Are low oil prices good or bad for oil traders?

Are low oil prices good or bad for oil traders?

In theory oil traders should not care about the price of oil; as they have reminded us many times recently, the big trading companies trade differentials and spreads, not flat (outright) price.

In a trader’s ideal world oil prices would fluctuate in a range, giving traders just enough volatility for risk-free plays on shipment dates and tonnages.

On the plus side, low prices have reduced financing costs and capital requirements. The halving of the oil price since June 2014 means that for the same amount of money, trading companies can hold twice as much stock, something that comes in rather handy with the current contango in the oil market.

So rather than being bullish or bearish on the flat price for 2015, oil traders may be wishing for a “buffalo” market where prices are at home in a range: a stable (but weak) flat price accompanied by a strong contango.

The world is beginning the New Year with an estimated oil surplus of one million barrels/day. This surplus could be cut if the situation in Libya worsens but neither OPEC nor Russia is likely to cut: they are more concerned about market share than price.

As for the US shale oil producers, the oil price drop should result in a sharp reduction in capital expenditure. However, a recent report by Citibank argued “a capex cut of up to 60% would still see growth (in production) in 2015 due to inertia, but could keep production volumes constant in 2016 (but with growth from 2017 onward)”.

Apart from a small increase in US gasoline usage, few traders expect the estimated surplus to be solved on the demand side. Demand is generally inelastic; it is the backdrop against which changes in supply play out.

The surplus will therefore have to be stored. The Chinese may already be taking a view on the flat price and could be importing more now to increase strategic reserves.

The heavy lifting however will have to be done by the market structure. Some analysts argue therefore the contango will have to strengthen to a level where floating storage in VLCCs (Very Large Crude Carriers) becomes economic.

Freight rates for VLCCs have risen sharply recently, mainly as a result of extra demand for vessels as importers building stocks but also (arguably) in anticipation of an increase in demand for storage. The increase in freight rates will mean that the oil price contango will have to widen further to make floating storage work.

For the contango to strengthen either spot oil prices have to fall or forward oil prices rise.

With the current slow growth in global oil demand it could take a while for demand to catch up with supply – and even when it does, stocks will have to be used up first. This makes it hard for traders to be too bullish about forward prices. It is therefore little surprise that spot prices have slid further over the past couple of weeks.

platts