Oil has long been one of the main drivers of the worldwide economy and for this reason it is closely watched by all investors and traders. The central role of what, back in the days, was called the “Black gold” is given by its high cross asset correlation. It has the power of leading the main indexes into bullish or bearish sentiment, to keep awake central bankers around the world trying to find a way to boost inflation in their countries through QE programs not appropriate for a low oil price environment, and to worry investment banking analysts carrying out valuations for possible M&As or bonds issuances, depending on the stage of the business cycle within the energy sector.
Therefore, we would like to analyse what stands behind the wide swings that affected the price of oil in the last few years, look at the fundamentals on which oil is traded, and try to understand if the actual price is in line with them or if it is affected by other exogenous variables. For this purpose, we had the opportunity to discuss with Francesco Martoccia, crude oil derivatives trader for ENI in London, who gave us a real-world insight about this uniquely complex industry.
First of all, to determine the price of oil we have to find out which fundamentals are closely watched by traders.
Apart from the widely used fundamentals that affect main asset classes, like specific countries’ GDP or expectations about growth, fundamental sources of information come from statistics about the daily production of barrels of oil, the level of retail sales, and sales in the automotive industry (more specifically sales of SUV and commercial vehicles, as they represent the main driver for the demand of gasoline). In addition, another closely watched metric for physical traders of oil comes from the cargo tracking. Traders watch at the number of contracts that are bought by oil producers to fill tanks and by comparing with historical data, they can determine whether there is over or under production.
For example, with a focus on the American production of oil, the most important indicator is the level of barrels that are stored in the Cushing region, Oklahoma. This is the main on-shore storage point in the US. It sits on the conjunction between the pipelines coming from drills all over the country. At the peak of the shale boom, roughly one year ago, the inventory level was around 66-67M barrels, with no possibility to increase that level, as the maximum threshold in terms of storage capacity had been reached. This glut in on-shore storage capacity in the US resulted in a sharp contango in WTI futures, which was subsequently called super-contango. The annualized basis for front-month futures contracts approached 100% of the current oil price, which lead to an unprecedented situation: combined with decreasing prices for oil tanker capacity (due to excessive supply of ships), oil traders opted for hiring tankers and using them for off-shore oil storage, rather than for transportation, thus locking profits from the enormous contango.
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