A Historical and International Perspective on the Oil Markets: The Need for Transparency

Transcription

1 A Historical and International Perspective on the Oil Markets: The Need for Transparency Principal, Premia Capital Management, LLC, and Research Associate, EDHEC Risk and Asset Management Research Centre, 1

2 Disclaimers This presentation is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities or other financial instruments. The opinions expressed during this presentation are the personal opinions of Hilary Till and do not necessarily reflect those of EDHEC Business School or those of other organizations with which Ms. Till is affiliated. 2

3 The Oil Markets* A. The Role of Price B. The Fundamentals: Oil Supply-and- Demand Data C. Preliminary Conclusions: Data Transparency D. The Technicals: The Interaction Effect Between Traders and Price Icon above is based on the statue in the Chicago Board of Trade plaza. * Based on Till (2008b). 3

4 The Oil Markets E. The Role of Currency and Store-of-Value F. Holbrook Working s Principles G. Conclusion 4

5 A. The Role of Price Dynamic Interplay There is a dynamic interplay between an oil product s price and its supply-anddemand situation. Gasoline and Short-Term U.S. Interest Rates Around the Time of Hurricane Katrina End-August through Mid-September 2005 With the onset of Hurricane Katrina, the price of gasoline rallied 18% in four days Novem ber 2005 Gas oline Contract before falling back about the same amount fifteen days later. Gasoline in Cents per Gallon /26/2005 8/29/2005 8/30/2005 8/31/2005 9/1/2005 9/2/2005 9/6/2005 9/7/2005 9/8/2005 9/9/2005 9/12/2005 9/13/2005 9/14/2005 9/15/2005 9/16/2005 March 2006 Eurodollar Contract Eurodollars (100 - Yield) Source: Till (2006a). 5

6 B. The Fundamentals Difficult Supply Situation (as of August 2008) Non-OPEC Supply Growth 2007/2008/2009 Thousands of Barrels Per Day North America Latin America Europe FSU Middle East Asia Africa Angola and Ecuador included in OPEC throughout Regional Totals exclude biofuel growth Total Non-OPEC Supply Growth (kb/d) Global Biofuels (kb/d) OPEC NGLs (kb/d) Source: IEA (2008). 6

7 B. The Fundamentals Expanding Demand (as of August 2008) Global Demand Growth 2007/2008/2009 Thousands of Barrels Per Day North America Europe Middle East FSU Asia Latin America Africa Global Demand Growth (mb/d) % % % Source: IEA (2008). 7

8 B. The Fundamentals Expanding Demand (as of December 2007) The two lower lines are the Energy Information Administration s (EIA s) high-growth case for China and India estimates are from the EIA. Source: Bannister (2007). 8

9 B. The Fundamentals Non-OECD Data One difficulty that the IEA admits to is that it is primarily an OECD organization in a world where non-oecd countries are now of crucial economic importance, especially in assessing oil demand trends. 9

10 B. The Fundamentals Non-OECD Data (as of August 2008) China s imports of oil products have been surging in recent months, but the IEA said it was unclear whether these volumes were being stockpiled ahead of the Olympic Games Thousand barrels per day Net imports Net exports China Net Fuel Imports: Monthly Data (January 2006 to July 2008) Source of Data: Reuters Calculations Based on Official Data; Graphic Based on Thomson Reuters/Catherine Trevethan Gas Diesel Source: Winning (2008). 10

11 B. The Fundamentals Non-OECD Data (as of August 2008) or [were] making up for the substantial loss of production from small refiners. Imports may also have been underpinned by buoyant demand growth fueled by economic growth. [Italics added.] US Consumption US and China's Oil Consumption in Thousands of Barrels Per Day (2004 to 2007) 21,800 21,600 21,400 21,200 21,000 20,800 20, Year Source of Data: BP Statistical Review of World Energy US China 7,900 7,700 7,500 7,300 7,100 6,900 6,700 Chinese Consumption Source: Winning (2008). 11

12 B. The Fundamentals Inferences from Price Relationships: Structural Breaks Chinese Holiday Calendar Example 58 Daily Crude, Soybeans and Copper Futures Prices (01/05/05 through 03/24/05) Crude in $/Barrel Soybeans in in $/Bushel c/bushel Copper in c/pound /05/05 01/19/05 02/01/05 02/14/05 02/28/05 03/11/05 03/24/ Front-Month Crude in $/Barrel (LHS) Front-Month Front-Month Soybeans Crude in in $/Bushel $/Barrel (LHS) (RHS) Front-Month Soybeans in c/bushel (RHS) Front-Month Copper in c/pound (RHS) Front-Month Copper in c/pound (RHS) Source: Based on Till and Eagleeye (2005). 12

13 B. The Fundamentals Inferences from Price Relationships Crude in and of itself is not valuable unless it is refined into useful products. Gasoline Crack Spreads Level of Front-Month Gasoline Crack Spread (in $ / barrel) on March 17th of Each Year (1989 to 2008) Level (in $ / barrel) Year Data Source: Bloomberg. 13

14 B. The Fundamentals Inferences from Price Relationships Heating Oil Crack Spreads Level of Front-Month Heating Oil Crack Spread (in $ / barrel) on March 17th of Each Year (1989 to 2008) Level (in $ / barrel) Year Data Source: Bloomberg. 14

15 B. The Fundamentals Inferences from Price Relationships Heating Oil Crack Spread in 2008 Front-Month Heating Oil Crack Spread (1/2/08 to 9/5/08) Level in $ / Barrel 1/2/2008 1/16/2008 1/30/2008 2/13/2008 2/27/2008 3/12/2008 3/26/2008 4/9/2008 4/23/2008 5/7/2008 5/21/2008 6/4/2008 6/18/2008 7/2/2008 7/16/2008 7/30/2008 8/13/2008 8/27/2008 Date Data Source: Bloomberg.

16 B. The Fundamentals Inferences from Price Relationships Commodity-market participants frequently also monitor the levels of the Baltic Dry Index (BDI), Source: Cui (2008). which is a measure of the cost of shipping raw materials [and can sometimes be a] good yardstick of commodity [demand] and, by extension, global economic growth, according to Gongloff (8/15/08). 16

17 9/11/2008 B. The Fundamentals Inferences from Price Relationships The BDI is managed by the Baltic Exchange in London, which is the global marketplace for brokering shipping contracts. 2,600 2,400 2,200 2,000 1,800 1,600 1,400 1,200 1, Baltic Exchange (Shipping Rate) Indices (1/31/08 to 9/12/08) Source of Data: Bloomberg. 17 Baltic Wet Index Levels 1/31/2008 2/7/2008 2/14/2008 2/21/2008 2/28/2008 3/6/2008 3/13/2008 3/20/2008 3/31/2008 4/7/2008 4/14/2008 4/21/2008 4/28/2008 5/6/2008 5/13/2008 5/20/2008 5/28/2008 6/4/2008 6/11/2008 6/18/2008 6/25/2008 7/2/2008 7/9/2008 7/16/2008 7/23/2008 7/30/2008 8/6/2008 8/13/2008 8/20/2008 8/28/2008 9/4/2008 Date 13,000 12,000 11,000 10,000 Baltic Dry Index Level This composite shipping index reached its peak level on 5/20/08, indicating extraordinary Baltic Clean Tanker Index Baltic Dirty Tanker Index Baltic Dry Index demand for shipping up until that point, which turned out to be temporary. 9,000 8,000 7,000 6,000 5,000 4,000

18 B. The Fundamentals Other Market Fundamentals: Light Sweet Crude Oil and Strict Environmental Mandates Crude oil spare capacity is concentrated in sour crude oil. Instead, it is the availability of light sweet crude oil, on the margin, which is important because of the (current) lack of sufficient complex refinery capacity to produce the mandated U.S. and E.U. fuels from sour crude. Source: Verleger (2008a, 2008b). 18

19 C. Preliminary Conclusions: Data Transparency Pre-Olympic Stocking 1. Pre-Olympic stocking may have contributed to 2008 s oilprice spike. Given how finely balanced global oil supply-anddemand had been prior to July 2008, it would be very helpful, going forward, for China s demand and inventory statistics to become as transparent as those in the OECD, in coordination with the IEA. 19

20 C. Preliminary Conclusions: Data Transparency Usefulness of Futures Markets 2. Futures markets provided alert participants with useful, concurrent information on underlying demand in the opaque global oil markets. That said, the interpretation of a price relationship is sometimes conditional on a particular state-of-theworld. Fundamental structural changes occur constantly in the commodity markets. 20

21 C. Preliminary Conclusions: Data Transparency Transparency of Reserve and Productive Capacity Information 3. It is clearly not a good state of affairs for oil to have been in such tight balance that: a. An extraordinary (and temporary) demand event could have plausibly caused oil prices to increase at such an extraordinary pace; and b. Relatively small supply disruptions in well-known unstable parts of the world could (still) cause oil prices to spike to over $250 per barrel, as discussed in scenarios by Blanco and Aragonés (2006). 21

22 C. Preliminary Conclusions: Data Transparency Transparency of Reserve and Productive Capacity Information Regarding the previous point, and consistent with the theme of data transparency, it would be very helpful if reserve-and-productive-capacity information from key oil exporters were not so opaque, as discussed in Khan (2008). For example, prior to July 2008, was Saudi Arabia incapable of serving its historical role as swing producer? 22

23 D. The Technicals Extrapolative Behavior in Tight Markets Gilbert (2007) explains: when markets become tight, inelastic supply and demand make prices somewhat arbitrary, at least in the short term. There will always be a market clearing price but its level may depend on incidental and not fundamental features of the market. [Italics added.] 23

24 D. The Technicals Dynamic Hedging Large-scale industrial consumers had purchased out-ofthe-money call options on oil futures contracts to protect against price rises. This likely resulted in accelerating dynamic-hedging purchases by bank dealers, as crude oil prices rose. Source: Verleger (2007). 24

25 D. The Technicals Liquidation Pressure The market tends to extract a large premium from a trader during a distressed liquidation with a consequent (but temporary) impact on price, and as covered in Till (2006b) in the case of Amaranth. Loss of Equity Margin Calls Critical Liquidation Cycle Forced Liquidation Source: De Souza and Smirnov (2004). 25

26 D. The Technicals Credit and Risk Environment Dow Jones AIG Commodity Index -Total Return and 3-Month U.S. Treasury Bills 3/3/08 to 3/27/ Source: Till (2008b). 26 DJAIG-TR level 3/3/2008 3/4/2008 3/5/2008 3/6/2008 3/7/2008 3/10/2008 3/11/2008 3/12/2008 3/13/2008 3/14/2008 3/17/2008 3/18/2008 3/19/2008 3/20/2008 3/24/2008 3/25/2008 3/26/2008 3/27/2008 Date T-Bill Yields (in %) DJAIG-TR Commodity Index 3-Month U.S. T-Bills

27 E. The Role of Currency and Store-of-Value Impact of Currency Trends Oil Prices Depend on "Currency" (12/31/01 through 8/29/08) Data Source: Bloomberg. 27 Price of 1 Unit of Oil in Each "Currency" Over Time Dec-01 Apr-02 Aug-02 Dec-02 Apr-03 Aug-03 Dec-03 Apr-04 Aug-04 Dec-04 Apr-05 Aug-05 Dec-05 Apr-06 Aug-06 Dec-06 Apr-07 Aug-07 Dec-07 Apr-08 Aug-08 Month-end Front-Month WTI Crude Price (in $) Front-Month WTI Crude Price (in Euros) Front-Month WTI Crude Price (in gold)

28 E. The Role of Currency and Store-of-Value Store-of-Value Historical Evolution of Harvard Management Company's Policy Portfolio Equities Domestic Equities Foreign Equities Emerging Markets Private Equities Total Equities Fixed Income Domestic Bonds Foreign Bonds High-Yield Total Fixed Income Real Assets Commodities Real Estate Inflation-indexed Bonds Total Real Assets Absolute Return and Special Situations Cash (1) (5) (5) (3) (5) (5) Source: El-Erian of Harvard Management Company (2007). TOTAL

29 E. The Role of Currency and Store-of-Value Store-of-Value Excerpt From Staff Report on Commodity Swap Dealers & Index Traders With Commission Recommendations Total OTC and On-Exchange Commodity Index Investment Activity 12/31/07 3/31/08 6/30/08 Crude Oil Index Values Measured in 408, , ,000 Futures [Contract] Equivalents Source: CFTC (2008). 29

30 F. Holbrook Working s Principles Holbrook Working s Four Conditions for a Futures Market to Survive and Prosper 1. The contract terms and commission charges must be such as to attract appreciable use of the futures contract for merchandising purposes. 2. There must exist a possibility of attracting enough speculation to provide at least a reasonably fluid market. Source: Working (1970). 30

31 F. Holbrook Working s Principles Holbrook Working 3. Handlers of the commodity must have reason to make substantial use of the futures contracts as temporary substitutes for merchandising contracts that they will make later. 4. There must exist adequate public recognition of the economic usefulness of the futures market. Source: Working (1970). 31

32 G. Conclusion Holbrook Working Drawing from Working, it will be a matter of public policy to decide whether the use of commodity futures contracts for inflation-hedging purposes is economically useful. Assuming that there is increased data transparency in the over-the-counter oil derivatives markets, one should employ past research by Working, as described by Sanders et al. (2008), to determine objectively whether there is excessive speculation (or excessive inflationhedging.) 32

33 G. Conclusion Tight Balance and Incidental Factors There are numerous, plausible fundamental explanations that can arise from any number of incidental factors that come into play when supply-and-demand are balanced so tightly, especially with light sweet crude oil, and as was the case until July In the short term, it is very plausible for the actions of traders to influence the price of a commodity, especially one that is exhibiting scarcity. 33

34 G. Conclusion Historical Skepticism on Futures Markets In both the United States and in Continental Europe, there is a long history, dating to at least the 1890 s the late great era of globalization of skepticism regarding commodity futures markets, as documented in Jacks (2007). Over the past 120 years, two determinations have prevented commodity futures trading from generally being banned or heavily restricted. 34

35 G. Conclusion Economic Function and Statistical Traditions The first supportive determination has been a general recognition that futures markets serve a legitimate social purpose. The second determination has been to base public policy on an objective examination of extensively gathered facts, which are summarized via appropriate statistical measures. Based on CFTC (2008), one can say that this tradition has been continuing. 35

36 G. Conclusion Transparency Finally, all efforts to make data transparent on the oil markets, whether regarding supply, demand, or marketparticipant statistics, are extremely important for making informed public-policy decisions about these markets. 36

37 References Bannister, B., 2007, From BRICs to Bricks: The Fundamental Drivers and Inevitability of an Energy Infrastructure Capital Spending Cycle, Stifel Nicolaus & Co., December 14. Blanco, C., and J. Aragonés, 2006, Funds and Commodities, Commodities Now, June, pp BP Statistical Review of World Energy, 2008, June. Commodity Futures Trading Commission (CFTC), 2008, Staff Report on Commodity Swap Dealers & Index Traders with Commission Recommendations, September 11. Cui, C., 2008, Commodities Rebound May Not Be Quick, Wall Street Journal, August 15. De Souza, C., and M. Smirnov, 2004, Dynamic Leverage, Journal of Portfolio Management, Fall, pp Gilbert, C., 2007, Commodity Speculation and Commodity Investments, University of Trento (Italy) and Birkbeck College (London), Paper for Presentation at The Globalization of Primary Commodity Markets, Stockholm, October Gongloff, M., 2008, Why Baltic Index Demands Attention, Wall Street Journal, August 15. El-Erian, M., 2007, Harvard Management Company, John Harvard Letter, August 21. International Energy Agency [IEA], 2008, Oil Market Report, August 12. Jacks, D., 2007, Populists Versus Theorists: Futures Markets and the Volatility of Prices, Explorations in Economic History, Elsevier, April, pp Khan, M., 2008, Oil Prices and the GCC: Could the Region Be Stoking Oil Prices?, Citi Economic and Market Analysis, July 4. Sanders, D.R., S.H. Irwin, and R.P. Merrin, 2008, The Adequacy of Speculation in Agricultural Futures Markets: Too Much of a Good Thing? Marketing and Outlook Research Report , Department of Agricultural and Consumer Economics, University of Illinois at Urbana-Champaign, June. Degas, Edgar, The Cotton Exchange at New Orleans, 1873, Musée Municipal, Pau, France. 37

38 References (Continued) Till, H., 2006a, Portfolio Risk Measurement in Commodity Futures Investments, a chapter in Portfolio Analysis: Advanced Topics in Performance Measurement, Risk and Attribution (Edited by T. Ryan), London: Risk Books, pp Till, H., 2006b, EDHEC Comments on the Amaranth Case: Early Lessons from the Debacle, EDHEC-Risk Publication, October 2; which, in turn, was cited in the following publications: the European Central Bank's Financial Stability Review, December 2006; the Banque de France s Financial Stability Review: Special Issue on Hedge Funds, April 2007; the Staff Report of the United States Senate s Permanent Subcommittee on Investigations, 6/25/07; the Bank of Japan s Paper Series on Risk Management in Financial Institutions, July 2007; and in the IMF s Global Financial Stability Report, October Till, H., 2008a, Case Studies and Risk Management Lessons in Commodity Derivatives Trading, a chapter in Risk Management in Commodity Markets: From Shipping to Agriculturals and Energy (Edited by H. Geman), John Wiley & Sons Ltd., Forthcoming. Till, H., 2008b, The Oil Markets: Let the Data Speak for Itself, EDHEC-Risk Publication, October. Till, H., and Eagleeye, J., 2005, Challenges in Commodity Risk Management, Commodities Now, September, pp Verleger, P., 2007, Prepared Testimony, The Permanent Subcommittee on Investigation of the U.S. Senate, Committee on Homeland Security and Governmental Affairs and The Subcommittee on Energy of the U.S. Senate, Committee on Energy and Natural Resources, December 11. Verleger, P., 2008a, $200 Oil!, The International Economy, Summer 2008, pp Verleger, P., 2008b, Comments on The Accidental Hunt Brothers Act 2, September 10. Winning, D., 2008, IEA Warns Considerable Risks To China 08 Oil Demand Outlook, Dow Jones Newswire, August 12. Working, H., 1970, Economic Functions of Futures Markets, a chapter in Futures Trading in Livestock Origins and Concepts (Edited by H. Bakken), Chicago Mercantile Exchange, as re-issued in Selected Writings of Holbrook Working: Book I, Compiled by A. Peck, Chicago Board of Trade,

39 Intelligent Commodity Investing Essential reading for commodity investors, or wouldbe investors everywhere. Sir Howard Davies, Director, London School of Economics and Political Science; and Former Chairman of the Financial Services Authority (UK) Link to Intelligent Commodity Investing : 39