Oil Hits 4-year Low After Saudi Discount
Neil Hume, Commodities Editor
Financial Times
Oil prices tumbled on Tuesday as the market reassessed the latest pricing announcement from Saudi Arabia and banks scrambled to hedge outstanding derivative positions.
Brent, the global oil marker, hit a four-year intraday low, while West Texas Intermediate, the US benchmark, declined to its lowest level since October 2011.
ICE December Brent fell as much as $2.70 to $82.08 a barrel, while Nymex December WTI lost $2.94 to $75.84.
The publication of Saudi Arabia’s official selling prices for December on Monday evening had initially been greeted with a degree of relief by the market. Opec’s biggest producer raised prices for Europe and Asia, putting to rest rumours that it had started a price war against its fellow members.
However, the calm did not last long, with the decision to cut price differentials for US seized upon as evidence that Saudi Arabia had taken its imagined fight for market share across the Atlantic to North America.
Although analysts cautioned against reading too much into the US price cut, which they said reflected a desire to remain competitive, traders said a skittish market had decided to shoot first and ask questions later.
“The reinterpretation of the OSP announcement saw the market go through lots of technical levels and it now feels we are into negative gamma territory where every move will overshoot on the downside,” said one trader, referring to the large number of outstanding put options, which entitle the holder to sell at a given price in the future.
Banks that had sold the options to clients were being forced to sell futures contracts to hedge against risks. The selling – known as delta hedging – intensified after Brent broke through $85 a barrel overnight and WTI through $80, said traders.
“The fact that the market has been waiting for the release of the Saudi official selling price the same way that it used to wait for the Department of Energy weekly statistics and the volatility that followed the release of the OSPs confirms that the only solution seen by the market to reduce the oversupplied outlook is an Opec cut led by Saudi Arabia,” commented Olivier Jakob of Petromatrix, a consultancy.
Opec is due to meet in Vienna later this month and many analysts believe the oil production cartel will not reach an agreement to lower output and prop up prices. Rising supply both in and outside Opec, combined with concerns about weakening demand growth, has seen Brent drop more than 25 per cent from this year’s peak of $115 a barrel in June. WTI is down 28 per cent over the same period.
However, some of the world’s biggest independent oil traders are not so pessimistic.
“My feeling is we’re underestimating now the possibility of Opec cutting,” Ian Taylor the chief executive of Vitol told a virtual commodities conference organised by Reuters. “Everybody says they are not going to cut, and I’m not 100 per cent sure. I think there will be serious discussions at the Opec meeting about cutting.”
Those comments were echoed by Marco Dunand, chief executive of Mercuria. He told the same conference that Opec needed to remove 1.5m barrels a day – assuming no lifting of sanctions on Iran.
“I am probably slightly more optimistic about the possibility of a cut, but I still don’t see that as a more than 50 per cent chance,” Mr Dunand said.
Last week, Abdalla El-Badri, secretary-general of Opec, said he expected a reduction in higher cost oil production such as US shale if Brent remained around $85 a barrel. Analysts say this translates to a price of $65-$75 at the wellhead in the Bakken, the region driving the US shale oil revolution.
“With the exception of Wood Mackenzie, who see more efficient drilling methods taking Bakken break-even rates down to $58 and a price of $70 at the wellhead shutting down only 150,000 barrels per day, most observers of the shale oil scene see $80/$85 Brent as a red alert level,” said David Hufton of PVM, a brokerage.
Traders said the fresh weakness in WTI could trigger selling by investors in passive commodity index funds. This is because the front end of the WTI futures curve has flipped into ‘contango’.
The structure of the forward curve is a critical component of returns for investors. When commodity contracts mature each month, fund managers usually sell and then buy back the next month’s contract to replace them, so when futures markets are in “contango”, the rollover leads to losses as investors are selling low and buying high.
“There is not yet enough of a contango in WTI to pay for storage but we are far away from the backwardation penalties to hold oil in storage seen during the summer. The move back to a contango structure in WTI should also start to trigger an outflow from financial exposure that is purely seeking the roll returns,” said Mr Jakob.
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| Oil pipeline in the Federal Republic of Nigeria. |
Financial Times
Oil prices tumbled on Tuesday as the market reassessed the latest pricing announcement from Saudi Arabia and banks scrambled to hedge outstanding derivative positions.
Brent, the global oil marker, hit a four-year intraday low, while West Texas Intermediate, the US benchmark, declined to its lowest level since October 2011.
ICE December Brent fell as much as $2.70 to $82.08 a barrel, while Nymex December WTI lost $2.94 to $75.84.
The publication of Saudi Arabia’s official selling prices for December on Monday evening had initially been greeted with a degree of relief by the market. Opec’s biggest producer raised prices for Europe and Asia, putting to rest rumours that it had started a price war against its fellow members.
However, the calm did not last long, with the decision to cut price differentials for US seized upon as evidence that Saudi Arabia had taken its imagined fight for market share across the Atlantic to North America.
Although analysts cautioned against reading too much into the US price cut, which they said reflected a desire to remain competitive, traders said a skittish market had decided to shoot first and ask questions later.
“The reinterpretation of the OSP announcement saw the market go through lots of technical levels and it now feels we are into negative gamma territory where every move will overshoot on the downside,” said one trader, referring to the large number of outstanding put options, which entitle the holder to sell at a given price in the future.
Banks that had sold the options to clients were being forced to sell futures contracts to hedge against risks. The selling – known as delta hedging – intensified after Brent broke through $85 a barrel overnight and WTI through $80, said traders.
“The fact that the market has been waiting for the release of the Saudi official selling price the same way that it used to wait for the Department of Energy weekly statistics and the volatility that followed the release of the OSPs confirms that the only solution seen by the market to reduce the oversupplied outlook is an Opec cut led by Saudi Arabia,” commented Olivier Jakob of Petromatrix, a consultancy.
Opec is due to meet in Vienna later this month and many analysts believe the oil production cartel will not reach an agreement to lower output and prop up prices. Rising supply both in and outside Opec, combined with concerns about weakening demand growth, has seen Brent drop more than 25 per cent from this year’s peak of $115 a barrel in June. WTI is down 28 per cent over the same period.
However, some of the world’s biggest independent oil traders are not so pessimistic.
“My feeling is we’re underestimating now the possibility of Opec cutting,” Ian Taylor the chief executive of Vitol told a virtual commodities conference organised by Reuters. “Everybody says they are not going to cut, and I’m not 100 per cent sure. I think there will be serious discussions at the Opec meeting about cutting.”
Those comments were echoed by Marco Dunand, chief executive of Mercuria. He told the same conference that Opec needed to remove 1.5m barrels a day – assuming no lifting of sanctions on Iran.
“I am probably slightly more optimistic about the possibility of a cut, but I still don’t see that as a more than 50 per cent chance,” Mr Dunand said.
Last week, Abdalla El-Badri, secretary-general of Opec, said he expected a reduction in higher cost oil production such as US shale if Brent remained around $85 a barrel. Analysts say this translates to a price of $65-$75 at the wellhead in the Bakken, the region driving the US shale oil revolution.
“With the exception of Wood Mackenzie, who see more efficient drilling methods taking Bakken break-even rates down to $58 and a price of $70 at the wellhead shutting down only 150,000 barrels per day, most observers of the shale oil scene see $80/$85 Brent as a red alert level,” said David Hufton of PVM, a brokerage.
Traders said the fresh weakness in WTI could trigger selling by investors in passive commodity index funds. This is because the front end of the WTI futures curve has flipped into ‘contango’.
The structure of the forward curve is a critical component of returns for investors. When commodity contracts mature each month, fund managers usually sell and then buy back the next month’s contract to replace them, so when futures markets are in “contango”, the rollover leads to losses as investors are selling low and buying high.
“There is not yet enough of a contango in WTI to pay for storage but we are far away from the backwardation penalties to hold oil in storage seen during the summer. The move back to a contango structure in WTI should also start to trigger an outflow from financial exposure that is purely seeking the roll returns,” said Mr Jakob.
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