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Supply losses drive market sentiment
12th March 2009 16:03 GMT

Crude oil experienced significant price weakness yesterday on the back of profit-taking and a larger than expected inventory build. This occurred while Cushing WTI inventories indicated a slight draw due to turnaround season refinery demand. This is not to indicate refinery demand is relatively strong; in fact refinery runs are quite soft and the Singapore Fuel Oil market continues to witness a similar reduction in supply as refinery action continues to mitigate. 

The Fuel Oil market has felt an even more direct impact from OPEC production cuts which have substantially removed medium and heavy sour crude from the market. While bunker fuel demand remains under pressure, the supply losses remain the foremost driver of market sentiment.

Sing Fuel Oil (Sing FO) implied volatility remained unchanged yesterday after weakening significantly on Tuesday. The considerable drop in front-month FO enables consumer hedgers to lock in price caps or sell price floors at a level close to the bottom of the current near-term price range. An April Sing FO 180 $250 price cap (call) can now be owned for Zero Cost by accepting a price floor (put) at $231.

Taking a different route, 10,000 MT of the $220 price floor (put) can be sold at $15.00 which indicates total premium received of $150,000 IF April Fuel Oil expires at or above $220. Below $220 the seller of the price floor still receives premium upon expiration so long as the underlying contract does not expire below $205 ($220 - $15 of premium received), below this point the hedge incurs losses equal to being long the underlying swap from $205. 

Similarly, if the underlying Fuel Oil swap moves higher the hedger will receive $150,000 of protection after expiration, basically mimicking a long swap position from $240 which is sold out at $255.

For a consumer hedger worried about a short-term rise in prices, the above strategy provides $15.00 of upside protection while not experiencing losses until the market moves below $205. With the tight trading ranges as of late, consumers with actual physical risk may opt for this strategy to reduce daily mark-to-market volatility seen with using only swaps for protection.

Jonathan Kornafel,
12th March 2009 16:03 GMT

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