Energy markets showed strength in late-day trading on Monday, recouping much of the losses from early Asian trading. WTI in particular surprised many traders by pushing higher on the day. This was after being offered more than one full standard deviation lower than unchanged, a volatile move which initially was a kneejerk reaction to OPEC’s announcement of no more immediate cuts.
Instead, the cartel took the much more shrewd step of stating it would focus on the remaining 800,000 bbls/day it had previously announced it would remove from the market. By not announcing further production cuts, OPEC took a gamble on not talking the market up with rhetoric that would see them have to remove more oil than necessary from the market to retain their hard-won credibility. Instead, by simply pushing to enforce greater accountability to recently announced cuts, the group’s compliance level should rise towards the 90% level: thus giving them greater pricing power in the long-term than simply taking the bait from the market and announcing more cuts than are necessary. Once digested, the market responded appropriately.
Consumer hedgers, if not before, should now be on high-alert for futures prices to trend higher. Further cuts in Middle Eastern crude, especially of the heavy, sour variety will lead to increased upward pressure on Fuel Oil prices. Ali Naimi, the Saudi Oil Minister, has specifically stated that a WTI price of between $60-75 is crucial to allowing marginal producers to continue producing heavy oil. Bunker hedgers looking to protect against a near-term rise in Fuel Oil prices can look to owning a 2Q09 $255 price cap in Singapore Fuel Oil (Sing FO 180) for zero cost by accepting a price floor of $240 in the same tenor. This hedge provides for unlimited upside protection (just as with a swap) with the added benefit of less painful margin calls should the market trend lower (vs a swap hedge).
Consumer hedgers looking for immediate protection without risk accumulating immediately on the downside can own an option structure from April09 through Dec09 which pays out $800,000 per 10,000 MT per month in Sing FO 180 if the underlying swap settles at the end of each month above the current price of approximately $255. If the underlying was to move lower, the hedge continues to pay out upon monthly expiration so long as the underlying settlement is not below $207. Below this level, losses begin to accumulate. Settlement at or above the current swap price of $255 results in payout each month of $800,000 per 10,000 MT, equating to $80 of upside protection regardless of whether the underlying expires at the current price of $255 or $80 higher or anywhere in-between.