in the short term.

CRUDE FOCUS

�� The drop in the volatility premium signals that market conditions will probably tend to get back to normal in the coming 4-5 weeks�� Brent’s volatility will likely move to the 35%-40% volatility range and it has 23.50% chance to remain there�� The increment in the oscillation rate in the very short term will cause some market instability but overall the volatility spike should be far from violent and the price trend should stabilize in coming weeks

The volatility premium quantifies the differential between realized vola-tility calculated, in this case using Brent Frontline swap prices, and the implied volatility computed using Brent Average Price Options.

The volatility premium spiked tremendously in the month of April and moved from 20.81% on April 3 to 104% on April 13 and dropped back down to 27.49% in April 28. The aggressive increase in the volatility premium was predominantly due to the fact that the realized volatility had fallen to 13.33% while the implied one was still trading around 27.17%. The volatility premium averaged 56.40% in April while its year-to-date value was 26.88% which implies that the differential between the two volatilities will tend to reduce over the next weeks.The drop in the volatility premium signals that market conditions will probably tend to get back to normal in the coming four to five weeks and that the implied volatility will likely tend to decrease more. Nevertheless, the fact that the volatility premium is still trading at a very high level compared to its two-year average (8.27%) indicates that the market could still experience some turbulence in the very short term but, on a monthly basis, things should progressively improve and the market should stabilize.

The leverage effect chart keeps suggesting that the inverse relationship between price and volatility is still not as good as it was in 2016 but it is almost as good as it was back in 2015. Consequently, hedging strategies such as protective puts or zero-cost collars would be effective but not as profitable as they used to be one year ago. The slope of the 2017 curve also signals that crude oil’s price trend is a lot more stable than it used to be and that probably this trend will continue throughout the whole year.

The Probability Distribution is a tool that uses the well-known

VOLATILITY PREMIUM

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BRENT LEVERAGE EFFECT

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mean reversion propensity of volatility to quantitatively understand the risk that the market is pricing.

The monthly volatility for the Dated Brent closed April trading at 24.45% placing itself in the 20-25 volatility range and it has a 6.98%



VOLATILITY ANALYSIS EMEA

Commodity Risk Solutions TeamVito Turitto, Manager, Quantitative [email protected]

For more information on Platts Risk Services, please contact Product Management by [email protected]

Content EditingMaurice Geller, Editorial Director, Central Editing [email protected]

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April 2017

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probability to remain there. Nevertheless, it is likely that the fluctuation rate will tend to increase in coming weeks, not that aggressively though, and reach the 25-30 range at first (14.13% probability) and then the 35-40 one where the volatility has 23.50% chance to remain. The increase in volatility will likely cause market instability in the very short term, however, once the oscillation rate reaches its average interval, the price trend should recover and slowly trend higher.

The volatility cones analysis quantifies the divergence between the actual fluctuation rate and its past performances. Volatility is mean reverting, it doesn’t trend, hence it is important to understand its previous distribution in order to create effective hedging strategies and place profitable trades.

The current volatility curve is still trading below the medium and low range curves implying that the mean reverting pressure, in the very short term, is fairly sustained and that a higher degree of market volatility should be expected. The rest of the current volatility curve remains well below the medium one implying that market participants are expecting a medium increase in the fluctuation rate not just in the short term but also in a 3-4 months period. The increment in the oscillation rate in the very short term will cause some turbulence and market instability but overall the volatility spike should be far from violent and the price trend should stabilize in coming weeks.The volatility cones analysis suggests the following hedging strategies:

1. Crude oil producers, or any entity whose revenues come from the sale of crude grades, should at first increase their hedging ratios but they should also be quick enough to adjust them to a probable change in market risk regime because Brent prices should stabilize

2. Refiners, given the nature of their business, should adopt a bilateral hedging strategy: they should gradually decrease their upside hedging ratios at first and increase it later because market stability will be lower in the beginning but will grow with time favoring a price recovery. Petroleum products, on the other hand, will benefit from greater market stability and a more stable trend, hence, refiners should progressively increase their downside protection only in the very short term to gradually release it as the volatility moves back down

DATED BRENT PROBABILITY DISTRIBUTION

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DATED BRENT: REALIZED VOLATILITY CONES

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3. Refined product buyers should decrease their upside hedging ratios at first but, as soon as the volatility will start dropping again, they will have to progressively increase them because a lower fluctuation rate will favor petroleum product prices

volatility analysis - platts · inventories in the us were as high as 532.34 million barrels which...

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