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Strong energy markets, downside risk
2nd February 2011 11:57 GMT

Energy markets remain on a strong upwards trend this week.  Renewed political risk in the form of possible regime change across the ME coupled with potential threats to the Suez Canal and Sumed pipeline (more from a lack of shipping agents and logistics issues than anything else) have finally pushed the Brent benchmark over $100.

Spread volatility (both inter- and intra-benchmark) continues to trump that of simple front-month futures.  While the reasons for WTI/Brent spread movements have been expounded on recently, it is interesting to see WTI March/May11 continue to expand as traders anticipate fund rolls (bloated land-locked Cushing inventories only add to the pain).  Any traders still long the March and waiting to roll continue to swim upstream against an overwhelming current.

While global economic growth continues to gather pace and GDP increases across the board persist in ratcheting higher (ignoring the UK), supply-demand fundamentals should also be expected to tighten further.  However, the recent price surge should be viewed with a grain of salt and expecting a 2008-type push ever higher may cause some disappointment.

Strong global growth and rising refinery runs (particularly in Asia) are all good signs, but it is important for consumer hedgers to keep in mind downside risk, particularly when purchasing swaps and costless structures.  For instance, when looking to protect against rising fuel oil prices, hedgers may wish to also enjoy a possible move lower (or not be locked-in at too high a relative price if product markets trend lower).  Thus, when buying protection in the Singapore Fuel Oil 180cst benchmark for all of 2H11 at the $600 level (long call strip), traders can offset the cost of this price ceiling by accepting a leveraged $480 price floor (short put strip).  This structure affords downside breathing room with ample upside protection.


Jonathan Kornafel,
2nd February 2011 11:57 GMT

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