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Rakesh Upadhyay

Rakesh Upadhyay

Rakesh Upadhyay is a writer for US-based Divergente LLC consulting firm.

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The Undeniable Winners Of The Oil Bust

Large oil trading companies such as Vitol have earned record profits in 2015, proving that they can profit regardless of prevailing trends.

The numbers speak for themselves: Vitol earned a net income of $1.6 billion, a 15 percent increase over 2015. Similarly, Gunvor netted a record $1.25 billion, while Trafigura gross profits saw a whopping 50 percent increase to $1.7 billion, as reported by the firm in December 2015.

This proves that the prevailing conditions since 2014 have favoured traders. All the firms have increased the total volume of oil they trade. Vitol shipped 6.2 million barrels per day, Trafigura handled 4 million (b/d), earning it the crown of world’s second-largest independent oil trader behind Vitol, while Gunvor shipped 3.7 million (b/d).

“I think we can say that in 2015 the group did well,” said Gunvor’s Chief Financial Officer Jacques Erni. “Underlying trading profitability increased and refining did very well and we’re very happy with that.” Related: Crude Oil Higher On Pre-Doha Hopes

Combined, they ship close to 15 percent of the world’s global demand, confirming that the current environment may be tough for producers, but traders are enjoying some good paydays.

The low price environment provides numerous opportunities for trading firms to profit. They make the most of the contango, buying crude oil at lower spot prices, storing it and selling it at higher prices at a future date. They manage their risk by shorting future derivatives, hence, they are certain of the prices they will receive for their deliveries.

Low prices have led to many strapped oil producers in urgent need of cash for their various needs. The large trading firms squeeze discounts from the producers, fulfilling the producers’ need of cash while the trading firms earn discounts. The trading firms bear the risk from the time of purchase to the time of delivery of the shipment. Related: U.S. Oil Industry Fears That New Regulation Could Cost $25B

Opportunities to profit also arose from the ability of the trading firms to move large volumes of crude oil from regions with lower oil prices to other destinations.

These firms also own refineries, which net them large profits; they can use the lower priced crude for the refineries and dispatch them at higher prices to the necessary destinations.

Volatility is a trader’s delight, because they get an opportunity to earn on both sides of the market using various strategies, meanwhile hedging their positions accordingly.

However, everything is not as easy as it sounds. A crisis brings about credit risks where firms fail to meet their obligations, regulatory risks, and bankruptcies. The trading firms have to be extra careful while dealing with such firms. Related: IEA Sees Oil Glut Gone By 2017

“Whilst the market structure favours a physical trader, the absolute price levels, and market volatility are causes for caution,” Vitol’s chief executive Ian Taylor said. “This current environment vindicates the extremely cautious approach we have long taken towards risk and debt. We believe it is prudent to continuously review both business lines and asset exposures.”

The firms are also at risk due to the large volumes of crude oil they trade each day. “Our core trading business is completely immune against price risk,” Trafigura Chief Financial Officer Christophe Salmon said in an interview. “It upsets me, but still today when the oil price drops by 15 or 20% we have calls from investors that say, ‘How much have you lost?’ Guys, we are hedged, we are 100% hedged.”

While crude oil producers continue to struggle with low oil prices, the oil traders continue to earn record profits. Sometimes, trading turns out to be more profitable than production.

By Rakesh Upadhyay for Oilprice.com

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  • JHM on April 15 2016 said:
    The fact that oil traders are able to lock in profits in contango being 100% hedged means that oil producers have failed to hedge sufficiently themselves. Oil producers need to sell more futures derivatives to lock in higher prices before traders have.that same oppportunity. Not only will this lock in higher prices for producers, but it will depress the futures curve.

    Depressing the futures curve will remove the arbitrage opportunity from traders while signaling to other producers when the future market is over supplied. This is a free market mechanism for managing the risk of over inveatment.

    My view is that oil producers too naively believe that OPEC will manage price risk for the industry through non-competitive collusion. This trust in benevolent market makers is the antithesis to belief in free market economics. The best free market mechanism for managing aggregate investment levels in supply is for producers to hedge fully against the oil futures curve. Stop believing in OPEC. If the futures curve is not high enough to hedge your project, don't do it. It really is that simple. Don’t imaging that you know better than the futures market which way oil is trending. You will lose money to oil traders that lock in profits against your miscalculation. So stop believing in your innate ability to outsmart the futures market.

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