The past month’s plunge in oil prices has turned the market for hedging upside down.
Oil producers have scaled back locking in future prices “considerably” since February, Societe Generale SA said in a report, citing a shift in options pricing driven by consumer companies like shippers and airlines. Late last year, sellers including U.S. shale drillers locked in prices in droves when benchmarks rose after OPEC announced plans to cut production.
“This is a significant shift in the relative producer-consumer hedging behavior,” wrote David Schenck, a cross-commodity strategist at Societe Generale. “While consumers may try to lock in low prices, most producers will simply refuse to lock-in loss-making prices.”
Crude prices plummeted to new year-to-date lows Tuesday after OPEC’s meeting in Vienna last month left market hopes for deeper output cuts unfulfilled. At the same time, the global glut of oil has come back to the fore, with unexpected increases in U.S. stockpiles of crude and products, and barrels returning from conflict-stricken Libya and Nigeria. The weakness in prices has left producers reluctant to lock in supplies at such low levels, while prompting interest from consumers.
Brent’s 12-month put skew closed at its lowest level since May 2016 on Monday. This indicator tends to rise when producers of oil are locking in their supply and fall when consumers, including shippers and airlines, hedge their output. The second-month equivalent was at its lowest level since December 2015. WTI skews have also fallen sharply since OPEC’s last meeting on May 25. Crude in New York touched $42.75 a barrel on Tuesday, the lowest level since Nov. 14, and was closing in on a bear market.
If prices remain lower for longer, new shale oil investments could be deterred, Schenck wrote. While Saudi Arabia’s energy minister said this week that the market remains on course to re-balance, several major banks, including JPMorgan Chase & Co. and Morgan Stanley, recently lowered their crude price forecasts for 2018, arguing that an inventory overhang is likely to linger. At the same time, the number of drilled-but-uncompleted U.S. oil wells is at its highest level in three years.
Shifting Dynamics
The shifting dynamics between producers and consumers aren’t just showing up in the options market. The crude oil curve has moved dramatically in recent days from a bullish structure known as backwardation to a bearish one called contango. Earlier in the year, U.S. producer hedging had made some contracts for later delivery cheaper than nearer contracts. But with prices tumbling, commercial buyers of oil have stepped into the place of the sellers, transforming the market’s structure.
“Commercial interest has shifted significantly from producers to consumers,” Citigroup Inc. analysts including Aakash Doshi wrote in an emailed report. The market structure has been transformed by “a combination of increased consumer hedging as a result of lower outright oil prices as well as a wash-out of fund length” on bullish spread positions, he wrote.
Source: Bloomberg