Managing Oil Price Risks Against the Current Volatile Market Petroleum Industry Workshop - by SPC & S&P Global Platts Auckland, New Zealand 22 March 2017 Presenter: Wu Tuck Leong Manager, Commodity Risk Solutions, Asia Email: tuckleong.wu@spglobal.com 1
MANAGER, COMMODITY RISK SOLUTIONS, ASIA Wu Tuck Leong holds a degree in Chemical Engineering from University College London U.K. and MBA (Banking & Finance) from Nanyang Technological University, Singapore 26 years in the petroleum industry : 11 years with Mobil/ExxonMobil and 15 years with ENOC Singapore Refinery Trading Supply & Planning Risk management Operations Compliance Refining Margin Optimization 2
Agenda Why is the oil market so volatile? How to manage oil price risks? Key issues risk managers face & strategies for risk management. How can forward curves be used to optimally impact the oil business? 3
Current Economic Backdrop Donald Trump as U.S. President TPP dead, China led RECP (40% of world trade), Iran?, pro-oil stance, U.S. centric. U.S. Shale Oil U.S. Federal Reserve rate increased 15 Mar 2017 Brexit effect on OTC derivatives, reporting, compliance OPEC s balancing act financialization of oil 4
Donald Trump as U.S. President Economic Model import substitution plus a) Bring foreign production facilities to the U.S. b) Foreign based American based Companies to serve non U.S. markets Financial regulations and laws deregulation a) Dodd Frank implemented in 2010 b) Volker Rule capital control on banks Key initiatives a) Deregulation b) Tax Reform c) Infrastructure & incentives to favour U.S. production & consumption of U.S. made goods & services 5
Economic break up & unsettling the financial industry? Sanction Iran? More and deeper collaboration with Russia? Pro-oil stance a) Shale oil & crude export from the U.S. b) More oil exploration and production in & around U.S. 6
Brexit effect on Derivative Trading Uncertainty on time line and outcome Approval to exit given 31 March 2017 Two years to complete exit Most moving OTC trading office to Europe Bad for OTC liquidity and transparency 7
OPEC s Balancing Act In the past production to meet budget Now revenue and market share Two stark realities 1. Financial Market has become key liquidity provider to oil markets. 2. Increasing Shale Oil production Secretary General early March met hedge funds in Houston. 8
Effect of OPEC s Cut Announced on 30 Nov 2016
Oil Volatility increase even more! Difficulty is all the aforementioned factors kick in at varying extent, at different times, to a changing context Only certainty is increasing oil volatility Hence the better you are at managing this volatility the better you can optimize your business 10
How to manage oil price risks? 11
Manage Oil Price Risks To manage, we need to quantify oil price risks Measure the daily price change price risk Daily forward curve volatility Daily Mark-to-Market ( MTM ) physical, derivatives and inventory Time frame daily change, Month to Date ( MTD ) & Year to Date ( YTD ) 12
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What Are The Key Issues? Increasing volatility non oil related geopolitics History cannot predict forward Quality daily, time synchronized, neutral & transparent, quality control Gaps in forward curves Accounting fair value measurement (IFRS13) Jan 2013; levels 1 to 3 - monthly & financial year end audit. Which platform OTC or exchange or both? Costs initial & variation margins Reporting requirements - regulations Credit risk 14
Speculation & illiquidity Always on one side of the market Post 2008 financial crisis Credit Risk payment default Regulations to prevent systemic risks U.S. Frank Dodd signed into law on 21 July 2010 European Market Infrastructure Regulations Aug 2012 ( EMIR ) Australian Securities & Investments ( ASIC ) OTC derivatives reform Jan 2013 Monetary Authority of Singapore ( MAS ) regulation of OTC derivatives 2012, progressing. 15
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Forward curves Daily, at the same time as spot assessment Region Asia, Europe, Americas Neutral, transparent, market, auditable Quality checked IOSCO etc. Good quantitative model to fill gaps Consumer Opposite side to refiner and trader 17
Avoid one sidedness through: Cracks, Spreads Trade with affiliates & subsidiaries Internal derivatives business unit. BUT be mindful of additional costs & tax implications admin, brokerage, initial & variation margins. Shorter hedging tenure Combine oil risk management with treasury Constant attention to small details Beware of consensus 18
How to use Forward Curves to optimally impact oil business? 19
Platts Forward Curves Price is the outcome of considerations Editorially assessed & Quantitative model Editorial Assessment market on close, daily Quantitative Model use today s editorial assessments ( TA ), build model that comprehends daily TA and dynamics to project forward. 20
Forward curves historical data analyse it for trend, volatility and statistical measures. Historical Spot Assessments TODAY Historical Forward Curves Account for seasonality, market disturbances etc. Identify asymmetries, non-normal distribution use nonparametric statistics or equivalent to analyse. Proxies use correlation and market intelligence to vet before adopting. 21
WHY PFC? PFC Other Sources Impact Actual traded /observed price using industry accepted MOC process Trade not evidenced, and usually average of bid & offer used Unsure where the market ended. Not suitable for trade price reference and/or validation Time Specific & Synchronized Singapore at 1630 London at 1630 New York at 1430 No vested interest, neutral Sufficient & extensive reach into the market: oil price reporting agency Enable complete and accurate PL, Volatility & Risk measurement Provided at the time requested by user and/or at the time provider decides to give the forward curves Vested interest, as provider is either a trading party and/or broker Limited to areas of interest to the provider Basis used for PL, volatility and risk measure are mixed timing issues etc. PL and volatility measure incorrect due to mismatch between spot assessment and forward curve and different timings of the individual forward curve Vested interest is incorporated into the forward curve and negatively impact quality of audited financials Incomplete view of the market Error embedded in the PL, Volatility & Risk measurement 22
PFC NEW DEVELOPMENT & ENHANCEMENTS Items Before Enhancements Platts Forward Curve Asia From 1 Sep 2016 Gasoline 92 RON FOB S pore 3 months Extended to 12 months Time spreads for Gasoline 92 RON FOB S pore Crack Spread 92 RON against Dubai & Brent Reforming Spread 92 RON vs Naphtha Till third month Nil Till third month Extended to 12 months Gasoline/dubai and gasoline/brent crack for 12 months. Extended to 12 months Platts Forward Curve Asia From 3 Oct 2016 Gasoline 95 RON FOB Fujairah Nil Balance, M1 & M2 Jet Kero FOB Fujairah Nil Balance, M1 & M2 Fuel Oil 380cst FOB Fujairah Nil Balance, M1 & M2 Changes to bids/offers MOC From 1 August 2016 Freeze time for bids/offers 5 mins before cut-off 1 min before cut-off 23
How to Monitor? RM Structure Risk structure portfolio, book, strategy, inventory and trades Control Risk Appetite define Mandate Volume limits MTD & YTD Value (USD) limits MTD & YTD Risk Management Set-Up Board of Directors Risk Management Committee CEO, CFO & Trading Manager Mid Office Manager 24
Managing Price Risks examples Industry Airline (consumer) Application of Forward Curves Target for jet price price lag & volatility Timing tool to spot price change and act on it Volatilities to derive premiums for options Bank Monitor loans to oil projects assess ability of borrowers to repay loan on a daily basis Refiners Refining margin > fixed + variable cost 25
After all that learning do you have 26