Oil Volatility at Seven Year High

Friday, January 29, 2016

In the latest edition of the Numbers Report, we'll take a look at some of the most interesting figures put out this week in the energy sector. Each week we'll dig into some data and provide a bit of explanation on what drives the numbers.

Let's take a look.

1. Currencies, foreign exchange under pressure

- This WSJ graphic highlights the growing currency problem stemming from the collapse in oil prices.
- Azerbaijan, which depends on oil prices for over 90 percent of export revenue, had to abandon its currency peg twice last year because of falling oil prices. Azerbaijan blew through 64 percent of its foreign exchange in 2015 to defend its currency peg. The state is now tapping its sovereign wealth fund as it scrambles for resources.
- Other oil producers are also in the firing line. Saudi Arabia's riyal and Nigeria's naira could be forced off their pegs.
- China is a much bigger worry. The surprise devaluation last year rattled financial markets. It is still burning through foreign exchange to defend its current exchange rate, but global markets are concerned that a further depreciation might be coming down the pike.
- The capital outflows reflect the souring investment climate for emerging markets. A record $732 billion in capital fled emerging market economies in 2015, a worrying sign for a world searching for a growth engine.

2. Trade volumes slowing

- Global trade has slowed over the past year, again because of a wavering in the Chinese economy. Trade volumes expanded by just 1.5 percent between September and November 2015 compared to a year earlier, which is close to the slowest rate of expansion since the financial crisis in 2008-2009.
- Traffic on all forms of trade transit - container, dry bulk, rail, air - are slowing as a result
- A knock on effect from lighter trade is lower-than-expected fossil fuel consumption. Jet fuel, heavy fuel oil, and diesel are seeing demand slow down.
- The oversupply of refined products, in turn, is squeezing refining margins for middle distillates, which are at their lowest levels since 2010.

3. LNG supplies up, prices down

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- Global LNG trade continues to rise. But a combination of factors has led to a crash in prices: weaker LNG demand; and surging supplies; and plunging oil prices caused oil-linked LNG contracts to crash.
- The main market for LNG exporters - Asia - has seen prices crash plummet from a peak near $20 per million Btu (MMBtu) in early 2014 to around $7/MMBtu today.
- The U.S. is poised to become a sizable LNG exporter, the delays with the first project by Cheniere Energy (NYSE: LNG) notwithstanding. But the market is pretty saturated for exporters who have not already lined up customers.
- Even with today's Henry Hub natural gas prices at around $2.20/MMBtu, which is historically low, it is still not profitable to export. After factoring in costs of around $5.30/MMBtu for liquefaction and transport, LNG exports from the U.S. are in the red.
- Still, there are some projects that have their shipments under contract, and thus, should be ok. Six terminals have been approved and are under construction in the U.S., backed by Cheniere Energy, Sempra (NYSE: SRA), Dominion (NYSE: D), and ConocoPhillips (NYSE: COP). But beyond those, new greenfield projects that have not received final investment decisions, will likely be put on hold. Global LNG prices will remain soft for the rest of the decade.

4. Tanker rates surge on oil volumes

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- Oil demand growth surged in 2015 to a five-year high of 1.8 mb/d. Higher volumes of oil moving around meant demand for oil tankers surged. More demand for tankers led to a spike in the cost to charter a tanker.
- Daily tanker rates are extremely volatile, and depend on short-term conditions. But, tanker rates briefly exceeded $100,000 per day in the fourth quarter of 2015, hitting seven-year highs.
- Onshore oil storage also began filling up last year, putting a premium on space. In certain key markets in China, Europe, and the Gulf of Mexico, floating storage became more common.
- While oil and gas companies have been slammed over the past 18 months, shipping companies are posting incredible profits.
- Nordic American (NYSE: NAT), for example, had a great year, and just raised its dividend by 13 percent.
- The boom times might not last, however. Oil production is likely to fall this year, onshore storage will be drawn down, and oil demand is also growing at a slower pace (1.2 mb/d) in 2016 compared to last year.
- Tanker rates are already down from the Q4 highs. They may fall further as a greater supply of tankers come online, pushing down day rates.

5. Falling natural gas prices are reducing the cost of electricity

- Natural gas prices have plunged to multi-year lows in the U.S., and cheap natural gas is reducing the cost of generating electricity.
- That is hurting merchant power producers, or owners of power plants in deregulated markets.
- Since electricity rates are determined by the marginal producer, cheaper natural gas is lowering the rates at which all power plants sell their electricity.
- Average electricity prices in the U.S. fell by 3.5 cents per kilowatt-hour in 2015. The WSJ reported that electricity sold for as cheap as 2.7 cents/KWh in the mid-Atlantic region, which has benefitted the most from the abundant shale gas nearby in the Marcellus. Average wholesale rates were about 7.6 cents/KWh in the region in 2008.
- The effect is mixed for utilities that own gas-fired power plants - they pay less for gas, but sell their electricity at lower rates. For producers of coal and for utilities that burn coal, the effect is negative.

6. Oil price volatility is spiking, but perhaps not as much as you think

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- Movements in oil prices are at their most volatile in seven years. The CBOE Crude Oil Volatility Index, which tracks the magnitude of price movements, is at a seven-year high.
- But with oil prices so low, the price movements seem more dramatic in percentage terms.
- This handy chart from Reuters goes a long way to keeping perspective. It shows that in dollar terms, the vast majority of trading days see oil prices moving by $2 per barrel or less. That has been relatively constant since 1990, right up through 2016. Only on rare occasions does oil exhibit larger swings.
- At $30 per barrel, however, a $2 swing is equivalent to a 6.66% movement, which appears to be a much more dramatic event than when oil was $100 per barrel. In that case, a $2 swing was only a 2% movement.
- Oil jumped by $1.34 per barrel on January 28, for example. With prices so low, that reads as a 4% jump. But that would not have been a notable figure (in dollar terms) back in 2014.
- Today's market is indeed a volatile one. But the media tends to go for hype, and thus readers may notice percentages used more in headlines these days rather than dollar figures.

7. Have net-short positions peaked?

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- Oil speculators began to cover their short positions last week, which helps explain the sharp rally in prices.
- An estimated 4 percent, or 16 million barrels, of net-short positions were liquidated for the week ending on January 19, providing a jolt to crude prices. WTI and Brent surged by about $6 on January 21 and 22.
- That has net-shorts down from a record high of 392 million barrels, ending the week at 376 million barrels.
- But the substantial accumulation of short positions as created the conditions for a reversal much more likely. Oil speculators, to an increasing degree, will see oil as oversold.
- That makes a sharp and sudden rally more likely, as we have seen over the past week. The Numbers Report predicted a sharp rally was just around the corner a few weeks ago, given the mass of shorts piling up. It is impossible, of course, to pinpoint when such a rally will occur, only to spot the conditions for one.
- The big question now is if speculators will continue to sell of their short positions, allowing prices to rise even further, or if, eyeing fundamentals, they believe oil is appropriately priced in the mid-$30s.

That's it for this week's Numbers Report. Thanks for reading, and we'll see you next week.